Office in Home Depreciation

When meeting with new clients that have sole proprietorships or single-member LLCs,  I often find that their prior accountant or CPA had them take depreciation on the portion of their home used for an office in home.  I am not necessarily against taking the deduction, but I do think it is not right for everyone and often business owners do not realize the ramifications if they sell their home.

Depreciation claimed on a qualified office in home (See IRS Pub 535) can come back and haunt you years later when you sell your home.  Under current tax law, you can you sell your primary residence that you have lived in and owned for two out of the last five years and exclude up to $250k of gain ($500k if married filing joint).  Of course I am simplifying IRC Sec 121 here – there are many other rules and exceptions (see IRS Pub 523) – but that is the basic idea and it is a great exlusion for most people as long as they have not lived in their homes for too long.  However, if you took any post May 6, 1997 depreciation on an office in home that was within the main dwelling unit or structure, then you are looking at some Section 1250 depreciation recapture upon sale – which is ordinary income.  In other words, all that depreciation you took over the years now has to be claimed as income, which is a very unwelcome surprise for most taxpayers to say the least…especially if they have the full 10 years of depreciation.  However, It is only money…right?

Now there are many exceptions and other rules involved with this issue.  First, any depreciation that was limited or not allowed does not have to be recaptured.  Also, there are a whole set of rules for office structures that are separate from the main dwelling unit, so if you have a greenhouse or separate office building on your property – be prepared for a lot of questions from your CPA.  Other than that, talk to your CPA or accountant in advance about this and do not wait until you are already in the process of selling your home as there is some planning that can be done to minimize the tax consequences.

For those of you just starting a business – you might want to consider not taking the depreciation component of the office in home deduction – especially if you are planning on moving in the next few years.  If you are in a home that you plan on staying in for the next 10+ years, then it might not be a bad idea, but regardless of you situation – hopefully you are now more aware of a potential problem and can start planning more effectively.


About Brian Germer, CPA

CPA with Parsons and Germer CPAs, LLP in Portland, OR

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