The Ins and Outs of the Home Office Deduction

Interesting article in the New York Times, Depreciation Appreciation 101: The Ins and Outs of Deducting for a Home Office, by Damon Darlin:

The IRS allows you to take a home office deduction if you meet certain conditions, and about 30 million taxpayers manage to meet them....

[W]hen you sell your home for a profit you have to recapture the depreciation you took on that office and pay taxes on it. For example, say you bought a house for $500,000 and used 10% of it for an office. (You figure that out by measuring the square footage of the office and dividing that by the square footage of the entire house.) You are allowed to depreciate 10 percent of the purchase price of the house each year using what the government succinctly calls the "39-year commercial property straight time depreciation schedule." That adds up to about $6,000 in depreciation over five years. You later sell the house for $750,000. The $250,000 in profit is excluded from tax. But the $6,000 you took in depreciation over the years must be reported as a gain on Schedule D, in the gains and losses section. It is taxed at a 25% rate.

What if you take other home office deductions and skip the depreciation? Nancy Mathis, an I.R.S. spokeswoman, says that will not help. "Even if you don't take this depreciation, it will be treated as if you did when it comes times for calculating the basis of the home sale and capital gains exclusion."...

Now for the more complicated question: Remember that the government allows a single person to exclude $250,000 of capital gains on a home sale and a married couple, $500,000. If you claimed 10 percent of your home as a home office and wrote that off over the years, when you sell the house, do you owe capital gains tax on 10 percent of the profit?...

The government used to say, you owe the tax on the portion of the residence that is used for commercial purposes. But it gave taxpayers a little gift when a new rule took effect in 2002. The home office inside the structure of your house is no longer considered commercial property. Everything is covered under the capital gains exclusion. If your accountant is not up to date on that, ask him or her to check it out....

But in changing the rules, the I.R.S. also made things more complicated. Funny how that happens. That no-tax rule applies only if the home office is part of the structure of the main residence.

(Thanks to Richard Winchester (Thomas Jefferson) for the tip.)