The Home Office Deduction – The Sword Cuts Two Ways

home office deduction

A taxpayer is generally allowed to deduct the expenses attributable to running a home office provided the space is used exclusively for that purpose. The rules permit a deduction for all the expenses attributable to running the household, including depreciation, based on the percentage of the home (calculated by square footage or # of rooms) used exclusively for business purposes.

In many cases, the actual deduction can be quite small, and the desire to take current deductions must be weighed against the long-term potential consequences of doing so.

It is generally known that the tax code allows an exclusion from gain on the sale of one’s principle residence. If, during the five year period ending on the date of sale, the taxpayers owned and used the property as their principal residence for periods aggregating two years or more, they are entitled to exclude from taxable income  $500,000 of the gain on the sale. This amount is $250,000 for non-married individuals.

But what if the taxpayers were claiming a home office deduction? That is where the sword cuts in the other direction. If a taxpayer were claiming that 20% of his or her home was being used for a qualified home office, 20% of the selling price and basis are not considered the sale of a principal residence and the gain on that portion would be subject to tax.

As an example, if a principal residence sold for $1,000,000 and the taxpayers’ basis was $500,000, the resulting $500,000 gain would be excluded from tax. If however, the taxpayer’s were claiming that 20% of the home was being used for a home office, they would have to report the sale of business property  with a sale price of $200,000, a basis of $100,000 and would thus have a taxable long term gain of $100,000.

It must be remembered that each case is unique, but both taxpayers and tax preparers should look at the potential consequences of taking a home office deduction and weigh the benefits of current deductions against the possibility of having income to report if the home were ever sold.