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Julian Block’s Tax Tips for Stock Photographers (Part 3)

July 13, 2009

Julian Block’s Tax Tips for Stock Photographers (Part 3)

PhotoEdit is proud to be working with Julian Block, an attorney and leading expert on taxes from Larchmont, New York, on a series of articles about tax tips for stock photographers. We are grateful to Julian for his time and his expertise. In part three of this series, he discusses the intricacies of how tax rules apply to stock shooters who would like to sell their houses which have been used partially as business offices for their photography work.

Q: Within the next few years, I plan to sell my home. I use one of its rooms only as a home office for my business as a stock photographer. I have been claiming office-at-home deductions for a proportional share of depreciation and other expenses associated with the room’s business use, just as I have been writing off all the equipment and furniture stuffed into the office. How do the tax rules work when I sell my home?

A: Prior to 2002, the rules were tougher if you used part of your residence for business purposes and then sold your home. Yes, the law allows an exclusion–an escape from taxes–of profit from sale of a principal residence. The exclusion amount generally is as much as $250,000 for single persons and married couples who file separate returns and $500,000 for married couples who file joint returns. But those rules authorized an exclusion only for the portion of the profit attributable to the residence part, prohibiting any exclusion for profit on the office part.

In effect, the IRS treated this kind of sale as if there had been a sale of two pieces of property: one a residence and the other business real estate. Consequently, the seller had to make separate calculations for the residence and business profits, dividing the selling price, selling expenses and basis between the residence and business parts.

Pregnant Korean young woman types on the keyboard of her computer in her office, Santa Monica, CA

The IRS scrapped the old rules and replaced them in 2002 with new ones that do away with an allocation between residence and business. The sale is a single transaction as long as the home office and the residential part are both within a single residence or, as the regulations put it, “dwelling unit.” Accordingly, someone like you can exclude the entire profit, despite using part of the home for business.

This break is subject to a “recapture” restriction designed to prevent a double benefit. You forfeit any exclusion for the part of the profit equal to any depreciation deductions allowed or allowable on the home office after May 6, 1997. Instead, you pay taxes on that part. (Allowed or allowable means what you claimed previously or, if you claimed less than you could have claimed, the amount that you could have claimed.) In this regard, the new rules do not differ from what the old rules obliged you to do.

This restriction lets the IRS recapture depreciation write-offs that you used to lower taxes in pre-sale years. The agency still applies the recapture rules even if you cease to use that room for business reason and the entire home is a principal residence for at least two years out of the five-year period that ends on the sale date.

White senior male photographer sits at desk and works on computer in his home office, Santa Monica, CA

For recapture not to apply, you have to show by “adequate records or other evidence that the depreciation deduction allowed was less than the amount allowable.” Then the amount that “you cannot exclude is the amount allowed.” (Usually, past returns should satisfy the requirement for adequate records–another reason why it is advisable to save copies of returns.)

To illustrate, assume that your home office qualified you to claim depreciation, but you can show that you never claimed any. Then there is no reduction of the exclusion amount and no recapture.

Recaptured depreciation is taxed at a maximum rate of 25 percent instead of the top rate of 15 percent for long-term capital gains, plus applicable state income taxes. As for the inescapable paperwork, the place for you to report the recaptured amount is Schedule D (Capital Gains and Losses), not Form 4797 (Sale of Business Property). On the plus side, you suffer no recapture of other expenses like real estate taxes and mortgage interest.

Hispanic male photographer using a digital camera takes pictures during the new computer giveaway event for sixth grade students at Elizabeth Virrick Park auditorium sponsored by Elevate Miami, a program designed to prepare citizens of Miami for leadership position in the global economy, Coconut Grove, Miami, FL

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This concludes the third article in the Tax Tips for Stock Photographers series. Stay tuned for future articles by our friend and colleague from New York. Julian Block, an attorney in Larchmont, New York, has been cited as a “leading tax professional” (New York Times), “an accomplished writer on taxes” (Wall Street Journal), and “an authority on tax planning” (Financial Planning Magazine). The information in the above article is excerpted from Tax Tips for Small Businesses: Savvy Ways for Writers, Photographers, Artists and Other Freelancers to Trim Taxes to the Legal Minimum, praised by law professor James E. Maule of Villanova University as “An easy-to-read and well-organized explanation of the tax rules. Business owners would be well advised to buy this book.” For more of Julian’s articles and to order his books, please visit julianblocktaxexpert.com. Copyright 2009 Julian Block. All rights reserved.

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