Yes! Always! No exceptions!
Unfortunately, some family child care providers are told by their tax preparer not to depreciate their home on their tax return (Form 8829 Expenses for Business Use of Your Home). You will be making a big mistake if you listen to anyone who tells you this.
Why? Two reasons.
Reason #1: Claiming depreciation on your home represents a big deduction and lower taxes for you. Home depreciation is based on the purchase price of your home (in most instances). Let's say you bought your home for $100,000 and your Time-Space Percentage is 40%. The business portion of your home is $40,000 ($100,00 x 40%) that would depreciate over 39 years. The represents about a $1,000 business deduction each year ($40,000 divided by 39 years). Not bad!
See my article "How to Depreciate Your Home" for more details.
Reason #2: When you sell you home you face two possible taxes. The first is capital gains tax on the profit on the sale of your home. You can avoid this tax on the first $250,000 of profit if you are single or $500,000 profit if you are married. Nice! Most child care providers can avoid worrying about this tax.
The second tax is tax on the house depreciation that you claimed while using your home for business. This tax is unavoidable and must be paid when you sell your home. The amount of tax you will owe will depend on your family's tax bracket at the time. The tax rate will be either 15% or 25%. Let's say you were in business for six years and claimed $1,000 in depreciation each year. Then you go out of business and five years later you sell your home. You will owe tax on $6,000 and will pay either $900 or $1,500.
What if you don't depreciate your home?
You will still owe $900 or $1,500 in taxes!
That's because the IRS rules clearly state that if you are entitled to claim the depreciation deduction on your home, you will be treated as if you did when you sell it. If house depreciation is "allowed or allowable" you must pay tax on it when you sell your home. The only situation where a provider would not be "allowed" to claim house depreciation is if they have a business loss. See IRS Publication 523 Selling Your Home.
Therefore - always depreciate your home, no matter what! You will owe the same tax later even if you didn't depreciate it and you will have lost a lot of deductions.
If you have not depreciated your home in earlier years, amend your tax return (Form 1040X) and get a refund.
Image credit: re-lianceinc.com
For more details see my Family Child Care Tax Workbook and Organizer.
Copyright 2011, Tom Copeland, www.tomcopelandblog.com
If I depreciate my home and then stop doing childcare after 5 years, so I have only depreciated for 5 years instead of 39, do I just stop taking the depreciation when I stop my business? Or do I have to continue to take the depreciation for 39 years?
Posted by: Aimee Shaffer | 01/31/2012 at 05:18 PM
And what about depreciation recapture? It's all so confusing that it's very tempting to not even bother. Especially considering the small amount of money I bring in from childcare.
Posted by: Aimee Shaffer | 01/31/2012 at 05:19 PM
You stop claiming depreciation on your home when you go out of business. So if you were in business for 5 years, you'll only get 5 years of depreciation.
When you sell your home you'll have to pay tax on this depreciation, whether or not you claim it, so claim it!
Posted by: Tom Copeland | 01/31/2012 at 05:33 PM
Where do you list depreciation of your home? Only on form 8829? or do you also list it on form 4562?
Posted by: Michelle | 02/06/2012 at 02:33 PM
In the first year you use your home for your business, list your home on Form 4562 and on Form 8829 (deduct it on Form 8829). After the first year, show house depreciation on Form 8829.
Posted by: Tom Copeland | 02/06/2012 at 03:23 PM
Do you pay taxes on all deductions or just the business use of home deduction?
Posted by: Alison Evangelista | 05/24/2012 at 11:19 AM
You don't pay taxes on your deductions. You pay taxes on the profit of your business. Your profit is determined by subtracting all your deductions (including business use of home deductions on Form 8829) from your income.
Posted by: Tom Copeland | 05/24/2012 at 11:22 AM
What happens if my Time-Space percentage changes from year to year? Do I recalculate the depreciation each year or am I locked into my first year?
Posted by: Jess | 02/12/2013 at 09:00 PM
When your time-space % changes it will affect your depreciation deduction. When you time-space % goes down, your depreciation deduction will go down and visa versa.
Posted by: tom | 02/12/2013 at 09:24 PM
What if the home is used for childcare more than 39 years? Since the home still has "basis" can I still depreciate it for more years? Or do I have to stop depreciating after 39 years no matter what?
Posted by: Kerry | 03/04/2013 at 01:17 PM
Once the 39 years is up, you can't claim any more depreciation on your home.
Posted by: tom | 03/05/2013 at 09:33 AM