Depreciation is the most confusing part of the full home office deduction, but it can be quite valuable when it comes to minimizing your tax bill. In fact, it’s one of the best tax benefits of working from home. [Be aware: Depreciation only applies if you own your home.]
The calculation itself can seem daunting – but you only have to do the hard part once, and after that it’s extremely simple. We’ll walk through that in detail, and also talk about the potential tax impact when you sell your house.
Figuring out depreciation expense
To make things easier, I created a free home office deduction worksheet that includes depreciation expense calculations. You can download that free worksheet here.
Before we start on the depreciation math, first comes the business percentage calculation. You can only take depreciation expense linked to the home office portion of your home.
To calculate the business percentage, divide the area of your home office (in square feet) by the total area of your home (in square feet). The result is your business percentage.
Now we can get down to business, and tackle the depreciation expense. The first time you work this out, you’ll need to gather up some information:
- The total cost of your house when you bought it (find that on your closing statement)
- The value of the land when you bought your home (that will be on your property assessment, and possibly on your closing statement or property tax bill)
- The fair market value (FMV) of your home at the time you started using a home office (use the sales prices of similar houses sold at that time, then back out the land portion of the price)
- The full cost of any whole-home improvements you’ve made
- Any casualty losses you’ve sustained related to your home (like flood damage)
The first number you need to come up with is the adjusted basis of your home. Here’s how to get that:
Adjusted basis = purchase price of home – land value + improvements – casualty losses
Compare the adjusted basis you just calculated to the FMV of your home (not including land). Whichever number is less is the number you’ll use going forward, and you never have to figure it out again.
What counts as a home improvement?
Home improvements include only things that increase the value of your house, not regular repairs and maintenance. Examples of improvements include replacing your roof, rewiring your electrical system, and adding on an addition.
Next comes the depreciation calculation – and this part is pretty straightforward. According to the IRS, your home office counts as “nonresidential rental property” that gets depreciated over 39 years using the straight-line method. Basically, just divide the lesser of your adjusted basis or FMV by 39, and that’s the annual depreciation.
The only time the number will be different is the first year you’re taking depreciation expense for your home office. Then, you have to use the IRS chart based on the month you started working at home. Choose the percentage that’s listed next to the month you started using the home office this year. For example, if you started using it in June, your percentage would be 1.391%, for month 6.
These percentages come directly from the IRS website, and, again, they’re only applicable for the first year that you’re taking the home office deduction.
Now that you’ve figured out the current year depreciation, you have to multiply that number by the business percentage you calculated.
Let’s take a look at an example:
Marsha started using a home office in April 2016. She originally bought her townhouse for $220,000. According to her property assessment, the land was worth $10,000. She hasn’t made any improvements, or suffered any casualty losses. Similar townhomes in her area were selling for about $250,000 in April. Her office is 120 square feet, and her whole townhome is 1,200 square feet.
Marsha’s adjusted basis of $210,000 ($220,000 – $10,000) is less than the FMV. Since she started using the home office in April, she multiplies her adjusted basis by 1.819% (according to the IRS chart). That means the total deprecation for 2016 equals
$210,000 x 1.819% = $3,819.90.
Next, Marsha has to multiply the total depreciation by her business percentage. Her business percentage works out to 10% (120/1200 = 10%). So her depreciation deduction for her home office in 2016 would be: $3,819.90 x 10% = $381.99.
Next year, and all the years she uses this home office, the total depreciation would equal $5,384.62 ($210,000/39 years). Her depreciation deduction every year would equal $538.46 ($5,384.62 x 10%).
You can find more detailed information about depreciation and how to calculate it in IRS Publication 946.
What happens when I sell my house?
One of the biggest worries about taking the depreciation expense deduction involves the tax bite when you sell the house. Yes, there may be one, but it will probably be a lot less than the deductions you’ve taken – a win for you.
Here’s the deal: Any deprecation you’ve taken on your house turns into a taxable gain when you sell your house. That’s because of an IRS concept called depreciation recapture.
If you take the full home office deduction (instead of the simplified version), this tax issue will crop up even if you don’t take the depreciation expense – it’s based on the amount of depreciation expense you could have taken. You don’t win by skipping it, so take the tax benefit now.
Here’s an example of how the recapture works:
Marsha (remember Marsha from the depreciation calculation?) sold her townhome for $275,000, for a gain of $55,000 ($275,000 – $220,000). Over the years, she took $2,535.83 in depreciation expense ($538.46 x 4 years + $381.99). On her current tax return, Marsha has to report that $2,535.83 recaptured depreciation as a capital gain and pay 25% tax on it (the current tax rate for recaptured depreciation).
Marsha’s tax on the recaptured depreciation comes to $633.96. Not a bad deal for 5 years of tax deductions – and probably less than she would have paid if she didn’t take those deductions.
And what about capital gains on the sale of the house? As long as your home office is actually inside your house – as opposed to in a detached garage or separate guesthouse, for example – it falls under the standard home sale exclusion, meaning not extra taxable.
The depreciation expense deduction is one of the more complicated issues on your tax return, but it’s well worth doing if you’re going take the full home office deduction. Most of the math is typically built right into tax prep software (though you won’t find a free version that will handle this), so the hardest part for you will be getting all the information together. If you have any questions about this – or any other tax issues – please ask them in the comments. I’ll be happy to answer.
where on 1040 will she repay the depreciation. I think it is Schedule D, but can you walk thru the process to figure the number. Thanks
Here is the appropriate guidance from the IRS: https://www.irs.gov/pub/irs-pdf/i4797.pdf
How do you account for the size of your home office changing over time? Say for example there was a storage shelf area that you needed to expand or contract slightly every 5 years or so. This is all accounted for correctly on the home office deduction forms for each tax year but what about the depreciation form? Would the current years home office percentage be the one you use for the home office (this is what Turbotax appears to do automatically but I’m just sure about the yearly total it comes up with)? How about any home improvements which got added as line items on the depreciation report, but occurred in later years so they may have originally had a slightly different home office percentage then the current one? (Turbotax doesn’t do this automatically but allows you to edit it.)
Hi there! Here is the IRS guidance on this topic. Hope it helps! https://www.irs.gov/publications/p587
If you make improvements over time how do you factor this in to the adjusted basis. You are saying you only have to come up with the adjusted basis once, for the first year you put your home in use. But how do you account for improvements over the years that would change that basis?
Thanks for your question! Each improvement starts a new depreciation asset for the home office. If the improvements are for the whole home, you can depreciate the proportion applicable to the home office. For example, a new roof would count as a new depreciable asset – improvements – and would begin depreciation the year that it was installed rather than being added on to the adjusted basis of the home that you’ve already begun depreciating.
Hi Michele, I own a condo and one room is used exclusively for my home office. To figure out the depreciation, one of the items is the “value of the land”. So what is the value of the land for a condo? Thank you.
Thanks for your question. You may be able to find that information in your closing documents/appraisal, your tax assessment, or from the condo association. Hope this helps!