Many people know that you can exclude up to $250,000 in capital gains (or $500,000 if married) when you sell your primary residence, as long as you lived there for 2 of the past 5 years. However, there is an important exception you need to be aware of.
If you claimed a home office deduction on your taxes by depreciating a portion of your home, you’ll need to recapture the depreciation and pay taxes on it when you sell – even if you fall under the capital gains exclusion limits. This tax is 25% of the total depreciation amount claimed over the years.
For example, if you claimed a $2,000 home office depreciation deduction for 10 years (totaling $20,000), you would owe $5,000 (25% of $20,000) in depreciation recapture taxes when you sell. This catches many people off guard because they assumed the capital gains exclusion meant no taxes owed.
It gets worse – you owe the depreciation recapture taxes even if you were eligible to claim the deduction but chose not to. The IRS assumes you could have claimed it, so you still have to pay. Because of this, it’s best to go ahead and claim the deduction to benefit now, and plan for the taxes later.
To avoid depreciation recapture completely, you can use the simpler “square footage method” to calculate your home office deduction instead of actual expenses. This method allows you to deduct $5 per square foot of home office space used (a set IRS rate). However, this likely results in a lower current deduction amount.
In summary, if you plan to sell a home office in the future, claim the actual expense deduction, but be sure to plan for paying back depreciation at your tax rate when you sell. And as always, consult a qualified CPA if you need help navigating real estate taxes!
