Making Sense of Depreciation Rules

Update: After further research I have made a change in this article to include land improvements and home improvements as eligible for the new $2,500 rule.

Recent major changes in depreciation rules affecting family child care providers are both welcome and somewhat confusing.

They are welcome because they eliminate the need to depreciate many items, saving providers the headache of record keeping and increasing their current tax deductions. But one of the changes is confusing and it’s not clear how it applies to providers.

Definition of Depreciation

The general rule is that items purchased for your business that last longer than one year and cost more than $200 must be depreciated. That is, instead of deducting the cost in one year you spread the deduction over a number of years to reflect the life of the item.

The new rules have drastically reduced the number of items that you must depreciate.

Categories of Depreciation

Here are the categories of items that are subject to depreciation rules:

Office Equipment (computers, printers, copiers, etc.) If an item individually cost less than $2,500 you can deduct it in one year. Remember to attach a statement to your tax return electing this rule. If an item individually cost more than $2,500 you can deduct it in one year using the 100% bonus depreciation rule.

If you purchased it new or used and use it more than 50% of the time in your business you can use the Section 179 rule and deduct the business portion in one year.

Personal Property (furniture, appliances, playground equipment, etc.) If an item individually cost less than $2,500 you can deduct it in one year. Remember to attach a statement to your tax return electing this rule. If an item individually cost more than $2,500 you can deduct the business portion in one year using the 100% bonus depreciation rule. If you purchased it new or used and use it more than 50% of the time in your business you can use the Section 179 rule and deduct the business portion in one year.

Land Improvement (fence, patio, driveway) If an item individually cost less than $2,500 you can deduct it in one year. Remember to attach a statement to your tax return electing this rule. If it costs more than $2,500 you can deduct the business portion in one year using the 100% bonus depreciation rule.

Home Improvement (remodeling, replacing roof, adding an addition) If an item individually cost less than $2,500 you can deduct it in one year. Remember to attach a statement to your tax return electing this rule. If it costs more than $2,500 you must depreciate it over 39 years. You cannot use the 100% bonus depreciation rule.

Note: See below for a situation where you may be able to deduct home improvements in one year.

Home You cannot use the $2,500 rule or the 100% bonus depreciation rule. You must depreciate your home over 39 years.

Repairs vs. Home Improvements A repair can be deducted in one year, regardless of the cost. A home improvement must be depreciated over 39 years. New IRS rules have expanded the definition of what is a repair vs. a home improvement. Now, under certain circumstances, the following could be considered as repairs: insulation, new windows or doors, new wood/tile floors, remodeling of a basement. Talk to your tax professional about whether your expense is a repair or improvement.

Safe Harbor for Small Taxpayers: Home and Land Improvements

You may be able to deduct home and land improvements in one year under the following conditions: The combination of the cost of home and land improvements and house repairs in one year is the lessor of 2% of the adjusted basis of the home or $10,000. If so deduct in one year.

Adjusted basis of home = purchase price of home, plus home improvements made before and after the business began.

Example: $250,000 purchase price + $50,000 home improvements in the current year = $300,000 x 2% = $6,000.

Therefore, if a provider spent a total of less than $6,000 (the lessor of $6,000 and $10,000) on home and land improvements and house repairs in the current year she would qualify for this rule. If her expenses were $6,500 this rule would not apply and the first $6,000 could not be deducted in one year.

Summary Considerations

• Since most office equipment and personal property items shown above will cost individually less than $2,500 there is no need to depreciate them or the Section 179 rule.

• If you are eligible to use the Section 179 rule, use the 100% bonus depreciation rule. The Section 179 rule allows you to deduct the entire business portion of an item in one year. But, if you use the Section 179 rule and later use the item less than 50% of the time for your business you will have to pay back some of the deductions you claimed.

• If you do spend money on a land or home improvement that costs more then $2,500, check to see if you are eligible to use the Safe Harbor for Small Taxpayers rule and deduct them in one year.

Depreciation is the most complicated area of the tax law! These new changes do make it easier to deduct items, so it's to your benefit to take advantage of them.

I've attached a handout that summarizes these rules that you can share with your tax professional or use in a training workshop.

My Family Child Care Tax Workbook and Organizer has a chapter on depreciation that explains these rules in more detail.

Tom Copeland - www.tomcopelandblog.com 

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