The Home Office Trap

The Home Office Trap

The Home Office Trap The previous section pointed out that any depreciation taken on investment property would not be shielded by the primary residence exemption.
The examples used so far have all been about rental or investment property converted to a primary residence.

Depreciation, however, is taken not just on rental property but also on other types of property used for business. One item commonly depreciated is the home office.

If you qualify, you have the right to allocate a portion of your home as a home office and to take expenses associated with that home office, including depreciation. The question is whether it is worth it.

Example:
Victor and Carol live in a small, but expensive, two-bedroom home. Victor is a real estate broker and does most of his business from home. Victor claims one bedroom of his home as a home office for tax purposes, using it exclusively for business. He has allocated 30 percent of his home as a home office and has taken a depreciation expense of approximately $5,500 on it for the last six years.

Unfortunately, many people don’t understand that the amount of depreciation taken on their home office will have to be recaptured and taxed when the home is sold. In the example above, if Victor and Carol sell their home this year, they will have to pay $8,250 in federal taxes and an additional amount to the state.

It is possible to do a 1031 exchange on that portion of the house used as an office into a corresponding percentage on the new house, but it becomes very complicated and tends to cause problems with mortgage providers.

Whether the immediate year-to-year tax advantages of a home office deduction are worthwhile depends on your own particular tax situation, but keep in mind the primary residence $250,000–$500,000 exclusion will not protect you from taxes due on the recapture of any depreciation taken after May 6, 1997.