How to Defend Your Home Office Deduction

Let's say you bought a house for $500,000 and held it for five years. You claimed a home office deduction and depreciation on 10% of the square footage each year, then sold it for $750,000. Your total deduction for depreciation over that time, based on the IRS's 39-year depreciation schedule (see Publication 946), would be about $1,200 a year, or $6,000 for the period.

If you're self-employed in the 28% tax bracket, you'll typically pay 5% or 6% in state taxes, plus about 15% in self-employment tax. Each dollar you deduct would save you 48 cents, so that $6,000 deduction would save you about $2,900 over five years.

In the year you sold the house, you'd pay taxes on that deduction, likely at a 25% rate (plus self-employment and applicable state taxes). The bill would be about $2,500, Levine says. So in the long run, the deduction would have saved you $400 or so. That seems like a lot of work for $400, but remember: That's likely just part of the savings you can reap when you factor in the deductions you can claim for utilities, improvements and repairs.

There is one exception: If your office is in a separate building, such as a shed or garage, it's considered a separate commercial structure. That means it gets treated as offices did before 2002, and it does not fall under the $250,000 exemption. If you claim the home office deduction in a detached building in three of the five years before you sell, you'll have to pay capital gains taxes on the value of the structure.

Bottom line? Consult a tax professional to see what works best for you. And if you're planning a move in the next few years, don't take the home office deduction.