Tax on the Profit
First the good news. You can avoid taxes on the profit on the sale of your home if the profit is less than $250,000 and you are single, or $500,000 if you are married. (Note: legally married same sex couples can now take advantage of this tax break.)
So, if you are single and bought your home for $150,000 and sell it for $400,100, you will owe taxes on $100 ($400,100 – $150,000 = $250,100) because the amount above the $250,000 exclusion is $100.
If you are married, you would owe no taxes on the profit because it’s less than $500,000.
As you can see, most family child care providers will not owe any tax on the profit on the sale of their home.
Tax on the Depreciation
This second tax is not avoidable. You will owe taxes on the amount of depreciation you were entitled to claim on your home since May 1997.
This is true even if you didn’t claim home depreciation on your tax return!
Let’s look at an example. Rosalie Ryder purchased her home in 2000 for $200,000. Her Time-Space Percentage is 40% each year. She entitled to claim a depreciation deduction each year of about $2,500 ($200,000 x 40% = $80,000 divided by 39 year deprecation rule = $2,500).
Rosalie does child care in her home until she sells it on December 31, 2013. She used her home for her business for 13 years. She will owe taxes on the amount of depreciation she was entittled to claim for the past 13 years, or $32,500 (13 x $2,500 = $32,500).
What if Rosalie didn’t claim house depreciation for some or all of these years?
She would still owe taxes on $32,500! The IRS rule says that if you are entitled to depreciate your home, you will owe taxes on this depreciation even if you didn’t claim it. Therefore, always depreciate your home!
Don’t let someone tell you, “Don’t depreciate your home because you will have to pay more taxes when you sell your home.” Since you will have to pay these taxes anyway, there is no reason to give up the tax benefit of claiming depreciation. You will always come out ahead financially when you depreciate your home because the taxes on the depreciation will be less than the tax benefit of claiming the depreciation.
You will owe this tax even if you stop doing child care for years before selling your home.
You will pay either a tax rate of 10%, 15% or 25% on the house depreciation. (The tax rate will be based on your tax bracket in the year you sell your home.)
So, Rosalie will either owe $3,250, $4,875 or $8,125 in taxes. Remember, she will owe these taxes even if she didn’t depreciate her home.
Note: I’ve simplified the above example to exclude the value of land, home improvements, and expenses associated with the sale of the home. See my annual Family Child Care Tax Workbook and Organizer for the chapter “Selling Your Home.”
If you show a loss for your business in one year, you won’t be entitled to claim house depreciation for that year. Therefore, you won’t owe tax on home depreciation for that year.
If you are single and live with someone else who owns the home, you aren’t entitled to claim house depreciation and therefore won’t owe any taxes on it when the home is sold. If you are married and your spouse (including legally married same sex couples) owns the home, you are still entitled to claim house depreciation and so would owe this tax.
If you haven’t been claiming depreciation on your home, you can recapture all previously unclaimed depreciation by filing IRS Form 3115 Application for Change in Accounting Method. If Rosalie had not depreciated her home between 2000 and 2013, she can claim $32,500 of previously unclaimed depreciation using Form 3115 by filing it with her 2013 tax return.
See my article: “How to Claim Previously Unclaimed Depreciation.”
Conclusion: if you are thinking about selling your home, talk with a tax professional who can advise you about the tax consequences of home depreciation.
I’ve written two other articles about home depreciation:
Tom Copeland – www.tomcopelandblog.com
For more information about how to depreciate your home and the tax consequences of selling your home, see my annual Family Child Care Tax Workbook and Organizer.