Two ways to claim in-home office tax deductions

Q: I have a small consulting practice that I run out of my home, and I use one room in the house for my office. I am not sure I want the hassle of keeping the records of the expenses, so I checked the IRS publication and it said there is an optional simplified method of claiming office-in-home expenses. Is this method worth using, or would I be leaving deductions on the table?

A: There are two options for claiming tax deductions for an in home office – actual expenses or the simplified method that bases the deduction on a standard amount per square foot.

To use actual costs, one must obviously keep records of those costs. The simplified method allows a deduction for $5 per square foot, limited to $1,500 in total. But the simplified method also allows mortgage interest and property taxes to be deducted on Schedule A (itemized deductions).

The simplified method deduction then replaces items such as utilities and insurance allocated to the portion of the home used for business.

The simplified method does not include an allowance for depreciation. This reduces the otherwise allowed deductions, but depreciation reduces the tax basis of the property so it creates gain when the property is sold.

When a house used as a principle residence is sold, the tax law allows an exclusion of $250,000 ($500,000 if married filing jointly) of any gain from that sale. However, if depreciation has been claimed for that residence, the law requires that gain be recognized up to the amount of the prior depreciation.

So the actual cost method will allow you to include depreciation as one of the deductions, but when the house is sold, this depreciation will be recovered as taxable gain. Because the simplified method does not include depreciation, the full exclusion of gain is available.

If actual costs are claimed, IRS Form 8829 must be completed and attached to your return. It is often thought that this form raises the likelihood of audit. The simplified method deduction is entered on line 30 of the Schedule C (used for selfemployed business reporting).

I can’t make the decision for you, but if you struggle with record-keeping, the simplified method will allow you to avoid a burden. And the decision to use actual costs or the simplified method is an annual one, and can be changed from one method to the other from year to year.

One other consideration is that the office-in-home deduction is limited to the gross income from the business (gross receipts minus allowed deductions). If the deduction exceeds the gross income, the excess carries forward to future years if the actual cost method is used. There is no carry forward for the simplified method.

Q: My employer provides us with $75 per month to use for membership at a health club. This is included on our W-2 income statement and we then have to pay taxes on it.

My question is whether this is the correct treatment or if there is some way that I could deduct it (maybe a medical expense)?

The employer’s treatment is correct. Tax law changes in 1984 made it clear that any economic benefit received by an employee was income unless a specific provision of the tax law said otherwise.

These 1984 changes added some new exclusions to the law, and one deals with health clubs. Unfortunately, the requirements of that tax exclusion do not apply to your situation.

The exclusion requires that the health club be owned and operated by the employer and be located on the employer’s premises. In addition, substantially all of the use of the club must be by employees and their family members.

Your benefit sounds like a reimbursement for an outside club and it would therefore not satisfy the exclusion.

A health club membership also does not meet the definition of a medical expense, except in very unusual circumstances.

Although your health club reimbursement is taxable, it remains a very attractive benefit. The cost of the membership then becomes the $75 times your marginal tax rate. For example, if your tax rate is 30 percent, the benefit means your monthly health club cost is $22.50 rather than $75.