Family child care providers and other taxpayers with a home office beware:
There are certain tax preparers out there who may advise you not to depreciate your home, if you own it. They may have good intentions and be ill informed, or they may not want to do the work, but this is bad advice. I suggest that you find another preparer if you get this recommendation.
Home depreciation allows you to take a tax deduction based on the cost or value of the building portion your home (whichever was lower when you started your child care business). This is not optional. The IRS treats depreciation as "allowed or allowable," meaning that whether you take the deduction or not, they will assume that you did. Any improvements you do after the purchase of your home are also depreciated.
If you are a home-owning child care provider and you have previously filed tax returns without claiming home depreciation, you should look into going back and deducting the prior year depreciation now.
Total current year depreciation for your home (and for household assets used in your business) will appear in Part III of Form 8829, Expenses for Business Use of Your Home. Be sure to also locate and review the depreciation schedules included with your tax return. That's where you will find a record of home depreciation deducted over the years. If you can't find any detailed depreciation information included with your tax return, contact your tax preparer or print the information from your software.
The bad news:
When you sell your home, you may be taxed on the amount of your “allowed or allowable” home depreciation. This is called “depreciation recapture.” Even if you never deducted home depreciation on your tax return, you may still have to pay the depreciation recapture tax when you sell. The only exception is if you sell your home for less than its "tax basis," which is generally the original purchase price, plus the cost of improvements, minus allowable depreciation...whether you actually deducted the depreciation or not.
Some taxpayers try to avoid the recapture tax by leaving depreciation off of their tax return and some tax preparers encourage this. Don't listen to them! You might as well get a tax benefit for the depreciation now, since you will have to pay the recapture tax later, regardless.
It makes no difference whether you sell your home while you are still in business or after your business has been closed for a long time. You will still owe the depreciation recapture tax.
The good news:
You will save more tax by deducting home depreciation on your tax return every year than you will eventually have to pay back at the time of sale. Also, current law lets you treat your home sale as a personal, non-business transaction. This means that your sale should be mostly nontaxable, except for the depreciation recapture. You must have lived in the home for 2 out of the last 5 years at the time of the sale.
Prior to 2001, many daycare providers shut down their businesses before selling to avoid having a taxable capital gain based on the business use of their home. This is no longer necessary.
If you own your home, be sure to deduct home depreciation. You always come out ahead that way. Avoid tax preparers who advise otherwise.
If you have neglected to deduct depreciation for a number of years, you can use IRS Form 3115 to catch up on all the missed depreciation in one year.
Last updated 5 October 2011