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By David I. Kempler, Esq., and Elizabeth Carrott Minnigh, Esq.
Buchanan Ingersoll & Rooney PC, Washington, DC
As a general rule, §280A(a) disallows any deduction for expenses related to a dwelling unit that is used as a residence by the taxpayer during the taxable year. However, §280A(c)(1) through (4) allow a deduction for expenses related to certain business or rental use of a dwelling unit, subject to the deduction limitation set forth in §280A(c)(5). Section 280A(c)(1) allows a deduction for a home office only if a portion of the home is used regularly and exclusively as (i) a principal place of business, or (ii) as a place to meet or deal with customers or clients in the ordinary course of business, or, in the case of a separate structure that is not attached to the dwelling unit, in connection with the taxpayer's trade or business. Under §280A(c)(1), taxpayers who are employees must meet an additional test-their use of the home office must be for the convenience of the employer.
Section 280A(c)(2) allows a deduction for expenses that are allocable to a portion of a residence used on a regular basis for the storage of inventory or product samples held for use in the taxpayer's trade or business of selling products at retail or wholesale if the residence is the sole fixed location of the trade or business. Section 280A(c)(3) allows a deduction for expenses that are attributable to the rental of the dwelling unit or a part of the unit. Finally, §280A(c)(4) allows a deduction for expenses that are allocable to the portion of residence used on a regular basis in the taxpayer's trade or business of providing day care for children, for individuals who are age 65 or older or for physically or mentally disabled individuals are deductible.
Section 280A(c)(5) imposes a gross income limitation on the deduction. Direct expenses for the business portion of the home are deductible in full, subject to a limitation of the gross income derived from that business use. Indirect expenses related to the entire residence, including mortgage interest, real estate taxes, insurance, utilities and depreciation, are deductible based on the percentage of the residence used for business. Expenses disallowed solely because of the gross income limitation use can be carried forward, subject to the gross income limitation in any future year.
The calculation of a home office deduction is complex and requires extensive recordkeeping. In Rev. Proc. 2013-13, 2013-6 I.R.B. 478, the IRS provided an optional safe harbor method that taxpayers may use to determine the amount of their deductible home office expenses. The safe harbor is effective for tax years beginning on or after January 1, 2013. Under §4.01(2) and (3) of the revenue procedure, taxpayers are permitted to deduct annually $5 per square foot of office, up to a maximum of 300 square feet, for a maximum deduction of $1,500. This new safe harbor provides an alternative to the calculation, allocation, and substantiation of actual expenses required under §280A. However, §4.02 provides that the safe harbor method is not available to an employee with a home office if he or she receives advances, allowances or reimbursements for expenses related to the business use of the employee's home under a reimbursement or other expense allowance arrangement with his or her employer.
Section 4.03 provides that a taxpayer may elect from tax year to tax year whether to use the safe harbor method or calculate and substantiate actual expenses under §280A. Section 4.03 further provides that a taxpayer elects the safe harbor by using the method to compute the deduction for the qualified business use of a home on his or her timely filed, original federal income tax return for the tax year. Once made, §4.03 provides that an election for the tax year is irrevocable.
The safe harbor is an alternative to the deduction of actual expenses. Accordingly, as a general rule, §4.05 provides that a taxpayer electing the safe harbor method for a tax year generally cannot deduct any actual expenses related to the qualified business use of that home for that tax year, with the exception of any trade or business expenses unrelated to the qualified business use of the home for that taxable year, such as expenses for advertising, wages, and supplies. Additionally, under §4.06, a taxpayer using the safe harbor cannot deduct any depreciation, including first-year bonus depreciation, or §179 expenses for any portion of the residence used for a qualified business use for that tax year. Finally, a taxpayer using the safe harbor method for a tax year cannot deduct any disallowed amount under §280A(c)(5) carried over from a prior tax year during which the taxpayer calculated and substantiated actual §280A expenses. Under §4.08(3), the taxpayer can deduct that carried-over amount in the next succeeding tax year in which the taxpayer calculates and substantiates actual §280A expenses.
The safe harbor does not affect the determination of whether a taxpayer qualifies for the home office deduction in the first place. A taxpayer must still prove that a portion of the dwelling unit is used "exclusively and on a regular basis" as the taxpayer's principal place of business or as a place to meet with clients and customers of the taxpayer's trade or business.
For more information, in the Tax Management Portfolios, see Wood, 547 T.M., Home Office, Vacation Home, and Home Rental Deductions, and in Tax Practice Series, see ¶2460, Vacation Home and Home Office Deductions.
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