Have you remodeled your kitchen, bathroom, or downstairs playroom in your home? Added a deck or central air conditioning? Replaced a furnace?
If so, there is good news!
Several recent IRS rules may allow you to deduct these expenses in one year or, at a minimum, allow you to deduct half of the depreciation in the first year. This will boost your tax deductions and make home improvements much more beneficial for family child care providers.
The old rule
For decades a home improvement has been defined as an expense that increases the value of your home. Examples include: replacing windows and doors, adding wood or tile floors, remodeling rooms, adding a deck, or shingling a roof.
Home improvements are depreciated over 39 years. As a result, providers would get only a small deduction each year. For example, if a provider spent $5,000 to remodel her basement play area used exclusively for her business, her annual depreciation deduction would be $128 ($5,000 divided by 39 years). Not a lot.
There are three new rules that may allow you to deduct home improvements in one year, or significantly increase your depreciation deduction for the first year.
Repair or improvement?
A home repair can be deducted in one year, regardless of its cost. In 2014 Congress passed a law that greatly expanded the definition of what can be treated as a repair. Under the new law replacing less than half your windows or doors or bathrooms or flooring (including wood and tile floors) can be treated as a repair!
For example, if you spent $4,000 to replace 5 of the 12 windows in your hone, you can treat this as a repair and deduct it in one year!
If you have previously depreciated items as home improvements in 2014 or 2015 and now realize you could have deducted them as repairs, you can file an amended tax return and get a refund.
See my article: “When is a Home Improvement Now a Repair?”
Safe Harbor Rule for Small Taxpayers
Let’s say you determine that you don’t have a repair and must treat your expense as a home improvement. Before depreciating it over 39 years, find out if you are eligible for the Safe Harbor for Small Taxpayers rule.
This rule says that you can deduct home improvements in one year if the cost of the improvements, plus any house repairs you make in one year is less than 2% of the purchase price of your home.
For example, if your home cost $300,000, then your expenses can’t exceed $6,000 ($300,000 x 2% = $6,000). So, if you spent $5,000 to remodel your basement and spent less than an additional $1,000 on home repairs, you can deduct the $5,000 in one year!
Note: The maximum expenses you can use with this rule is $10,000 ($500,000 home x 2% = $10,000).
This rule also went into effect in 2014 and you can amend your tax return if you qualify for this rule.
See my article: “When Can Your Home/Land Improvements Be Deducted in One Year?”
Now let’s say that you don’t have a repair and don’t qualify for the Safe Harbor for Small Taxpayers rule. Don’t give up!
A new IRS rule for 2016 has expanded the bonus depreciation rule to include eligible items called “qualified improvement property.”
Qualified improvement property is defined as “any improvement to an interior portion of a building which is nonresidential real property” made after the home was first used in your business. It doesn’t include adding an addition to your home or improving the “internal structural framework” of your home.
Improving the internal structural framework of your home means moving internal load bearing walls, columns, girders or beams that are essential to the stability of your home. So, if remodel your basement and put up new walls or tear down existing non load bearing walls you can use this bonus depreciation rule.
For 2016 and 2017 the bonus depreciation rule allows you to deduct 50% of the depreciation in the first year.
For example, let’s say you spent $5,000 to remodel your basement and it doesn’t qualify as a repair or for the Safe Harbor for Small Taxpayers rule. If you use your basement for business and personal purposes, use your Time-Space Percentage to the cost and then apply the 50% bonus depreciation.
Let’s say your Time-Space Percentage is 40%: $5,000 x 40% = $2,000. Deduct half of this the first year ($1,000) and depreciate the remaining $1,000 over 39 years ($25 a year).
Remember, without this new rule you would only be able to deduct $50 a year ($2,000 divided by 39 years).
Home improvements you made to your home before you went into business cannot use the bonus depreciation rule and must be depreciated over 39 years.
See my article: “Bonus Depreciation Rule Explained.”
Depreciation rules are complicated. Here’s what you want to remember:
- If you buy something for less than $2,500 you can deduct it in one year.
- If it costs more than $2,500 you may have a repair or a home improvement.
- If you have a home improvement you may be able to deduct it one year using the Safe Harbor for Small Taxpayer rule.
- You can always use the bonus depreciation rule on a home improvement.
Share this information with your tax preparer to make sure you get the largest deduction possible.
See my article: “Major Changes in Depreciation Rules Benefit Providers!”
Tom Copeland – www.tomcopelandblog.com
Image credit: https://www.flickr.com/photos/steve-wilson/
For more details on how to apply these rules to your 2016 tax return, see my 2016 Family Child Care Tax Workbook and Organizer.