The Home Office Deduction: What happens when you sell your home?
The home office deduction is one of those deductions people often tout as an advantage of having your own business. But one of the disadvantages of taking the home office deduction people don't really talk about is its effects when you finally sell your house.
Say you work from your home and over the course of several years you took the home office deduction including $5,000 in depreciation expense on the portion of the house used in business. When you sell that home, the depreciation you took in prior years is not excludable. In fact, you have taxable gain of $5,000. And not a long-term capital gain. It's a called Unrecaptured Section 1250 Gain. You report this on Schedule D, Line 19. This amount then gets transferred to the utterly confusing Schedule D Tax Worksheet.
If you can wade through the worksheet, you'll find that this gain is taxed at a flat 25%. This means that the depreciation deduction you take for your home office today is really just a deferral of taxes to future years.
Add to this the fact that the home office deduction is a red flag for IRS audits and your mortgage interest and property taxes are already deductible. That's why if there's any question as to your elibigility for taking the deduction, don't. When you get down to really crunching the numbers, the actual monetary benefit is rarely outweighs the hassle.