Selling a home with a home-based business
Businesses are constantly worried about taking a tax deduction for a home office and associated expenses for a home-based business. On top of that, they worry about what taxes they might owe when they sell their home and home-based business.
First of all, the home office is a great tax deduction that should not be avoided, if you qualify. To make sure that you qualify, refer back to the article about preparing for a tax audit of your home business.
Then the question is, What tax consequences do I incur when I sell my home since I took the home office tax deduction?
Capital gain on sale of home plus home business
People still ask me all the time whether they will owe tax on any gain on the sale of the home, based on the business percentage they used for a home office. This is no longer true based on a change of law that dates back to December, 2002. Therefore, if your house has a 10% business home office use, you no longer owe tax on 10% of the gain. But you will owe tax based upon the amount of depreciation allowable for the home business (explained below). The only time that you will owe tax on the business percentage of any gain incurred on the sale of your home is if your home office is a separate structure, like a separate barn in your back yard. Read more about how to calculate your home business space deduction.
Ownership and use requirements for excluding capital gain
When you sell your home with a home office, you first must go through the regular tax rules for the sale of your home and make sure that you meet the ownership and use requirements. You can exclude from taxes the gain on the sale of a principal residence ($500,000 for joint filers and $250,000 for single filers) if you meet certain qualifications. The exclusion of a gain on a home sale is only available if you owned and used your home as your principal residence for at least two years out of five years before the sale. Read more about how to qualify for a capital gains exclusions for home sales
Depreciation recapture on a home office
Then, if you had a home office, you have to pay tax on any depreciation you were eligible to take for the periods after May 6, 1997. This depreciation recapture is taxed at a maximum tax rate of 25% tax rate. Even if you took various home office expenses and missed taking the depreciation deduction, you must pay tax on the depreciation that would have been allowable if you took the home office deduction. Read more about depreciation recapture
If your home business is in a separate structure
As mentioned above, if your home business is in a separate structure from your home, none of the capital gains from that portion of the home can be excluded when the home is sold. For example, if the home office is in a detached garage, that portion of the sale price is not part of the principal residence, and the capital gains on the sale of that portion of the home price must be paid.
In conclusion, you can see that if you can meet the requirements for a capital gains exclusion on the sale of your home plus home office, it makes the home office deduction a very significant tax savings device that businesses should investigate if they are eligible.
Gail Rosen, CPA is the owner of a well-respected boutique accounting firm in Martinsville, NJ that has been serving individual and business clients for over 27 years. In addition to tax preparation, the firm specializes in assisting business start-ups in understanding their tax responsibilities and what deductions they are entitled to. Gail has earned a reputation for putting complex tax issues into language others can comprehend and profit from. You can email her at grosen@gailrosencpa.com.
More Information on Tax Consequences of Selling Your Home
For more information on the sale of your home, see William Perez's article on his Tax Planning GuideSite: Sale of Your Home.
And attorney Julian Block on Home buying/Selling has more on tax consequence for your home office after a home sale
