Archive for the ‘office-in-home’ Tag

Home Office Part I – New Option for 2013

Originally published in the Cedar Street Times

July 26, 2013

In January, the IRS issued Revenue Procedure 2013-13 which discusses a new option for calculating the home office deduction.  (You may want to clip this article and put it in your tax file as a reminder.) Instead of tracking the actual expenses of operating your home office such as water, utilities, garbage, repairs and maintenance, depreciation, etc., you can now elect a safe harbor $5 per square foot of qualified office space, up to 300 square feet ($1,500).  It is kind of like taking a standard mileage deduction on your car instead of tracking gas and repair receipts, and calculating depreciation expense.  Unlike vehicles, however, you can switch methods back and forth from one year to the next.

There are a few interesting provisions that will make it a good option for some people, and a bad option for others.  In other words, when preparing your return you will need to analyze the short and long term impacts, and determine which method is best each year. Since the $5 per square foot figure is not adjusted by region or for inflation, individuals living in high cost states like California are at a disadvantage.

If there is more than one person in the house, such as a spouse or roommate, they can each use the safe harbor as long as they are not counting the same space.  If one person has more than one office in the home for more than one business, the person can either use actual expenses for all the businesses, or the person must use the safe harbor for all the businesses.  However, the maximum deduction allowed is still $1,500 for all the businesses in the home combined, which may have to be allocated pro rata to the businesses based on square footage used by each. If one person has qualified home offices in more than one home, the person can use the safe harbor for one home, but must use actual expenses for the other home.

When claiming the safe harbor deduction, you are allowed to take your property taxes and mortgage interest in full as itemized deductions on Schedule A as well as claiming the safe harbor deduction.  On the surface this sounds like a plus, but for self-employed individuals you are effectively converting expenses that used to be on your Schedule C reducing self-employment taxes to itemized deductions which do not reduce self-employment taxes, and perhaps do not even reduce income taxes if you do not itemize.

Another big difference when claiming the safe harbor deduction is that no depreciation expense is allowed to be taken.  Traditionally, any depreciation expense taken on your home is required to be recaptured at the time you sell your house, and you must pay tax on it.  Even the section 121 exclusion ($250,000 tax-free gain for single/$500,000 for married couples) when living in the house for two out of the last five years will not exempt you from recapture taxes.  Occasionally that can produce negative results, but it is usually helpful because it often helps people avoid income AND self-employment tax which are typically higher than recapture rates.  Nonetheless, I regularly see tax returns where no depreciation was taken on a home office, to “avoid recapture.”  This is incorrect as recapture rules require you to recapture any depreciation “allowed or allowable.”  It does not matter whether you took the deduction or not, you are technically still on the hook for the recapture.

One other notable exception in the 15 pages of new rules explaining the safe harbor is that carryover expenses are not allowed for safe harbor years.  Ordinarily, if your business produces a loss, you are not allowed to create a bigger loss from business use of home expenses with the exception of the portion of mortgage interest, property taxes, or casualty losses which would have been allowed as itemized deductions even if you had no business.  The rest of the expenses get carried over to future years until you make a profit and can use the losses.  Using the safe harbor, any loss generated by the safe harbor disappears forever.  You would be better off in these years using actual expenses in order to preserve the losses for the future.

At the end of the day, you might as well just continue to track the actual expenses, and let your tax professional figure out which method will give you the best benefit each year.

In two weeks, we will go over the basic requirements in order to claim a home office deduction.

Prior articles are republished on my website at www.tlongcpa.com/blog.

IRS Circular 230 Notice: To the extent this article concerns tax matters, it is not intended to be used and cannot be used by a taxpayer for the purpose of avoiding penalties that may be imposed by law.

Travis H. Long, CPA is located at 706-B Forest Avenue, PG, 93950 and focuses on trust, estate, individual, and business taxation. He can be reached at 831-333-1041.

Lost in Transition

Originally Published in the Pacific Grove Hometown Bulletin

March 16, 2011

 

In my experience in the tax profession and from my vantage point as a Certified Public Accountant, I can tell you stories that will make your heart sing.  I can also tell you stories that will make you shudder like you just heard a bad contestant on American Idol.  The stories that make you cringe are usually caused by moments of stupidity by other tax preparers, or sadly, by people losing at a game of Tax Return Russian Roulette1.  I like to think the stories of hearts singing involve me riding in on a metaphorical white horse to save the day, heralding a banner “To correct stupidity and promote safety locks on roulette guns…”  I grant you, it is an unusual banner.

If I may spare you some pain, dear reader, I would say be mindful of transitions between tax preparers (including yourself) – particularly if you are “downgrading” the type of preparer you use.  Over the years I have seen countless returns where valuable tax attributes from prior returns were not carried forward to the next year’s returns by a new preparer (effects ranging from hundreds to several hundred thousand dollars in tax).  Some of you may be under the impression that your tax returns each year are distinct; this is rarely true.

Let us look at a simple example and suppose that you bought or inherited some mutual funds in 2007 worth $11,000; you sold them in 2009 for $6,000 resulting in a $5,000 loss.  There is a good chance you would have been limited to using $3,000 of this loss in 2009 and the other $2,000 would have been a capital loss carryover to your 2010 returns that could save you $500 or more in tax.  Of course, if you switch preparers and the new preparer does not have the training or presence of mind to find the Schedule D from 2009 and look for any unused capital losses, the cost of your new tax preparer just went up by $500.  Sadly, you probably would never know a costly mistake was made.

There are many areas similar to the above item including: carryovers of net operating losses, basis in retirement contributions and depreciable assets, state tax payments or refunds, office-in-home expenses, charitable contributions, rental property expenses (passive activity losses), alternative minimum tax (AMT) credits, foreign tax credits, general business credits, etc.  Often there are different amounts for the federal and state returns, and perhaps even AMT amounts for each of those if you are or may become subject to AMT.  Unfortunately these are scattered throughout forms in the return, and just because your new preparers show you comparative figures in a tax summary when you pick up your returns, does not mean they entered any of the carryovers in their software.

You do not have to be rich or have a complicated return to be affected by a number of these.  However, it does generally hold true, that the more money you make and the more types of activities you are involved with (rental properties, investments, etc.) the more heavily you are affected.

If you are doing the returns yourself with tax software for the first time, look carefully through the returns for hints of the above mentioned items, and be very diligent in answering the tax software questions.  Also, be wary of deleting items you think you no longer have, as they may have carryover or suspended items attached to them.  One of your big challenges is to know what the returns are supposed to look like when you are through.  If you are switching preparers, make sure the new preparer is qualified.  You may want to ask what specific carryover information was picked up from the old returns.

Let it be said of you, “You have chosen…wisely.”  I hope I do not have to saddle up my white horse on your behalf, as I still prefer a regular appointment.

Travis H. Long, CPA is located at 706-B Forest Avenue, PG, 93950.  He can be reached at 831-333-1041.

 

Tax Return Russian Roulette – noun – a form of legalized gambling with generally poor odds whereby untrained participants willingly subject themselves to cruel and unusual punishment in the form of self-tax preparation, risking thousands of dollars in order to save hundreds.