The best trick that solopreneurs, freelancers and home-based business owners’ resort to is to deduct home office expense. Home office tax deduction can be simple and yet complex.
For instance, if you work from home, and have an office that roughly encompasses 20% of your entire house, you can legally take off 20% of the total cost of maintaining that house, writing it off as business expenditure. This also includes the interest rate on your mortgage, household repairs, maintenance, utilities, insurance, etc.
However, what are the tax implications of selling a house that you also use as a home office when it comes to home office tax deduction? Should you consider the office portion of your house a business income after you sell it? Alternatively, if you are married, and filing for taxes jointly, does that mean the profit on the sale of the house comes under the $250,000 or $500,000 sale tax exclusion?
This can seem a bit confusing, which is why it is imperative that you narrow the conundrum down to just two questions in order to handle the situation effectively. And they are:
Is Your Home Office Located Within The House or Outside of It?
If your home office lies within the four walls of your abode, then there is good news for you! Fortunately, when you sell your house you will not have to share or divide the profit between your business expenses or personal taxes. The profit will legally qualify as sales tax exclusion.
For further simplifications, here is a good example. Imagine Adam runs a photography studio from his bedroom or basement. And Adam has determined that his office envelopes 20% of the house. So, when he sells, and let’s assume that he makes a gain of $100,000 – not all of this sum will be subject to home office tax deduction. But that will only hold true if Adam was living at that house for at least two years out of the past five years before selling his house.
On the flip side, if your home office is in your backyard, and you decide to sell your house, your office will be counted as a ‘second property’. You will be liable to pay tax on the sale of your office. Moreover, it is mandatory to file the income from the sale of the office in the 4797 Tax Form.
Did You Account for Depreciation and Deducted Individual Expenses Or Opt for Simple Deduction?
You are liable to pay taxes based on your approach to filing your deductions. If you have made individual calculations on the expenses surrounding your property, you may have likely also added the annual deduction that is allowed for the total depreciation. If this is so, you are still going to have to pay an average of 25% of tax on the deductions you have made on your house’s depreciation over the years.
To clarify, if Adam took out $5,000 from his studio business, which he calculated as his business expenses, he would have to pay $1,250 in taxes after selling his home.
However, if you went with the simplified deduction method, which will enable you to calculate your depreciation based on the total square footage of your home office, there will be no depreciation. And that means you will not have to pay any taxes after the sale.
Tax savings on selling a house that contains an office depends on the location of the house. You can file for tax deductions if the offices is located inside the four walls of your house. You will not be able to claim tax deductions if the office is located in your backyard.
As a professional tip, you could benefit from calculating your tax deductions (if your office is located inside the house) by just using simplified deduction. You will not be liable to pay any additional taxes this way.
If you’d like to learn more about tax laws and your business, we at Akif CPA are here to help. Learn about our services here.
Do you have unique issues or concerns not discussed in this blog then please contact us by email or phone. We are here to help.
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