There is a right and wrong way to do things.
This recently became clear to me when I helped two family child care providers. They were being audited about depreciation deductions claimed on their household items.
It’s important to understand that you are entitled to claim depreciation deductions on household items that you purchased before your business began.
You should depreciate each item based on the lower amount of the purchase price or the value of the item at the time it was first used in your business.
This includes couches, tables, chairs, beds, freezer, refrigerator, washer/dryer, desk, lamps, rugs, and so on. It also includes smaller items such as pots and pans, bedding, towels, pictures on the wall, garden hose, tools, etc.
The IRS Child Care Provider Audit Technique Guide is clear: “For many providers, when they start their business many items that were personal use only are used in the business. They are entitled to depreciate the business use portion of those assets.”
All child care providers should do an inventory of these items. See my article: “Conduct a Household Inventory to Save Money”.
Here’s the right and wrong way to do this.
The Right Way
When Cathy Alcantara began her business in 1998 she did a comprehensive inventory of 157 household items and estimated their total value at $37,670. She typed out each item on a spreadsheet. She didn’t have receipts because the items were purchased before she thought about using them in a business. Instead, she took pictures of the items. The IRS auditor was willing to allow her to deduct only 20% of these items. We appealed to Tax Court.
At first the IRS lawyer questioned two of her items (pictures on a wall and a fake Christmas tree). I told her that the pictures were used to help create a home environment and that the daycare children put ornaments on the Christmas tree. In the end, all of her 157 items were allowed to be depreciated. See my article on this case.
The Wrong Way
Later, another family child care provider called me about being audited on her depreciation of household items. This provider had two pieces of paper written in pencil. Some of the words had been crossed out or erased. She listed about 20 items and said their value was over $157,000. She said her piano was worth $20,000, her china closet was worth $10,000, her paintings were worth thousands of dollars, and so on. She didn’t have receipts or pictures.
I asked her how she came up with these values. She said her tax preparer told her to “go wild” in her estimates. She admitted that her values did not represent what they were worth. I told her to re-estimate their value based on what someone would pay for them at the time her business began. A few days later she called me back and gave me a new estimate of about $20,000. Ultimately, the IRS accepted her lower values.
It is always a good idea to claim depreciation on your household items. It can represent a significant tax savings. For example, if your items are worth $10,000 and your Time-Space Percentage is 40%, you will get a tax deduction of about $570 each year for seven years ($10,000 x 40% = $4,000 divided by 7 years = $570).
Just be reasonable about estimating the value of your items!
Tom Copeland – www.tomcopelandblog.com
Image credit: homeofyourown.com