The home sale exclusion is one of the biggest tax breaks around. If you qualify, you can exclude tax on up to $250,000 of profit from a sale if you’re a single filer or $500,000 if you file jointly. Often, you’ll pay zero capital gains tax.
However, there’s a little-known tax trap if you’ve claimed home office deductions in the past.
If you use part of your home regularly and exclusively as your principal place of business or otherwise qualify, you are eligible for home office deductions. In that case, you could offset some business income through direct expenses (e.g., painting the office) and indirect expenses (e.g., utilities, repairs, insurance, property taxes and mortgage interest, etc.) based on the business use of the home.
But when you sell the home, you must recapture some of the prior tax benefits, resulting in an unexpected tax bill when you file your return.
The tax law says you must recapture the depreciation claimed for home office deductions claimed after May 6, 1997. The recaptured depreciation is taxed at a special 25 percent tax rate instead of the usual 15 percent rate (20 percent for certain high-income taxpayers) on long-term capital gains.
This recapture rule applies to “allowed or allowable” depreciation. In other words, you may have to pay a recapture tax, even if you didn’t claim home office deductions in one or several years.
Despite this drawback, the benefits of home office deductions generally outweigh the potential for the recapture tax. Just make sure you understand the tax ramifications.
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