Many farmers and other small business owners operate their business out of their home. The tax laws allow a deduction for part of the expenses related to the home such as insurance, utilities and repairs based upon the square footage of the business portion to the total home size.
For example, if the farmer uses a 200 square foot room in a home with 2,000 square feet, the farmer would be allowed to deduct 10% of their home expenses that are otherwise non-deductible plus 10% of real estate taxes and home mortgage interest. This deduction reduces self-employment taxes. They are also allowed to depreciate part of their home in addition to the other allowed deductions.
The major drawback to this deduction is the amount of time and effort spent in arriving at the deduction. The IRS has been aware of this issue and today finally released a new Procedure to help reduce this burden.
The safe harbor election allows a taxpayer to simply determine the amount of square footage used for business (which is already reported on the tax return normally) and multiply this by $5 with a limit of 300 square feet or a maximum $1,500 deduction. Additionally, the total amount of real estate taxes and home mortgage interest is then allowed to be deducted fully on Schedule A. However, no depreciation or other deductions (such as insurance, repairs, etc.) is allowed as a deduction.
This election is voluntary each year. You can take actual one year, the safe harbor the next and then revert back to actual.
The normal rules related to qualifying for the deduction still apply.
In many cases, the next deduction found on many of these returns is much less than $1,500 and this may actually resulted in a higher deduction with minimal effort.
This safe harbor deduction is not allowed on your 2012 tax return, but you may start using it for 2013.
Paul Neiffer, CPA