Often taxpayers using a portion of their house, garage, or basement as a home-office are advised to claim a business expense tax deduction for the space used as office. However, it is always advisable to take into consideration a future sale scenario of the house as depreciation and re-capture rules may apply. Also, a common misconception is that the home-office deduction claim could result in a tax audit, despite the Internal Revenue Service (IRS) assuring taxpayers that it is not the case.
No matter what the taxpayer’s or tax advisor’s opinion may be about the home-office tax deduction, here are few points from AG Tax analysts that taxpayers should take into consideration before claiming the home-office tax deduction.
The home-office tax deduction may increase the work required to complete the tax filing, which will most likely add to the tax preparation fees. Additionally, if the taxpayer claims actual expenses instead of the simple home office deduction limit of $1,500, he/she would need to maintain record of the expenses claimed and copies of the receipts and other paperwork for at least seven years to validate the claims in case the IRS sends an audit notification. This leads to more time being consumed in keeping track of expenses and deductions, and/or resulting in an additional expense in case a professional needs to be hired to maintain the records.
Tax Rates May Differ For the Sale of a Home Partially Used As an Office
The IRS once required taxpayers to allocate the sale proceeds of a house used as a home-office separately to the home and office part of the residence. While the IRS has since updatedregulation , l an in-home workplace could still add to post-sale tax costs, as houses used only for residential purposes are taxed with more favorable rates than houses used for residential and business purposes.
While claiming the home-office deduction, taxpayers are allowed to deduct depreciation for the portion of the house used as an office. When a house is used as an office, it is considered a business property subject to depreciation. However, taxpayers should be aware that this depreciation is reduced from the cost of the property which may result in a higher amount of profit when the property is sold. This could cause the gain on the sale to be higher than the IRS allowed home-owner exclusion limit for qualifying home-owners of $250,000 ($500,000 if you are filing a joint return).
Section 1250 Depreciation Recapture Rule
As mentioned above, when one claims depreciation on a home office space, the amount claimed as depreciation is reduced from the cost basis of the property when calculating the profit from the sale, thus increasing the profit amount, which may result in profits above the allowed exclusion limit. Furthermore, the recaptured depreciation amount (claimed in previous tax years) is taxed at a rate higher than the typical capital gains tax rate of 10% and 15%, regardless of whether the profit is within or beyond the exclusion limit, or above the taxpayer’s ordinary income tax limit.
Therefore, one may or may not want to claim this depreciation deduction. Unfortunately, regardless of the fact that one does or does not claim the allowed depreciation deduction, recapture of depreciation is automatically applied during the sale of the residence used as home-office.
This may seem like a disadvantage, but in reality many tax professionals believe the tax savings that a home office deduction produces over the years might indeed outweigh any future tax that the IRS will recapture when the property is sold. Therefore, it is highly recommended to consult a tax professional before the sale of a residence office, and when claiming depreciation expense.
That being said, this is a basic overview of depreciation deduction and home-office expense, situations could vary based on individual tax scenarios.
AG Tax LLP Can Help
If you have any tax-related queries or need assistance with tax planning or filing please contact AG Tax. Our tax professionals are highly-experienced with US and Canadian tax laws and can provide you the right guidance to handle your tax situation.
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