Home office deductions & mortgage interest on Sch A

[stech]

I have my business home office expenses to deduct for 2020 taxes. I have listed mortgage interest & property taxes in Sch A. Does this mean, I can’t enter those to as home office? (10% business use)

if so, wouldn’t it make more tax advantage to enter all mortgage related items on business then Sch A?

also, mortgage payments are not deductible? Only interest is? I can’t use full payment I pay each month? (Interest + principle)

[Bsch4477]

First, be sure that you qualify for a home office. You should be self employed and use the space regularly and exclusively for your business activities. If you use your den and someone also watches TV in it, it doesn’t qualify. 

yes, only the interest portion of your mortgage payment can be deducted. You can deduct 90% of that  interest and 90% of property tax on Sch A if you itemize and 10% of those expenses as a business expense on Sch C. 

There is also a simplified office deduction available to you which you can read about here:

https://www.irs.gov/businesses/small-businesses-self-employed/simplified-option-for-home-office-dedu...

[VolvoGirl]

To expense the whole mortgage payment you would need to set it up as an ASSET and depreciate the purchase cost over several years.  That covers the principle part.  

[stech]

@VolvoGirl 

Can you please provide more details or if there is an online tool to help with this. I found this https://www.irstaxapp.com/depreciation-calculator-for-home-office/

I used $595K, $0 for Land (idk at this point) and Jan 1, 2020 as an example. I got $1,464. does this see accurate?

@Bsch4477  yes, I am self-employed as a day trader stocks. I have a separate room office in house which isn't used by anyone. 

[Opus 17]

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@stech wrote:

@VolvoGirl 

Can you please provide more details or if there is an online tool to help with this. I found this https://www.irstaxapp.com/depreciation-calculator-for-home-office/

I used $595K, $0 for Land (idk at this point) and Jan 1, 2020 as an example. I got $1,464. does this see accurate?

@Bsch4477  yes, I am self-employed as a day trader stocks. I have a separate room office in house which isn't used by anyone. 

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Your mortgage payment includes principal (the amount you borrowed to buy the house) and interest.  Interest is a deductible business expense.  If 10% of your home is a qualified home office, you would deduct 10% of your interest on schedule C and 90% of the interest on schedule A. 

To get a deduction for the actual value of the house itself (wear and tear) you take depreciation, not a deduction for the mortgage principal.  Depreciation for non-residential commercial property is over 40 years. Using a value of $595,000 for the house, $1464 seems about correct for 1 year's worth of depreciation for 10% of the home.

However, you can't set the land value to zero.  Land does not depreciate (lose value due to wear and tear).  If you don't know the value of the land your home is built on, your county tax assessor will have that information.  Also, your base value for depreciation is the price you paid for the home when you bought it (minus value of the land), OR the fair market value when you placed it in service for business (minus value of the land), whichever is less.   Real estate usually goes up in value, but not always. 

Also be aware that when you sell the home, you will have a taxable capital gain due to depreciation recapture, even if the rest of the capital gains are covered by the usual $250,000/$500,000 exclusion for your personal home.  You deduct deprecation now, and when you sell the home you have to repay that tax deduction.  You have to repay the depreciation you took or could have taken, so you might as well take it.  And keep all your records for as long as you own the home plus 3 years after you sell.  Don't start tossing old tax returns, they contain depreciation information you will need when you sell.

If you take the home office safe harbor deduction, that is $5 per square foot up to $1500 maximum (300 square feet).  In that case, you claim all your mortgage interest on schedule A, and you don't claim deprecation now, and you don't pay depreciation recapture when you sell.  (You would lose the deduction for 10% of your utilities and 10% of your homeowners insurance.)  The safe harbor may be worth considering since it means less compliance paperwork and may result in similar tax savings. 

[stech]

never heard of that recapture depreciation rule. Then no one would use depreciation for businesses if they have to payback

If I use regular method, then I would need to get my home office deduction to be greater than $15,000 (to beat the simplified amount of $1,500). which is not possible.

Only way to do that, is to use depreciation of $1,464 + $580.18 (10.21% * 5,682 home expenses, excluding interest/property taxes for now, all on sch A) .

[Opus 17]

@stech 

Depreciation and recapture is definitely something you must be aware of if you are going to be in business. You can read this to get started.

https://www.irs.gov/pub/irs-pdf/p544.pdf

Let me give you an example of how it works in your favor.  Suppose you buy a computer for $2000, exclusively for business, which has a class life of five years. You deduct $400 of depreciation as a business expense every year for five years.  At the end of that time, the computer is worthless and outdated, so you throw it away. You were able to deduct the full cost of the computer over its useful life, which is exactly what is supposed to happen.

Now, let’s suppose you sell the used computer for $200.  You have been taking depreciation based on the concept that the computer will be used up and worthless after five years. Every year that you take the $400 depreciation deduction, you are taking $400 that you invested in the computer out of the computer. By the end of the depreciation life, you don’t have any of your own money invested in the computer anymore. It’s adjusted cost basis is zero, it has cost you nothing to use that computer for five years. If you now sell the computer for $200, you are making a $200 profit on some thing that is theoretically worthless.  The computer has no value, because you depreciated it, so that $200 represents a recapture of the depreciation deduction that you previously took. Therefore, that $200 is taxable income.  You don’t have to pay tax on  the entire $2000, you only have to pay tax on the amount that you recaptured in the sale.  

Commercial property depreciates over 40 years. Most factories or shopping centers will not be worth as much at the end of that time, simply due to wear and tear and because time and technology march on. But because most houses and residential real estate appreciates significantly in value, it will almost always be the case that you will sell your house for more than you paid and that means that any depreciation deduction that you claimed for wear and tear gets re-captured in the sale.  Taking a depreciation deduction for your home office is essentially saying that your house is worth less each year because of the business use and therefore the lost value is a business expense. Since you will probably sell the house for more than you paid for it, you are proving that the house did not really lose value, and so you have to pay back the depreciation that you previously took. And the tax regulations require that you must repay the depreciation that you claimed or could have claimed.  

even so, there is value to taking depreciation using a concept called “present value of money“. Suppose you took a $1500 deduction each year for 10 years, and at the end of that time you sold the house, and had to include $15,000 extra in your taxable income for the recapture. Because of inflation, $15,000 10 years from now is less real money than $15,000 today. If you simply took the $400 in net tax savings from the deduction and invested it for 10 years you would have more money at the end of that 10 years than the tax you would owe on that recaptured income.

[Opus 17]

@stech 

Specific to your situation, it sounds like you can deduct all your interest and property taxes on schedule A plus the $1500 safe harbor, or you can deduct your mortgage interest and taxes partly on schedule A and partly on schedule C, and then deduct an additional $2000 as a business expense. The $1500 safe harbor deduction has no strings attached while the $2000 deduction has definite future strings attached.

You can read more about the simplified home office deduction here. TurboTax does include this option.

https://www.irs.gov/businesses/small-businesses-self-employed/simplified-option-for-home-office-dedu...