HOME OFFICE – DEPRECIATION, LIMITTATION, and SIMPLIFIED APPROACH
In the previous https://longterm.work/brickmortar-homeoffice blog post, we went over the definition of home office and deductibility criteria. If your home office meets these criteria, you will be able to take the deduction including the pro-rata expense portion of utilities, maintenance, and repairs. Today, let’s explore an important category of home office deductions, which is depreciation.
Simply put, a home office is considered a nonresidential real property because the part of the home is being used for commercial/non-residential use. As previously mentioned, the home-office provision was signed into law by President Bill Clinton in 1997; hence, let’s consider all home office was placed in service after 1993 which allows you to use 39-year life depreciation. Yay, more legitimate deductions!
Now, let’s discuss the downside of taking home-office depreciation deduction. Home-office depreciation is an allowed or allowable deduction. This means that if you didn’t take the deduction but were entitled to deduct, you are still on the hook as you did take the depreciation. Why is this so important?
It is because you must reduce the basis of your property by this “phantom” deduction, which potentially gives you a bigger gain when you decide to sell.
Additionally, you will be subject to unrecaptured Section 1250 gain. In essence, the depreciation deduction you claimed over the years (since 1997) for that home office is a deferral of taxes; hence you sell the home, you will need to recapture those deferred deductions. However, the unrecaptured Section 1250 gain is taxable at a maximum 25 percent rate regardless of your ordinary income tax bracket. This is worthwhile to consider in your tax planning because the long-term capital gain rate is between 0 percent to 15 percent rate depending on your ordinary income tax bracket.
OK, enough with the not-so-good news. Let’s now discuss the home-office deduction limitation. It may not create or increase a net loss from the business to which it relates. The excess expenses can be carried over to the tax year. The calculation is lengthy; hence I won’t include it here. Your tax advisor can most definitely help with this task.
WOW, so much information. Here is the good news though, the IRS also thinks that home-office provision is very confusing; hence they added a simplified approach to the home-office provision in 2013 (16 years after it was signed into law). In essence, it is five dollars per square foot of the home office. The max number of square feet is 300, up to a $1,500 deduction per year.
At this point, you might be in a debacle on whether to take home office deductions. Sadly, there is not a simple answer to that question. It has to be modeled out with your specific current situation and future goals. Please reach out for any further questions. Thank you for visiting.
