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Small Biz Adviser: Depreciation
rules and taxes for home-based businesses
Dear Small Biz Adviser
Can I depreciate my home if I don't have my own small business?
If I can, then, if I depreciate part of my home as "business use
of the home," where do I depreciate the rest of my home?
Dear Kent:
Your first question can be answered immediately. You cannot depreciate
your home on IRS returns if there is no business use of the structure.
It is only when you operate a business out of the home or rent part
of the home that depreciation can be taken. If you operate a home
office as an employee this depreciation expense cannot be deducted.
Typically, when qualified, depreciation on the
home is for a period of 39 years. And you depreciate only that portion
of the home devoted to the small business or rental activity.
You deduct depreciation only on that percent
of the home that is devoted to the business or rental activity.
Furthermore, you can depreciate beginning only at the point in the
39-year time span of ownership that the office or rental space has
been designated.
And example of this situation is the following:
- Original value when you assumed ownership
of the home is $390,000.
- Depreciation is limited to only 39 years.
- In this example the annual depreciation is
equal to $10,000 annually.
- Your home office or rental area equals 10
percent of the total square footage of the building.
- Therefore, you can depreciate only 10 percent
of the annual depreciation, which equals $1,000. The other $9,000
cannot be depreciated.
- The depreciation expense is deducted only
from the business or rental income.
- If you started the office or began renting
the space in the 16th year since owning the home, your depreciation
expense can be deducted only for 24 years.
I operate a home-based business,
but did some very serious homework on the issue before filing my
first IRS returns. If you eventually sell your home the IRS will
expect you to add up the years of depreciation deductions. You see,
the IRS is going to charge you a tax rate of 25 percent on that
total depreciation deducted. Uncle Sam sees the sale of your house
as an opportunity to recapture the taxes you avoided in the past.
Regarding this IRS rule, do recall you are exempt
of tax on gains up to $250,000 profit from the sale of your primary
residence, and if you lived in the residence for two of the last
five years before selling it. That exemption increases to $500,000
for a married couple. But any depreciation for business use of a
home claimed after May 6, 1997 cannot be exempted. You'll need to
report the gain on the portion of the house that was used for business
purposes and pay taxes on that gain. IRS
Publication 523 explains in more detail, and gives an example
of the tricky math involved to arrive at the gain.
I am not familiar with your personal financial
status or the success you apparently have encountered operating
the home business, but you'll need to figure out whether the tax
at the back end is worth the savings now.
I would like to suggest you read my
column of Jan. 4, 2001, on home office deductions. Some are
commonly known, while deductions for certain home maintenance, finance
and utility expenses can be partially directed to the business.
Review IRS
Publication 587 for more details on those deductible expenses.
I wish you well.
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