Monday, July 21, 2008

Don't Claim the Home Office Deduction

Looking for a quick tax deduction this year?

If so, most tax preparers and unscrupulous accountants may steer you towards the Home Office Deduction. DIY tax preparation software such as TurboTax or TaxCut will also lead you down this road.

However, if you are fortunate enough to have hired a knowledgeable CPA who is ethical and looking to establish a long-term accountant/client relationship with you, you will not be claiming that Home Office Deduction anytime soon.

Claiming this deduction will save you a few hundred dollars on your current tax return. Sounds great, right? Even if claiming this deduction will expose yourself to significantly higher audit risk, you are willing to do it in exchange for those couple hundred dollars.

However, what you haven’t been told up until now is the long-term impact of claiming the home office deduction…how it can cost you up to $15,000 in additional taxes when you eventually sell your house!

Considering that the average homeowner who claims the home office deduction saves approximately $450 in taxes each year, they would have to live in their house for over 33 years to ensure that they have saved enough taxes each year to cover the potential $15,000 tax bill.

How does claiming the home office deduction lead to a high tax bill in the year you sell your house? Well, the IRS allows a $500,000 capital gain exclusion to married couples who file a joint tax return. What this means is that, given certain requirements are met, you can sell your house for a profit of up to $500,000 without having to pay a penny in capital gains taxes. However, if you allocate 20% of your house to your “home office” for purposes of claiming the home office deduction, you run the risk of losing 20% of your capital gain exclusion. Losing 20% of this $500,000 exclusion means that $100,000 of your gain would be taxed at the capital gains rate (currently 15%) and you would be faced with a $15,000 tax bill.

One caveat – renters. If you rent your home instead of owning it, you can claim the home office deduction without having to worry about this long-term negative financial impact. Keep in mind, that your tax returns will still remain subject to additional IRS scrutiny as the home office deduction is an often-challenged deduction.


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