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H rblock com 3. H rblock com   Ordinary or Capital Gain or Loss for Business Property Table of Contents Introduction Topics - This chapter discusses: Useful Items - You may want to see: Section 1231 Gains and LossesNonrecaptured section 1231 losses. H rblock com Depreciation RecaptureSection 1245 Property Section 1250 Property Installment Sales Gifts Transfers at Death Like-Kind Exchanges and Involuntary Conversions Multiple Properties Introduction When you dispose of business property, your taxable gain or loss is usually a section 1231 gain or loss. H rblock com Its treatment as ordinary or capital is determined under rules for section 1231 transactions. H rblock com When you dispose of depreciable property (section 1245 property or section 1250 property) at a gain, you may have to recognize all or part of the gain as ordinary income under the depreciation recapture rules. H rblock com Any remaining gain is a section 1231 gain. H rblock com Topics - This chapter discusses: Section 1231 gains and losses Depreciation recapture Useful Items - You may want to see: Publication 534 Depreciating Property Placed in Service Before 1987 537 Installment Sales 547 Casualties, Disasters and Thefts 551 Basis of Assets 946 How To Depreciate Property Form (and Instructions) 4797 Sales of Business Property See chapter 5 for information about getting publications and forms. H rblock com Section 1231 Gains and Losses Section 1231 gains and losses are the taxable gains and losses from section 1231 transactions (discussed below). H rblock com Their treatment as ordinary or capital depends on whether you have a net gain or a net loss from all your section 1231 transactions. H rblock com If you have a gain from a section 1231 transaction, first determine whether any of the gain is ordinary income under the depreciation recapture rules (explained later). H rblock com Do not take that gain into account as section 1231 gain. H rblock com Section 1231 transactions. H rblock com   The following transactions result in gain or loss subject to section 1231 treatment. H rblock com Sales or exchanges of real property or depreciable personal property. H rblock com This property must be used in a trade or business and held longer than 1 year. H rblock com Generally, property held for the production of rents or royalties is considered to be used in a trade or business. H rblock com Depreciable personal property includes amortizable section 197 intangibles (described in chapter 2 under Other Dispositions). H rblock com Sales or exchanges of leaseholds. H rblock com The leasehold must be used in a trade or business and held longer than 1 year. H rblock com Sales or exchanges of cattle and horses. H rblock com The cattle and horses must be held for draft, breeding, dairy, or sporting purposes and held for 2 years or longer. H rblock com Sales or exchanges of other livestock. H rblock com This livestock does not include poultry. H rblock com It must be held for draft, breeding, dairy, or sporting purposes and held for 1 year or longer. H rblock com Sales or exchanges of unharvested crops. H rblock com The crop and land must be sold, exchanged, or involuntarily converted at the same time and to the same person and the land must be held longer than 1 year. H rblock com You cannot keep any right or option to directly or indirectly reacquire the land (other than a right customarily incident to a mortgage or other security transaction). H rblock com Growing crops sold with a lease on the land, though sold to the same person in the same transaction, are not included. H rblock com Cutting of timber or disposal of timber, coal, or iron ore. H rblock com The cutting or disposal must be treated as a sale, as described in chapter 2 under Timber and Coal and Iron Ore. H rblock com Condemnations. H rblock com The condemned property must have been held longer than 1 year. H rblock com It must be business property or a capital asset held in connection with a trade or business or a transaction entered into for profit, such as investment property. H rblock com It cannot be property held for personal use. H rblock com Casualties and thefts. H rblock com The casualty or theft must have affected business property, property held for the production of rents and royalties, or investment property (such as notes and bonds). H rblock com You must have held the property longer than 1 year. H rblock com However, if your casualty or theft losses are more than your casualty or theft gains, neither the gains nor the losses are taken into account in the section 1231 computation. H rblock com For more information on casualties and thefts, see Publication 547. H rblock com Property for sale to customers. H rblock com   A sale, exchange, or involuntary conversion of property held mainly for sale to customers is not a section 1231 transaction. H rblock com If you will get back all, or nearly all, of your investment in the property by selling it rather than by using it up in your business, it is property held mainly for sale to customers. H rblock com Example. H rblock com You manufacture and sell steel cable, which you deliver on returnable reels that are depreciable property. H rblock com Customers make deposits on the reels, which you refund if the reels are returned within a year. H rblock com If they are not returned, you keep each deposit as the agreed-upon sales price. H rblock com Most reels are returned within the 1-year period. H rblock com You keep adequate records showing depreciation and other charges to the capitalized cost of the reels. H rblock com Under these conditions, the reels are not property held for sale to customers in the ordinary course of your business. H rblock com Any gain or loss resulting from their not being returned may be capital or ordinary, depending on your section 1231 transactions. H rblock com Copyrights. H rblock com    The sale of a copyright, a literary, musical, or artistic composition, or similar property is not a section 1231 transaction if your personal efforts created the property, or if you acquired the property in a way that entitled you to the basis of the previous owner whose personal efforts created it (for example, if you receive the property as a gift). H rblock com The sale of such property results in ordinary income and generally is reported in Part II of Form 4797. H rblock com Treatment as ordinary or capital. H rblock com   To determine the treatment of section 1231 gains and losses, combine all your section 1231 gains and losses for the year. H rblock com If you have a net section 1231 loss, it is ordinary loss. H rblock com If you have a net section 1231 gain, it is ordinary income up to the amount of your nonrecaptured section 1231 losses from previous years. H rblock com The rest, if any, is long-term capital gain. H rblock com Nonrecaptured section 1231 losses. H rblock com   Your nonrecaptured section 1231 losses are your net section 1231 losses for the previous 5 years that have not been applied against a net section 1231 gain. H rblock com Therefore, if in any of your five preceding tax years you had section 1231 losses, a net gain for the current year from the sale of section 1231 assets is ordinary gain to the extent of your prior losses. H rblock com These losses are applied against your net section 1231 gain beginning with the earliest loss in the 5-year period. H rblock com Example. H rblock com In 2013, Ben has a $2,000 net section 1231 gain. H rblock com To figure how much he has to report as ordinary income and long-term capital gain, he must first determine his section 1231 gains and losses from the previous 5-year period. H rblock com From 2008 through 2012 he had the following section 1231 gains and losses. H rblock com Year Amount 2008 -0- 2009 -0- 2010 ($2,500) 2011 -0- 2012 $1,800 Ben uses this information to figure how to report his net section 1231 gain for 2013 as shown below. H rblock com 1) Net section 1231 gain (2013) $2,000 2) Net section 1231 loss (2010) ($2,500)   3) Net section 1231 gain (2012) 1,800   4) Remaining net section 1231 loss from prior 5 years ($700)   5) Gain treated as  ordinary income $700 6) Gain treated as long-term  capital gain $1,300 Depreciation Recapture If you dispose of depreciable or amortizable property at a gain, you may have to treat all or part of the gain (even if otherwise nontaxable) as ordinary income. H rblock com To figure any gain that must be reported as ordinary income, you must keep permanent records of the facts necessary to figure the depreciation or amortization allowed or allowable on your property. H rblock com This includes the date and manner of acquisition, cost or other basis, depreciation or amortization, and all other adjustments that affect basis. H rblock com On property you acquired in a nontaxable exchange or as a gift, your records also must indicate the following information. H rblock com Whether the adjusted basis was figured using depreciation or amortization you claimed on other property. H rblock com Whether the adjusted basis was figured using depreciation or amortization another person claimed. H rblock com Corporate distributions. H rblock com   For information on property distributed by corporations, see Distributions to Shareholders in Publication 542, Corporations. H rblock com General asset accounts. H rblock com   Different rules apply to dispositions of property you depreciated using a general asset account. H rblock com For information on these rules, see Publication 946. H rblock com Section 1245 Property A gain on the disposition of section 1245 property is treated as ordinary income to the extent of depreciation allowed or allowable on the property. H rblock com See Gain Treated as Ordinary Income, later. H rblock com Any gain recognized that is more than the part that is ordinary income from depreciation is a section 1231 gain. H rblock com See Treatment as ordinary or capital under Section 1231 Gains and Losses, earlier. H rblock com Section 1245 property defined. H rblock com   Section 1245 property includes any property that is or has been subject to an allowance for depreciation or amortization and that is any of the following types of property. H rblock com Personal property (either tangible or intangible). H rblock com Other tangible property (except buildings and their structural components) used as any of the following. H rblock com See Buildings and structural components below. H rblock com An integral part of manufacturing, production, or extraction, or of furnishing transportation, communications, electricity, gas, water, or sewage disposal services. H rblock com A research facility in any of the activities in (a). H rblock com A facility in any of the activities in (a) for the bulk storage of fungible commodities (discussed on the next page). H rblock com That part of real property (not included in (2)) with an adjusted basis reduced by (but not limited to) the following. H rblock com Amortization of certified pollution control facilities. H rblock com The section 179 expense deduction. H rblock com Deduction for clean-fuel vehicles and certain refueling property. H rblock com Deduction for capital costs incurred in complying with Environmental Protection Agency sulfur regulations. H rblock com Deduction for certain qualified refinery property. H rblock com Deduction for qualified energy efficient commercial building property. H rblock com Amortization of railroad grading and tunnel bores, if in effect before the repeal by the Revenue Reconciliation Act of 1990. H rblock com (Repealed by Public Law 99-514, Tax Reform Act of 1986, section 242(a). H rblock com ) Certain expenditures for child care facilities if in effect before repeal by Public Law 101-58, Omnibus Budget Reconciliation Act of 1990, section 11801(a)(13) (except with regards to deductions made prior to November 5, 1990). H rblock com Expenditures to remove architectural and transportation barriers to the handicapped and elderly. H rblock com Deduction for qualified tertiary injectant expenses. H rblock com Certain reforestation expenditures. H rblock com Deduction for election to expense qualified advanced mine safety equipment property. H rblock com Single purpose agricultural (livestock) or horticultural structures. H rblock com Storage facilities (except buildings and their structural components) used in distributing petroleum or any primary product of petroleum. H rblock com Any railroad grading or tunnel bore. H rblock com Buildings and structural components. H rblock com   Section 1245 property does not include buildings and structural components. H rblock com The term building includes a house, barn, warehouse, or garage. H rblock com The term structural component includes walls, floors, windows, doors, central air conditioning systems, light fixtures, etc. H rblock com   Do not treat a structure that is essentially machinery or equipment as a building or structural component. H rblock com Also, do not treat a structure that houses property used as an integral part of an activity as a building or structural component if the structure's use is so closely related to the property's use that the structure can be expected to be replaced when the property it initially houses is replaced. H rblock com   The fact that the structure is specially designed to withstand the stress and other demands of the property and cannot be used economically for other purposes indicates it is closely related to the use of the property it houses. H rblock com Structures such as oil and gas storage tanks, grain storage bins, silos, fractionating towers, blast furnaces, basic oxygen furnaces, coke ovens, brick kilns, and coal tipples are not treated as buildings, but as section 1245 property. H rblock com Facility for bulk storage of fungible commodities. H rblock com   This term includes oil or gas storage tanks and grain storage bins. H rblock com Bulk storage means the storage of a commodity in a large mass before it is used. H rblock com For example, if a facility is used to store oranges that have been sorted and boxed, it is not used for bulk storage. H rblock com To be fungible, a commodity must be such that one part may be used in place of another. H rblock com   Stored materials that vary in composition, size, and weight are not fungible. H rblock com Materials are not fungible if one part cannot be used in place of another part and the materials cannot be estimated and replaced by simple reference to weight, measure, and number. H rblock com For example, the storage of different grades and forms of aluminum scrap is not storage of fungible commodities. H rblock com Gain Treated as Ordinary Income The gain treated as ordinary income on the sale, exchange, or involuntary conversion of section 1245 property, including a sale and leaseback transaction, is the lesser of the following amounts. H rblock com The depreciation and amortization allowed or allowable on the property. H rblock com The gain realized on the disposition (the amount realized from the disposition minus the adjusted basis of the property). H rblock com A limit on this amount for gain on like-kind exchanges and involuntary conversions is explained later. H rblock com For any other disposition of section 1245 property, ordinary income is the lesser of (1) earlier or the amount by which its fair market value is more than its adjusted basis. H rblock com See Gifts and Transfers at Death, later. H rblock com Use Part III of Form 4797 to figure the ordinary income part of the gain. H rblock com Depreciation taken on other property or taken by other taxpayers. H rblock com   Depreciation and amortization include the amounts you claimed on the section 1245 property as well as the following depreciation and amortization amounts. H rblock com Amounts you claimed on property you exchanged for, or converted to, your section 1245 property in a like-kind exchange or involuntary conversion. H rblock com Amounts a previous owner of the section 1245 property claimed if your basis is determined with reference to that person's adjusted basis (for example, the donor's depreciation deductions on property you received as a gift). H rblock com Depreciation and amortization. H rblock com   Depreciation and amortization that must be recaptured as ordinary income include (but are not limited to) the following items. H rblock com Ordinary depreciation deductions. H rblock com Any special depreciation allowance you claimed. H rblock com Amortization deductions for all the following costs. H rblock com Acquiring a lease. H rblock com Lessee improvements. H rblock com Certified pollution control facilities. H rblock com Certain reforestation expenses. H rblock com Section 197 intangibles. H rblock com Childcare facility expenses made before 1982, if in effect before the repeal of IRC 188. H rblock com Franchises, trademarks, and trade names acquired before August 11, 1993. H rblock com The section 179 deduction. H rblock com Deductions for all the following costs. H rblock com Removing barriers to the disabled and the elderly. H rblock com Tertiary injectant expenses. H rblock com Depreciable clean-fuel vehicles and refueling property (minus the amount of any recaptured deduction). H rblock com Environmental cleanup costs. H rblock com Certain reforestation expenses. H rblock com Qualified disaster expenses. H rblock com Any basis reduction for the investment credit (minus any basis increase for credit recapture). H rblock com Any basis reduction for the qualified electric vehicle credit (minus any basis increase for credit recapture). H rblock com Example. H rblock com You file your returns on a calendar year basis. H rblock com In February 2011, you bought and placed in service for 100% use in your business a light-duty truck (5-year property) that cost $10,000. H rblock com You used the half-year convention and your MACRS deductions for the truck were $2,000 in 2011 and $3,200 in 2012. H rblock com You did not take the section 179 deduction. H rblock com You sold the truck in May 2013 for $7,000. H rblock com The MACRS deduction in 2013, the year of sale, is $960 (½ of $1,920). H rblock com Figure the gain treated as ordinary income as follows. H rblock com 1) Amount realized $7,000 2) Cost (February 2011) $10,000   3) Depreciation allowed or allowable (MACRS deductions: $2,000 + $3,200 + $960) 6,160   4) Adjusted basis (subtract line 3 from line 2) $3,840 5) Gain realized (subtract line 4 from line 1) $3,160 6) Gain treated as ordinary income (lesser of line 3 or line 5) $3,160 Depreciation on other tangible property. H rblock com   You must take into account depreciation during periods when the property was not used as an integral part of an activity or did not constitute a research or storage facility, as described earlier under Section 1245 property. H rblock com   For example, if depreciation deductions taken on certain storage facilities amounted to $10,000, of which $6,000 is from the periods before their use in a prescribed business activity, you must use the entire $10,000 in determining ordinary income from depreciation. H rblock com Depreciation allowed or allowable. H rblock com   The greater of the depreciation allowed or allowable is generally the amount to use in figuring the part of gain to report as ordinary income. H rblock com However, if in prior years, you have consistently taken proper deductions under one method, the amount allowed for your prior years will not be increased even though a greater amount would have been allowed under another proper method. H rblock com If you did not take any deduction at all for depreciation, your adjustments to basis for depreciation allowable are figured by using the straight line method. H rblock com   This treatment applies only when figuring what part of gain is treated as ordinary income under the rules for section 1245 depreciation recapture. H rblock com Multiple asset accounts. H rblock com   In figuring ordinary income from depreciation, you can treat any number of units of section 1245 property in a single depreciation account as one item if the total ordinary income from depreciation figured by using this method is not less than it would be if depreciation on each unit were figured separately. H rblock com Example. H rblock com In one transaction you sold 50 machines, 25 trucks, and certain other property that is not section 1245 property. H rblock com All of the depreciation was recorded in a single depreciation account. H rblock com After dividing the total received among the various assets sold, you figured that each unit of section 1245 property was sold at a gain. H rblock com You can figure the ordinary income from depreciation as if the 50 machines and 25 trucks were one item. H rblock com However, if five of the trucks had been sold at a loss, only the 50 machines and 20 of the trucks could be treated as one item in determining the ordinary income from depreciation. H rblock com Normal retirement. H rblock com   The normal retirement of section 1245 property in multiple asset accounts does not require recognition of gain as ordinary income from depreciation if your method of accounting for asset retirements does not require recognition of that gain. H rblock com Section 1250 Property Gain on the disposition of section 1250 property is treated as ordinary income to the extent of additional depreciation allowed or allowable on the property. H rblock com To determine the additional depreciation on section 1250 property, see Additional Depreciation, below. H rblock com Section 1250 property defined. H rblock com   This includes all real property that is subject to an allowance for depreciation and that is not and never has been section 1245 property. H rblock com It includes a leasehold of land or section 1250 property subject to an allowance for depreciation. H rblock com A fee simple interest in land is not included because it is not depreciable. H rblock com   If your section 1250 property becomes section 1245 property because you change its use, you can never again treat it as section 1250 property. H rblock com Additional Depreciation If you hold section 1250 property longer than 1 year, the additional depreciation is the actual depreciation adjustments that are more than the depreciation figured using the straight line method. H rblock com For a list of items treated as depreciation adjustments, see Depreciation and amortization under Gain Treated as Ordinary Income, earlier. H rblock com For the treatment of unrecaptured section 1250 gain, see Capital Gains Tax Rate, later. H rblock com If you hold section 1250 property for 1 year or less, all the depreciation is additional depreciation. H rblock com You will not have additional depreciation if any of the following conditions apply to the property disposed of. H rblock com You figured depreciation for the property using the straight line method or any other method that does not result in depreciation that is more than the amount figured by the straight line method; you held the property longer than 1 year; and, if the property was qualified property, you made a timely election not to claim any special depreciation allowance. H rblock com In addition, if the property was in a renewal community, you must not have elected to claim a commercial revitalization deduction for property placed in service before January 1, 2010. H rblock com The property was residential low-income rental property you held for 162/3 years or longer. H rblock com For low-income rental housing on which the special 60-month depreciation for rehabilitation expenses was allowed, the 162/3 years start when the rehabilitated property is placed in service. H rblock com You chose the alternate ACRS method for the property, which was a type of 15-, 18-, or 19-year real property covered by the section 1250 rules. H rblock com The property was residential rental property or nonresidential real property placed in service after 1986 (or after July 31, 1986, if the choice to use MACRS was made); you held it longer than 1 year; and, if the property was qualified property, you made a timely election not to claim any special depreciation allowance. H rblock com These properties are depreciated using the straight line method. H rblock com In addition, if the property was in a renewal community, you must not have elected to claim a commercial revitalization deduction. H rblock com Depreciation taken by other taxpayers or on other property. H rblock com   Additional depreciation includes all depreciation adjustments to the basis of section 1250 property whether allowed to you or another person (as carryover basis property). H rblock com Example. H rblock com Larry Johnson gives his son section 1250 property on which he took $2,000 in depreciation deductions, of which $500 is additional depreciation. H rblock com Immediately after the gift, the son's adjusted basis in the property is the same as his father's and reflects the $500 additional depreciation. H rblock com On January 1 of the next year, after taking depreciation deductions of $1,000 on the property, of which $200 is additional depreciation, the son sells the property. H rblock com At the time of sale, the additional depreciation is $700 ($500 allowed the father plus $200 allowed the son). H rblock com Depreciation allowed or allowable. H rblock com   The greater of depreciation allowed or allowable (to any person who held the property if the depreciation was used in figuring its adjusted basis in your hands) generally is the amount to use in figuring the part of the gain to be reported as ordinary income. H rblock com If you can show that the deduction allowed for any tax year was less than the amount allowable, the lesser figure will be the depreciation adjustment for figuring additional depreciation. H rblock com Retired or demolished property. H rblock com   The adjustments reflected in adjusted basis generally do not include deductions for depreciation on retired or demolished parts of section 1250 property unless these deductions are reflected in the basis of replacement property that is section 1250 property. H rblock com Example. H rblock com A wing of your building is totally destroyed by fire. H rblock com The depreciation adjustments figured in the adjusted basis of the building after the wing is destroyed do not include any deductions for depreciation on the destroyed wing unless it is replaced and the adjustments for depreciation on it are reflected in the basis of the replacement property. H rblock com Figuring straight line depreciation. H rblock com   The useful life and salvage value you would have used to figure straight line depreciation are the same as those used under the depreciation method you actually used. H rblock com If you did not use a useful life under the depreciation method actually used (such as with the units-of-production method) or if you did not take salvage value into account (such as with the declining balance method), the useful life or salvage value for figuring what would have been the straight line depreciation is the useful life and salvage value you would have used under the straight line method. H rblock com   Salvage value and useful life are not used for the ACRS method of depreciation. H rblock com Figure straight line depreciation for ACRS real property by using its 15-, 18-, or 19-year recovery period as the property's useful life. H rblock com   The straight line method is applied without any basis reduction for the investment credit. H rblock com Property held by lessee. H rblock com   If a lessee makes a leasehold improvement, the lease period for figuring what would have been the straight line depreciation adjustments includes all renewal periods. H rblock com This inclusion of the renewal periods cannot extend the lease period taken into account to a period that is longer than the remaining useful life of the improvement. H rblock com The same rule applies to the cost of acquiring a lease. H rblock com   The term renewal period means any period for which the lease may be renewed, extended, or continued under an option exercisable by the lessee. H rblock com However, the inclusion of renewal periods cannot extend the lease by more than two-thirds of the period that was the basis on which the actual depreciation adjustments were allowed. H rblock com Applicable Percentage The applicable percentage used to figure the ordinary income because of additional depreciation depends on whether the real property you disposed of is nonresidential real property, residential rental property, or low-income housing. H rblock com The percentages for these types of real property are as follows. H rblock com Nonresidential real property. H rblock com   For real property that is not residential rental property, the applicable percentage for periods after 1969 is 100%. H rblock com For periods before 1970, the percentage is zero and no ordinary income because of additional depreciation before 1970 will result from its disposition. H rblock com Residential rental property. H rblock com   For residential rental property (80% or more of the gross income is from dwelling units) other than low-income housing, the applicable percentage for periods after 1975 is 100%. H rblock com The percentage for periods before 1976 is zero. H rblock com Therefore, no ordinary income because of additional depreciation before 1976 will result from a disposition of residential rental property. H rblock com Low-income housing. H rblock com    Low-income housing includes all the following types of residential rental property. H rblock com Federally assisted housing projects if the mortgage is insured under section 221(d)(3) or 236 of the National Housing Act or housing financed or assisted by direct loan or tax abatement under similar provisions of state or local laws. H rblock com Low-income rental housing for which a depreciation deduction for rehabilitation expenses was allowed. H rblock com Low-income rental housing held for occupancy by families or individuals eligible to receive subsidies under section 8 of the United States Housing Act of 1937, as amended, or under provisions of state or local laws that authorize similar subsidies for low-income families. H rblock com Housing financed or assisted by direct loan or insured under Title V of the Housing Act of 1949. H rblock com   The applicable percentage for low-income housing is 100% minus 1% for each full month the property was held over 100 full months. H rblock com If you have held low-income housing at least 16 years and 8 months, the percentage is zero and no ordinary income will result from its disposition. H rblock com Foreclosure. H rblock com   If low-income housing is disposed of because of foreclosure or similar proceedings, the monthly applicable percentage reduction is figured as if you disposed of the property on the starting date of the proceedings. H rblock com Example. H rblock com On June 1, 2001, you acquired low-income housing property. H rblock com On April 3, 2012 (130 months after the property was acquired), foreclosure proceedings were started on the property and on December 3, 2013 (150 months after the property was acquired), the property was disposed of as a result of the foreclosure proceedings. H rblock com The property qualifies for a reduced applicable percentage because it was held more than 100 full months. H rblock com The applicable percentage reduction is 30% (130 months minus 100 months) rather than 50% (150 months minus 100 months) because it does not apply after April 3, 2012, the starting date of the foreclosure proceedings. H rblock com Therefore, 70% of the additional depreciation is treated as ordinary income. H rblock com Holding period. H rblock com   The holding period used to figure the applicable percentage for low-income housing generally starts on the day after you acquired it. H rblock com For example, if you bought low-income housing on January 1, 1997, the holding period starts on January 2, 1997. H rblock com If you sold it on January 2, 2013, the holding period is exactly 192 full months. H rblock com The applicable percentage for additional depreciation is 8%, or 100% minus 1% for each full month the property was held over 100 full months. H rblock com Holding period for constructed, reconstructed, or erected property. H rblock com   The holding period used to figure the applicable percentage for low-income housing you constructed, reconstructed, or erected starts on the first day of the month it is placed in service in a trade or business, in an activity for the production of income, or in a personal activity. H rblock com Property acquired by gift or received in a tax-free transfer. H rblock com   For low-income housing you acquired by gift or in a tax-free transfer the basis of which is figured by reference to the basis in the hands of the transferor, the holding period for the applicable percentage includes the holding period of the transferor. H rblock com   If the adjusted basis of the property in your hands just after acquiring it is more than its adjusted basis to the transferor just before transferring it, the holding period of the difference is figured as if it were a separate improvement. H rblock com See Low-Income Housing With Two or More Elements, next. H rblock com Low-Income Housing With Two or More Elements If you dispose of low-income housing property that has two or more separate elements, the applicable percentage used to figure ordinary income because of additional depreciation may be different for each element. H rblock com The gain to be reported as ordinary income is the sum of the ordinary income figured for each element. H rblock com The following are the types of separate elements. H rblock com A separate improvement (defined below). H rblock com The basic section 1250 property plus improvements not qualifying as separate improvements. H rblock com The units placed in service at different times before all the section 1250 property is finished. H rblock com For example, this happens when a taxpayer builds an apartment building of 100 units and places 30 units in service (available for renting) on January 4, 2011, 50 on July 18, 2011, and the remaining 20 on January 18, 2012. H rblock com As a result, the apartment house consists of three separate elements. H rblock com The 36-month test for separate improvements. H rblock com   A separate improvement is any improvement (qualifying under The 1-year test, below) added to the capital account of the property, but only if the total of the improvements during the 36-month period ending on the last day of any tax year is more than the greatest of the following amounts. H rblock com Twenty-five percent of the adjusted basis of the property at the start of the first day of the 36-month period, or the first day of the holding period of the property, whichever is later. H rblock com Ten percent of the unadjusted basis (adjusted basis plus depreciation and amortization adjustments) of the property at the start of the period determined in (1). H rblock com $5,000. H rblock com The 1-year test. H rblock com   An addition to the capital account for any tax year (including a short tax year) is treated as an improvement only if the sum of all additions for the year is more than the greater of $2,000 or 1% of the unadjusted basis of the property. H rblock com The unadjusted basis is figured as of the start of that tax year or the holding period of the property, whichever is later. H rblock com In applying the 36-month test, improvements in any one of the 3 years are omitted entirely if the total improvements in that year do not qualify under the 1-year test. H rblock com Example. H rblock com The unadjusted basis of a calendar year taxpayer's property was $300,000 on January 1 of this year. H rblock com During the year, the taxpayer made improvements A, B, and C, which cost $1,000, $600, and $700, respectively. H rblock com The sum of the improvements, $2,300, is less than 1% of the unadjusted basis ($3,000), so the improvements do not satisfy the 1-year test and are not treated as improvements for the 36-month test. H rblock com However, if improvement C had cost $1,500, the sum of these improvements would have been $3,100. H rblock com Then, it would be necessary to apply the 36-month test to figure if the improvements must be treated as separate improvements. H rblock com Addition to the capital account. H rblock com   Any addition to the capital account made after the initial acquisition or completion of the property by you or any person who held the property during a period included in your holding period is to be considered when figuring the total amount of separate improvements. H rblock com   The addition to the capital account of depreciable real property is the gross addition not reduced by amounts attributable to replaced property. H rblock com For example, if a roof with an adjusted basis of $20,000 is replaced by a new roof costing $50,000, the improvement is the gross addition to the account, $50,000, and not the net addition of $30,000. H rblock com The $20,000 adjusted basis of the old roof is no longer reflected in the basis of the property. H rblock com The status of an addition to the capital account is not affected by whether it is treated as a separate property for determining depreciation deductions. H rblock com   Whether an expense is treated as an addition to the capital account may depend on the final disposition of the entire property. H rblock com If the expense item property and the basic property are sold in two separate transactions, the entire section 1250 property is treated as consisting of two distinct properties. H rblock com Unadjusted basis. H rblock com   In figuring the unadjusted basis as of a certain date, include the actual cost of all previous additions to the capital account plus those that did not qualify as separate improvements. H rblock com However, the cost of components retired before that date is not included in the unadjusted basis. H rblock com Holding period. H rblock com   Use the following guidelines for figuring the applicable percentage for property with two or more elements. H rblock com The holding period of a separate element placed in service before the entire section 1250 property is finished starts on the first day of the month that the separate element is placed in service. H rblock com The holding period for each separate improvement qualifying as a separate element starts on the day after the improvement is acquired or, for improvements constructed, reconstructed, or erected, the first day of the month that the improvement is placed in service. H rblock com The holding period for each improvement not qualifying as a separate element takes the holding period of the basic property. H rblock com   If an improvement by itself does not meet the 1-year test (greater of $2,000 or 1% of the unadjusted basis), but it does qualify as a separate improvement that is a separate element (when grouped with other improvements made during the tax year), determine the start of its holding period as follows. H rblock com Use the first day of a calendar month that is closest to the middle of the tax year. H rblock com If there are two first days of a month that are equally close to the middle of the year, use the earlier date. H rblock com Figuring ordinary income attributable to each separate element. H rblock com   Figure ordinary income attributable to each separate element as follows. H rblock com   Step 1. H rblock com Divide the element's additional depreciation after 1975 by the sum of all the elements' additional depreciation after 1975 to determine the percentage used in Step 2. H rblock com   Step 2. H rblock com Multiply the percentage figured in Step 1 by the lesser of the additional depreciation after 1975 for the entire property or the gain from disposition of the entire property (the difference between the fair market value or amount realized and the adjusted basis). H rblock com   Step 3. H rblock com Multiply the result in Step 2 by the applicable percentage for the element. H rblock com Example. H rblock com You sold at a gain of $25,000 low-income housing property subject to the ordinary income rules of section 1250. H rblock com The property consisted of four elements (W, X, Y, and Z). H rblock com Step 1. H rblock com The additional depreciation for each element is: W-$12,000; X-None; Y-$6,000; and Z-$6,000. H rblock com The sum of the additional depreciation for all the elements is $24,000. H rblock com Step 2. H rblock com The depreciation deducted on element X was $4,000 less than it would have been under the straight line method. H rblock com Additional depreciation on the property as a whole is $20,000 ($24,000 − $4,000). H rblock com $20,000 is lower than the $25,000 gain on the sale, so $20,000 is used in Step 2. H rblock com Step 3. H rblock com The applicable percentages to be used in Step 3 for the elements are: W-68%; X-85%; Y-92%; and Z-100%. H rblock com From these facts, the sum of the ordinary income for each element is figured as follows. H rblock com   Step 1 Step 2 Step 3 Ordinary Income W . H rblock com 50 $10,000 68% $ 6,800 X -0- -0- 85% -0- Y . H rblock com 25 5,000 92% 4,600 Z . H rblock com 25 5,000 100% 5,000 Sum of ordinary income of separate elements $16,400 Gain Treated as Ordinary Income To find what part of the gain from the disposition of section 1250 property is treated as ordinary income, follow these steps. H rblock com In a sale, exchange, or involuntary conversion of the property, figure the amount realized that is more than the adjusted basis of the property. H rblock com In any other disposition of the property, figure the fair market value that is more than the adjusted basis. H rblock com Figure the additional depreciation for the periods after 1975. H rblock com Multiply the lesser of (1) or (2) by the applicable percentage, discussed earlier under Applicable Percentage. H rblock com Stop here if this is residential rental property or if (2) is equal to or more than (1). H rblock com This is the gain treated as ordinary income because of additional depreciation. H rblock com Subtract (2) from (1). H rblock com Figure the additional depreciation for periods after 1969 but before 1976. H rblock com Add the lesser of (4) or (5) to the result in (3). H rblock com This is the gain treated as ordinary income because of additional depreciation. H rblock com A limit on the amount treated as ordinary income for gain on like-kind exchanges and involuntary conversions is explained later. H rblock com Use Form 4797, Part III, to figure the ordinary income part of the gain. H rblock com Corporations. H rblock com   Corporations, other than S corporations, must recognize an additional amount as ordinary income on the sale or other disposition of section 1250 property. H rblock com The additional amount treated as ordinary income is 20% of the excess of the amount that would have been ordinary income if the property were section 1245 property over the amount treated as ordinary income under section 1250. H rblock com Report this additional ordinary income on Form 4797, Part III, line 26 (f). H rblock com Installment Sales If you report the sale of property under the installment method, any depreciation recapture under section 1245 or 1250 is taxable as ordinary income in the year of sale. H rblock com This applies even if no payments are received in that year. H rblock com If the gain is more than the depreciation recapture income, report the rest of the gain using the rules of the installment method. H rblock com For this purpose, include the recapture income in your installment sale basis to determine your gross profit on the installment sale. H rblock com If you dispose of more than one asset in a single transaction, you must figure the gain on each asset separately so that it may be properly reported. H rblock com To do this, allocate the selling price and the payments you receive in the year of sale to each asset. H rblock com Report any depreciation recapture income in the year of sale before using the installment method for any remaining gain. H rblock com For a detailed discussion of installment sales, see Publication 537. H rblock com Gifts If you make a gift of depreciable personal property or real property, you do not have to report income on the transaction. H rblock com However, if the person who receives it (donee) sells or otherwise disposes of the property in a disposition subject to recapture, the donee must take into account the depreciation you deducted in figuring the gain to be reported as ordinary income. H rblock com For low-income housing, the donee must take into account the donor's holding period to figure the applicable percentage. H rblock com See Applicable Percentage and its discussion Holding period under Section 1250 Property, earlier. H rblock com Part gift and part sale or exchange. H rblock com   If you transfer depreciable personal property or real property for less than its fair market value in a transaction considered to be partly a gift and partly a sale or exchange and you have a gain because the amount realized is more than your adjusted basis, you must report ordinary income (up to the amount of gain) to recapture depreciation. H rblock com If the depreciation (additional depreciation, if section 1250 property) is more than the gain, the balance is carried over to the transferee to be taken into account on any later disposition of the property. H rblock com However, see Bargain sale to charity, later. H rblock com Example. H rblock com You transferred depreciable personal property to your son for $20,000. H rblock com When transferred, the property had an adjusted basis to you of $10,000 and a fair market value of $40,000. H rblock com You took depreciation of $30,000. H rblock com You are considered to have made a gift of $20,000, the difference between the $40,000 fair market value and the $20,000 sale price to your son. H rblock com You have a taxable gain on the transfer of $10,000 ($20,000 sale price minus $10,000 adjusted basis) that must be reported as ordinary income from depreciation. H rblock com You report $10,000 of your $30,000 depreciation as ordinary income on the transfer of the property, so the remaining $20,000 depreciation is carried over to your son for him to take into account on any later disposition of the property. H rblock com Gift to charitable organization. H rblock com   If you give property to a charitable organization, you figure your deduction for your charitable contribution by reducing the fair market value of the property by the ordinary income and short-term capital gain that would have resulted had you sold the property at its fair market value at the time of the contribution. H rblock com Thus, your deduction for depreciable real or personal property given to a charitable organization does not include the potential ordinary gain from depreciation. H rblock com   You also may have to reduce the fair market value of the contributed property by the long-term capital gain (including any section 1231 gain) that would have resulted had the property been sold. H rblock com For more information, see Giving Property That Has Increased in Value in Publication 526. H rblock com Bargain sale to charity. H rblock com   If you transfer section 1245 or section 1250 property to a charitable organization for less than its fair market value and a deduction for the contribution part of the transfer is allowable, your ordinary income from depreciation is figured under different rules. H rblock com First, figure the ordinary income as if you had sold the property at its fair market value. H rblock com Then, allocate that amount between the sale and the contribution parts of the transfer in the same proportion that you allocated your adjusted basis in the property to figure your gain. H rblock com See Bargain Sale under Gain or Loss From Sales and Exchanges in chapter 1. H rblock com Report as ordinary income the lesser of the ordinary income allocated to the sale or your gain from the sale. H rblock com Example. H rblock com You sold section 1245 property in a bargain sale to a charitable organization and are allowed a deduction for your contribution. H rblock com Your gain on the sale was $1,200, figured by allocating 20% of your adjusted basis in the property to the part sold. H rblock com If you had sold the property at its fair market value, your ordinary income would have been $5,000. H rblock com Your ordinary income is $1,000 ($5,000 × 20%) and your section 1231 gain is $200 ($1,200 – $1,000). H rblock com Transfers at Death When a taxpayer dies, no gain is reported on depreciable personal property or real property transferred to his or her estate or beneficiary. H rblock com For information on the tax liability of a decedent, see Publication 559, Survivors, Executors, and Administrators. H rblock com However, if the decedent disposed of the property while alive and, because of his or her method of accounting or for any other reason, the gain from the disposition is reportable by the estate or beneficiary, it must be reported in the same way the decedent would have had to report it if he or she were still alive. H rblock com Ordinary income due to depreciation must be reported on a transfer from an executor, administrator, or trustee to an heir, beneficiary, or other individual if the transfer is a sale or exchange on which gain is realized. H rblock com Example 1. H rblock com Janet Smith owned depreciable property that, upon her death, was inherited by her son. H rblock com No ordinary income from depreciation is reportable on the transfer, even though the value used for estate tax purposes is more than the adjusted basis of the property to Janet when she died. H rblock com However, if she sold the property before her death and realized a gain and if, because of her method of accounting, the proceeds from the sale are income in respect of a decedent reportable by her son, he must report ordinary income from depreciation. H rblock com Example 2. H rblock com The trustee of a trust created by a will transfers depreciable property to a beneficiary in satisfaction of a specific bequest of $10,000. H rblock com If the property had a value of $9,000 at the date used for estate tax valuation purposes, the $1,000 increase in value to the date of distribution is a gain realized by the trust. H rblock com Ordinary income from depreciation must be reported by the trust on the transfer. H rblock com Like-Kind Exchanges and Involuntary Conversions A like-kind exchange of your depreciable property or an involuntary conversion of the property into similar or related property will not result in your having to report ordinary income from depreciation unless money or property other than like-kind, similar, or related property is also received in the transaction. H rblock com For information on like-kind exchanges and involuntary conversions, see chapter 1. H rblock com Depreciable personal property. H rblock com   If you have a gain from either a like-kind exchange or an involuntary conversion of your depreciable personal property, the amount to be reported as ordinary income from depreciation is the amount figured under the rules explained earlier (see Section 1245 Property), limited to the sum of the following amounts. H rblock com The gain that must be included in income under the rules for like-kind exchanges or involuntary conversions. H rblock com The fair market value of the like-kind, similar, or related property other than depreciable personal property acquired in the transaction. H rblock com Example 1. H rblock com You bought a new machine for $4,300 cash plus your old machine for which you were allowed a $1,360 trade-in. H rblock com The old machine cost you $5,000 two years ago. H rblock com You took depreciation deductions of $3,950. H rblock com Even though you deducted depreciation of $3,950, the $310 gain ($1,360 trade-in allowance minus $1,050 adjusted basis) is not reported because it is postponed under the rules for like-kind exchanges and you received only depreciable personal property in the exchange. H rblock com Example 2. H rblock com You bought office machinery for $1,500 two years ago and deducted $780 depreciation. H rblock com This year a fire destroyed the machinery and you received $1,200 from your fire insurance, realizing a gain of $480 ($1,200 − $720 adjusted basis). H rblock com You choose to postpone reporting gain, but replacement machinery cost you only $1,000. H rblock com Your taxable gain under the rules for involuntary conversions is limited to the remaining $200 insurance payment. H rblock com All your replacement property is depreciable personal property, so your ordinary income from depreciation is limited to $200. H rblock com Example 3. H rblock com A fire destroyed office machinery you bought for $116,000. H rblock com The depreciation deductions were $91,640 and the machinery had an adjusted basis of $24,360. H rblock com You received a $117,000 insurance payment, realizing a gain of $92,640. H rblock com You immediately spent $105,000 of the insurance payment for replacement machinery and $9,000 for stock that qualifies as replacement property and you choose to postpone reporting the gain. H rblock com $114,000 of the $117,000 insurance payment was used to buy replacement property, so the gain that must be included in income under the rules for involuntary conversions is the part not spent, or $3,000. H rblock com The part of the insurance payment ($9,000) used to buy the nondepreciable property (the stock) also must be included in figuring the gain from depreciation. H rblock com The amount you must report as ordinary income on the transaction is $12,000, figured as follows. H rblock com 1) Gain realized on the transaction ($92,640) limited to depreciation ($91,640) $91,640 2) Gain includible in income (amount not spent) 3,000     Plus: fair market value of property other than depreciable personal property (the stock) 9,000 12,000 Amount reportable as ordinary income (lesser of (1) or (2)) $12,000   If, instead of buying $9,000 in stock, you bought $9,000 worth of depreciable personal property similar or related in use to the destroyed property, you would only report $3,000 as ordinary income. H rblock com Depreciable real property. H rblock com   If you have a gain from either a like-kind exchange or involuntary conversion of your depreciable real property, ordinary income from additional depreciation is figured under the rules explained earlier (see Section 1250 Property), limited to the greater of the following amounts. H rblock com The gain that must be reported under the rules for like-kind exchanges or involuntary conversions plus the fair market value of stock bought as replacement property in acquiring control of a corporation. H rblock com The gain you would have had to report as ordinary income from additional depreciation had the transaction been a cash sale minus the cost (or fair market value in an exchange) of the depreciable real property acquired. H rblock com   The ordinary income not reported for the year of the disposition is carried over to the depreciable real property acquired in the like-kind exchange or involuntary conversion as additional depreciation from the property disposed of. H rblock com Further, to figure the applicable percentage of additional depreciation to be treated as ordinary income, the holding period starts over for the new property. H rblock com Example. H rblock com The state paid you $116,000 when it condemned your depreciable real property for public use. H rblock com You bought other real property similar in use to the property condemned for $110,000 ($15,000 for depreciable real property and $95,000 for land). H rblock com You also bought stock for $5,000 to get control of a corporation owning property similar in use to the property condemned. H rblock com You choose to postpone reporting the gain. H rblock com If the transaction had been a sale for cash only, under the rules described earlier, $20,000 would have been reportable as ordinary income because of additional depreciation. H rblock com The ordinary income to be reported is $6,000, which is the greater of the following amounts. H rblock com The gain that must be reported under the rules for involuntary conversions, $1,000 ($116,000 − $115,000) plus the fair market value of stock bought as qualified replacement property, $5,000, for a total of $6,000. H rblock com The gain you would have had to report as ordinary income from additional depreciation ($20,000) had this transaction been a cash sale minus the cost of the depreciable real property bought ($15,000), or $5,000. H rblock com   The ordinary income not reported, $14,000 ($20,000 − $6,000), is carried over to the depreciable real property you bought as additional depreciation. H rblock com Basis of property acquired. H rblock com   If the ordinary income you have to report because of additional depreciation is limited, the total basis of the property you acquired is its fair market value (its cost, if bought to replace property involuntarily converted into money) minus the gain postponed. H rblock com   If you acquired more than one item of property, allocate the total basis among the properties in proportion to their fair market value (their cost, in an involuntary conversion into money). H rblock com However, if you acquired both depreciable real property and other property, allocate the total basis as follows. H rblock com Subtract the ordinary income because of additional depreciation that you do not have to report from the fair market value (or cost) of the depreciable real property acquired. H rblock com Add the fair market value (or cost) of the other property acquired to the result in (1). H rblock com Divide the result in (1) by the result in (2). H rblock com Multiply the total basis by the result in (3). H rblock com This is the basis of the depreciable real property acquired. H rblock com If you acquired more than one item of depreciable real property, allocate this basis amount among the properties in proportion to their fair market value (or cost). H rblock com Subtract the result in (4) from the total basis. H rblock com This is the basis of the other property acquired. H rblock com If you acquired more than one item of other property, allocate this basis amount among the properties in proportion to their fair market value (or cost). H rblock com Example 1. H rblock com In 1988, low-income housing property that you acquired and placed in service in 1983 was destroyed by fire and you received a $90,000 insurance payment. H rblock com The property's adjusted basis was $38,400, with additional depreciation of $14,932. H rblock com On December 1, 1988, you used the insurance payment to acquire and place in service replacement low-income housing property. H rblock com Your realized gain from the involuntary conversion was $51,600 ($90,000 − $38,400). H rblock com You chose to postpone reporting the gain under the involuntary conversion rules. H rblock com Under the rules for depreciation recapture on real property, the ordinary gain was $14,932, but you did not have to report any of it because of the limit for involuntary conversions. H rblock com The basis of the replacement low-income housing property was its $90,000 cost minus the $51,600 gain you postponed, or $38,400. H rblock com The $14,932 ordinary gain you did not report is treated as additional depreciation on the replacement property. H rblock com If you sold the property in 2013, your holding period for figuring the applicable percentage of additional depreciation to report as ordinary income will have begun December 2, 1988, the day after you acquired the property. H rblock com Example 2. H rblock com John Adams received a $90,000 fire insurance payment for depreciable real property (office building) with an adjusted basis of $30,000. H rblock com He uses the whole payment to buy property similar in use, spending $42,000 for depreciable real property and $48,000 for land. H rblock com He chooses to postpone reporting the $60,000 gain realized on the involuntary conversion. H rblock com Of this gain, $10,000 is ordinary income from additional depreciation but is not reported because of the limit for involuntary conversions of depreciable real property. H rblock com The basis of the property bought is $30,000 ($90,000 − $60,000), allocated as follows. H rblock com The $42,000 cost of depreciable real property minus $10,000 ordinary income not reported is $32,000. H rblock com The $48,000 cost of other property (land) plus the $32,000 figured in (1) is $80,000. H rblock com The $32,000 figured in (1) divided by the $80,000 figured in (2) is 0. H rblock com 4. H rblock com The basis of the depreciable real property is $12,000. H rblock com This is the $30,000 total basis multiplied by the 0. H rblock com 4 figured in (3). H rblock com The basis of the other property (land) is $18,000. H rblock com This is the $30,000 total basis minus the $12,000 figured in (4). H rblock com The ordinary income that is not reported ($10,000) is carried over as additional depreciation to the depreciable real property that was bought and may be taxed as ordinary income on a later disposition. H rblock com Multiple Properties If you dispose of depreciable property and other property in one transaction and realize a gain, you must allocate the amount realized between the two types of property in proportion to their respective fair market values to figure the part of your gain to be reported as ordinary income from depreciation. H rblock com Different rules may apply to the allocation of the amount realized on the sale of a business that includes a group of assets. H rblock com See chapter 2. H rblock com In general, if a buyer and seller have adverse interests as to the allocation of the amount realized between the depreciable property and other property, any arm's length agreement between them will establish the allocation. H rblock com In the absence of an agreement, the allocation should be made by taking into account the appropriate facts and circumstances. H rblock com These include, but are not limited to, a comparison between the depreciable property and all the other property being disposed of in the transaction. H rblock com The comparison should take into account all the following facts and circumstances. H rblock com The original cost and reproduction cost of construction, erection, or production. H rblock com The remaining economic useful life. H rblock com The state of obsolescence. H rblock com The anticipated expenditures required to maintain, renovate, or modernize the properties. H rblock com Like-kind exchanges and involuntary conversions. H rblock com   If you dispose of and acquire depreciable personal property and other property (other than depreciable real property) in a like-kind exchange or involuntary conversion, the amount realized is allocated in the following way. H rblock com The amount allocated to the depreciable personal property disposed of is treated as consisting of, first, the fair market value of the depreciable personal property acquired and, second (to the extent of any remaining balance), the fair market value of the other property acquired. H rblock com The amount allocated to the other property disposed of is treated as consisting of the fair market value of all property acquired that has not already been taken into account. H rblock com   If you dispose of and acquire depreciable real property and other property in a like-kind exchange or involuntary conversion, the amount realized is allocated in the following way. H rblock com The amount allocated to each of the three types of property (depreciable real property, depreciable personal property, or other property) disposed of is treated as consisting of, first, the fair market value of that type of property acquired and, second (to the extent of any remaining balance), any excess fair market value of the other types of property acquired. H rblock com If the excess fair market value is more than the remaining balance of the amount realized and is from both of the other two types of property, you can apply the unallocated amount in any manner you choose. H rblock com Example. H rblock com A fire destroyed your property with a total fair market value of $50,000. H rblock com It consisted of machinery worth $30,000 and nondepreciable property worth $20,000. H rblock com You received an insurance payment of $40,000 and immediately used it with $10,000 of your own funds (for a total of $50,000) to buy machinery with a fair market value of $15,000 and nondepreciable property with a fair market value of $35,000. H rblock com The adjusted basis of the destroyed machinery was $5,000 and your depreciation on it was $35,000. H rblock com You choose to postpone reporting your gain from the involuntary conversion. H rblock com You must report $9,000 as ordinary income from depreciation arising from this transaction, figured as follows. H rblock com The $40,000 insurance payment must be allocated between the machinery and the other property destroyed in proportion to the fair market value of each. H rblock com The amount allocated to the machinery is 30,000/50,000 × $40,000, or $24,000. H rblock com The amount allocated to the other property is 20,000/50,000 × $40,000, or $16,000. H rblock com Your gain on the involuntary conversion of the machinery is $24,000 minus $5,000 adjusted basis, or $19,000. H rblock com The $24,000 allocated to the machinery disposed of is treated as consisting of the $15,000 fair market value of the replacement machinery bought and $9,000 of the fair market value of other property bought in the transaction. H rblock com All $16,000 allocated to the other property disposed of is treated as consisting of the fair market value of the other property that was bought. H rblock com Your potential ordinary income from depreciation is $19,000, the gain on the machinery, because it is less than the $35,000 depreciation. H rblock com However, the amount you must report as ordinary income is limited to the $9,000 included in the amount realized for the machinery that represents the fair market value of property other than the depreciable property you bought. H rblock com Prev  Up  Next   Home   More Online Publications
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Page Last Reviewed or Updated: 23-Mar-2014

The H Rblock Com

H rblock com 8. H rblock com   Business Expenses Table of Contents Introduction Useful Items - You may want to see: Bad DebtsAccrual method. H rblock com Cash method. H rblock com Car and Truck ExpensesOffice in the home. H rblock com Methods for Deducting Car and Truck Expenses Reimbursing Your Employees for Expenses Depreciation Employees' PayFringe benefits. H rblock com InsuranceHow to figure the deduction. H rblock com Interest Legal and Professional FeesTax preparation fees. H rblock com Pension Plans Rent Expense Taxes Travel, Meals, and EntertainmentTransportation. H rblock com Taxi, commuter bus, and limousine. H rblock com Baggage and shipping. H rblock com Car or truck. H rblock com Meals and lodging. H rblock com Cleaning. H rblock com Telephone. H rblock com Tips. H rblock com More information. H rblock com Business Use of Your HomeExceptions to exclusive use. H rblock com Other Expenses You Can Deduct Expenses You Cannot Deduct Introduction You can deduct the costs of operating your business. H rblock com These costs are known as business expenses. H rblock com These are costs you do not have to capitalize or include in the cost of goods sold but can deduct in the current year. H rblock com To be deductible, a business expense must be both ordinary and necessary. H rblock com An ordinary expense is one that is common and accepted in your field of business. H rblock com A necessary expense is one that is helpful and appropriate for your business. H rblock com An expense does not have to be indispensable to be considered necessary. H rblock com For more information about the general rules for deducting business expenses, see chapter 1 in Publication 535, Business Expenses. H rblock com If you have an expense that is partly for business and partly personal, separate the personal part from the business part. H rblock com The personal part is not deductible. H rblock com Useful Items - You may want to see: Publication 463 Travel, Entertainment, Gift, and Car Expenses 535 Business Expenses 946 How To Depreciate Property See chapter 12 for information about getting publications and forms. H rblock com Bad Debts If someone owes you money you cannot collect, you have a bad debt. H rblock com There are two kinds of bad debts, business bad debts and nonbusiness bad debts. H rblock com A business bad debt is generally one that comes from operating your trade or business. H rblock com You may be able to deduct business bad debts as an expense on your business tax return. H rblock com Business bad debt. H rblock com   A business bad debt is a loss from the worthlessness of a debt that was either of the following. H rblock com Created or acquired in your business. H rblock com Closely related to your business when it became partly or totally worthless. H rblock com A debt is closely related to your business if your primary motive for incurring the debt is a business reason. H rblock com   Business bad debts are mainly the result of credit sales to customers. H rblock com They can also be the result of loans to suppliers, clients, employees, or distributors. H rblock com Goods and services customers have not paid for are shown in your books as either accounts receivable or notes receivable. H rblock com If you are unable to collect any part of these accounts or notes receivable, the uncollectible part is a business bad debt. H rblock com    You can take a bad debt deduction for these accounts and notes receivable only if the amount you were owed was included in your gross income either for the year the deduction is claimed or for a prior year. H rblock com Accrual method. H rblock com   If you use an accrual method of accounting, you normally report income as you earn it. H rblock com You can take a bad debt deduction for an uncollectible receivable if you have included the uncollectible amount in income. H rblock com Cash method. H rblock com   If you use the cash method of accounting, you normally report income when you receive payment. H rblock com You cannot take a bad debt deduction for amounts owed to you that you have not received and cannot collect if you never included those amounts in income. H rblock com More information. H rblock com   For more information about business bad debts, see chapter 10 in Publication 535. H rblock com Nonbusiness bad debts. H rblock com   All other bad debts are nonbusiness bad debts and are deductible as short-term capital losses on Form 8949 and Schedule D (Form 1040). H rblock com For more information on nonbusiness bad debts, see Publication 550, Investment Income and Expenses. H rblock com Car and Truck Expenses If you use your car or truck in your business, you may be able to deduct the costs of operating and maintaining your vehicle. H rblock com You also may be able to deduct other costs of local transportation and traveling away from home overnight on business. H rblock com You may qualify for a tax credit for qualified plug-in electric vehicles, qualified plug-in electric drive motor vehicles, and alternative motor vehicles you place in service during the year. H rblock com See Form 8936 and Form 8910 for more information. H rblock com Local transportation expenses. H rblock com   Local transportation expenses include the ordinary and necessary costs of all the following. H rblock com Getting from one workplace to another in the course of your business or profession when you are traveling within the city or general area that is your tax home. H rblock com Tax home is defined later. H rblock com Visiting clients or customers. H rblock com Going to a business meeting away from your regular workplace. H rblock com Getting from your home to a temporary workplace when you have one or more regular places of work. H rblock com These temporary workplaces can be either within the area of your tax home or outside that area. H rblock com Local business transportation does not include expenses you have while traveling away from home overnight. H rblock com Those expenses are deductible as travel expenses and are discussed later under Travel, Meals, and Entertainment. H rblock com However, if you use your car while traveling away from home overnight, use the rules in this section to figure your car expense deduction. H rblock com   Generally, your tax home is your regular place of business, regardless of where you maintain your family home. H rblock com It includes the entire city or general area in which your business or work is located. H rblock com Example. H rblock com You operate a printing business out of rented office space. H rblock com You use your van to deliver completed jobs to your customers. H rblock com You can deduct the cost of round-trip transportation between your customers and your print shop. H rblock com    You cannot deduct the costs of driving your car or truck between your home and your main or regular workplace. H rblock com These costs are personal commuting expenses. H rblock com Office in the home. H rblock com   Your workplace can be your home if you have an office in your home that qualifies as your principal place of business. H rblock com For more information, see Business Use of Your Home, later. H rblock com Example. H rblock com You are a graphics designer. H rblock com You operate your business out of your home. H rblock com Your home qualifies as your principal place of business. H rblock com You occasionally have to drive to your clients to deliver your completed work. H rblock com You can deduct the cost of the round-trip transportation between your home and your clients. H rblock com Methods for Deducting Car and Truck Expenses For local transportation or overnight travel by car or truck, you generally can use one of the following methods to figure your expenses. H rblock com Standard mileage rate. H rblock com Actual expenses. H rblock com Standard mileage rate. H rblock com   You may be able to use the standard mileage rate to figure the deductible costs of operating your car, van, pickup, or panel truck for business purposes. H rblock com For 2013, the standard mileage rate is 56. H rblock com 5 cents per mile. H rblock com    If you choose to use the standard mileage rate for a year, you cannot deduct your actual expenses for that year except for business-related parking fees and tolls. H rblock com Choosing the standard mileage rate. H rblock com   If you want to use the standard mileage rate for a car or truck you own, you must choose to use it in the first year the car is available for use in your business. H rblock com In later years, you can choose to use either the standard mileage rate or actual expenses. H rblock com   If you use the standard mileage rate for a car you lease, you must choose to use it for the entire lease period (including renewals). H rblock com Standard mileage rate not allowed. H rblock com   You cannot use the standard mileage rate if you: Operate five or more cars at the same time, Claimed a depreciation deduction using any method other than straight line, for example, ACRS or MACRS, Claimed a section 179 deduction on the car, Claimed the special depreciation allowance on the car, Claimed actual car expenses for a car you leased, or Are a rural mail carrier who received a qualified reimbursement. H rblock com Parking fees and tolls. H rblock com   In addition to using the standard mileage rate, you can deduct any business-related parking fees and tolls. H rblock com (Parking fees you pay to park your car at your place of work are nondeductible commuting expenses. H rblock com ) Actual expenses. H rblock com   If you do not choose to use the standard mileage rate, you may be able to deduct your actual car or truck expenses. H rblock com    If you qualify to use both methods, figure your deduction both ways to see which gives you a larger deduction. H rblock com   Actual car expenses include the costs of the following items. H rblock com Depreciation Lease payments Registration Garage rent Licenses Repairs Gas Oil Tires Insurance Parking fees Tolls   If you use your vehicle for both business and personal purposes, you must divide your expenses between business and personal use. H rblock com You can divide your expenses based on the miles driven for each purpose. H rblock com Example. H rblock com You are the sole proprietor of a flower shop. H rblock com You drove your van 20,000 miles during the year. H rblock com 16,000 miles were for delivering flowers to customers and 4,000 miles were for personal use (including commuting miles). H rblock com You can claim only 80% (16,000 ÷ 20,000) of the cost of operating your van as a business expense. H rblock com More information. H rblock com   For more information about the rules for claiming car and truck expenses, see Publication 463. H rblock com Reimbursing Your Employees for Expenses You generally can deduct the amount you reimburse your employees for car and truck expenses. H rblock com The reimbursement you deduct and the manner in which you deduct it depend in part on whether you reimburse the expenses under an accountable plan or a nonaccountable plan. H rblock com For details, see chapter 11 in Publication 535. H rblock com That chapter explains accountable and nonaccountable plans and tells you whether to report the reimbursement on your employee's Form W-2, Wage and Tax Statement. H rblock com Depreciation If property you acquire to use in your business is expected to last more than 1 year, you generally cannot deduct the entire cost as a business expense in the year you acquire it. H rblock com You must spread the cost over more than 1 tax year and deduct part of it each year on Schedule C. H rblock com This method of deducting the cost of business property is called depreciation. H rblock com The discussion here is brief. H rblock com You will find more information about depreciation in Publication 946. H rblock com What property can be depreciated?   You can depreciate property if it meets all the following requirements. H rblock com It must be property you own. H rblock com It must be used in business or held to produce income. H rblock com You never can depreciate inventory (explained in chapter 2) because it is not held for use in your business. H rblock com It must have a useful life that extends substantially beyond the year it is placed in service. H rblock com It must have a determinable useful life, which means that it must be something that wears out, decays, gets used up, becomes obsolete, or loses its value from natural causes. H rblock com You never can depreciate the cost of land because land does not wear out, become obsolete, or get used up. H rblock com It must not be excepted property. H rblock com This includes property placed in service and disposed of in the same year. H rblock com Repairs. H rblock com    You cannot depreciate repairs and replacements that do not increase the value of your property, make it more useful, or lengthen its useful life. H rblock com You can deduct these amounts on line 21 of Schedule C or line 2 of Schedule C-EZ. H rblock com Depreciation method. H rblock com   The method for depreciating most business and investment property placed in service after 1986 is called the Modified Accelerated Cost Recovery System (MACRS). H rblock com MACRS is discussed in detail in Publication 946. H rblock com Section 179 deduction. H rblock com   You can elect to deduct a limited amount of the cost of certain depreciable property in the year you place the property in service. H rblock com This deduction is known as the “section 179 deduction. H rblock com ” The maximum amount you can elect to deduct during 2013 is generally $500,000 (higher limits apply to certain property). H rblock com See IRC 179(e). H rblock com   This limit is generally reduced by the amount by which the cost of the property placed in service during the tax year exceeds $2 million. H rblock com The total amount of depreciation (including the section 179 deduction) you can take for a passenger automobile you use in your business and first place in service in 2013 is $3,160 ($11,160 if you take the special depreciation allowance for qualified passenger automobiles placed in service in 2013). H rblock com Special rules apply to trucks and vans. H rblock com For more information, see Publication 946. H rblock com It explains what property qualifies for the deduction, what limits apply to the deduction, and when and how to recapture the deduction. H rblock com    Your section 179 election for the cost of any sport utility vehicle (SUV) and certain other vehicles is limited to $25,000. H rblock com For more information, see the Instructions for Form 4562 or Publication 946. H rblock com Listed property. H rblock com   You must follow special rules and recordkeeping requirements when depreciating listed property. H rblock com Listed property is any of the following. H rblock com Most passenger automobiles. H rblock com Most other property used for transportation. H rblock com Any property of a type generally used for entertainment, recreation, or amusement. H rblock com Certain computers and related peripheral equipment. H rblock com   For more information about listed property, see Publication 946. H rblock com Form 4562. H rblock com   Use Form 4562, Depreciation and Amortization, if you are claiming any of the following. H rblock com Depreciation on property placed in service during the current tax year. H rblock com A section 179 deduction. H rblock com Depreciation on any listed property (regardless of when it was placed in service). H rblock com    If you have to use Form 4562, you must file Schedule C. H rblock com You cannot use Schedule C-EZ. H rblock com   Employees' Pay You can generally deduct on Schedule C the pay you give your employees for the services they perform for your business. H rblock com The pay may be in cash, property, or services. H rblock com To be deductible, your employees' pay must be an ordinary and necessary expense and you must pay or incur it in the tax year. H rblock com In addition, the pay must meet both the following tests. H rblock com The pay must be reasonable. H rblock com The pay must be for services performed. H rblock com Chapter 2 in Publication 535 explains and defines these requirements. H rblock com You cannot deduct your own salary or any personal withdrawals you make from your business. H rblock com As a sole proprietor, you are not an employee of the business. H rblock com If you had employees during the year, you must use Schedule C. H rblock com You cannot use Schedule C-EZ. H rblock com Kinds of pay. H rblock com   Some of the ways you may provide pay to your employees are listed below. H rblock com For an explanation of each of these items, see chapter 2 in Publication 535. H rblock com Awards. H rblock com Bonuses. H rblock com Education expenses. H rblock com Fringe benefits (discussed later). H rblock com Loans or advances you do not expect the employee to repay if they are for personal services actually performed. H rblock com Property you transfer to an employee as payment for services. H rblock com Reimbursements for employee business expenses. H rblock com Sick pay. H rblock com Vacation pay. H rblock com Fringe benefits. H rblock com   A fringe benefit is a form of pay for the performance of services. H rblock com The following are examples of fringe benefits. H rblock com Benefits under qualified employee benefit programs. H rblock com Meals and lodging. H rblock com The use of a car. H rblock com Flights on airplanes. H rblock com Discounts on property or services. H rblock com Memberships in country clubs or other social clubs. H rblock com Tickets to entertainment or sporting events. H rblock com   Employee benefit programs include the following. H rblock com Accident and health plans. H rblock com Adoption assistance. H rblock com Cafeteria plans. H rblock com Dependent care assistance. H rblock com Educational assistance. H rblock com Group-term life insurance coverage. H rblock com Welfare benefit funds. H rblock com   You can generally deduct the cost of fringe benefits you provide on your Schedule C in whatever category the cost falls. H rblock com For example, if you allow an employee to use a car or other property you lease, deduct the cost of the lease as a rent or lease expense. H rblock com If you own the property, include your deduction for its cost or other basis as a section 179 deduction or a depreciation deduction. H rblock com    You may be able to exclude all or part of the fringe benefits you provide from your employees' wages. H rblock com For more information about fringe benefits and the exclusion of benefits, see Publication 15-B, Employer's Tax Guide to Fringe Benefits. H rblock com Insurance You can generally deduct premiums you pay for the following kinds of insurance related to your business. H rblock com Fire, theft, flood, or similar insurance. H rblock com Credit insurance that covers losses from business bad debts. H rblock com Group hospitalization and medical insurance for employees, including long-term care insurance. H rblock com Liability insurance. H rblock com Malpractice insurance that covers your personal liability for professional negligence resulting in injury or damage to patients or clients. H rblock com Workers' compensation insurance set by state law that covers any claims for bodily injuries or job-related diseases suffered by employees in your business, regardless of fault. H rblock com Contributions to a state unemployment insurance fund are deductible as taxes if they are considered taxes under state law. H rblock com Overhead insurance that pays for business overhead expenses you have during long periods of disability caused by your injury or sickness. H rblock com Car and other vehicle insurance that covers vehicles used in your business for liability, damages, and other losses. H rblock com If you operate a vehicle partly for personal use, deduct only the part of the insurance premium that applies to the business use of the vehicle. H rblock com If you use the standard mileage rate to figure your car expenses, you cannot deduct any car insurance premiums. H rblock com Life insurance covering your employees if you are not directly or indirectly the beneficiary under the contract. H rblock com Business interruption insurance that pays for lost profits if your business is shut down due to a fire or other cause. H rblock com Nondeductible premiums. H rblock com   You cannot deduct premiums on the following kinds of insurance. H rblock com Self-insurance reserve funds. H rblock com You cannot deduct amounts credited to a reserve set up for self-insurance. H rblock com This applies even if you cannot get business insurance coverage for certain business risks. H rblock com However, your actual losses may be deductible. H rblock com For more information, see Publication 547, Casualties, Disasters, and Thefts. H rblock com Loss of earnings. H rblock com You cannot deduct premiums for a policy that pays for your lost earnings due to sickness or disability. H rblock com However, see item (8) in the previous list. H rblock com Certain life insurance and annuities. H rblock com For contracts issued before June 9, 1997, you cannot deduct the premiums on a life insurance policy covering you, an employee, or any person with a financial interest in your business if you are directly or indirectly a beneficiary of the policy. H rblock com You are included among possible beneficiaries of the policy if the policy owner is obligated to repay a loan from you using the proceeds of the policy. H rblock com A person has a financial interest in your business if the person is an owner or part owner of the business or has lent money to the business. H rblock com For contracts issued after June 8, 1997, you generally cannot deduct the premiums on any life insurance policy, endowment contract, or annuity contract if you are directly or indirectly a beneficiary. H rblock com The disallowance applies without regard to whom the policy covers. H rblock com Insurance to secure a loan. H rblock com If you take out a policy on your life or on the life of another person with a financial interest in your business to get or protect a business loan, you cannot deduct the premiums as a business expense. H rblock com Nor can you deduct the premiums as interest on business loans or as an expense of financing loans. H rblock com In the event of death, the proceeds of the policy are not taxed as income even if they are used to liquidate the debt. H rblock com Self-employed health insurance deduction. H rblock com   You may be able to deduct the amount you paid for medical and dental insurance and qualified long-term care insurance for you and your family. H rblock com How to figure the deduction. H rblock com   Generally, you can use the worksheet in the Form 1040 instructions to figure your deduction. H rblock com However, if any of the following apply, you must use the worksheet in chapter 6 of Publication 535. H rblock com You have more than one source of income subject to self-employment tax. H rblock com You file Form 2555 or Form 2555-EZ (relating to foreign earned income). H rblock com You are using amounts paid for qualified long-term care insurance to figure the deduction. H rblock com Prepayment. H rblock com   You cannot deduct expenses in advance, even if you pay them in advance. H rblock com This rule applies to any expense paid far enough in advance to, in effect, create an asset with a useful life extending substantially beyond the end of the current tax year. H rblock com Example. H rblock com In 2013, you signed a 3-year insurance contract. H rblock com Even though you paid the premiums for 2013, 2014, and 2015 when you signed the contract, you can only deduct the premium for 2013 on your 2013 tax return. H rblock com You can deduct in 2014 and 2015 the premium allocable to those years. H rblock com More information. H rblock com   For more information about deducting insurance, see chapter 6 in Publication 535. H rblock com Interest You can generally deduct as a business expense all interest you pay or accrue during the tax year on debts related to your business. H rblock com Interest relates to your business if you use the proceeds of the loan for a business expense. H rblock com It does not matter what type of property secures the loan. H rblock com You can deduct interest on a debt only if you meet all of the following requirements. H rblock com You are legally liable for that debt. H rblock com Both you and the lender intend that the debt be repaid. H rblock com You and the lender have a true debtor-creditor relationship. H rblock com You cannot deduct on Schedule C or C-EZ the interest you paid on personal loans. H rblock com If a loan is part business and part personal, you must divide the interest between the personal part and the business part. H rblock com Example. H rblock com In 2013, you paid $600 interest on a car loan. H rblock com During 2013, you used the car 60% for business and 40% for personal purposes. H rblock com You are claiming actual expenses on the car. H rblock com You can only deduct $360 (60% × $600) for 2013 on Schedule C or C-EZ. H rblock com The remaining interest of $240 is a nondeductible personal expense. H rblock com More information. H rblock com   For more information about deducting interest, see chapter 4 in Publication 535. H rblock com That chapter explains the following items. H rblock com Interest you can deduct. H rblock com Interest you cannot deduct. H rblock com How to allocate interest between personal and business use. H rblock com When to deduct interest. H rblock com The rules for a below-market interest rate loan. H rblock com (This is generally a loan on which no interest is charged or on which interest is charged at a rate below the applicable federal rate. H rblock com ) Legal and Professional Fees Legal and professional fees, such as fees charged by accountants, that are ordinary and necessary expenses directly related to operating your business are deductible on Schedule C or C-EZ. H rblock com However, you usually cannot deduct legal fees you pay to acquire business assets. H rblock com Add them to the basis of the property. H rblock com If the fees include payments for work of a personal nature (such as making a will), you can take a business deduction only for the part of the fee related to your business. H rblock com The personal part of legal fees for producing or collecting taxable income, doing or keeping your job, or for tax advice may be deductible on Schedule A (Form 1040) if you itemize deductions. H rblock com For more information, see Publication 529, Miscellaneous Deductions. H rblock com Tax preparation fees. H rblock com   You can deduct on Schedule C or C-EZ the cost of preparing that part of your tax return relating to your business as a sole proprietor or statutory employee. H rblock com You can deduct the remaining cost on Schedule A (Form 1040) if you itemize your deductions. H rblock com   You can also deduct on Schedule C or C-EZ the amount you pay or incur in resolving asserted tax deficiencies for your business as a sole proprietor or statutory employee. H rblock com Pension Plans You can set up and maintain the following small business retirement plans for yourself and your employees. H rblock com SEP (Simplified Employee Pension) plans. H rblock com SIMPLE (Savings Incentive Match Plan for Employees) plans. H rblock com Qualified plans (including Keogh or H. H rblock com R. H rblock com 10 plans). H rblock com SEP, SIMPLE, and qualified plans offer you and your employees a tax favored way to save for retirement. H rblock com You can deduct contributions you make to the plan for your employees on line 19 of Schedule C. H rblock com If you are a sole proprietor, you can deduct contributions you make to the plan for yourself on line 28 of Form 1040. H rblock com You can also deduct trustees' fees if contributions to the plan do not cover them. H rblock com Earnings on the contributions are generally tax free until you or your employees receive distributions from the plan. H rblock com You may also be able to claim a tax credit of 50% of the first $1,000 of qualified startup costs if you begin a new qualified defined benefit or defined contribution plan (including a 401(k) plan), SIMPLE plan, or simplified employee pension. H rblock com Under certain plans, employees can have you contribute limited amounts of their before-tax pay to a plan. H rblock com These amounts (and earnings on them) are generally tax free until your employees receive distributions from the plan. H rblock com For more information on retirement plans for small business, see Publication 560, Retirement Plans for Small Business (SEP, SIMPLE, and Qualified Plans). H rblock com Publication 590, Individual Retirement Arrangements (IRAs), discusses other tax favored ways to save for retirement. H rblock com Rent Expense Rent is any amount you pay for the use of property you do not own. H rblock com In general, you can deduct rent as a business expense only if the rent is for property you use in your business. H rblock com If you have or will receive equity in or title to the property, you cannot deduct the rent. H rblock com Unreasonable rent. H rblock com   You cannot take a rental deduction for unreasonable rents. H rblock com Ordinarily, the issue of reasonableness arises only if you and the lessor are related. H rblock com Rent paid to a related person is reasonable if it is the same amount you would pay to a stranger for use of the same property. H rblock com Rent is not unreasonable just because it is figured as a percentage of gross receipts. H rblock com   Related persons include members of your immediate family, including only brothers and sisters (either whole or half), your spouse, ancestors, and lineal descendants. H rblock com For a list of the other related persons, see section 267 of the Internal Revenue Code. H rblock com Rent on your home. H rblock com   If you rent your home and use part of it as your place of business, you may be able to deduct the rent you pay for that part. H rblock com You must meet the requirements for business use of your home. H rblock com For more information, see Business Use of Your Home , later. H rblock com Rent paid in advance. H rblock com   Generally, rent paid in your business is deductible in the year paid or accrued. H rblock com If you pay rent in advance, you can deduct only the amount that applies to your use of the rented property during the tax year. H rblock com You can deduct the rest of your payment only over the period to which it applies. H rblock com More information. H rblock com   For more information about rent, see chapter 3 in Publication 535. H rblock com Taxes You can deduct on Schedule C or C-EZ various federal, state, local, and foreign taxes directly attributable to your business. H rblock com Income taxes. H rblock com   You can deduct on Schedule C or C-EZ a state tax on gross income (as distinguished from net income) directly attributable to your business. H rblock com You can deduct other state and local income taxes on Schedule A (Form 1040) if you itemize your deductions. H rblock com Do not deduct federal income tax. H rblock com Employment taxes. H rblock com   You can deduct the social security, Medicare, and federal unemployment (FUTA) taxes you paid out of your own funds as an employer. H rblock com Employment taxes are discussed briefly in chapter 1. H rblock com You can also deduct payments you made as an employer to a state unemployment compensation fund or to a state disability benefit fund. H rblock com Deduct these payments as taxes. H rblock com Self-employment tax. H rblock com   You can deduct one-half of your self-employment tax on line 27 of Form 1040. H rblock com Self-employment tax is discussed in chapters 1 and 10. H rblock com Personal property tax. H rblock com   You can deduct on Schedule C or C-EZ any tax imposed by a state or local government on personal property used in your business. H rblock com   You can also deduct registration fees for the right to use property within a state or local area. H rblock com Example. H rblock com May and Julius Winter drove their car 7,000 business miles out of a total of 10,000 miles. H rblock com They had to pay $25 for their annual state license tags and $20 for their city registration sticker. H rblock com They also paid $235 in city personal property tax on the car, for a total of $280. H rblock com They are claiming their actual car expenses. H rblock com Because they used the car 70% for business, they can deduct 70% of the $280, or $196, as a business expense. H rblock com Real estate taxes. H rblock com   You can deduct on Schedule C or C-EZ the real estate taxes you pay on your business property. H rblock com Deductible real estate taxes are any state, local, or foreign taxes on real estate levied for the general public welfare. H rblock com The taxing authority must base the taxes on the assessed value of the real estate and charge them uniformly against all property under its jurisdiction. H rblock com   For more information about real estate taxes, see chapter 5 in Publication 535. H rblock com That chapter explains special rules for deducting the following items. H rblock com Taxes for local benefits, such as those for sidewalks, streets, water mains, and sewer lines. H rblock com Real estate taxes when you buy or sell property during the year. H rblock com Real estate taxes if you use an accrual method of accounting and choose to accrue real estate tax related to a definite period ratably over that period. H rblock com Sales tax. H rblock com   Treat any sales tax you pay on a service or on the purchase or use of property as part of the cost of the service or property. H rblock com If the service or the cost or use of the property is a deductible business expense, you can deduct the tax as part of that service or cost. H rblock com If the property is merchandise bought for resale, the sales tax is part of the cost of the merchandise. H rblock com If the property is depreciable, add the sales tax to the basis for depreciation. H rblock com For information on the basis of property, see Publication 551, Basis of Assets. H rblock com    Do not deduct state and local sales taxes imposed on the buyer that you must collect and pay over to the state or local government. H rblock com Do not include these taxes in gross receipts or sales. H rblock com Excise taxes. H rblock com   You can deduct on Schedule C or C-EZ all excise taxes that are ordinary and necessary expenses of carrying on your business. H rblock com Excise taxes are discussed briefly in chapter 1. H rblock com Fuel taxes. H rblock com   Taxes on gasoline, diesel fuel, and other motor fuels you use in your business are usually included as part of the cost of the fuel. H rblock com Do not deduct these taxes as a separate item. H rblock com   You may be entitled to a credit or refund for federal excise tax you paid on fuels used for certain purposes. H rblock com For more information, see Publication 510, Excise Taxes. H rblock com Travel, Meals, and Entertainment This section briefly explains the kinds of travel and entertainment expenses you can deduct on Schedule C or C-EZ. H rblock com Table 8-1. H rblock com When Are Entertainment Expenses Deductible? (Note. H rblock com The following is a summary of the rules for deducting entertainment expenses. H rblock com For more details about these rules, see Publication 463. H rblock com ) General rule You can deduct ordinary and necessary expenses to entertain a client, customer, or employee if the expenses meet the directly-related test or the associated test. H rblock com Definitions Entertainment includes any activity generally considered to provide entertainment, amusement, or recreation, and includes meals provided to a customer or client. H rblock com An ordinary expense is one that is common and accepted in your field of business, trade, or profession. H rblock com A necessary expense is one that is helpful and appropriate, although not necessarily required, for your business. H rblock com Tests to be met Directly-related test Entertainment took place in a clear business setting, or Main purpose of entertainment was the active conduct of business, and You did engage in business with the person during the entertainment period, and You had more than a general expectation of getting income or some other specific business benefit. H rblock com   Associated test Entertainment is associated with your trade or business, and Entertainment directly precedes or follows a substantial business discussion. H rblock com Other rules You cannot deduct the cost of your meal as an entertainment expense if you are claiming the meal as a travel expense. H rblock com You cannot deduct expenses that are lavish or extravagant under the circumstances. H rblock com You generally can deduct only 50% of your unreimbursed entertainment expenses. H rblock com Travel expenses. H rblock com   These are the ordinary and necessary expenses of traveling away from home for your business. H rblock com You are traveling away from home if both the following conditions are met. H rblock com Your duties require you to be away from the general area of your tax home (defined later) substantially longer than an ordinary day's work. H rblock com You need to get sleep or rest to meet the demands of your work while away from home. H rblock com Generally, your tax home is your regular place of business, regardless of where you maintain your family home. H rblock com It includes the entire city or general area in which your business is located. H rblock com See Publication 463 for more information. H rblock com   The following is a brief discussion of the expenses you can deduct. H rblock com Transportation. H rblock com   You can deduct the cost of travel by airplane, train, bus, or car between your home and your business destination. H rblock com Taxi, commuter bus, and limousine. H rblock com   You can deduct fares for these and other types of transportation between the airport or station and your hotel, or between the hotel and your work location away from home. H rblock com Baggage and shipping. H rblock com   You can deduct the cost of sending baggage and sample or display material between your regular and temporary work locations. H rblock com Car or truck. H rblock com   You can deduct the costs of operating and maintaining your vehicle when traveling away from home on business. H rblock com You can deduct actual expenses or the standard mileage rate (discussed earlier under Car and Truck Expenses), as well as business-related tolls and parking. H rblock com If you rent a car while away from home on business, you can deduct only the business-use portion of the expenses. H rblock com Meals and lodging. H rblock com   You can deduct the cost of meals and lodging if your business trip is overnight or long enough that you need to stop for sleep or rest to properly perform your duties. H rblock com In most cases, you can deduct only 50% of your meal expenses. H rblock com Cleaning. H rblock com   You can deduct the costs of dry cleaning and laundry while on your business trip. H rblock com Telephone. H rblock com   You can deduct the cost of business calls while on your business trip, including business communication by fax machine or other communication devices. H rblock com Tips. H rblock com   You can deduct the tips you pay for any expense in this list. H rblock com More information. H rblock com   For more information about travel expenses, see Publication 463. H rblock com Entertainment expenses. H rblock com   You may be able to deduct business-related entertainment expenses for entertaining a client, customer, or employee. H rblock com In most cases, you can deduct only 50% of these expenses. H rblock com   The following are examples of entertainment expenses. H rblock com Entertaining guests at nightclubs, athletic clubs, theaters, or sporting events. H rblock com Providing meals, a hotel suite, or a car to business customers or their families. H rblock com To be deductible, the expenses must meet the rules listed in Table 8-1. H rblock com For details about these rules, see Publication 463. H rblock com Reimbursing your employees for expenses. H rblock com   You generally can deduct the amount you reimburse your employees for travel and entertainment expenses. H rblock com The reimbursement you deduct and the manner in which you deduct it depend in part on whether you reimburse the expenses under an accountable plan or a nonaccountable plan. H rblock com For details, see chapter 11 in Publication 535. H rblock com That chapter explains accountable and nonaccountable plans and tells you whether to report the reimbursement on your employee's Form W-2, Wage and Tax Statement. H rblock com Business Use of Your Home To deduct expenses related to the part of your home used for business, you must meet specific requirements. H rblock com Even then, your deduction may be limited. H rblock com To qualify to claim expenses for business use of your home, you must meet the following tests. H rblock com Your use of the business part of your home must be: Exclusive (however, see Exceptions to exclusive use , later), Regular, For your business, and The business part of your home must be one of the following: Your principal place of business (defined later), A place where you meet or deal with patients, clients, or customers in the normal course of your business, or A separate structure (not attached to your home) you use in connection with your business. H rblock com Exclusive use. H rblock com   To qualify under the exclusive use test, you must use a specific area of your home only for your trade or business. H rblock com The area used for business can be a room or other separately identifiable space. H rblock com The space does not need to be marked off by a permanent partition. H rblock com   You do not meet the requirements of the exclusive use test if you use the area in question both for business and for personal purposes. H rblock com Example. H rblock com You are an attorney and use a den in your home to write legal briefs and prepare clients' tax returns. H rblock com Your family also uses the den for recreation. H rblock com The den is not used exclusively in your profession, so you cannot claim a business deduction for its use. H rblock com Exceptions to exclusive use. H rblock com   You do not have to meet the exclusive use test if you use part of your home in either of the following ways. H rblock com For the storage of inventory or product samples. H rblock com As a daycare facility. H rblock com For an explanation of these exceptions, see Publication 587, Business Use of Your Home (Including Use by Daycare Providers). H rblock com Regular use. H rblock com   To qualify under the regular use test, you must use a specific area of your home for business on a continuing basis. H rblock com You do not meet the test if your business use of the area is only occasional or incidental, even if you do not use that area for any other purpose. H rblock com Principal place of business. H rblock com   You can have more than one business location, including your home, for a single trade or business. H rblock com To qualify to deduct the expenses for the business use of your home under the principal place of business test, your home must be your principal place of business for that business. H rblock com To determine your principal place of business, you must consider all the facts and circumstances. H rblock com   Your home office will qualify as your principal place of business for deducting expenses for its use if you meet the following requirements. H rblock com You use it exclusively and regularly for administrative or management activities of your business. H rblock com You have no other fixed location where you conduct substantial administrative or management activities of your business. H rblock com   Alternatively, if you use your home exclusively and regularly for your business, but your home office does not qualify as your principal place of business based on the previous rules, you determine your principal place of business based on the following factors. H rblock com The relative importance of the activities performed at each location. H rblock com If the relative importance factor does not determine your principal place of business, you can also consider the time spent at each location. H rblock com   If, after considering your business locations, your home cannot be identified as your principal place of business, you cannot deduct home office expenses. H rblock com However, for other ways to qualify to deduct home office expenses, see Publication 587. H rblock com Deduction limit. H rblock com   If your gross income from the business use of your home equals or exceeds your total business expenses (including depreciation), you can deduct all your business expenses related to the use of your home. H rblock com If your gross income from the business use is less than your total business expenses, your deduction for certain expenses for the business use of your home is limited. H rblock com   Your deduction of otherwise nondeductible expenses, such as insurance, utilities, and depreciation (with depreciation taken last), allocable to the business is limited to the gross income from the business use of your home minus the sum of the following. H rblock com The business part of expenses you could deduct even if you did not use your home for business (such as mortgage interest, real estate taxes, and casualty and theft losses that are allowable as itemized deductions on Schedule A (Form 1040)). H rblock com The business expenses that relate to the business activity in the home (for example, business phone, supplies, and depreciation on equipment), but not to the use of the home itself. H rblock com Do not include in (2) above your deduction for one-half of your self-employment tax. H rblock com   Use Form 8829, Expenses for Business Use of Your Home, to figure your deduction. H rblock com New simplified method. H rblock com    The IRS now provides a simplified method to determine your expenses for business use of your home. H rblock com The simplified method is an alternative to calculating and substantiating actual expenses. H rblock com In most cases, you will figure your deduction by multiplying $5 by the area of your home used for a qualified business use. H rblock com The area you use to figure your deduction is limited to 300 square feet. H rblock com For more information, see the Instructions for Schedule C. H rblock com More information. H rblock com   For more information on deducting expenses for the business use of your home, see Publication 587. H rblock com Other Expenses You Can Deduct You may also be able to deduct the following expenses. H rblock com See Publication 535 to find out whether you can deduct them. H rblock com Advertising. H rblock com Bank fees. H rblock com Donations to business organizations. H rblock com Education expenses. H rblock com Energy efficient commercial buildings deduction expenses. H rblock com Impairment-related expenses. H rblock com Interview expense allowances. H rblock com Licenses and regulatory fees. H rblock com Moving machinery. H rblock com Outplacement services. H rblock com Penalties and fines you pay for late performance or nonperformance of a contract. H rblock com Repairs that keep your property in a normal efficient operating condition. H rblock com Repayments of income. H rblock com Subscriptions to trade or professional publications. H rblock com Supplies and materials. H rblock com Utilities. H rblock com Expenses You Cannot Deduct You usually cannot deduct the following as business expenses. H rblock com For more information, see Publication 535. H rblock com Bribes and kickbacks. H rblock com Charitable contributions. H rblock com Demolition expenses or losses. H rblock com Dues to business, social, athletic, luncheon, sporting, airline, and hotel clubs. H rblock com Lobbying expenses. H rblock com Penalties and fines you pay to a governmental agency or instrumentality because you broke the law. H rblock com Personal, living, and family expenses. H rblock com Political contributions. H rblock com Repairs that add to the value of your property or significantly increase its life. H rblock com Prev  Up  Next   Home   More Online Publications