The Home-Office Pitfall



  The Home-Office Pitfall

When the IRS relaxed the rules on home office deductions many years ago, CPAs across the country were inundated with phone calls from clients anxious to "cash in" on their new tax break.  

However, after careful consideration, many of them decided that the "downside" of taking the deduction outweighed the benefit.

How is that so?  Basically, its because when you take a home office deduction, you are in essence converting that portion of your home that you use as your office to "business property."

When you later sell your home, you may end up paying tax on part of your home-sale profit. 

Many taxpayers who have taken advantage of the home office deduction rules over the years are surprised to learn that the home-sale tax exemption ($500,000 for joint returns and $250,000 for unmarried individuals) can't be used to protect the portion of your gain that is equal to any depreciation deductions allowed for business or rental use of the property for periods after May 6, 1997.

Basically, the home-sale exemption requires that 100 percent of your home qualify as a principal residence for at least two of the five years preceding a sale.  If you decide to take the home office deduction and determine that 10% of your home is used for your business office, then 10% of your home-sale profits will be subject to capital gains tax.  The home-sale exemption can be used only for the portion of your home used for personal purposes for at least two of the five year

We often advise our clients against using the home office deduction if they have plans of selling their home within a few years for a very large profit.  The tax savings they receive from taking a home office deduction could pale in comparison to the capital gains tax they might have to pay when they sell their home.

However, that does not mean that you should never take advantage of the home office deduction if you have plans to sell.  With some very careful planning, you may still be able to take the home office deduction so long as you don't claim it for more than three of the last five years before you sell your home.  

Remember as we stated above, the home-sale tax exemption simply requires that you maintain 100 percent of your home as a principal residence for at least two of the five years preceding a sale.

We would encourage you to contact us before converting a portion of your home into an office with the intentions of taking the home office deduction.  As you can see, there is a huge trap that you need to avoid and some long-range family planning issues that need to be discussed beforehand.


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