Many self-employed professionals and small business owners in the United States work exclusively from the comfort of their homes, earning their income without having to commute to and from an outside office. If you are one of these people, then you can recapture or claim home office depreciation for the portion of your home that you use exclusively for business. Depreciation is an allowance for the wear and tear on the part of your home used for business.
The Internal Revenue Service (IRS) allows a deduction for business use of your home for expenses such as mortgage interest, utilities, and depreciation. However, this applies only if you use part of your residence exclusively for business.
Ordinarily, when you sell your home, you may be able to exclude up to $250,000 of the gain on the sale from your taxable income. But if your home contains a home office for which you have recaptured depreciation, you cannot exclude the portion of the gain equal to the amount of depreciation deducted or deductible.
You will be required to pay tax only on the depreciated total after selling your home. This holds whether or not you took the depreciation on your taxes in the mean time. The recaptured depreciation is usually taxed at a special capital gains rate as high as 25 percent.
For example, you sell your home in 2014 for $60,000 more than you purchased it back in 2006. This $60,000 gain is shielded from income if you meet the ownership and use conditions. However, if you had a home office in 2013 and claimed $800 of depreciation on your Form 8829 that year, this amount ($800) must be recognized as a gain on the Schedule D you file with your 2014 income tax return. This means that the gain shielded from income has dropped from $60,000 to $59,200.
Benefits of recapturing home depreciation deduction
While you are not required to depreciate for having a home office, there are good reasons for claiming depreciation if you are claiming a home office tax deduction.
The main reason why most people who qualify to claim home office depreciation do so is to reduce their taxable income. However, not all those working from home are required to take home office deduction, and not all those who take the deduction would recapture depreciation. For example, a renter who works from home may take the home office deduction and deduct a qualified portion of their rental expense—but there is no depreciation because they don’t own the home.
What if you don’t recapture depreciation?
If you own your home and claim home office tax deduction but decide not to recapture depreciation, then you won’t realize the full value of the tax deduction. Depreciation alters the tax deduction calculation and lowers your income taxes significantly when you take it.
However, if you want to create recapture income from depreciation along with other possible tax consequences at the time you sell your home, do not take the home office tax deduction at all. Similarly, if you want to keep your tax filing as uncomplicated as possible, you can decide to forego the deduction, especially if you think it’s not worth the time and trouble.
How do you determine home office depreciation?
To figure out your depreciation deduction, you need to know the following:
- The month and year you started using your home—or part of your home—for business.
- The adjusted basis and fair market value of your home (excluding the land) as of the time you started using it for business.
- The cost of any improvements or renovations made before and after you started using the property for business.
- The percentage of your home used for the business.
To determine the percentage of your home that you use for business, you can use either of two methods. The first method is to divide the number of rooms used for business by the total number of rooms in your house. So, if you use one room for business out of the five rooms in your house, your business home percentage use will be 1/5 or 20 percent. But this method is only preferred if all the rooms in your house are of about the same size.
The second method, which is more objective, involves dividing the area—in square meters—used for your home business by the total area of your home.
On a final note… The IRS included depreciation recapture in the tax law so you are liable whether you used it or not. So, you must recapture depreciation you actually claimed or could have claimed for renting out the house.