 Hello and welcome to the session in which we will discuss Certain business expenses that could apply differently for self-employed and employee Which is they require a little bit of explanation if you are self-employed you prepare a Schedule C so you prepare a schedule C you would list your income and you would list your Expenses and you'll either net have a net income or a net loss then eventually the net income or the net loss Will go to your form 1040 whether it's net income or a net loss and This is adjusted gross income. It's listed above adjusted gross income So any expenses you take are for adjusted gross income however, if you are an employee and You qualify for certain deduction. It's gonna go on schedule a so you add up all your deductions Which is some of them will be office in the home and they are deducted Below AGI which is from AGI. So it's very important to understand this Concept I repeat I repeat this concept every time because it's worth remembering Let's go ahead and get started to see how office in the home Works and what are the requirements? Before we proceed any further. I have a public announcement about my company farhat lectures comm Farhat accounting lectures is a supplemental educational tool That's gonna help you with your CPA exam preparation as well as your accounting courses My CPA material is aligned with your CPA review course such as Becker, Roger, Wiley, Gleam, Miles My accounting courses are aligned with your accounting courses broken down by chapter and topics. My resources consist of Lectures multiple choice questions through false questions as well as exercises go ahead start your free trial today Deductability here is very restrictive because the possibility of abuse remember if you're working from home What's personal and what's business gets blended? So we the IRS have specific rules the office must be used Primarily it means exclusive only for business purposes and it must be used on a regular consistent basis it should be considered your main place of business and It should be utilized by client patient and customer. So when someone comes, you know a customer a patient a client You meet them in that office on a regular basis. So what's a what's what's a main clip? What's a main place of business? What does that mean? What constitute a main place of business? Well, if the tax if you carry out administrative, you do all the paperwork Management work and and we have to be careful and this is very important for employees and it's used Not for your convenience for the convenience of your employer. So your employer is asking you to work from home Okay, so it's not optional. So a few you do this for your own convenience If you're an employee remember, this is an employee then it doesn't qualify So you are working from home because your employer asks you to do so it's for their Convenience not for your convenience So you have to do administrative management work and it has to be for the convenience of your employer Now if you are an employee if you are self-employed, that's a different story That's you as long as you meet those criteria then the office in the home is deductible now Bear in mind if you're an employee those deductions will be suspended from 2018 to 2025 How you determine how much to deduct you can either one of two methods either the regular method which is called the actual expense method or the Simplified method or the safe harbor method. Let's start by looking at the regular method Okay under the regular method you have various expenses. You're gonna you're gonna categorize them as direct Expenses or indirect expenses? What does that mean direct expenses means they are related specifically to that office space indirect It means they could benefit the business and the personnel. We're gonna see what they are direct expenses only the part of the home That's designated for the office. So any expense you incur there for example, if you paint the wall It's assumed. This is the office. This is specifically for the benefit of this office If you put a carpet there for that office if we change the carpet specific for that office Those are deducted in full Now there are certain expenses that you cannot break them between personal and business for example utilities Taxes insurance you pay insurance for the whole home. You don't buy insurance specifically for the office Same thing with taxes when you pay the taxes you pay the taxes for the whole house Same thing with utilities unless you have separate utilities, which is not likely you would allocate between business and personal based on the allocation base Home office expense if you are self-employed means you have a trade then those expenses are deductible for AGI they're basically part of your Part of your schedule C. So that's that's fine So allowable home office expenses cannot create a loss What does that mean if you're self-employed and you are computing your net income and at the end of the day The home office expense cannot create a net loss for you and you can break even Okay, same concept as hobby or rental of vacation homes where if you have a an access expenses of Those home office expenses and you no longer have income to offset them then that's it You can no longer take them. Some of them can be carried forward like depreciation Okay, and what happened is any amount that's not used for example Interests on the home taxes they can be used somewhere else like on schedule a assuming you itemized Okay amount allowed as itemized deductions or deducted first must be deducted first when you Perform your computation. The first thing you do is you deduct After cost of goods sold mortgage interest and real estate because those are deductible anyway Let's take a look at this example. Adam a CPA working as a tax manager in a CPA regional firm He runs a tutoring business on the side He dedicate two rooms in his basement for the sole purpose of a CPA tutoring business These two rooms occupy 200 and square feet equivalent to 10% of his residence which total 2,500 square feet the tutoring business generates a gross income of 6,000 for this particular year with expenses Execluding home office expenses of 4,000 amounting to 4,000 So this is basically software advertising supplies for the office So on and so forth and Adam had the following home expenses Interest on the mortgage for the whole home taxes on the property for the whole property home owners insurance and Makers depreciation of 400. How do we compute? The home office expense. Well first thing we do is we'll take the 6,000 of income Minus basically the cost of the business 4,000 equal to 2,000 then we're gonna deduct the interest and the taxes first and this is gonna be 10% of those 9,000 plus 5,000 equal to 14,000 times 10% that's gonna be 1,400. We're gonna take the 2,000 minus 1,400 that's gonna give us $600 left an income then we're gonna take 10% of the home owners insurance, which is 600 minus 250 will give us $350 now we have depreciation remember we cannot incur a loss From the home office expense therefore of the 400 we're gonna be using 350 and what's left $50 will be carried The access depreciation for future years Let's look at the simplified method. Well simplified method Well, you are allowed under the simplified method You don't have to keep track of things $5 per square foot and you are limited to 300 square foot So you are limited to 1500 deduction. No deduction is allowed for depreciation or actual expenses They're just saying you can take $5 per square feet up to 300 Okay, now this is good because what you can do you can free up interest and taxes to take on schedule a and there is no Carry over of any unused depreciation. Let's look at this example the same example as Aram But using the simplified method again, we'll start $6,000 of income minus $4,000 of supplies advertising and software cost $2,000 what's left is he he occupied 250 feet times five Which is $1250 $2,000 minus $1250 you'd have a net income of $750 now now bear in mind that That he did not use his home mortgage and taxes which he can use fully now on schedule a Usually usually the simplified method is is less usually the simplified method is less now Which method to use well, you have to know the rules for both because now with the simplified method It present an annual decision The the taxpayer has to either take the Simplified method or the actual when considering the two method first you have to understand the regular and exclusive Apply to both so that doesn't change between the two now bear in mind the simplified method require fewer Calculation and less record keeping why because you just need to know how many square footage you are occupying That's all what you have to know By eliminating depreciation because you don't take depreciation you avoid that 25% real estate Tax for depreciation recapture. What does that mean when you take depreciation on the house? And you sell the house later you are required to do what to recapture this depreciation Well, if you don't take the depreciation, you don't have to recapture it And as I mentioned the simplified method will free up your interest and mortgage to be deductible on schedule a assuming you Are itemizing assuming you are itemizing in most cases the regular method Will have a smaller amount because you could the maximum is 1500 And it does not allow for any unused deductions specifically for mortgage And once the taxpayer taxpayer has made a choice it cannot be changed in other words You cannot amend your return and change it from one method to the other. That's fine What should you do now go to far hat lectures look at additional mcqs That's going to help you understand this concept better whether you are a cpa candidate Accounting student or an enrolled agent far hat lectures can help. Good luck study hard and stay safe