Whenever we mention the home office deduction, we invariably get some form of “I heard that taking the home office deduction affects you when you sell your home…” Today, we want to go into the nuances of taking the home office deduction.
What is the Home Office Deduction?
First off, when you report your home office expenses, you can take a deduction for depreciation of your home. You would take the fair value of your home and multiply it by a percentage given by the IRS that is based on the month you started using your home for business. This will give you the amount to take in depreciation for your home.
The Home Office Deduction and Selling your Home
So what happens when you have been taking the home office depreciation deduction and you decide to sell your home? When you sell your home, the profit on the sale of your home up to $250,000 is not taxed if you are filing as a single, or $500,000 if you are filing as married filing joint. If your profit is greater than these amounts, you will have to pay capital gains on the amount greater than the limit. This rate is usually around 15%. When you are calculating the profit of the sale of your home, you will need to reduce your basis in your home (which is what you paid for your home plus and minus a few adjustments) by the amount of depreciation taken on your home office. In some cases, this may end up driving up your profit, which would cause you to have to pay capital gains taxes. As a result, for any depreciation deductions you took after May 6, 1997, you will have to pay a capital gains tax of 25% on the deductions. However, if your tax rate is less than 25%, you would be taxed at the lower rate.
However, even if you don’t end up going over the exemption amount, you may still have to pay some taxes when the government “recaptures” the tax on the depreciation of any business use of a sold property. You would end up reporting this on Schedule D of your tax return, which is used to show all your capital gain transactions. This would be what is known as unrecaptured Section 1250 gain. This is done because what is happened is that you have used your property for both business and residential purposes. You would be taxed at a rate of 25 percent, regardless of your ordinary tax bracket.
Should I or Shouldn’t I?
So what happens if you don’t claim depreciation on your home office? What if you just claimed exemptions for the space and the proportionate costs for rent and mortgage payments, as well as utilities and maintenance, do you still have to pay taxes on an unrecaptured gain?
Unfortunately, the answer is yes. According to the IRS, the unrecaptured Section 1250 applies to depreciation whether or not you took it. So, since you are going to have to pay the tax, you may as well get the benefit of the home office deduction.
Confusing? If you have any questions, check with a good accountant who can walk you through all your options.
Chris Peden, CPA, CMA, CFM has over 15 years in the corporate world helping companies meet their regulatory compliance requirements. He also assists small business owners with organizing and making sense of their finance information. You can reach him at firstname.lastname@example.org, or check out his blog at www.theaccountingscribe.com . In accordance with Circular 230 Treasury Department Regulations, we are required to advise you that any tax advice contained in this article may not be relied upon to avoid penalties under the Internal Revenue Code. If you are interested in a written opinion that can be relied upon to prevent the imposition of tax-related penalties, please contact the author.