Below are some topics that may be of interest to you.
The information below should be used for educational purposes only and it is not a complete list nor may it apply to your situation or circumstance. You should consult with your tax advisor to find out the tax ramification of the transaction that pertains to you.
If you have any questions or need information on any of the items below, please do not hesitate to call David Silkman, CPA, MST, Broker at 310.478.9200 x301 or email him at david@SilkRoadRealtyInc.com.
Home Office Deduction
Generally, a self-employed individual will qualify for a home office deduction if the office is a place where the taxpayer meets with customers, patients or clients, or is used on an exclusive and regular basis for administrative or management activities of his or her trade or business, and there is no other fixed location of the business where the taxpayer conducts substantial administrative or management activities of the business. Even if a taxpayer conducts administrative activities at a fixed location outside the home, he or she is still eligible to claim a deduction as long as the administrative activities conducted at the outside location aren't substantial. Space in the home used to store inventory for a wholesale or retail business also qualifies as business use of the home.
Deductible home office expenses fall under two basic categories: direct and indirect expenses. Expenses that are directly attributable to the home office, such as painting the office, repairs to the office space, etc., are 100% deductible to the business. The second category is indirect expenses that are attributable to the entire home, for which only a fraction of the total amount is allocated to the home. These include home mortgage interest, property taxes, insurance, certain utilities, property taxes, homeowners association dues, gardener, pool service and depreciation. If the home is rented, substitute rent paid for interest, taxes and depreciation. The fraction used to allocate business portions of the indirect expenses is determined by dividing the business use square footage by the total square footage of the home.
Example - Assume you are self-employed and you work out of your home. The total square footage or your home is 1,000 sq. ft. You have a room that is dedicated and used exclusively as an office and it is 200 sq. ft. Therefore, 20% (200/1,000) of all your home expenses including depreciation are tax deductible. And, it does not matter whether you own or rent.
The home office deduction is, however, limited to the gross income of the business derived from the use of the home for that business, and where the gross income is less than the expenses, certain expenses can be carried forward for the same trade or business in the subsequent years but cannot be used against a positive income from another business. Carryover never includes home interest, taxes and casualty losses because they are allowed without regard to the gross income limitation.
If the self-employed taxpayer owns the home, there is a negative aspect to the home office deduction that can create unexpected consequences when the home is sold. First, the allowable home office depreciation is never excluded under the $250,000 ($500,000 for joint filers) exclusion of gain for primary residences and will end up being recaptured as taxable income upon sale. But, the current maximum tax rate on the recapture is only 25%. Furthermore, if the office is located in a separate structure, then the home sale is treated as two sales, the sale of the home portion and a sale of the office portion. Any gain from the office portion would not qualify for the home gain exclusion and would be taxable.
Example - A married couple sells a home that includes a home office in a separate structure that is 20% of the total home square footage. The home, originally costing $150,000, is sold for $500,000. If the home office had never been claimed, or if the office had not been in a separate structure, the entire home gain, except recaptured depreciation, could be excluded from income. However, in this case, $70,000 (20% of the gain) becomes taxable income. (For this example, to keep it simple, we haven't taken into account improvements, selling costs, or depreciation.)
Rent Vs. Buy
To help you compare the costs of renting to the costs of buying a home and perhaps to show you that it may not cost you that much more to be an owner, and in some situations less if you own, please click here. Because there are other factors to consider, (interest, property taxes, tax savings, appreciation, opportunity costs, closing costs, selling costs, etc.) it is complicated to compare the cost of renting to the cost of buying. This calculator attempts to take all of these factors into consideration in order for you to make an informed decision.
If you would like to calculate how much it will cost you after tax savings if you purchase a property and compare that to what you are paying in rent, please click here. Also, keep in mind that as a renter you are not building any equity for yourself. Actually, you are building equity for your landlord. But, as a long-term homeowner mostly likely you will build equity and your property will increase in value.