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<<I've heard that the tax break for selling one's principle residence (up to $500,000 in profit for joint filers) is void if the home office deduction has been used. Is this true?>>

I sure don't think so, but it seems that there are a number of people out there with the same misperception.

If you DO have an office in the home, and then sell the home, you are actually selling two separate properties: A principal residence (on which the universal exclusion applies), and a business property (on which there is no tax break, and on which taxes will be due).

This is nothing new. It has worked this way under the old law for years and years.

What HAS changed is that the universal exclusion will not apply to any depreciation deductions taken against the property after May 6, 1997. And this is a BIG change.

This means that any depreciation taken after May 6th, either for an office in home deduction or for a rental property, will be subject to tax when the home is sold (generally at a 25% rate). Remember that under the old rules this depreciation could be "rolled over" into the new residence. But since the rollover rules no longer exist, any gain due to depreciation will be recognized.

For example...lets say that you bought a home in 1997. In 1998 and 1999, you took the office in home deduction (including depreciation), but could not qualify for the office in home deduction in year 2000. In year 2000, you sell the property for $150k. You then immediately turn around and buy a new home for $175k. You had a TOTAL gain on the sale of the property of $20,000, including depreciation taken on the property (after May 6th) of $4,500.

Under the OLD rules, you could "roll over" your gain from the first property to the second property, and have NO current tax liability. Since the office portion of the home was not in force when the home was sold, you didn't have to realize any gain on the depreciation taken (even though the basis in the new property had to be adjusted to reflect the depreciation).

But now, since the rollover rules are no longer in effect, you would have to recognize (and pay tax on) the portion of the gain attributable to the depreciation taken ($4,500 in this example). So while the total gain was $20k, only $15,500 could be excluded from income. The remaining $4,500 gain, in the form of depreciation taken after May 6th would have to be recognized (at a maximum 25% rate).

And the entire situation could be MUCH WORSE (from a tax and complexity standpoint) if the office in home WAS still in force when the property was sold.

See how it works??

So while the office in home deduction does not invalidate the home sale exclusion, it certainly muddies the water. If you are one of the few people who still uses the office in home deduction, you'll really have to look at ALL of the pros and cons of the situation to see if it is really worthwhile for you in the months and years to come.

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