Michigan State University Extension
Home-Based Business - 09159412
10/01/98
If you sell a residence and buy another, you can roll over the gain you made on the house you are selling into the house you are buying, even if you have a gain. You won't have to pay a capital-gains tax until you sell your last house or start down-sizing and buy a house that is worth less than the house you are buying. If you wait until you are over 55 to do the downsizing, you may be able to exclude the first $125,000 of gain.
If you have depreciated a portion of your house, condo, or co-op as an office, that part is considered business and not residential. You can't roll over the capital gain; you have to pay tax on the prorated portion of it that represents the home-office deduction you have taken. There is a way to get around this. Move your office out of your home in the year that you sell your home and don't take any deduction for your home office in that year. It is suggested you rent an office elsewhere to provide documentation that you do not have an active home office while you are selling your house.
To keep your home office deductions clean and profitable, you need to remember the primary IRS criteria: regular use and principal place of business. To help follow these eight timely tips:
- Use form 8829, "Expenses for Business Use of Your Home." This form walks you through every calculation related to the business use of your home and keeps you from making mistakes. For sole proprietors, it's the only way to get the home-office deduction.
- Measure your office. Your deduction will be prorated by the percentage of your home's square footage used as an office. Although the IRS suggests you can use square feet, number of rooms, or "any other reasonable method" of comparing your office to the total space available in your home, IRS agents tend to prefer square footage.
- Take all the related deductions. Your home office entitles you to depreciation or deducting a portion of your rent, and proration of utilities (except phone service). If you own your home, prorate and deduct the business portion of your mortgage and property taxes; they are worth more on the Schedule C, where Form 8829 totals are reported, and where they can offset the 15.3 percent self-employment tax.
- Consider remodeling. New construction to create a home office may be 100 percent deductible in the year you do the construction under Section 179 of the tax code. This section enables you to take up to $10,000 of your depreciable expenses in the year you incur them.
- Stake out your space. You are allowed to take a deduction if your home office is only a portion of a room, but do all you can to keep it separate. Use the fabric screen approach, pile file boxes around you or stick a line of tape on the floor to keep other family members away from your office space.
- Be too legit to hit. The more exclusive your office is the better. Take pictures of your home office, or keep a schematic floor plan (with home-office dimensions) on file in case of an audit.
- Think twice about incorporating. The home-office deduction is available only to sole proprietors and not one-person corporations.
- Avoid computer games in the office. Chances are the IRS auditor will never get a peek at your hard-disk drive, but the game will ruin your profitability nevertheless.
As far as your computer is concerned, you do not need to use it exclusively for business purposes to take a tax deduction for the expense of the computer. But if you share the computer, keep a log of how much time is used for each purpose and deduct a proportional amount for your business use. There is a software package, Timeslips from Timeslips Corp. (800)285-0999, that will help you calculate the total hours spent on any project. But remember that if the family uses the computer in your home office for personal matters, the office space will be disqualified.
Source: "The Home-Office Deduction: Don't Worry, Be Happy", Home Office Computing, February 1993.
Edwards, Paul and Sarah. "Writing Off Your Home Office," Home Office Computing, October 1994.