20 January 2006

The Ins and Outs of the Home Office Deduction

I blogged earlier this week about CNNMoney's suggestion to aggressively take home office deductions whenever possible. I suggested that might not be the best idea because the percentage of the home that is used to take the deduction is disallowed when calculating the capital gains exclusion for home sales.

I was only partially right. You must pay capital gains on any depreciation that you have taken. The rules were changed in 2002 to allow the entire home to be excluded, but still require depreciation recapture (the fancy term for paying tax on deductions already taken). But it gets worse. If you follow CNNMoney's suggestion to take other deductions, such as utilities, even if you don't qualify for the depreciation deduction, you will get quite the surprise when you sell the home.

What if you take other home office deductions and skip the depreciation? Nancy Mathis, an I.R.S. spokeswoman, says that will not help. "Even if you don't take this depreciation, it will be treated as if you did when it comes times for calculating the basis of the home sale and capital gains exclusion."

So, even if you don't take the depreciation deduction you will still pay capital gains as if you did if you claim other home office deductions.

That's why it always pays to talk to a professional if you plan on taking any overly aggressive positions on your tax returns. In this case, you are chancing an audit and chancing having to pay taxes on expenses you didn't even deduct. Doesn't sound like such a hot idea to me.

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