Depreciating Your Home
If you own your home and qualify to deduct expenses for its business use, you can claim a deduction for depreciation. Depreciation is an allowance for the wear and tear on the part of your home used for business. You cannot depreciate the cost or value of the land. You recover its cost when you sell or otherwise dispose of the property.
Before you figure your depreciation deduction, you need to know the following information.
- The month and year you started using your home for business.
- The adjusted basis and fair market value of your home at the time you began using it for business.
- The cost of any improvements before and after you began using the property for business.
- The percentage of your home used for business. See Business Percentage, earlier.
Adjusted basis defined. The adjusted basis of your home is generally its cost, plus the cost of any permanent improvements you made to it, minus any casualty losses or depreciation deducted in earlier tax years. For a discussion of adjusted basis, see Publication 551.
Permanent improvements. A permanent improvement increases the value of property, adds to its life, or gives it a new or different use. Examples of improvements are replacing electric wiring or plumbing, adding a new roof or addition, paneling, or remodeling.
If you make repairs as part of an extensive remodeling or restoration of your home, the entire job is an improvement. You must carefully distinguish between repairs and improvements. You also must keep accurate records of these expenses. These records will help you decide whether an expense is a deductible or capital (added to the basis) expense.
Example. You buy an older home and fix up two rooms as a beauty salon. You patch the plaster on the ceilings and walls, paint, repair the floor, install an outside door, and install new wiring, plumbing, and other equipment. Normally, the patching, painting, and floor work are repairs and the other expenses are permanent improvements. However, because the work gives your property a new use, the entire remodeling job is a permanent improvement and its cost is added to the basis of the property. You cannot deduct any portion of it as a repair expense.
Adjusting for depreciation deducted in earlier years. Decrease the basis of your property by the depreciation you deducted, or could have deducted, on your tax returns under the method of depreciation you properly selected. If you took less depreciation than you could have under the method you selected, decrease the basis by the amount you could have taken under that method. If you did not take a depreciation deduction, decrease the basis by the amount you could have deducted.
If you deducted more depreciation than you should have, decrease your basis by the amount you should have deducted, plus the part of the excess deducted that actually decreased your tax liability for any year.
If you deducted the incorrect amount of depreciation, see How Do You Correct Depreciation Deductions? in Publication 946.
Fair market value defined. The fair market value of your home is the price at which the property would change hands between a buyer and a seller, neither having to buy or sell, and both having reasonable knowledge of all necessary facts. Sales of similar property, on or about the date you begin using your home for business, may be helpful in figuring the property's fair market value.
Figuring the Depreciation Deduction for the Current Year
If you began using your home for business before 2002, continue to use the same depreciation method you used in past tax years.
If you began using your home for business in 2002, depreciate the business part as nonresidential real property under the modified accelerated cost recovery system (MACRS). Under MACRS, nonresidential real property is depreciated using the straight line method over 39 years. For more information on MACRS and other methods of depreciation, see Publication 946.
To figure the depreciation deduction, you must first figure the part of the cost of your home that can be depreciated (depreciable basis). The depreciable basis is figured by multiplying the percentage of your home used for business by the smaller of the following.
- The adjusted basis of your home (excluding land) on the date you began using your home for business.
- The fair market value of your home (excluding land) on the date you began using your home for business.
Depreciation table. If 2002 was the first year you used your home for business, you can figure your 2002 depreciation for the business part of your home by using the appropriate percentage from the following table.
MACRS Percentage Table for 39-Year Nonresidential Real Property
| Month First Used for Business |
Percentage To Use |
| 1 |
2.461% |
| 2 |
2.247% |
| 3 |
2.033% |
| 4 |
1.819% |
| 5 |
1.605% |
| 6 |
1.391% |
| 7 |
1.177% |
| 8 |
0.963% |
| 9 |
0.749% |
| 10 |
0.535% |
| 11 |
0.321% |
| 12 |
0.107% |
Multiply the depreciable basis of the business part of your home by the percentage from the table for the first month you use your home for business. See Table A-7a in Appendix A of Publication 946 for the percentages for the remaining tax years of the recovery period.
Example. In May, George Miller began to use one room in his home exclusively and regularly to meet clients. This room is 8% of the square footage of his home. He bought the home in 1993 for $125,000. He determined from his property tax records that his adjusted basis in the house (exclusive of land) is $115,000. In May, the house had a fair market value of $165,000. He multiplies his adjusted basis (which is less than the fair market value) by 8%. The result is $9,200, his depreciable basis for the business part of the house.
George files his return based on the calendar year. May is the 5th month of his tax year. He multiplies his depreciable basis of $9,200 by 1.605% (.01605), the percentage from the table for the 5th month. The result is $147.66, his depreciation deduction.
Depreciating Permanent Improvements
Add the costs of permanent improvements made before you began using your home for business to the basis of your property. Depreciate these costs as part of the cost of the house as explained earlier. The costs of improvements made after you begin using your home for business (that affect the business part of your home, such as a new roof) are depreciated separately. Multiply the cost of the improvement by the business-use percentage and depreciate the result over the recovery period that would apply to your home if you began using it for business at the same time as the improvement. For improvements made this year, the recovery period is 39 years. For the percentage to use for the first year, see MACRS Percentage Table for 39-Year Nonresidential Real Property, earlier. For more information on recovery periods, see Which Recovery Period Applies? in chapter 4 of Publication 946.
Day-Care Facility
If you use space in your home on a regular basis for providing day care, you may be able to deduct the business expenses for that part of your home even though you use the same space for nonbusiness purposes. To qualify for this exception to the exclusive use rule, you must meet the following requirements.
- You must be in the trade or business of providing day care for children, persons age 65 or older, or persons who are physically or mentally unable to care for themselves.
- You must have applied for, been granted, or be exempt from having a license, certification, registration, or approval as a day-care center or as a family or group day-care home under state law. You do not meet this requirement if your application was rejected or your license or other authorization was revoked.
Figuring the deduction. If you regularly use part of your home for day care, figure what part is used for day care, as explained earlier under Business Percentage. If you use that part exclusively for day care, deduct all the allocable expenses, subject to the deduction limit, as explained earlier.
If the use of part of your home as a day-care facility is regular, but not exclusive, you must figure what part of available time you actually use it for business. A room that is available for use throughout each business day and that you regularly use in your business is considered to be used for day care throughout each business day. You do not have to keep records to show the specific hours the area was used for business. You may use the area occasionally for personal reasons. However, a room you use only occasionally for business does not qualify for the deduction.
To find what part of the available time you actually use your home for business, compare the total time used for business to the total time that part of your home can be used for all purposes. You can compare the hours of business use in a week with the number of hours in a week (168). Or you can compare the hours of business use for the year with the number of hours in the year (8,760 in 2002).
Example 1. Mary Lake uses her basement to operate a day-care business for children. She figures the business percentage of the basement as follows.
| Square footage of the basement Square footage of her home |
= |
1,600 3,200 |
= |
50% |
family can use the basement. She figures the percentage of time the basement is available for use as follows.
| Number of hours available for use (12 x 5 x 50) Total number of hours in the year (24 x 365) |
= |
3,000 8,760 |
= |
34.25% |
entire house, she can deduct only 17.13% of the indirect expenses. She figures the percentage for her indirect expenses as follows.
| Business percentage of the basement |
50% |
| Multiplied by: Percentage of time used |
× 34.25% |
| Percentage for indirect expenses |
17.13% |
Mary completes Form 8829 as shown in Figure B. In Part I, she figures the percentage of her home used for business, including the percentage of time the basement is used.
In Part II, Mary figures her deductible expenses. She uses the following information to complete Part II.
| Gross income from her day-care business |
$50,000 |
| Expenses not related to the business use of the home |
$25,000 |
| Tentative profit |
$25,000 |
| Rent |
$8,400 |
| Utilities |
$850 |
| Painting the basement |
$500 |
Mary enters her tentative profit, $25,000, on line 8. (This figure is the same as the amount on line 29 of her Schedule C.)
The expenses she paid for rent and utilities relate to her entire home. Therefore, she enters them in column (b) on the appropriate lines. She adds these two expenses ( line 21) and multiplies the total by the percentage on line 7 and enters the result, $1,585, on line 22.
Mary paid $500 to have the basement painted. The painting is a direct expense. However, because she does not use the basement exclusively for day care, she must multiply $500 by the percentage of time the basement is used for day care (34.25% - line 6). She enters $171 (34.25% × $500) on line 18, column (a). She adds lines 21 and 22 and enters $1,756 ($171 + $1,585) on line 24. This is less than her deduction limit ( line 15), so she can deduct the entire amount. She completes the rest of Part II by entering $1,756 on lines 32 and 34. She then carries the $1,756 to line 30 of her Schedule C (not shown).
Figure B—Part I of Form 8829
Example 2. Assume the same facts as in Example 1 except that Mary also has another room that is available each business day for children to take naps in. Although she did not keep a record of the number of hours the room was actually used for naps, it was used for part of each business day. Since the room was available during regular operating hours each business day and was used regularly in the business, it is considered to be used for day care throughout each business day. The basement and room are 60% of the total area of her home. In figuring her expenses, 34.25% of any direct expenses for the basement and room are deductible. In addition, 20.55% (34.25% × 60%) of her indirect expenses are deductible.
Meals. If you provide food for your day-care recipients, do not include the expense as a cost of using your home for business. Claim it as a separate deduction on your Schedule C (Form 1040). You can never deduct the cost of food consumed by you or your family. You can deduct as a business expense 100% of the cost of food consumed by your day-care recipients and generally only 50% of the cost of food consumed by your employees. However, you can deduct 100% of the cost of food consumed by your employees if its value can be excluded from their wages as a de minimis fringe benefit. For more information on meals that meet these requirements, see Meals in Publication 15-B, Employer's Tax Guide to Fringe Benefits.
If you deduct the cost of food for your day-care business, keep a separate record (with receipts) of your family's food costs.
Reimbursements you receive from a sponsor under the Child and Adult Food Care Program of the Department of Agriculture are taxable only to the extent they exceed your expenses for food for eligible children. If your reimbursements are more than your expenses for food, show the difference as income in Part I of Schedule C. If your food expenses are greater than the reimbursements, show the difference as an expense in Part V of Schedule C. Do not include payments or expenses for your own children if they are eligible for the program. Follow this procedure even if you receive a Form 1099 reporting a payment from the sponsor.
Sale or Exchange of Your Home
If you sell or exchange your home, you may be able to exclude up to $250,000 ($500,000 for certain married persons filing a joint return) of the gain on the sale or exchange if you meet the ownership and use tests.
Ownership and use tests. To claim the exclusion, you must meet the ownership and use tests. This means that during the 5-year period ending on the date of the sale, you met both the following tests.
- You owned the home for at least 2 years (ownership test).
- You lived in the home as your main home for at least 2 years (use test).
Business use during the ownership and use periods. If you used part of your home for business during the ownership and use periods, the exclusion generally applies only to the gain attributable to the personal part of your home.
Depreciation. If you were entitled to take depreciation deductions because you used your home for business, you cannot exclude the part of your gain equal to any depreciation allowed or allowable as a deduction for periods after May 6, 1997. If you can show by adequate records or other evidence that the depreciation deduction allowed was less than the amount allowable, the amount you cannot exclude is the amount allowed.
Basis adjustment. If you used any part of your home for business, you must adjust the basis of your home for any depreciation that was allowable for its business use, even if you did not claim it. If you took less depreciation than you could have under the method you properly selected, you must decrease the basis by the amount you could have taken under that method. If you took more depreciation than you should have under the method you properly selected, you must decrease the basis by the amount you should have deducted, plus the part of the excess deducted that actually decreased your tax liability for any year. For more information on reducing the basis of your property for depreciation, see Publication 551.
More information. This section covers only the basic rules for the sale or exchange of your home. For more information, see Publication 523.
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