Home Offices

If you have used part of your home as a home office, you haven't been using that part of your home as a principal residence at the same time.

Therefore, if you've used your home office for more than three of the past five years, you will have to divide up your property into two pieces: the "principal residence" part, on which up to $250,000 in gain may be excluded, and the "business" part, which is treated as a taxable sale of business real estate.

You'll have to compute the gain on each portion of the house separately. Assuming the home was owned for at least one year, the maximum tax rate on the business portion will be the long-term capital gains rate of 20 percent. However, the amount of gains up to the amount of any depreciation ever claimed on the home will be taxed at a rate of 25 percent.

If you have not used your home office for more than three of the last five years, you can exclude most of your gains on the sale of the home. However, you'll still have to pay a 25 percent tax on gains up to the amount of any depreciation claimed for periods after May 6, 1997.

Separating your property into the "home" portion and the "business" portion is generally necessary whenever you use some of the property for commercial or rental activities, and some for living space. Another situation where this frequently arises is illustrated in the case study for partially-residential property.