A question was raised as to whether a home office can be included in the total of qualified property used in determining QBI when using the section 199A(b)(2)(B)(ii) 2.5% of unadjusted basis of qualified property (UBIA) limitation.
Background:
When claiming a home office deduction, a taxpayer has two options, either use the simplified method in which no depreciation is determined or reported or the actual method that includes depreciation in the deduction. When using the simplified method, the deduction is based upon the fixed amount of $5 per square foot, maximum 300 square feet for the year. On the other hand, if the actual method is used depreciation is determined and reported along with a prorated portion of actual expenses such as mortgage interest, real estate taxes, homeowner insurance, utilities, etc.
For the Section 199A deduction, when the taxpayer’s 1040 taxable income exceeds the phaseout threshold plus $50K ($100K for MFJ), section 199A(b)(2)(B)(ii) limits the section 199A deduction for qualified trades or businesses (QTBs) (not specified service trades or businesses - SSTBs) to the lesser of:
1. 20% of QBI (net of certain required adjustments), or2. The wage limitation, which is the greater of:
- 50% of the W-2 wages paid by the business or
- 25% of the W-2 wages paid by the business plus 2.5% of the unadjusted basis of the business’s qualified property (abbreviated UBIA).
Thus, in some cases a taxpayer’s 199A deduction may be based upon 25% of the wages paid by the business plus 2.5% of the business’s UBIA. With no W-2 wages the deduction may become just 2.5% of UBIA. The question presented by the use of a taxpayer’s home for business is this: Does the UBIA include the business use portion of the unadjusted basis of the home (net of land value)? The answer is maybe.
Reg Sec 1.199A-2(a)(3) provides: “The UBIA of qualified property is presumed to be zero if not determined and reported for each trade or business (or aggregated trade or business. This means that the UBIA must be “determined and reported” on the tax return. Where a taxpayer is figuring a business tax deduction for the portion of their home used for business, they have two options, either use the actual expense method or the simplified method prescribed by Rev Proc 2013-13. In using the simplified method, it is not necessary to calculate (“determine and report…”) the adjusted basis of the portion of the home used as an office. (See section 4.06 of Rev Proc 2012-13). However, if the taxpayer uses the simplified method in one year and the actual expense method in the next year the adjusted basis of the portion of the home used as an office must be computed in that subsequent year (see section 4.07(1) of Rev Proc 2012-13). So, it would seem that, if the simplified method is used in the first year or years, then the home office is not included in UBIA. However, if the taxpayer switches to the actual method in a subsequent year and the depreciation is “determined and reported,” then the home office would be included in UBIA for the year of the switch.
Qualified Property: Sec. 199A(b)(6) defines “qualified property” as meaning:
- tangible property of a character subject to the allowance for depreciation under 167,
- which is held by, and available for use in, the qualified trade or business at the close of the taxable year,
- which is used at any point during the taxable year in the production of qualified business income, and
- the depreciable period for which has not ended before the close of the taxable year.
Except as outlined above, the section 199A regulations do not include any restrictions related to the inclusion in UBIA of the potion of the home used as an office.
It is significant to note that the benefit is generally trivial. The following example demonstrates that:
Example: Assume the home’s unadjusted basis is $500,000 and the land portion is valued at $200,000. If the business use of the home is 10% then the UBIA of the home office would be $30,000 (($500,000 - $200,000) x 10%). 2.5% of the $30,000 would be only $750 and that would increase the 199A deduction by only $150.