If you claim home office deductions you may have a nasty surprise when you sell your home. You might wind up paying taxes on a transaction that could be tax-exempt.
Ordinarily, if you’ve lived in a house for more than two years, up to $250,000 worth of gains are tax-free. Married couples get a $500,000 tax exemption. However, your home office is not considered part of your primary residence, so that portion of the sale will be taxed.
If you have been claiming a 10% home office deduction, 10% of your home sale will be taxable. Depreciation deductions you’ve taken will be recaptured at a 25% rate and the rest of your home office profit probably will be taxed at the 20% rate on long-term gains.
To avoid this problem, stop claiming home office deductions at least two years prior to a sale. You’ll return that space to personal use, which qualifies for the tax exemption when you sell your home.