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Rita owns a sole proprietorship in which she works as a management consultant. She maintains an office in her home (500 square feet) where she meets with clients, prepares bills, and performs other work-related tasks. Her business expenses, other than home office expenses, total $5,840. The following home-related expenses have been allocated to her home office under the actual expense method for calculating home office expenses.

Real property taxes	$	1,720
Interest on home mortgage		5,280
Operating expenses of home		860
Depreciation		1,672

Also, assume that, not counting the sole proprietorship, Rita’s AGI is $62,400.

Assume Rita’s consulting business generated $15,600 in gross income. (Leave no answer blank. Enter zero if applicable.)

a. What is Rita’s home office deduction for the current year?

b. What would Rita’s home office deduction be if her business generated $10,600 of gross income instead of $15,600? (Answer for both the actual expense method and the simplified method.)

Answer 1

a)
Using the actual expense method
Gross Income	$ 15,600.00
Less: business expenses	$   5,840.00
Balance	$   9,760.00
Less: Tier 1 expenses (interest $5,280 + $1,720 Taxes)	$   7,000.00
Balance after tier 1 expenses	$   2,760.00
Less Tier 2 expenses (operating expenses)	$      860.00
Balance after tier 2 expenses	$   1,900.00
Less: Tier 3 expenses (depreciation)	$   1,672.00
Net income from business	$      228.00
Rita’s home office deduction for the current year is $9532
Rita is allowed to deduct all expenses allocated to the home office  ($7,000 interest and taxes + 860 home operating expenses + depreciation 1,672)
Under the simplified method, Rita’s home office deduction would have been limited to $1,500 (300 squarefeet × $5 application rate). However, she also would have been able to deduct all of the $7,000 for interest and taxes as itemized deductions. This would have provided her with $1,500 + $7,000 = $8500 of deductions but this is still less than the $9,532 in deductions under the actual method
b)
Using the actual expense method
Gross Income	$ 10,600.00
Less: business expenses	$   5,840.00
Balance	$   4,760.00
Less: Tier 1 expenses (interest $5,280 + $1,720 Taxes)	$   7,000.00
Balance after tier 1 expenses	$ (2,240.00)
Less Tier 2 expenses (operating expenses)	$              -
Balance after tier 2 expenses	$ (2,240.00)
Less: Tier 3 expenses (depreciation)	$              -
Net loss from business	$ (2,240.00)
Rita’s home office deduction for the current year is $7000
Rita is allowed to deduct only the mortgage interest and real property taxes allocated to the business use ofthe home. The remaining expenses (tier 2 and tier 3) are suspended and carried over to next year