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Bankrate's 2010 Tax Guide
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Home office can have hidden tax costs

So, as with most tax situations, you need to run the numbers a couple of ways. The tax savings that a home office deduction produces over the years might indeed outweigh any future tax that the IRS will recapture when you sell. But before you claim it on your next return, make sure you have an idea of the deduction's potential tax costs down the road. Below is a simple example of what you might have to ultimately pay for your home office.

Consequences of claiming the home office deduction
You bought your home in 2000 and set up your home office in a spare bedroom as soon as you got settled. Over the years, you wrote off various home office expenses, as well as claimed depreciation of $10,000 on the space.

Last year, you sold your home and made a profit of $200,000. Because it was your primary residence for the IRS-required time (at least two of the five years before it sold), you're eligible for the home-sale exclusion of up to $250,000.

Since the IRS changed the rules in 2002, the business use of your spare room is not a tax problem. As long as the office is within the house, rather than in a separate structure such as a guest house on the property, you no longer have to allocate the sale profits between residence and business as was the case before. All the home-sale gains are considered excludable from taxes.

The depreciation component, however, will cost you. You'll owe taxes at the 25 percent rate on that $10,000 you wrote off. So instead of no taxes due upon the sale of your home, you will owe Uncle Sam $2,500.

Also remember that if you decide not to claim a home office deduction, you can still claim other deductions for your small business.

"You'd still be entitled to deduct a separate business phone line and other equipment, desk and furniture, supplies, etc.," says Tollaksen. "You don't negate those other business expenses. What you're saying to the IRS is: I really don't have a home office.

To convince the IRS that, according to the tax rules, your workspace is not a true home office, you also could, for example, use the room to maintain your personal financial records or have a TV in there where the kids are allowed to watch DVDs.

"I don't discourage taxpayers from taking it (the home office deduction), but I definitely explain the rules if they're going to take it," Tollaksen says. "Then we look at if it is really going to be beneficial. You don't want to be surprised when you sell."

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