Part 5B: Business and Hobby expenses: Depreciation and expensing revised 5/3/00
Apr 07 '00 (Updated May 03 '00)
(Revised 5/3/00)
This Epinion deals with business and hobby deductions related to depreciation and section 179 expensing. All other business and hobby deductions are in part 5C.
What is depreciation?
Depreciation is a way of accounting for the costs associated with durable goods used in a business. Basically, an expected life is assigned by the IRS, and you deduct the cost of the item over that life. For example, residential real estate (the portion of your house allocated to your business/hobby, or any residential rental property) is depreciated over 27.5 years (40 for the Alternative Minimum Tax (AMT)); other real estate is depreciated over 39 years (40 for AMT); office furniture is depreciated over 7 years (10 for AMT), computers are generally depreciated over 5 years, computer software is generally depreciated over 3 years, etc. (Note also that AMT depreciation schedules may be slower than regular depreciation schedules, even if the depreciation time is the same.) See IRS Publication 946 for more details, and almost all of the information in this epinion.
Only the percentage of the cost corresponding to the percentage of use attributable to deductible purposes can be depreciated; costs attributable to personal use are NEVER deductible or depreciable.
Depreciation starts when the property is acquired and placed in service for deductible purposes -- there are some circumstances in which either can come first.
Durable goods which, in fact, last less than one year can be deducted in full, even if they fall into an IRS class which is depreciable. Tax preparation software in a tax preparation business is a good example.
What is listed property?
This is property subject to special rules for depreciation. It includes automobiles, "...property ... generally used for entertainment, recreation, or amusement" (quote from publication 946), a computer not owned and used exclusively for business purposes by the operator of the business, and cell-phones. If listed property is not used 50% for business, then, even if it is deductible, the AMT depreciation schedules must be used.
Section 179:
Generally, if you have an "active" business (rentals and hobbies do not qualify); if you acquire a total of less than $200,000 in depreciable assets (no problem), you can expense up to $19,000 of total (business/investment) costs of those assets, with the exception of property not used 50% in business. The property must both be placed in service and acquired in the tax year.
This amount is further limited by the total amount of taxable income from "active" businesses, including employment. Any amount limited by this can be carried forward to the next year.
You must make the election to use section 179 on either an original tax return (whether or not timely), an amended return filed by the due date including extensions, or on an amended return filed within 6 months of the due date of a timely filed return (excluding extensions) which does not claim the election. (This last is a special situation, requiring specific wording on the amended return.) Other changes in depreciation are almost never allowed except in the first two instances, or to correct an illegal depreciation rate.
IMHO, you should always use this if you can. However, there may be some problems, as described in the next section.
Depreciation recapture
Generally, if your business/investment use decreases (for an asset expensed under section 179), or if your business use falls below 50%, (for an asset expensed under section 179 or for listed property), you need to recalculate what your depreciation would have been if you had depreciated the reduced percentage instead of expensing it, and add that back to income on form 4797 (sale of business assets).
Final comments
Depreciation is mandatory; whether or not you actually take deduct it, it is subtracted from the basis of the item; if you sell the item, you will be taxed on that amount, so you might as well use it.
Business for Epinionators
1. Your computer
Do you really use your computer over 50% for Epinion (and other business) activities? Even if you include reading Epinions as part of your business activity (an aggressive tactic), I doubt it. If not, the business use of the computer can only be depreciated on the AMT schedule over 5 years, and section 179 expensing is not available.
2. Items purchased for review
This depends on what you do with the item afterwards. If you use it over a period of time for personal activities, it would be difficult to justify a business purpose, even if you continue to update your review. If you sell the item, obviously the depreciation recapture section above applies. If you give to a friend (or an enemy, I suppose), that is considered conversion to personal use. If you donate it to a charity, then it really doesn't matter much whether you depreciated it; you may have both depreciation recapture (income) and a charitable deduction for the same item. Only if you keep the item and do not use it for personal reasons, can you keep the section 179 deduction or continue to depreciate the item.
Added 5/3/2000
If the item is not durable (has an actual expected life of less than one year), and you are buying it for the primary purpose of rating it (either for Epinions, or for future buying decisions), and you dispose of it by normal consumption (i.e., not using it once and donating it to charity, if it can normally be used 10 times), you may be able to deduct a fraction of its cost from your Epinions revenue on 1040 Schedule C.
I was thinking about the question of whether 50% of the cost of a restaurant meal could be deducted if you review the restaurant, and I believe the answer is yes. Just don't get carried away, and say that you have to continually monitor the restaurant's food and service in order to keep the review updated.
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Arthur.Rubin
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Expert in mathematics, computers, income tax, with a wide variety of interests.
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