How to Claim the Home Depreciation Tax Deduction

Home depreciation is a tax deduction allowing property owners to recover the cost of a home, or a portion of it, that is used for generating income. This deduction accounts for the wear and tear on the property over time and is considered a non-cash expense, meaning you can claim it without an actual cash outlay for the year. The deduction is primarily available to individuals who use part of their home for a qualifying home office or for rental purposes.

Determining Eligibility and Depreciable Basis

To claim a deduction for home depreciation, you must first meet specific eligibility criteria. The two main scenarios that qualify are using a portion of your home as a home office or operating a residential rental property. For a home office, the space must be used “exclusively and regularly” for your trade or business. This means the area is used only for business activities and on a continuous basis. The home office must also be your “principal place of business,” a location where you conduct substantial administrative or management activities.

Once eligibility is established, you must determine the property’s depreciable basis. Your initial basis is what you paid for the property, including certain settlement fees from the closing statement, such as legal and recording fees, but not costs like mortgage insurance premiums. To this amount, you add the cost of any significant improvements that add to the property’s value or prolong its life. The result is the home’s adjusted basis.

A fundamental rule in depreciation is that land is not depreciable because it does not wear out. Therefore, you must separate the cost of the building from the cost of the land. This allocation can often be done using the property tax assessment from your local government, which typically shows separate values for the land and the building. Alternatively, a professional appraisal can provide this breakdown. The depreciable basis is the lesser of the home’s adjusted basis (excluding land) or its fair market value at the time you begin using it for business.

The final step before calculation is to determine the business-use percentage. For a home office, this is found by dividing the square footage of the office space by the total square footage of your home. For example, if your office is 200 square feet and your home is 2,000 square feet, your business-use percentage is 10%. If the entire property is used as a rental, the business-use percentage is 100%.

Calculating the Annual Depreciation Deduction

Before calculating depreciation for a home office, taxpayers can consider an alternative: the simplified method. This option allows a deduction at a standard rate of $5 per square foot for the business-use part of the home, up to a maximum of 300 square feet for a total deduction of $1,500. Choosing the simplified method avoids the need to calculate depreciation and track actual expenses.

The Internal Revenue Service requires using the Modified Accelerated Cost Recovery System (MACRS) to depreciate residential property. Under MACRS, the General Depreciation System (GDS) is the most common method used. GDS sets specific recovery periods, which are the number of years over which you can depreciate the property.

The recovery period for your property depends on its use. A property used as a residential rental has a recovery period of 27.5 years. For a home office, the recovery period is 39 years as nonresidential real property. However, if the office is in a residential rental property you own and operate, it is depreciated over 27.5 years with the rest of the dwelling.

To calculate your annual depreciation deduction, the depreciable basis of the building is multiplied by the business-use percentage, and the result is divided by the applicable recovery period. For instance, if a home office has a depreciable basis of $300,000, a business-use percentage of 10%, and a 39-year recovery period, the annual depreciation would be approximately $769.

The mid-month convention applies to real property, treating it as placed in service in the middle of the month it was first used for business, regardless of the actual day. This means for the first year, you can only deduct a half-month’s worth of depreciation for the starting month, plus depreciation for any remaining full months. Tax software and IRS publications provide tables to simplify this first-year calculation.

Tax Implications Upon Sale of the Home

Claiming depreciation on your home has tax consequences when you sell the property. The total amount of depreciation you deducted, or were entitled to deduct, is subject to depreciation recapture, which requires you to pay taxes on the benefits you received. The recaptured amount is treated as ordinary income. Taxpayers who use the simplified method for their home office have no depreciation to recapture upon selling their home.

The tax rate applied to recaptured depreciation is a maximum of 25%, which is distinct from the more favorable long-term capital gains rates. You are responsible for recapturing depreciation even if you failed to claim the deduction in prior years but were eligible to do so.

The home sale exclusion allows eligible homeowners to exclude up to $250,000 of capital gains ($500,000 for married couples filing jointly) from the sale of their primary residence. However, this exclusion does not apply to the portion of the gain attributable to depreciation recapture.

For example, imagine you sell your home and have a total gain of $300,000. Over the years, you claimed $40,000 in depreciation deductions for a home office. The first $40,000 of your gain is considered depreciation recapture and will be taxed at the 25% rate. The remaining $260,000 of the gain is a capital gain, which may be partially or fully offset by your home sale exclusion.

Reporting Home Depreciation on Your Tax Return

The primary form for reporting depreciation is Form 4562, Depreciation and Amortization. On this form, you detail the property’s basis, the date it was placed in service for business use, and the depreciation method you are using.

The calculated depreciation from Form 4562 has a different destination depending on the business use. For a home office as a sole proprietor, the deduction flows to Form 8829, Expenses for Business Use of Your Home. The total from Form 8829 is then carried to Schedule C, Profit or Loss from Business, to reduce your business income. Taxpayers using the simplified method for their home office do not file these forms and instead take their deduction directly on Schedule C.

For a residential rental property, the depreciation from Form 4562 is transferred directly to Schedule E, Supplemental Income and Loss. On Schedule E, this deduction is subtracted from your total rental income along with other related expenses to determine your net rental income or loss.