Depreciation

A. Your house and items in your house that are used at all in your business are being worn out at a faster rate than if you were not doing family child care. As a result, you can deduct, or depreciate, a portion of the cost of these items as business expenses.

B. Items that are used for business purposes and are expected to last more than 1 year should be expensed over several years, under the rules of depreciation. The area of depreciation is one of the most confusing and complex areas of the tax law.

C. Any provider who plans to prepare their own tax return should obtain a copy of IRS Publication 587 (Business Use of Your Home) and Publication 534 (Depreciation). These publications can be ordered by calling the IRS at 1-800-829-3676.

D. As a general rule of thumb, the IRS will allow taxpayers to expense in one-year items that cost less than $2,500, but only if a special election is made when you file your tax return, and if you have adopted an accounting policy in your business to expense such items. Items that must be depreciated fall into one of seven distinct categories, and each category has its own depreciation rules. Depreciation expenses are claimed on Form 4562. 

E. There is a special rule allowing a deduction for the full cost of the business portion of assets purchased during the year (Section 179 expense). Under this rule, if an asset is used more than 50% in child care; the provider can elect to claim the depreciation deduction for the entire business use portion in the year of purchase. For example, if a provider purchases a play structure for $1,000 and it is used 80% for child care and 20% for personal purposes, the provider can elect to claim all of the $800 depreciation deduction for the business portion of the cost in the year of purchase rather than claiming it over a seven year period. However, if the provider claims the expense in the first year, and quits using the item for child care before the end of it’s tax life (seven years in this example) a portion of the expense claimed in the first year will have to be recaptured.

F. For tax year 2016 through 2019, there is a special rule allowing taxpayers to deduct up to 50% of the business use portion of the cost of a new depreciable item purchased during the year. For example, if you purchased a couch for $1,000 that was used 40% for business, you could claim bonus depreciation of $200 in 2016 (1,000 x .4 x 50%).

G. Be aware that if you purchase 40% or more of items that last longer than one year during the last three months of the year, you may not get all the deductions for all of your capital expenses in that year. To avoid this “mid-quarter convention” rule, plan your purchases before October or after December.

H. Calculating how much an asset is used in the business is necessary before you begin depreciating the asset. Some assets, which are purchased and used only for the child-care business, for instance a children’s outdoor play structure, are clearly 100% business.

I. Some assets are purchased with the intent to be used both for business and personal purposes, for example a computer. In the case of this type of asset, you must keep records of business and personal use. At a minimum, you should keep records for a portion of the year to establish an average percent of business use. For example, you might keep notes on the hours the computer is used during the month of April, and calculate the percent of the hours the computer was used for business during that month and use that percentage for the year. Be aware, however, that the more complete and accurate your records are to support your business use, the lower the possibility that the business deduction will be disallowed in an IRS audit.

J. The business use percentage of many assets may be the same as the time-space percentage. Assets that typically fall into this percentage of business use include your home, appliances, furniture, etc.

K. Many child care providers use assets in their business that they owned before they began their child care business. These assets can be depreciated.

  • The value you must use for depreciation purposes is the lower of what you originally paid for the item, or what the item was worth at the time you began using it for business.
    • For example, assume you began your business on January 1, 2016. At that time, you owned a washer and dryer that you will be using in your child care business. The business portion of the washer and dryer may be depreciated. The value you use for the washer and dryer would be the lower of what you paid for the appliances when you originally purchased them, or what they were worth as of January 1, 2016.
  • When a provider commences operations, he/she should prepare a list of all assets to be Aused in the business, and the cost of each item as well as the item’s value on the date the business began.

L. It is extremely important to keep careful records of depreciation claimed on each business asset so gain or loss on the asset can be properly computed in the year when the asset is sold.

M. Appendix 6 is a form that can be used to list the assets used in your business.

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