In January, the IRS issued Rev. Proc. 2013-13, (1) detailing an optional safe-harbor method available to individual taxpayers when calculating a home office deduction. For years, taxpayers and tax practitioners have struggled with the recordkeeping required to claim a deduction for expenses generated by a home office. However, beginning with the 2013 tax year, taxpayers can use the safe-harbor method, which requires much less recordkeeping than the traditional actual-expense method of calculating the deduction.
The announcement of a new method might have come as a surprise to practitioners who are knowledgeable about the home office deduction, but according to an IRS spokesman, the idea for simplifying the deduction has been on the table for a number of years. While the spokesman declined to identify any particular impetus for the newly issued revenue procedure, he acknowledged that the IRS has long been aware that the effort necessary to compute the home office deduction can be unnecessarily time-consuming and overly burdensome. (2)
Although Sec. 61 provides for a broad, all-inclusive definition of income, deductions are said to be granted by "legislative grace" and are not allowable unless specifically enumerated by statute. (3) In determining what is deductible, taxpayers and tax practitioners can face significant challenges with expenses that have both personal and business characteristics. While business expenses are allowed as deductions under Sec. 162, most personal expenses (other than itemized deductions reported on Schedule A, itemized Deductions) are disallowed as deductions under Sec. 262, forcing taxpayers to segregate the two types of expenses.
The home office deduction is particularly tricky because it requires taxpayers to track expenses for business use of the home, which often intertwine with personal expenses that are either nondeductible or deductible only on Schedule A of Form 1040, U.S. Individual income Tax Return. Depreciation and income limitations only add to the confusion surrounding home office expenses. At first review, Rev. Proc. 2013-13 provides welcome relief to taxpayers and tax practitioners, and this article sheds light on the revenue procedure and its anticipated effects on calculating and claiming the home office deduction.
The next section provides a brief history of the home office deduction before continuing with an explanation of the pre-Rev. Proc. 2013-13 rules. The article then explains in detail the changes on the horizon considering the revenue ruling, with numerical examples that illustrate the differences between pre-Rev. Proc. 2013-13 rules (which can still be used) and the revenue procedure treatment. The article closes with some potential pitfalls and unintended consequences resulting from the application of Rev. Proc. 2013-13.
The legislative history of the home office deduction is relatively sparse. In fact, it was not specifically codified until 1976. (4) Until that time, the authority allowing a deduction for the business use of a home was Regs. Sec. 1.262-1 (b)(3), which states that "if, however, he [the taxpayer] uses part of the house as his place of business, such portion of the rent and other similar expenses as is properly attributable to such place of business is deductible as a business expense." As mentioned before. Sec. 162 allows a deduction for "ordinary and necessary expenses ... in carrying on any trade or business," with interpretation of the terms "ordinary" and "necessary" resulting in wide variation from one taxpayer to the next. Lack of detailed procedures, along with creative arguments from taxpayers defending so-called ordinary and necessary home office expenses, eventually prompted Congress to consider legislation specifically addressing these expenses.
In 1976, Congress enacted Sec. 280A in an attempt to provide objective criteria to evaluate the appropriateness of home office deductions. (5) As Sec. 280A is a disallowance statute, it states that unless a deduction is specifically provided for in that Code section, no business deduction is allowed for the use of a taxpayer's residence.
The statute remained relatively unchanged until 1993, when the Supreme Court ruled, in Soliman, that a home office used solely for administrative tasks did not qualify for the home office deduction under the definition of "principal place of business" in Sec. 280A. (6) This ruling led to a substantive revision of Sec. 280A, with the addition of Sec. 280A(c)(1), which includes use of a home office for "administrative or management activities" as a principal place of business when there is no other fixed location to perform these activities. (7) Until the beginning of 2013, the remainder of Sec. 280A was rarely addressed.
Current Rules Under Section 280A
Given that Sec. 280A is a disallowance provision, the general rules that allow for the home office deduction are found in the exceptions of Sec. 280A(c). In particular, the section allows a deduction for certain business use for an allocable portion of a dwelling unit that is "exclusively used on a regular basis: (1) as the principal place of business ...; (2) as a place of business used in meeting with patients, clients, or customers ...; or (3) in the case of a separate structure which is not attached to the dwelling unit, in connection with the taxpayer's trade or business." The business use allocation percentage is typically calculated by dividing the square footage of the claimed "business use" area by the square footage of the entire dwelling unit.
It is usually straightforward to justify a home office deduction for a self-employed taxpayer. However, for a taxpayer who is an employee, the exclusive use of the office must be for the employer's convenience. (8) This requirement is most easily met if an employee who works from home part time or full time has no office space set aside elsewhere by the employer. Special rules apply for providing day care services or for use of the space to store inventory, but a home office deduction is also allowable in those scenarios. (9)
A typical fact pattern might involve an individual taxpayer who is a sole proprietor with an unincorporated business. Such an individual would be required to report his or her income and expenses on Form 1040, Schedule. C, Profit or Loss from Business (Sole Proprietorship). In addition, if the taxpayer works from a home office, Form 8829, Expenses for Business Use of Your Home, would be used to determine any deduction allowable for the business use of his or her residence. The current version of Form 8829 has 43 lines and can require a significant time commitment by the taxpayer to compile the required information. This form cannot be used by employees or partners.
The expenses reported on Form 8829 are considered "dual-purpose" expenses and require allocation between business and personal use. In addition, the expenses may be limited by the business income limitation in Sec. 280A(c)(5). If a taxpayer's gross income from the business use of his or her home equals or exceeds the taxpayer's total business expenses (including depreciation), the taxpayer can deduct all the business expenses related to the use of the home. If a taxpayer's gross income from the business use of his or her home is less than his or her total business expenses, the deduction for certain expenses for the business use of the home is limited.
Because of the limitation, a taxpayer with a net loss from his or her business must consider all business expenses as well as the type of home office expenses to determine his or her final home office expense deduction. A taxpayer can deduct expenses in the following order:
The taxpayer is first allowed to deduct business expenses not related to the business use of the home (e.g., wages and supplies);
Next, to the extent of the...