For Homeowners, the Home Office Deduction Can Cost a Bundle

Once a week, I drag my daughter into my office and force her to e-mail her friends, visit a Web site, play in my chair. I won’t allow my husband to transfer his favorite computer game onto the machinery in the other room. That game stays in my office. Period. I may even set aside a corner of my desk for crafts, just to make it clear that this isn’t just an office, it’s a place for recreation.

This may appear moderately insane to anyone who has ever tried to battle their family and friends to maintain a quiet corner in their house dedicated to work. But there’s a method to my madness.

I’m trying to prove that I can’t possibly take a tax deduction.

During 1999, it became easier to take home office tax deductions. These deductions allow you to write off a portion of the value of your house as a business expense. I have a legitimate home office. But I don’t want the tax deductions and I’m willing to deal with some inconvenience to keep them at bay.

Why? As a homeowner, I know that these deductions could actually cost me money.

The reason is complex, as is common when dealing with the U.S. tax code, where a byzantine tangle of rules and regulations seemingly conspire to trap the unwary. In fact, three sets of regulations come into play--the complicated home office deduction rules themselves, the home sale rules, and depreciation “recapture.”

Let’s take it step by step:

* Rule 1: Home office deductions allow you to subtract a portion of the cost of maintaining your home or apartment from your taxable income. For a renter, that cost is easy to figure and the home office deduction is well worth taking. If one-quarter of your apartment is used exclusively for work, you can deduct one-quarter of your rent and utility expenses.

But, if you’re a homeowner, the calculation is more complex, and the value of the deduction becomes dubious. To figure your write-off, you determine what percentage of your home is used as an office. You multiply that percentage by the value of your home, exclusive of land. Then, you depreciate, or write off, that amount over time.

For instance, if you have a $100,000 home, $20,000 of its appraised value may be for the land that it’s sitting on. You subtract that amount from the total value, to get the house’s value of $80,000. Now, you multiply $80,000 by the percentage of the home that you use as an office. Let’s say that’s 25%. You will be able to deduct $20,000 of your home’s value as “depreciation” over time. The catch: It’s a long time--39 years to be precise.

In any given year, you’ll get to subtract just $512.82 in “depreciation” expenses from your income. In addition, you can deduct utility and other maintenance expenses that are attributable to that home office, too. These expenses might add up to, say, another $100 annually, quite possibly less.

What about the cost of a second telephone line, office supplies and equipment? Those are deductible separately, either as business expenses on a Schedule C or as miscellaneous itemized deductions. You don’t need an official home office to claim them.

In the above example, the total home office deduction amounts to $612.82 annually. If you’re in the 28% federal tax bracket, that will save you $171.59 in federal income tax.

* Rule 2: Since mid-1997, federal tax law has allowed homeowners to exclude up to $250,000 per person ($500,000 per couple) in profits from the sale of a personal residence from tax. Your personal residence is where you have lived for at least two of the past five years.

* Rule 3: Any portion of your home that was deducted as a home office does not qualify for the home sale tax exclusion. In fact, any depreciation that you claimed after 1997 must be “recaptured” when you sell the house. The amount you depreciated generally will be taxed at a 25% federal rate, regardless of your bracket.

* The bottom line: Let’s say you save $172 per year for 10 years by claiming home office deductions. At the end of that period you then want to sell your home for $150,000. You don’t have to pay tax on the profit from your personal residence. But, by claiming the home office in previous years, you have stated that 25% of your house wasn’t your personal residence, it was an office. That means 25% of your $50,000 gain is taxable. Capital gains taxes on 25% of that $50,000 profit (or $12,500) will set you back $2,500 at the usual 20% rate.

Moreover, you have to pay tax on recaptured depreciation, which would have amounted to $5,128 over a 10-year period (you got to write off 1/39th of $20,000 each year, which amounted to $512.80 per year). You’ll pay $1,282 in federal income tax, or 25%, on that amount.

Compare that with your 10-year cumulative savings from claiming the home office deductions and you find that home office deductions cost you money in the long run.

Worse still, you’ve had to grapple with additional tax forms each year. (Home office deductions are claimed on a Form 2108 if you are a company employee, or on a Form 8829 if you are a business owner who files a Schedule C.) Moreover, claiming a home office flags your tax return for possible audit.

If this added risk and complexity makes it impossible for you to file your own return, you end up spending even more on tax-preparation expenses.

Certainly, there may be some homeowners out there who can still find home office deductions worth taking. But, for many of us, the substantial risks are simply not worth the relatively minor deductions.

It’s worth noting that the tax law compels you to claim all the deductions for which you qualify. If you don’t want to claim the home office deduction, you must make sure you don’t meet the requirements.

That used to be simple. Before 1999, if you didn’t meet clients in your home office, it was difficult to justify the deduction. But, that changed last year. Now, you don’t have to meet clients in your home office, as long as it is your principal place of business, where you “perform substantial administrative or managerial activities.”

But there’s one more requirement. For people who don’t want to claim the home office, it’s your ace in the hole: The office must be used exclusively for business. If you watch television in the office after hours, if your kids use your office computer for games or Internet access, if your teenager uses your office phone to call her friends--no matter how rarely--the deductions are disallowed.

So, invite your friends and family into your home office now and again. Play a little. This is one tax deduction a lot of homeowners can do without.

Times staff writer Kathy M. Kristof welcomes your comments and suggestions for columns but regrets that she cannot respond individually to letters or phone calls. Write to Personal Finance, Business Section, Los Angeles Times, Times Mirror Square, Los Angeles, CA 90053, or e-mail kathy.kristof@latimes.com.