Home Based Business Brings Recapture Concerns

Working at home has become almost as common as living at home.  Some employers will tell you the two are synonymous while many spouses – especially seniors and aging Baby Boomers not used to having their partner in the home all day—wonder if home-based work really is a good idea.

If you have turned the den or study into a home office – via a complex remodel or by simple paint and wall covering – you are not alone.  Since 1990, the number of home workers has grown at a rate of 15 percent a year mainly because of the convenience, tax and selling advantages.

It’s now relatively easy for taxpayers to deduct the cost of a home office.  To qualify for a deduction, the space must be used exclusively and on a regular basis for either the entire business or its administrative and management activities.

A home office deduction is comprised mainly of depreciation, utilities and insurance. For example, if a home has 2,500 square feet and the old den now deemed “the office” is 250 square feet, then 10 percent of the utilities and insurance are deductible.

The actual office depreciation is 10 percent of what would be a depreciation deduction if the entire home were being depreciated for tax purposes. (Depreciation is not allowed on a typical principal residence, so the square footage allotted to “residence” would not qualify.) Supplies and other expenses directly related to the home office are fully deductible.

The area used for your home business can be depreciated using the 39-year depreciation method. The lower of your home’s adjusted cost basis, or its market value on the day business use began, can be the starting points.

However, all these benefits do come at a price. The tax law states that if you sell your home at a gain any depreciation for a home office will have to be “recaptured.” That means that any profit on the business portion is taxable as capital gain.

In a nutshell, if you bought your home for $100,000 and sold it for a net figure of $300,000, your capital gain would amount to $200,000. Because the business portion does not escape the new primary residence exclusions, 10 percent, or $20,000 (the 250 square feet of office space) would be taxable.

One way of possibly avoiding the home office tax would be to eliminate your home business two years before selling the home. If you can find another place to work, you could revert the usage back a 100 percent primary residence.

Because depreciation can be confusing, it’s always best to consult an accountant or a tax attorney. The Internal Revenue Service’s Publication 587 “Business Use of Your Home” is accessible on the Internet.