How Do You Claim Expenses for Items You Bought Before Your Business Began?

There are two different tax rules to apply to items you bought before your family child care business began.

Therefore, we must separate these expenses into two categories.

Items Purchased Specifically For the Business (Start-Up Expenses)

The first category of expenses are those items you bought specifically for the business. They could be a fire extinguisher, toys, supplies, curriculum, advertising, training fees, playground equipment, and so on.

You can deduct up to $5,000 of these expenses in the year your business begins. Start-up expenses are those that individually cost less than $2,500 or will last less than one year.

* If your start-up expenses exceed $5,000, you must deduct any amounts above $5,000 over 15 years.

* If you bought an item that cost more than $2,500 and will last longer than one year, you must depreciate it over 15 years once your business begins.

*For example, let's say you bought: $500 toys, $600 curriculum, $1,000 in advertising and $100 in training fees between October and December ($2,200 total). Your business began on January 1st of the next year. You can deduct all of the items because they together cost less than $5,000.

If you bought a $3,500 playground equipment set in December, your total would be $5,700. You would spread the the amount that exceed $5,000 (or $700) over 15 years.

What if You Haven't Depreciated Your Items?

Many providers fail to claim the depreciation they are entitled to. If you did not claim depreciation for household items you owned before you went into business, you can file IRS Form 3115 and recapture all previously unclaimed depreciation on your current tax return. You can also use this form to recapture depreciation on items you bought after you went into business, but didn't depreciate. There is no limit on how far back you can go to recapture this depreciation.

Items Not Purchased Specifically For the Business

The second category of expenses are those items you bought before your business began that were not purchased specifically for your business. They include everything you owned before your business began, then you started using them for your business.

These expenses include: furniture (beds, tables, chairs, sofa), appliances (washer, dryer, freezer, stove, refrigerator, stove, microwave), rugs, lamps, end tables, pots and pans, silverware, television, computer, bedding, pictures on the wall, lawn mower, snow blower, and so on.

These expenses must be depreciated once your business begins. You will depreciate them based on the lower of two numbers: the original price or its fair market value at the time you started using it in your business. In almost every situation this will be the fair market value.

It doesn't matter what the original purchase price or the fair market value was, or if the items were ones that you would normally not depreciate if you purchased them after your business began. Everything must be depreciated.

You can obtain a substantial tax deduction if you conduct an inventory of virtually everything in your home.

For example, let's say you purchased a clock for $25 before your business began and it was not purchased specifically for your business. You would have to depreciate it once your business began. If you bought the same $25 clock after your business began, you would be able to deduct it in one year because it cost less than $2,500.

Special Circumstances

If you made a home improvement before your business began, add the cost of the home improvement to your house and depreciate it as part of your home.

If you made house repairs before your business began and they were done to help you get ready for your business, treat them as Start-Up Expenses. If you made a house repair before your business began that was unrelated to your business, you cannot deduct it.

If you know you are going to have a loss in your first year of your business, you can elect to depreciate over 15 years all of your start-up expenses. See IRS Publication 535 Business Expenses.

* Note: Technically, when I say to depreciate these items, IRS rules say to amortize them. What's the difference? In this case, amortizing means to spread the deduction over 180 months (15 years). It's possible for these months to extend over 15 years. Aren't you glad you know this?

Final Note

I've heard from several family child care providers recently that their tax preparer wouldn't allow them to claim any start-up expenses or depreciate household items they owned before their business began. You may need to insist that you want to claim deductions for both categories of expenses I described above.

If your tax preparer says you can't claim start-up expenses, tell them to read IRS Publication 535 Business Expenses.

If your tax preparer says you can't depreciate household items you owned before your business began, tell them to read the IRS Child Care Provider Audit Techniques Guide. This Guide says: "For many providers, when they start their business many items which were personal use only are used in the business. They are entitled to depreciate the business use portion of those assets. For assets purchased prior to being placed into service, the basis for depreciation is the lower of the cost or the fair market value at the time the asset is placed in service."

Tom Copeland - www.tomcopelandblog.com

Image credit: https://www.pxfuel.com/en/free-photo-oxpfg

For details on how to depreciate items, see my Family Child Care Tax Workbook and Organizer.