Working at home pays off . . . sometimes. As you've probably discovered, you get a tax break as soon as you open for business because you're allowed to depreciate the portion of your home you use as an office. Well, there's one little catch: When you sell your house, you'll recapture that depreciation and pay tax separately on your home office.
"You have to calculate two separate gains," says James Ferrell, a CPA with accounting firm Chastang, Ferrell, Sims, & Eiserman, P.A. in Winter Park, Florida. "If you use 10 percent of your home for your office, you have to allocate 90 percent of the gain to the personal side of the home and 10 percent to the business."
For example, let's say you bought your home for $120,000. You subtract out the land cost of $20,000, leaving an actual structure cost of $100,000. If you use 10 percent of your home as an office, you can depreciate $10,000 over 39 years, which works out to approximately $256 per year. After three years, you've depreciated the business portion of the house by $768, which gives you a tax basis on the business portion of the house of $11,232 ($12,000, which is 10 percent of the purchase price of your home, minus $768).
You then sell your house for $150,000--$30,000 over the purchase price. Because you took a home office deduction instead of a realized gain of $30,000 on your personal residence, you'll have a realized gain of $27,000 on your residence and a recognized gain of $3,768 ($3,000 plus $768) on your home office.
The $27,000 is a realized gain but not a recognized gain if you purchase another home that is more expensive than the one you sold. Therefore, you can defer the tax on the personal residence portion of the gain. However, the office portion of the gain of $3,768 must be recognized unless you stopped using the space as an office at least one year prior to the sale. In that instance, the total gain can be rolled over and tax-deferred, or if you sell your house for less than the purchase price, no tax will be due.
But if you're going to have to pay that tax when you sell your house, you may wonder if the home office deduction is worth taking. "It's worth it because the name of the game in tax planning is deferral," says Ferrell. "If you can defer a tax liability to a later date, you should."
When you sell your house, you'll have to deal with the home office tax issue; when dealing with taxes, consult with your tax advisor first.