Q: I had a home office for 6 months of 2003. I want to know if I convert the office back to residential purposes, how it will affect the capital gains when and if I sell the home.
I have read that claiming a home office deduction can reduce the amount that is excluded from the taxes owed on any profit. The rule also seems to state the portion of the home used for a home business isn’t eligible for the exclusion until two years after its converted back to residential use.
I do not want to take the deduction or depreciation if I will have to pay taxes on the office portion of my home when I sell because I anticipate a large appreciation of my home and the home office deductions are relatively small. What do you think I should do?
A: If you have no home office in your home and did not use any portion of your home for business purposes, when you sell your home current tax laws allow you to exclude up to $250,000 in profits, if you are single, or up to $500,000, if you are married, from the sale and not pay any taxes on that amount.
One of the restrictions is that you have to have lived in the property as your primary residence for two of the last five years. If you qualify for the exclusion, the benefits are great.
If you own a home and half of the home is rented or used for a business purpose, that portion of the home does not qualify for the tax exclusion. So, if you sell a home for $250,000 and fifty percent of the sales price is considered personal profit for purposes of the exclusion, the other fifty percent would be taxed.
While this example simplifies the concepts, if there is a large profit from the sale of a home, the business at the home could result in a payment of income taxes due to the business use.
Fortunately, if your business use is small or you decide not to take the home office deduction, you could take the full amount of the exclusion, up to the $250,000 or $500,000 level, whichever applies in your situation.
But, it’s worth spending some time with your accountant or tax advisor to go over the details.
On the other hand, let’s say you had been taking the business deduction for years. Now what?
Quite simply, if you benefited from deductions or depreciation in connection with the business use of your home, you may have to pay taxes on the amount of your prior savings. Your accountant can assist you in determining this amount.
Here’s something else to think about. If you did take the home office deduction, you may not need to wait two years to sell the home to benefit from the tax exclusion. Remember, you need to have lived in the home at least two of the last five years. If you had a rental home for the past ten years and decided to move into it, you would be able to take the exclusion as long as you live there for two full years prior to selling it. You will have to pay taxes on the depreciation previously taken, but would most likely benefit from the tax exclusion.
The IRS has more information on its website at www.irs.gov. Finally, don’t forget to check your state’s income tax laws and how they will affect you on the sale of your home.
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