In our article, Home Office Deduction Actual Cost Method Part One: Direct and Indirect Costs, we introduce the Actual Cost Method, explain the square footage percentage, and discuss direct and indirect home office costs. This article wraps up the Actual Cost Method with the basics of home office depreciation.
Before we continue – a warning: Depreciation is highly complex. It’s both technical and nuanced, making it difficult to explain in non-technical terms. As we discuss in our article on vehicle depreciation, Congress’s tendency to change depreciation rules compounds this complexity. Fortunately, however, the home office depreciation is relatively straight-forward. The rules have also remained the same, with a few minor exceptions, for well over a decade. Although I still recommend that someone claiming actual home office expenses obtain the assistance of a tax professional, these facts increase my confidence that this article will not become obsolete in a few months.
Home Office Depreciation: If you own your home (are not renting it) and deduct actual home office costs, the portion of the house used as a home office must be depreciated – expensed a little each year for a proscribed number of years. A home office is considered a commercial building. Commercial buildings are depreciated over 39 years using what is called straight-line depreciation. Straight-Line depreciation expenses an equal portion of an asset’s value (in this case, the home office) each year or part of the year the home office qualifies. For a commercial building, the value of the asset is divided by thirty-nine to determine the amount of depreciation claimed for a full year.
As a general rule, the amount of depreciation deducted on a home office is a function of the depreciable value of the home and the percentage occupied by the home office. Depreciable value, also called basis, is the lower of the asset’s cost or fair market value when the property is placed in service. These terms can also be a little confusing. So, here’s a brief overview of each as they apply to a home office:
Land: When calculating depreciation, the value of the property on which the home sits is not included in the basis of the house because land is not depreciable.
Example Home Depreciation: The easiest way to explain home office depreciation is by using an example: Jim paid $250,000 for his home a few years ago. The house is now worth $265,000, so the basis of the home for depreciation is its cost, $250,000, which is lower than the homes fair market value.
Now that Jim knows that he will be using the home’s cost as its basis, he needs to subtract the value of the land from the property. Jim can’t remember what the appraised value of the land was when he purchased it (who can?) so, he needs a way to approximate its value. On his last property tax assessment, the assessed value of the land was 13% of the value of the property as a whole. So, a reasonable estimate of the land’s value is 13% of $250,000 or $32,500. The basis of Jim’s home is $217,500 ($250,000 minus $32,500).
Because Jim uses a percentage of his home as a home office, he must adjust the home’s basis by that percentage. If Jim’s home office is 124 square feet and the total area of his home is 2,200 square feet, the portion of the house that constitutes the home office is 5.6% (124 / 2,200). The result: 5.6% of the home’s $217,500 basis is $12,180. $12,180 is the depreciable basis of the home office.
The portion of the home representing the home office, $12,180, is depreciated over thirty-nine years using the straight-line method. The straight-line method deducts the same amount of depreciation each full year the home office qualifies. $12,180 divided by 39 years is $312.31 per year. Depreciation is reported in part III of Form 8829.
Notes on Home Office Depreciation: Here are a few items to keep in mind regarding home office depreciation.
Take Away: Depreciating the home office is required when you own your home and use the Actual Cost Method for deducting home office expenses. Depreciation is reasonably complex and must be tracked from year to year, even if business-use stops. It can also create a taxable gain when the home is sold. If you are planning to use the Actual Cost Method for your home office, we highly recommend that you obtain the assistance of a tax professional. The tax-savings will often outweigh the cost. Using a professional will also reduce the likelihood of errors and, therefore, potential problems with the IRS.
Summary and Invite: We hope this article helped you to understand the home office depreciation. If you’d like to learn more about cutting your most significant expense, TAXES, check out our Real Estate Agent Tax Cut Library. The Real Estate Agent Tax Cut Library includes over eight hours of video broken into twenty-nine searchable volumes and covers every possible deduction a Real Estate Agent can take on their tax return. Our Broker Version will help your entire agency cut their taxes! We also invite you to browse our courses.
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