Selling property with home office deduction
|  Dear
Tax Talk,
My husband and I sold our town house this year. While we owned and
used the house for over two years, I also used the home office deduction
for a room in the town house. We received a 1099-S for the sale
of the house.
While
the capital gain is less than the $500,000 for a married-filing-joint exclusion,
how do I handle this on the Schedule D? Is it true that I have to add back in
all depreciation into regular income, and if so, on what line of which form will
it go? Thanks for your help.
-- Jacqueline
Dear Jacqueline,
The downside to claiming home
office deductions is that it makes part of the gain on the sale of your home taxable.
In exchange for a few dollars in depreciation deductions, you're creating a tax
problem when you sell the home.
Suppose you used 10 percent of
your $390,000 home for business for five years. Ignoring land issues, you would
have claimed depreciation over 39 years, since it is commercial property. That
$390,000 divided by 39 years at 10 percent for five years equals $5,000 in depreciation
deductions. Suppose you sold the home for $690,000 so your gain is $300,000. You
would record $30,000 in Section 1231 gain on the sale of the home plus $5,000
in unrecaptured Section 1250 depreciation deductions. The $5,000
is taxed at a maximum rate of 25 percent ($1,250 in tax) and the $30,000 is taxed
at a maximum rate of 15 percent ($4,500 in tax). So on what would have been a
tax-free sale you could end up paying as much as $5,750 in tax. The $5,000 in
depreciation deductions may have saved you around $2,500 in tax if you were in
the highest tax bracket and you figure in self-employment taxes. While $3,250
in tax cost is small compared to the hypothetical gain, it's still better in your
hands than Uncle Sam's.
You should report the business part of the sale on Form
4797 part 3. Use the percentage you used on Form
8829 to figure the home office deduction, as the percentage
of the sales price and cost that should be entered on Form 4797.
The $5,000 in depreciation recapture flows through as capital gains
but it is disclosed on line
19 of Schedule D.
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