Home office deduction - simplified vs. actual
Home office deduction - simplified vs. actual
Spouse has a sole prop business for software consulting. Has a dedicated home office (300 sq ft) used exclusively for this purpose that represents ~6% of the sq ft of the house. Note that we itemize are are in the highest marginal bracket.
2021 was the first year of the business so we are deciding between actual expenses vs. simplified for this year.
Here are the numbers:
- $13k cost to build home office in beginning of 2021
- $4k purchase of office furniture
- $4k of allocated annual expenses (6% of $72k of whole house expenses including interest, taxes, insurance, utilities, security, etc)
Given the above would you take the actual expenses and deal with future depreciation complexity or just take the simplified method even though it is a smaller amount ($1500)? How does choosing the simplified method affect the ability to deduct the initial office construction and/or the office furniture cost?
When I ran the #s in turbotax with the Actual expenses vs. Simplified, the total differential for federal and state was around $1k more of taxes with simplified. Worth it to avoid future depreciation recapture upon future sale of house?
thanks
2021 was the first year of the business so we are deciding between actual expenses vs. simplified for this year.
Here are the numbers:
- $13k cost to build home office in beginning of 2021
- $4k purchase of office furniture
- $4k of allocated annual expenses (6% of $72k of whole house expenses including interest, taxes, insurance, utilities, security, etc)
Given the above would you take the actual expenses and deal with future depreciation complexity or just take the simplified method even though it is a smaller amount ($1500)? How does choosing the simplified method affect the ability to deduct the initial office construction and/or the office furniture cost?
When I ran the #s in turbotax with the Actual expenses vs. Simplified, the total differential for federal and state was around $1k more of taxes with simplified. Worth it to avoid future depreciation recapture upon future sale of house?
thanks
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Re: Home office deduction - simplified vs. actual
There's an article on Nerdwallet that explains the pros vs cons pretty well (https://www.nerdwallet.com/article/taxe ... -deduction), but allow me to point out a few things.
The office furniture is not part of the home office deduction either way. If they are used exclusively in the business, they are depreciable assets on their own...or you can choose to take the full expense in 2021 as a section 179 deduction.
The cost you list for "building the home office" isn't clear. Was this simply (for example) painting/re-carpeting? If so, it's a direct expense and can be counted 100% as actual expenses. But if you actually did construction work (and therefore did a capital improvement to your property), then those costs are added to the cost basis of the property as a whole and depreciated proportionately.
The office furniture is not part of the home office deduction either way. If they are used exclusively in the business, they are depreciable assets on their own...or you can choose to take the full expense in 2021 as a section 179 deduction.
The cost you list for "building the home office" isn't clear. Was this simply (for example) painting/re-carpeting? If so, it's a direct expense and can be counted 100% as actual expenses. But if you actually did construction work (and therefore did a capital improvement to your property), then those costs are added to the cost basis of the property as a whole and depreciated proportionately.
Re: Home office deduction - simplified vs. actual
Good info thanks. I'm having a tough time estimating the impact of depreciation in future years. Let's say I sell the house in 10 years after depreciating the home office for each of those years, will the extra tax owed on 6% of any gain due to depreciation nullify any extra tax savings I had along the way? If so it would make sense to do simplified and settle for a smaller deduction today, so that any future gain won't be taxable.
Good to know re: office furniture and home office construction.
Good to know re: office furniture and home office construction.
Re: Home office deduction - simplified vs. actual
This is a good question to ask--and it is one I have spent a little time thinking about. I'd like to hear more from others.petebogle wrote: ↑Mon Oct 03, 2022 12:46 pm I'm having a tough time estimating the impact of depreciation in future years. Let's say I sell the house in 10 years after depreciating the home office for each of those years, will the extra tax owed on 6% of any gain due to depreciation nullify any extra tax savings I had along the way? If so it would make sense to do simplified and settle for a smaller deduction today, so that any future gain won't be taxable.
But in partial answer to your question: it depends a lot on your tax rates in the relevant years. If you are in a higher bracket when taking the depreciation deduction and a lower bracket at recapture, you will, generally, be ahead.
Also keep in mind that the home office deduction reduces Schedule C profit and therefore will, generally, reduce SS and Medicare payroll taxes. These are not recaptured upon sale of the house. In other words, the recapture amount does not go on your Schedule C in the year of sale--it goes only on Schedule D (I think--happy to hear thoughts of others).
As with most tax issues the best way to come up with a strategy is to run the numbers using estimates based on your situation--current and expected future tax rates, how long you will keep the house, expected cap gain/loss on house and then fill out worksheet in Pub 523 based on those estimates.
P.S., not sure I understand "will the extra tax owed on 6% of any gain due""--the recapture amount reduces your basis.
The above is my layman's understanding--happy to hear other thoughts.
Re: Home office deduction - simplified vs. actual
The home office deduction does not contemplate the things that go into the office or the construction thereof, those are capital assets, BogleTaxPro already discussed how to deduct the expenses.
So, you're left with choosing the standard deduction or an actual cost deduction. One thing to consider is the possibility of an increased chance of audit and potential disallowance. However, I would probably put that risk at fairly low these days given the fact that everyone is working from home now. As opposed to pre-pandemic when taking a home office deduction was extremely rare.
So, you're left with choosing the standard deduction or an actual cost deduction. One thing to consider is the possibility of an increased chance of audit and potential disallowance. However, I would probably put that risk at fairly low these days given the fact that everyone is working from home now. As opposed to pre-pandemic when taking a home office deduction was extremely rare.
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Re: Home office deduction - simplified vs. actual
I saw this thread and I have similar questions, but they are slightly different from the original poster.
I do my own taxes via TurboTax, so I'm not a tax expert. I own a small business where the home office is 165 SF (about 5% of the size of the home). I am thinking I may have the business for another five years. Perhaps I sell the house then or continue to live in it. Using Turbotax, if I use actuals, I save an $220 in taxes this year (over simplified method) and depreciate my home by $640.
If I use the simplified method, I will pay an extra $220 in taxes, but don't have to recapture the depreciation wherever I sell the home. I am in the 22% tax bracket.
Saving $220 in taxes isn't material to me. I am more concerned that whenever I sell my home, it complicates the taxes such that I have to pay higher taxes since it's been partially depreciated for the next five years. If I save $220 * 5 = $1100 over five years (it would be nice), but would that be essentially a wash when the depreciation is recaptured when I sell my home?
Thanks again for the help...
I do my own taxes via TurboTax, so I'm not a tax expert. I own a small business where the home office is 165 SF (about 5% of the size of the home). I am thinking I may have the business for another five years. Perhaps I sell the house then or continue to live in it. Using Turbotax, if I use actuals, I save an $220 in taxes this year (over simplified method) and depreciate my home by $640.
If I use the simplified method, I will pay an extra $220 in taxes, but don't have to recapture the depreciation wherever I sell the home. I am in the 22% tax bracket.
Saving $220 in taxes isn't material to me. I am more concerned that whenever I sell my home, it complicates the taxes such that I have to pay higher taxes since it's been partially depreciated for the next five years. If I save $220 * 5 = $1100 over five years (it would be nice), but would that be essentially a wash when the depreciation is recaptured when I sell my home?
Thanks again for the help...
Re: Home office deduction - simplified vs. actual
Based on the numbers you quoted I would use the simplified deduction.BogleBall2 wrote: ↑Tue Mar 05, 2024 9:37 am I saw this thread and I have similar questions, but they are slightly different from the original poster.
I do my own taxes via TurboTax, so I'm not a tax expert. I own a small business where the home office is 165 SF (about 5% of the size of the home). I am thinking I may have the business for another five years. Perhaps I sell the house then or continue to live in it. Using Turbotax, if I use actuals, I save an $220 in taxes this year (over simplified method) and depreciate my home by $640.
If I use the simplified method, I will pay an extra $220 in taxes, but don't have to recapture the depreciation wherever I sell the home. I am in the 22% tax bracket.
Saving $220 in taxes isn't material to me. I am more concerned that whenever I sell my home, it complicates the taxes such that I have to pay higher taxes since it's been partially depreciated for the next five years. If I save $220 * 5 = $1100 over five years (it would be nice), but would that be essentially a wash when the depreciation is recaptured when I sell my home?
Thanks again for the help...
Are you taking all the relevant expenses into account? 5% of property taxes, home-wide maintenance, utilities, etc.?
Also keep in mind that you can (I believe) use short term cap gain losses to offset depreciation recapture in the year of sale. Double check me on that.
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Re: Home office deduction - simplified vs. actual
I just have property taxes, utilities, insurance, and maintenance. No interest. Turbotax calculated the depreciation of $640 resulting in the $220 of actual tax savings. I don't know if I'll have short term cap gains when I sell my house (as I don't know if I will sell my house).cowdogman wrote: ↑Tue Mar 05, 2024 10:01 am Based on the numbers you quoted I would use the simplified deduction.
Are you taking all the relevant expenses into account? 5% of property taxes, home-wide maintenance, utilities, etc.?
Also keep in mind that you can (I believe) use short term cap gain losses to offset depreciation recapture in the year of sale. Double check me on that.
Re: Home office deduction - simplified vs. actual
Maybe I'm misunderstanding.BogleBall2 wrote: ↑Tue Mar 05, 2024 6:17 pm Turbotax calculated the depreciation of $640 resulting in the $220 of actual tax savings.
Under the non-simplified approach, you would take the calculated depreciation and add to it 5% of property taxes, home-wide maintenance, home insurance, utilities, etc. to come up with your home office deduction.
Under the simplified method, your deduction is $5 x the relevant square footage.
If you're saying depreciation alone is giving you a tax savings of $220, then your actual home office deduction savings are going to be higher when you add on property taxes, etc.
Or maybe you meant to say "Turbotax calculated the home office deduction of $640 resulting in the $220 of actual tax savings".
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Re: Home office deduction - simplified vs. actual
Sorry, I'm not doing a good job of explaining it. Let me try again:
A) If I do the simplified approach, let's say I owe $0 in taxes. (Yes = $5 * SF)
B) If I do the actual approach, Turbotax is calculating that I would get a $220 refund. While depreciating my home $640. Therefore, when I recapture the depreciation, I assume I will owe something to the IRS when I sell my home.
I believe I will be using a home office for the next five or so years. Therefore, keeping things even, I will get an extra $1100 ($220 * 5) in my pocket. But, If I sell my home in say 6 years, I don't know what kind of taxes I would have to pay when my home is sold for a gain and I recapture the depreciation. My understanding is that the simplified approach doesn't depreciate your home. But if you do the actual approach, your home is depreciated regardless if you take the depreciation or not.
A) If I do the simplified approach, let's say I owe $0 in taxes. (Yes = $5 * SF)
B) If I do the actual approach, Turbotax is calculating that I would get a $220 refund. While depreciating my home $640. Therefore, when I recapture the depreciation, I assume I will owe something to the IRS when I sell my home.
I believe I will be using a home office for the next five or so years. Therefore, keeping things even, I will get an extra $1100 ($220 * 5) in my pocket. But, If I sell my home in say 6 years, I don't know what kind of taxes I would have to pay when my home is sold for a gain and I recapture the depreciation. My understanding is that the simplified approach doesn't depreciate your home. But if you do the actual approach, your home is depreciated regardless if you take the depreciation or not.
cowdogman wrote: ↑Tue Mar 05, 2024 6:34 pmMaybe I'm misunderstanding.BogleBall2 wrote: ↑Tue Mar 05, 2024 6:17 pm Turbotax calculated the depreciation of $640 resulting in the $220 of actual tax savings.
Under the non-simplified approach, you would take the calculated depreciation and add to it 5% of property taxes, home-wide maintenance, home insurance, utilities, etc. to come up with your home office deduction.
Under the simplified method, your deduction is $5 x the relevant square footage.
If you're saying depreciation alone is giving you a tax savings of $220, then your actual home office deduction savings are going to be higher when you add on property taxes, etc.
Or maybe you meant to say "Turbotax calculated the home office deduction of $640 resulting in the $220 of actual tax savings".
Re: Home office deduction - simplified vs. actual
I agree the simple approach is better for you. Or, at least, it's what I would do. You don't have to deal with recapture.BogleBall2 wrote: ↑Tue Mar 05, 2024 7:22 pm
I believe I will be using a home office for the next five or so years. Therefore, keeping things even, I will get an extra $1100 ($220 * 5) in my pocket. But, If I sell my home in say 6 years, I don't know what kind of taxes I would have to pay when my home is sold for a gain and I recapture the depreciation. My understanding is that the simplified approach doesn't depreciate your home. But if you do the actual approach, your home is depreciated regardless if you take the depreciation or not.
I have a much larger home deduction (expensive house, high real property taxes, expensive insurance) and so go with the actual calculation, but I have a largish short term cap loss carryforward that I hope to keep intact until we sell--probably in the next couple years).
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Re: Home office deduction - simplified vs. actual
Thanks. I don't know want to not take deductions from the IRS, but I also don't want to make my life unnecessarily complicated.cowdogman wrote: ↑Tue Mar 05, 2024 8:23 pm I agree the simple approach is better for you. Or, at least, it's what I would do. You don't have to deal with recapture.
I have a much larger home deduction (expensive house, high real property taxes, expensive insurance) and so go with the actual calculation, but I have a largish short term cap loss carryforward that I hope to keep intact until we sell--probably in the next couple years).
Re: Home office deduction - simplified vs. actual
Also note that for some people, the home office deduction is less valuable than the fact that you can deduct all mileage from your home to any client locations. Normally mileage from your home is considered normal commuting and non-deductible, but you can deduct it as business mileage if you are departing from your home office.
Re: Home office deduction - simplified vs. actual
Are you saying:billaster wrote: ↑Wed Mar 06, 2024 5:07 pm Also note that for some people, the home office deduction is less valuable than the fact that you can deduct all mileage from your home to any client locations. Normally mileage from your home is considered normal commuting and non-deductible, but you can deduct it as business mileage if you are departing from your home office.
1. a taxpayer has to take the home office deduction in order to deduct mileage for travel from home or
2. a taxpayer has to have a home office as his principal place of business in order to deduct mileage for travel from home or
3. both?
2 is true but I don't think 1 or 3 is.
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Re: Home office deduction - simplified vs. actual
I use TurboTax and don’t sweat this much because it’s a small amount of money if you are in the highest marginal bracket either way. It takes more time to optimize this than to simply consult for another half hour and earn back the difference.
Re: Home office deduction - simplified vs. actual
2 is correct. In this case the OP is a software consultant. It is unlikely they have an office other then their home office so that is their principal place of business. Any mileage from their home office to their clients would be business travel.cowdogman wrote: ↑Sat Mar 09, 2024 9:28 amAre you saying:billaster wrote: ↑Wed Mar 06, 2024 5:07 pm Also note that for some people, the home office deduction is less valuable than the fact that you can deduct all mileage from your home to any client locations. Normally mileage from your home is considered normal commuting and non-deductible, but you can deduct it as business mileage if you are departing from your home office.
1. a taxpayer has to take the home office deduction in order to deduct mileage for travel from home or
2. a taxpayer has to have a home office as his principal place of business in order to deduct mileage for travel from home or
3. both?
2 is true but I don't think 1 or 3 is.
If you have no other place for administration and management of your business, then your home office would be your principal place of business. That would be the case for most people doing consulting or part time gigs. You can deduct all travel from your home office.
On the other hand, if one ran a plumbing business, you may have a home office where you do some of your paperwork but your plumbing shop would most likely be your principal place of business. You could not deduct mileage from your home office to your shop as that would be normal commuting.
As to 1, if you have your home office as principal place of business, you may as well take the home office deduction.
Re: Home office deduction - simplified vs. actual
If the taxpayer meets the exclusive use test.
We take the home office deduction for my wife's biz but not mine--her space is exclusive, I just work out of the den. I realize I'm probably being conservative in this approach.
Re: Home office deduction - simplified vs. actual
The IRS has gone less strict on exclusive use. It used to require a separate room off limits to other activities but now they allow just a portion of a room to be exclusive use. For example if you had a desk and file cabinet in the corner of your den exclusively used for business, that would qualify. This works well for the simplified method because you can just plug in the square feet of your office space within the room.