Avoiding primary residence capital gains tax on home office
The primary residence capital gains tax is something you can avoid. You can even be avoiding capital gains tax when you have a home office. Your Uncle Sam really favors home owners. Not only does he allow you some tax free gains on your principle residence. He also gives you more tax free and deferred cash if you use the home as your office or rental. You must know the rules and play the game accordingly to avoid the taxes. It takes some planning but as you will see it is well worth it. I have been using my primary residence property as a rental for the past 2.5 years. I will employ these rules to avoid and defer tax liability. The strategy involves combining Section 121 exclusions with a 1031 exchange
Tax Free Sale of Home with Home Office
You bought a home for $200,000 and sell it for $300,000. Over that time you have taken $30,000 in home office depreciation, which is 20% of your home. Your adjusted cost basis in the property is $170,000. This gives a capital gain of $130, 000. This is how it breaks out.
The IRS defines the order on which the exclusions are made:
- Section 121 comes first. It cannot be applied to depreciation claimed after May 6, 1997.
- Tax on gain is imposed on gains over the Section 121 limits.
- 1031 exchange is applied to the business portion to defer business tax liabilities
- You add the Section 121 exemptions to the adjusted basis of the new property.
| Total | Home | Office | |
| Basis of Property | $200,000 | $160,000 | $40,000 |
| Depreciation | ($30,000) | NA | ($30,000) |
| Adjusted Basis | $170,000 | $160,000 | $10,000 |
| Gain from sale | $130,000 | $104,000 | $26,000 |
| Section 121 exclusion (1, 2) | (120,000) | ($104,000) | ($16,000) |
| 1031 Exchange (3) | ($10,000) | NA | ($10,000) |
| Gain subject to tax | Zero | Zero | Zero |
The example shows that 15% capital gains tax was avoided and the 31% tax on ordinary income.
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DISCLAIMER
This article is for training purposes only. Jody Wall does not warranty the accuracy of the training. It is not intended to be legal or accounting advice. Seek competent consultation for your particular situation. Readers assume all responsibility for their decisions.
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