How to Recapture Previously Unclaimed Depreciation!

If you have been in the family child care business for more than two years, is it too late to claim expenses for items you purchased before your business began?

No! Is it too late to claim these expenses even if you have been in business for over 20 years?

No! In a previous article ("The Start-Up Rule: How to Claim Expenses Before Your Business Began"), I explained how you can use the Start-up Rule to claim expenses for items you owned before your business began.

In this article, we will discuss how to use IRS Form 3115 to recapture previously unclaimed depreciation.

Let’s say you started your business in 2008. At that time, you had a house full of items that you started using in your business: furniture, appliances, swing set, fence, toys, silverware, bedding, snow blower, and so on. You probably had hundreds of such items in your home. Once you started using them in your business, you were entitled to start claiming them as business expenses using the rules of depreciation and amortization.

Most family child care providers did not claim these expenses when their businesses began. By not doing so, you lost out on what could have been a substantial deduction that probably would have reduced your taxes.

But it’s not too late to recapture these deductions now! Here’s how.

First, do an inventory of all items you owned in your home before your business began and that you later used in your business. See my article, “It’s Time to do a Household Inventory,” for an explanation on how to do this. Only include items that you are still using in your business in the current year.

Divide your items into two categories:

Individual items costing/valued at $200 or less

Under the Start-Up Rule, you can deduct up to $5,000 of these items in the first year you used them for your business. Any amount over $5,000 must be amortized over 180 months (15 years). For example, you began your business in 20__ and your inventory shows you had $9,000 of items individually valued at $200 or less (as of 20__). (Note: The $9,000 represents the value of these items in 20__ multiplied by your Time-Space Percentage.) You were allowed to deduct $5,000 of this amount on your tax return, but you didn’t.

You can now use IRS Form 3115 and recapture the $5,000 on your current year’s tax return. In addition, you were entitled to amortize the remaining $4,000 over 180 months. If you are filing your tax return nine years after your business began, that means you are entitled to claim 9 years’ worth of deductions, or 108 months of the 180 months. This is equal to $2,400 ($4,000 divided by 180 months x 108 months = $2,400). Add this amount as well to your Form 3115 for a new total of $7,400. You can continue to deduct $267 ($4,000 divided by 180 months x 12 months = $267) on your 2018 tax return and for the next five years.

Individual items costing/valued at more than $200

You were entitled to depreciate these items when your business began, under the depreciation rules in effect in the year you first started using them for your business. Depreciation rules allowed you to depreciate furniture, appliances and play equipment over 7 years, a fence, patio and driveway over 15 years and a home improvement or home over 39 years. (Note: The depreciation rules started to change in 2014, so check with your tax preparer to find out what rules to apply in that year and after.) Let’s say you owned a $500 refrigerator, an $800 table and a $6,000 fence in 2008 and your Time-Space Percentage was 30% for every year since then. You were entitled to claim $56 on your 2008 tax return for the refrigerator and table, but you didn’t. ($500 + $800 = $1,300 x 30% = $390 divided by 7 years = $56*.) But if you use IRS Form 3115 you can recapture all depreciation from 2008 to the current year at once. Because 7 years has passed, you can claim the full $390 of depreciation on this form and deduct it in the current tax year!

You were entitled to claim $120 in depreciation on the fence in 2008, but you didn’t: $6,000 x 30% Time-Space % = $1,800 divided by 15 years = $120*.) If you are filing your 2018 taxes, you have 10 years of depreciation to recapture on Form 3115, or $1,200 ($120 x 10 years). In addition, you can deduct another $120 on Form 4562 as the 11th year depreciation deduction.

Note: Many providers failed to start depreciating their home when their business began. You are always better off depreciating your home! See my article “Should You Depreciate Your Home?” You can also use Form 3115 to recapture home depreciation.

What if you bought something after your business began but did not deduct it in the year your bought it?

If the item cost more than $200, you were entitled to depreciate it, so you can use Form 3115 and recapture any unclaimed depreciation from previous years. If it cost less than $200, you could only recapture this deduction back 3 years by amending your tax return.

Summary

Is all of this worth doing? Recapturing depreciation on a $500 refrigerator may not be worth the effort (or cost of having your tax preparer file Form 3115 for one item). But, you likely have hundreds of such items, valued at thousands of dollars. Therefore, it is probably worth it!

If you use a tax preparer, present your inventory and tell him/her that you want to take advantage of Form 3115. Let your tax preparer do the calculations.

I have a chapter in my Family Child Care Tax Workbook and Organizer on Form 3115 that explains in detail how to fill out this form.

Thanks again to Bill Porter for helping me understand these tax rules. *Actually, depreciation is slightly more complicated. You must apply a half year convention in the first year of depreciation, so your deduction would actually be $28 for the refrigerator and table and $60 for the fence. In later years, you would claim the full $56 and $120 and pick up the last $28 and $60 in the last year of depreciation.

Tom Copeland – www.tomcopelandblog.com

Image credit: https://en.wikipedia.org/wiki/Julia_Child%27s_kitchen#/media/File:Julia_Child%27s_kitchen_by_Matthew_Bisanz.JPG

For more information, see my Family Child Care Tax Workbook and Organizer.