Hi there! It's coming up soon: tax time! Some look forward to it, some dread it. I thought it would be a good time to mention something to make you think.
We all know that owning a business puts a stress on us at tax time. We search and scrounge for deductions because every little bit helps us, right? The more deductions we have, the better! For most of us, this is absolutely true! What I want to address is a common deduction that you may want to reconsider: the Business Use of Home Deduction.
* Business Use of Home: This deduction is calculated on the square footage of your home versus the square footage of your office. A percentage is used to decide which part of your mortgage, utilities, insurance, etc are a business expense. The office space is also depreciated. For most people, this results in a nice tax deduction. Deducting the cost of a home office is a great way to reduce your income and resulting tax liability but you may want to consider this: Once you claim your home office or studio as a business deduction, it in effect becomes business property.
It means nothing much for now in that it's just a room in your home that you use as an office or studio. However, if say, 5, 10, even 20 years from now, you decide to sell your home, that room comes into play. For one thing, when you claim it as a deduction on your taxes, your basis in the home is reduced by the amount you depreciated. Please keep in mind that once you claim the space as business space, it doesn't matter if you refuse to depreciate it. IRS codes provide that you use allowed or allowable depreciation to determine basis. Basically this means that if it was allowed to be depreciated but wasn't, you still deduct the amount you would have taken. This adds to the profit by the sale of your home. Normally this wouldn't matter much because the IRS lets you exclude most or all of your profit from sale of the home on your taxes.
However, part of the home is business property. Even if you haven't had business in ages, that small part of your home is still considered business property. This means you get to fill out the lovely form 4797, Sale of Business Property and a percentage of your selling price is not excludable income. You are in effect incurring a business gain. Ouch, right? It's not something you think about at tax time but you really should. This same problem occurs when claiming auto expense deductions and you depreciate your vehicle. You can talk to your tax advisor before making any decisions or refer to the IRS website, http://www.irs.gov for more information or IRS Publication 587, Business Use of your Home. Here are some links :
Info on Business Use of Home deduction: http://www.irs.gov/taxtopics/tc509.html
Form 4797 PDF: http://www.irs.gov/pub/irs-pdf/f4797.pdf
Reporting Capital Gains: http://www.irs.gov/newsroom/article/0,,id=170634,00.html
Pub 544, Sales and other Dispositions of Assets: http://www.irs.gov/publications/p544/index.html
Please keep in mind that this blog is just to advise you that you should think about it before you act. Your best course of action is always to consult your tax advisor or accountant. I really hope this helps!