by Richard Schneider
Emeritus Professor of Accounting
Well we have sold our home and home ownership tax deductions to a wonderful young family. We are now renting a home for a year. The home is very nice, but our rental payments provide no tax deductions. At the closing I was reminded that not all of the gain may be excluded, since Iíve had a home office deduction for several years.
Normally you can exclude the gain on the sale of a main residence from tax, according to code section 121; the exclusion is $250,000 per taxpayer, which translates to $500,000 for a married couple filing jointly. At the time of closing the bank involved is required to comply with the proper IRS reporting of a sale, one question was; Did you have an in-home business since 1997?. What had slipped my mind was that I had a small tax practice for which I had claimed a home office, up until the year 2000. Since we converted the space back to family living, non-business use, for at least two of the last five years prior to sale, the gain on that part of the home is available for the section 121 exclusion, except for depreciation claimed since May 6th, 1997.
I was now on the hunt for those old tax returns, and/or depreciation records. Being an accountant, I have our tax returns back to the early 1970ís. The total depreciation taken from May 6th, 1997 to the close of the practice in 2000 was about $2,000. This amount needs to be recaptured, brought back into taxable income, if the home is sold at a gain. IRS publication 523, pages 23 - 25, provides a great example of how to report the recapture. The recaptured depreciation is treated as a capital gain, and if youíve owned your home over 12 months, it is long term capital gain. This turns out be a bonus for the Schneiders, since a quirk in the tax law, provides for 0% tax on long term capital gains in the years 2008, 2009, and 2010, for taxpayers in the 15% or lower tax brackets.
A home office or home business can provide for some additional tax deductions, but generally the space must meet the exclusive use rule, 24 hours a day. As I noted before if you contemplate selling your home in the future, say with in the next 3 Ė 5 years, and at a gain, you may want to convert the space back to personal use for 2 years. The rule is it must be personal use for at least 2 of the last 5 years prior to date of sale. This will avoid being taxed on the gain, although you will still have to recapture the post May 6, 1997 depreciation claimed. For more information on home office deductions see IRS publication 587, at IRS.GOV, or consult your tax advisor. I would advise using your tax professional to be sure you follow the rules, keep the proper records, and discontinue the home office deduction in a timely manner.