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Form 1040

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Form 1040

Form 1040 3. Form 1040   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. Form 1040 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. Form 1040 Its treatment as ordinary or capital is determined under rules for section 1231 transactions. Form 1040 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. Form 1040 Any remaining gain is a section 1231 gain. Form 1040 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. Form 1040 Section 1231 Gains and Losses Section 1231 gains and losses are the taxable gains and losses from section 1231 transactions (discussed below). Form 1040 Their treatment as ordinary or capital depends on whether you have a net gain or a net loss from all your section 1231 transactions. Form 1040 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). Form 1040 Do not take that gain into account as section 1231 gain. Form 1040 Section 1231 transactions. Form 1040   The following transactions result in gain or loss subject to section 1231 treatment. Form 1040 Sales or exchanges of real property or depreciable personal property. Form 1040 This property must be used in a trade or business and held longer than 1 year. Form 1040 Generally, property held for the production of rents or royalties is considered to be used in a trade or business. Form 1040 Depreciable personal property includes amortizable section 197 intangibles (described in chapter 2 under Other Dispositions). Form 1040 Sales or exchanges of leaseholds. Form 1040 The leasehold must be used in a trade or business and held longer than 1 year. Form 1040 Sales or exchanges of cattle and horses. Form 1040 The cattle and horses must be held for draft, breeding, dairy, or sporting purposes and held for 2 years or longer. Form 1040 Sales or exchanges of other livestock. Form 1040 This livestock does not include poultry. Form 1040 It must be held for draft, breeding, dairy, or sporting purposes and held for 1 year or longer. Form 1040 Sales or exchanges of unharvested crops. Form 1040 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. Form 1040 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). Form 1040 Growing crops sold with a lease on the land, though sold to the same person in the same transaction, are not included. Form 1040 Cutting of timber or disposal of timber, coal, or iron ore. Form 1040 The cutting or disposal must be treated as a sale, as described in chapter 2 under Timber and Coal and Iron Ore. Form 1040 Condemnations. Form 1040 The condemned property must have been held longer than 1 year. Form 1040 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. Form 1040 It cannot be property held for personal use. Form 1040 Casualties and thefts. Form 1040 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). Form 1040 You must have held the property longer than 1 year. Form 1040 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. Form 1040 For more information on casualties and thefts, see Publication 547. Form 1040 Property for sale to customers. Form 1040   A sale, exchange, or involuntary conversion of property held mainly for sale to customers is not a section 1231 transaction. Form 1040 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. Form 1040 Example. Form 1040 You manufacture and sell steel cable, which you deliver on returnable reels that are depreciable property. Form 1040 Customers make deposits on the reels, which you refund if the reels are returned within a year. Form 1040 If they are not returned, you keep each deposit as the agreed-upon sales price. Form 1040 Most reels are returned within the 1-year period. Form 1040 You keep adequate records showing depreciation and other charges to the capitalized cost of the reels. Form 1040 Under these conditions, the reels are not property held for sale to customers in the ordinary course of your business. Form 1040 Any gain or loss resulting from their not being returned may be capital or ordinary, depending on your section 1231 transactions. Form 1040 Copyrights. Form 1040    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). Form 1040 The sale of such property results in ordinary income and generally is reported in Part II of Form 4797. Form 1040 Treatment as ordinary or capital. Form 1040   To determine the treatment of section 1231 gains and losses, combine all your section 1231 gains and losses for the year. Form 1040 If you have a net section 1231 loss, it is ordinary loss. Form 1040 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. Form 1040 The rest, if any, is long-term capital gain. Form 1040 Nonrecaptured section 1231 losses. Form 1040   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. Form 1040 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. Form 1040 These losses are applied against your net section 1231 gain beginning with the earliest loss in the 5-year period. Form 1040 Example. Form 1040 In 2013, Ben has a $2,000 net section 1231 gain. Form 1040 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. Form 1040 From 2008 through 2012 he had the following section 1231 gains and losses. Form 1040 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. Form 1040 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. Form 1040 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. Form 1040 This includes the date and manner of acquisition, cost or other basis, depreciation or amortization, and all other adjustments that affect basis. Form 1040 On property you acquired in a nontaxable exchange or as a gift, your records also must indicate the following information. Form 1040 Whether the adjusted basis was figured using depreciation or amortization you claimed on other property. Form 1040 Whether the adjusted basis was figured using depreciation or amortization another person claimed. Form 1040 Corporate distributions. Form 1040   For information on property distributed by corporations, see Distributions to Shareholders in Publication 542, Corporations. Form 1040 General asset accounts. Form 1040   Different rules apply to dispositions of property you depreciated using a general asset account. Form 1040 For information on these rules, see Publication 946. Form 1040 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. Form 1040 See Gain Treated as Ordinary Income, later. Form 1040 Any gain recognized that is more than the part that is ordinary income from depreciation is a section 1231 gain. Form 1040 See Treatment as ordinary or capital under Section 1231 Gains and Losses, earlier. Form 1040 Section 1245 property defined. Form 1040   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. Form 1040 Personal property (either tangible or intangible). Form 1040 Other tangible property (except buildings and their structural components) used as any of the following. Form 1040 See Buildings and structural components below. Form 1040 An integral part of manufacturing, production, or extraction, or of furnishing transportation, communications, electricity, gas, water, or sewage disposal services. Form 1040 A research facility in any of the activities in (a). Form 1040 A facility in any of the activities in (a) for the bulk storage of fungible commodities (discussed on the next page). Form 1040 That part of real property (not included in (2)) with an adjusted basis reduced by (but not limited to) the following. Form 1040 Amortization of certified pollution control facilities. Form 1040 The section 179 expense deduction. Form 1040 Deduction for clean-fuel vehicles and certain refueling property. Form 1040 Deduction for capital costs incurred in complying with Environmental Protection Agency sulfur regulations. Form 1040 Deduction for certain qualified refinery property. Form 1040 Deduction for qualified energy efficient commercial building property. Form 1040 Amortization of railroad grading and tunnel bores, if in effect before the repeal by the Revenue Reconciliation Act of 1990. Form 1040 (Repealed by Public Law 99-514, Tax Reform Act of 1986, section 242(a). Form 1040 ) 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). Form 1040 Expenditures to remove architectural and transportation barriers to the handicapped and elderly. Form 1040 Deduction for qualified tertiary injectant expenses. Form 1040 Certain reforestation expenditures. Form 1040 Deduction for election to expense qualified advanced mine safety equipment property. Form 1040 Single purpose agricultural (livestock) or horticultural structures. Form 1040 Storage facilities (except buildings and their structural components) used in distributing petroleum or any primary product of petroleum. Form 1040 Any railroad grading or tunnel bore. Form 1040 Buildings and structural components. Form 1040   Section 1245 property does not include buildings and structural components. Form 1040 The term building includes a house, barn, warehouse, or garage. Form 1040 The term structural component includes walls, floors, windows, doors, central air conditioning systems, light fixtures, etc. Form 1040   Do not treat a structure that is essentially machinery or equipment as a building or structural component. Form 1040 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. Form 1040   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. Form 1040 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. Form 1040 Facility for bulk storage of fungible commodities. Form 1040   This term includes oil or gas storage tanks and grain storage bins. Form 1040 Bulk storage means the storage of a commodity in a large mass before it is used. Form 1040 For example, if a facility is used to store oranges that have been sorted and boxed, it is not used for bulk storage. Form 1040 To be fungible, a commodity must be such that one part may be used in place of another. Form 1040   Stored materials that vary in composition, size, and weight are not fungible. Form 1040 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. Form 1040 For example, the storage of different grades and forms of aluminum scrap is not storage of fungible commodities. Form 1040 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. Form 1040 The depreciation and amortization allowed or allowable on the property. Form 1040 The gain realized on the disposition (the amount realized from the disposition minus the adjusted basis of the property). Form 1040 A limit on this amount for gain on like-kind exchanges and involuntary conversions is explained later. Form 1040 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. Form 1040 See Gifts and Transfers at Death, later. Form 1040 Use Part III of Form 4797 to figure the ordinary income part of the gain. Form 1040 Depreciation taken on other property or taken by other taxpayers. Form 1040   Depreciation and amortization include the amounts you claimed on the section 1245 property as well as the following depreciation and amortization amounts. Form 1040 Amounts you claimed on property you exchanged for, or converted to, your section 1245 property in a like-kind exchange or involuntary conversion. Form 1040 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). Form 1040 Depreciation and amortization. Form 1040   Depreciation and amortization that must be recaptured as ordinary income include (but are not limited to) the following items. Form 1040 Ordinary depreciation deductions. Form 1040 Any special depreciation allowance you claimed. Form 1040 Amortization deductions for all the following costs. Form 1040 Acquiring a lease. Form 1040 Lessee improvements. Form 1040 Certified pollution control facilities. Form 1040 Certain reforestation expenses. Form 1040 Section 197 intangibles. Form 1040 Childcare facility expenses made before 1982, if in effect before the repeal of IRC 188. Form 1040 Franchises, trademarks, and trade names acquired before August 11, 1993. Form 1040 The section 179 deduction. Form 1040 Deductions for all the following costs. Form 1040 Removing barriers to the disabled and the elderly. Form 1040 Tertiary injectant expenses. Form 1040 Depreciable clean-fuel vehicles and refueling property (minus the amount of any recaptured deduction). Form 1040 Environmental cleanup costs. Form 1040 Certain reforestation expenses. Form 1040 Qualified disaster expenses. Form 1040 Any basis reduction for the investment credit (minus any basis increase for credit recapture). Form 1040 Any basis reduction for the qualified electric vehicle credit (minus any basis increase for credit recapture). Form 1040 Example. Form 1040 You file your returns on a calendar year basis. Form 1040 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. Form 1040 You used the half-year convention and your MACRS deductions for the truck were $2,000 in 2011 and $3,200 in 2012. Form 1040 You did not take the section 179 deduction. Form 1040 You sold the truck in May 2013 for $7,000. Form 1040 The MACRS deduction in 2013, the year of sale, is $960 (½ of $1,920). Form 1040 Figure the gain treated as ordinary income as follows. Form 1040 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. Form 1040   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. Form 1040   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. Form 1040 Depreciation allowed or allowable. Form 1040   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. Form 1040 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. Form 1040 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. Form 1040   This treatment applies only when figuring what part of gain is treated as ordinary income under the rules for section 1245 depreciation recapture. Form 1040 Multiple asset accounts. Form 1040   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. Form 1040 Example. Form 1040 In one transaction you sold 50 machines, 25 trucks, and certain other property that is not section 1245 property. Form 1040 All of the depreciation was recorded in a single depreciation account. Form 1040 After dividing the total received among the various assets sold, you figured that each unit of section 1245 property was sold at a gain. Form 1040 You can figure the ordinary income from depreciation as if the 50 machines and 25 trucks were one item. Form 1040 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. Form 1040 Normal retirement. Form 1040   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. Form 1040 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. Form 1040 To determine the additional depreciation on section 1250 property, see Additional Depreciation, below. Form 1040 Section 1250 property defined. Form 1040   This includes all real property that is subject to an allowance for depreciation and that is not and never has been section 1245 property. Form 1040 It includes a leasehold of land or section 1250 property subject to an allowance for depreciation. Form 1040 A fee simple interest in land is not included because it is not depreciable. Form 1040   If your section 1250 property becomes section 1245 property because you change its use, you can never again treat it as section 1250 property. Form 1040 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. Form 1040 For a list of items treated as depreciation adjustments, see Depreciation and amortization under Gain Treated as Ordinary Income, earlier. Form 1040 For the treatment of unrecaptured section 1250 gain, see Capital Gains Tax Rate, later. Form 1040 If you hold section 1250 property for 1 year or less, all the depreciation is additional depreciation. Form 1040 You will not have additional depreciation if any of the following conditions apply to the property disposed of. Form 1040 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. Form 1040 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. Form 1040 The property was residential low-income rental property you held for 162/3 years or longer. Form 1040 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. Form 1040 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. Form 1040 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. Form 1040 These properties are depreciated using the straight line method. Form 1040 In addition, if the property was in a renewal community, you must not have elected to claim a commercial revitalization deduction. Form 1040 Depreciation taken by other taxpayers or on other property. Form 1040   Additional depreciation includes all depreciation adjustments to the basis of section 1250 property whether allowed to you or another person (as carryover basis property). Form 1040 Example. Form 1040 Larry Johnson gives his son section 1250 property on which he took $2,000 in depreciation deductions, of which $500 is additional depreciation. Form 1040 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. Form 1040 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. Form 1040 At the time of sale, the additional depreciation is $700 ($500 allowed the father plus $200 allowed the son). Form 1040 Depreciation allowed or allowable. Form 1040   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. Form 1040 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. Form 1040 Retired or demolished property. Form 1040   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. Form 1040 Example. Form 1040 A wing of your building is totally destroyed by fire. Form 1040 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. Form 1040 Figuring straight line depreciation. Form 1040   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. Form 1040 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. Form 1040   Salvage value and useful life are not used for the ACRS method of depreciation. Form 1040 Figure straight line depreciation for ACRS real property by using its 15-, 18-, or 19-year recovery period as the property's useful life. Form 1040   The straight line method is applied without any basis reduction for the investment credit. Form 1040 Property held by lessee. Form 1040   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. Form 1040 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. Form 1040 The same rule applies to the cost of acquiring a lease. Form 1040   The term renewal period means any period for which the lease may be renewed, extended, or continued under an option exercisable by the lessee. Form 1040 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. Form 1040 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. Form 1040 The percentages for these types of real property are as follows. Form 1040 Nonresidential real property. Form 1040   For real property that is not residential rental property, the applicable percentage for periods after 1969 is 100%. Form 1040 For periods before 1970, the percentage is zero and no ordinary income because of additional depreciation before 1970 will result from its disposition. Form 1040 Residential rental property. Form 1040   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%. Form 1040 The percentage for periods before 1976 is zero. Form 1040 Therefore, no ordinary income because of additional depreciation before 1976 will result from a disposition of residential rental property. Form 1040 Low-income housing. Form 1040    Low-income housing includes all the following types of residential rental property. Form 1040 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. Form 1040 Low-income rental housing for which a depreciation deduction for rehabilitation expenses was allowed. Form 1040 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. Form 1040 Housing financed or assisted by direct loan or insured under Title V of the Housing Act of 1949. Form 1040   The applicable percentage for low-income housing is 100% minus 1% for each full month the property was held over 100 full months. Form 1040 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. Form 1040 Foreclosure. Form 1040   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. Form 1040 Example. Form 1040 On June 1, 2001, you acquired low-income housing property. Form 1040 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. Form 1040 The property qualifies for a reduced applicable percentage because it was held more than 100 full months. Form 1040 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. Form 1040 Therefore, 70% of the additional depreciation is treated as ordinary income. Form 1040 Holding period. Form 1040   The holding period used to figure the applicable percentage for low-income housing generally starts on the day after you acquired it. Form 1040 For example, if you bought low-income housing on January 1, 1997, the holding period starts on January 2, 1997. Form 1040 If you sold it on January 2, 2013, the holding period is exactly 192 full months. Form 1040 The applicable percentage for additional depreciation is 8%, or 100% minus 1% for each full month the property was held over 100 full months. Form 1040 Holding period for constructed, reconstructed, or erected property. Form 1040   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. Form 1040 Property acquired by gift or received in a tax-free transfer. Form 1040   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. Form 1040   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. Form 1040 See Low-Income Housing With Two or More Elements, next. Form 1040 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. Form 1040 The gain to be reported as ordinary income is the sum of the ordinary income figured for each element. Form 1040 The following are the types of separate elements. Form 1040 A separate improvement (defined below). Form 1040 The basic section 1250 property plus improvements not qualifying as separate improvements. Form 1040 The units placed in service at different times before all the section 1250 property is finished. Form 1040 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. Form 1040 As a result, the apartment house consists of three separate elements. Form 1040 The 36-month test for separate improvements. Form 1040   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. Form 1040 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. Form 1040 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). Form 1040 $5,000. Form 1040 The 1-year test. Form 1040   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. Form 1040 The unadjusted basis is figured as of the start of that tax year or the holding period of the property, whichever is later. Form 1040 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. Form 1040 Example. Form 1040 The unadjusted basis of a calendar year taxpayer's property was $300,000 on January 1 of this year. Form 1040 During the year, the taxpayer made improvements A, B, and C, which cost $1,000, $600, and $700, respectively. Form 1040 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. Form 1040 However, if improvement C had cost $1,500, the sum of these improvements would have been $3,100. Form 1040 Then, it would be necessary to apply the 36-month test to figure if the improvements must be treated as separate improvements. Form 1040 Addition to the capital account. Form 1040   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. Form 1040   The addition to the capital account of depreciable real property is the gross addition not reduced by amounts attributable to replaced property. Form 1040 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. Form 1040 The $20,000 adjusted basis of the old roof is no longer reflected in the basis of the property. Form 1040 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. Form 1040   Whether an expense is treated as an addition to the capital account may depend on the final disposition of the entire property. Form 1040 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. Form 1040 Unadjusted basis. Form 1040   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. Form 1040 However, the cost of components retired before that date is not included in the unadjusted basis. Form 1040 Holding period. Form 1040   Use the following guidelines for figuring the applicable percentage for property with two or more elements. Form 1040 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. Form 1040 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. Form 1040 The holding period for each improvement not qualifying as a separate element takes the holding period of the basic property. Form 1040   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. Form 1040 Use the first day of a calendar month that is closest to the middle of the tax year. Form 1040 If there are two first days of a month that are equally close to the middle of the year, use the earlier date. Form 1040 Figuring ordinary income attributable to each separate element. Form 1040   Figure ordinary income attributable to each separate element as follows. Form 1040   Step 1. Form 1040 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. Form 1040   Step 2. Form 1040 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). Form 1040   Step 3. Form 1040 Multiply the result in Step 2 by the applicable percentage for the element. Form 1040 Example. Form 1040 You sold at a gain of $25,000 low-income housing property subject to the ordinary income rules of section 1250. Form 1040 The property consisted of four elements (W, X, Y, and Z). Form 1040 Step 1. Form 1040 The additional depreciation for each element is: W-$12,000; X-None; Y-$6,000; and Z-$6,000. Form 1040 The sum of the additional depreciation for all the elements is $24,000. Form 1040 Step 2. Form 1040 The depreciation deducted on element X was $4,000 less than it would have been under the straight line method. Form 1040 Additional depreciation on the property as a whole is $20,000 ($24,000 − $4,000). Form 1040 $20,000 is lower than the $25,000 gain on the sale, so $20,000 is used in Step 2. Form 1040 Step 3. Form 1040 The applicable percentages to be used in Step 3 for the elements are: W-68%; X-85%; Y-92%; and Z-100%. Form 1040 From these facts, the sum of the ordinary income for each element is figured as follows. Form 1040   Step 1 Step 2 Step 3 Ordinary Income W . Form 1040 50 $10,000 68% $ 6,800 X -0- -0- 85% -0- Y . Form 1040 25 5,000 92% 4,600 Z . Form 1040 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. Form 1040 In a sale, exchange, or involuntary conversion of the property, figure the amount realized that is more than the adjusted basis of the property. Form 1040 In any other disposition of the property, figure the fair market value that is more than the adjusted basis. Form 1040 Figure the additional depreciation for the periods after 1975. Form 1040 Multiply the lesser of (1) or (2) by the applicable percentage, discussed earlier under Applicable Percentage. Form 1040 Stop here if this is residential rental property or if (2) is equal to or more than (1). Form 1040 This is the gain treated as ordinary income because of additional depreciation. Form 1040 Subtract (2) from (1). Form 1040 Figure the additional depreciation for periods after 1969 but before 1976. Form 1040 Add the lesser of (4) or (5) to the result in (3). Form 1040 This is the gain treated as ordinary income because of additional depreciation. Form 1040 A limit on the amount treated as ordinary income for gain on like-kind exchanges and involuntary conversions is explained later. Form 1040 Use Form 4797, Part III, to figure the ordinary income part of the gain. Form 1040 Corporations. Form 1040   Corporations, other than S corporations, must recognize an additional amount as ordinary income on the sale or other disposition of section 1250 property. Form 1040 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. Form 1040 Report this additional ordinary income on Form 4797, Part III, line 26 (f). Form 1040 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. Form 1040 This applies even if no payments are received in that year. Form 1040 If the gain is more than the depreciation recapture income, report the rest of the gain using the rules of the installment method. Form 1040 For this purpose, include the recapture income in your installment sale basis to determine your gross profit on the installment sale. Form 1040 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. Form 1040 To do this, allocate the selling price and the payments you receive in the year of sale to each asset. Form 1040 Report any depreciation recapture income in the year of sale before using the installment method for any remaining gain. Form 1040 For a detailed discussion of installment sales, see Publication 537. Form 1040 Gifts If you make a gift of depreciable personal property or real property, you do not have to report income on the transaction. Form 1040 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. Form 1040 For low-income housing, the donee must take into account the donor's holding period to figure the applicable percentage. Form 1040 See Applicable Percentage and its discussion Holding period under Section 1250 Property, earlier. Form 1040 Part gift and part sale or exchange. Form 1040   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. Form 1040 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. Form 1040 However, see Bargain sale to charity, later. Form 1040 Example. Form 1040 You transferred depreciable personal property to your son for $20,000. Form 1040 When transferred, the property had an adjusted basis to you of $10,000 and a fair market value of $40,000. Form 1040 You took depreciation of $30,000. Form 1040 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. Form 1040 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. Form 1040 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. Form 1040 Gift to charitable organization. Form 1040   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. Form 1040 Thus, your deduction for depreciable real or personal property given to a charitable organization does not include the potential ordinary gain from depreciation. Form 1040   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. Form 1040 For more information, see Giving Property That Has Increased in Value in Publication 526. Form 1040 Bargain sale to charity. Form 1040   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. Form 1040 First, figure the ordinary income as if you had sold the property at its fair market value. Form 1040 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. Form 1040 See Bargain Sale under Gain or Loss From Sales and Exchanges in chapter 1. Form 1040 Report as ordinary income the lesser of the ordinary income allocated to the sale or your gain from the sale. Form 1040 Example. Form 1040 You sold section 1245 property in a bargain sale to a charitable organization and are allowed a deduction for your contribution. Form 1040 Your gain on the sale was $1,200, figured by allocating 20% of your adjusted basis in the property to the part sold. Form 1040 If you had sold the property at its fair market value, your ordinary income would have been $5,000. Form 1040 Your ordinary income is $1,000 ($5,000 × 20%) and your section 1231 gain is $200 ($1,200 – $1,000). Form 1040 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. Form 1040 For information on the tax liability of a decedent, see Publication 559, Survivors, Executors, and Administrators. Form 1040 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. Form 1040 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. Form 1040 Example 1. Form 1040 Janet Smith owned depreciable property that, upon her death, was inherited by her son. Form 1040 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. Form 1040 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. Form 1040 Example 2. Form 1040 The trustee of a trust created by a will transfers depreciable property to a beneficiary in satisfaction of a specific bequest of $10,000. Form 1040 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. Form 1040 Ordinary income from depreciation must be reported by the trust on the transfer. Form 1040 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. Form 1040 For information on like-kind exchanges and involuntary conversions, see chapter 1. Form 1040 Depreciable personal property. Form 1040   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. Form 1040 The gain that must be included in income under the rules for like-kind exchanges or involuntary conversions. Form 1040 The fair market value of the like-kind, similar, or related property other than depreciable personal property acquired in the transaction. Form 1040 Example 1. Form 1040 You bought a new machine for $4,300 cash plus your old machine for which you were allowed a $1,360 trade-in. Form 1040 The old machine cost you $5,000 two years ago. Form 1040 You took depreciation deductions of $3,950. Form 1040 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. Form 1040 Example 2. Form 1040 You bought office machinery for $1,500 two years ago and deducted $780 depreciation. Form 1040 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). Form 1040 You choose to postpone reporting gain, but replacement machinery cost you only $1,000. Form 1040 Your taxable gain under the rules for involuntary conversions is limited to the remaining $200 insurance payment. Form 1040 All your replacement property is depreciable personal property, so your ordinary income from depreciation is limited to $200. Form 1040 Example 3. Form 1040 A fire destroyed office machinery you bought for $116,000. Form 1040 The depreciation deductions were $91,640 and the machinery had an adjusted basis of $24,360. Form 1040 You received a $117,000 insurance payment, realizing a gain of $92,640. Form 1040 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. Form 1040 $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. Form 1040 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. Form 1040 The amount you must report as ordinary income on the transaction is $12,000, figured as follows. Form 1040 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. Form 1040 Depreciable real property. Form 1040   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. Form 1040 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. Form 1040 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. Form 1040   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. Form 1040 Further, to figure the applicable percentage of additional depreciation to be treated as ordinary income, the holding period starts over for the new property. Form 1040 Example. Form 1040 The state paid you $116,000 when it condemned your depreciable real property for public use. Form 1040 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). Form 1040 You also bought stock for $5,000 to get control of a corporation owning property similar in use to the property condemned. Form 1040 You choose to postpone reporting the gain. Form 1040 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. Form 1040 The ordinary income to be reported is $6,000, which is the greater of the following amounts. Form 1040 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. Form 1040 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. Form 1040   The ordinary income not reported, $14,000 ($20,000 − $6,000), is carried over to the depreciable real property you bought as additional depreciation. Form 1040 Basis of property acquired. Form 1040   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. Form 1040   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). Form 1040 However, if you acquired both depreciable real property and other property, allocate the total basis as follows. Form 1040 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. Form 1040 Add the fair market value (or cost) of the other property acquired to the result in (1). Form 1040 Divide the result in (1) by the result in (2). Form 1040 Multiply the total basis by the result in (3). Form 1040 This is the basis of the depreciable real property acquired. Form 1040 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). Form 1040 Subtract the result in (4) from the total basis. Form 1040 This is the basis of the other property acquired. Form 1040 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). Form 1040 Example 1. Form 1040 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. Form 1040 The property's adjusted basis was $38,400, with additional depreciation of $14,932. Form 1040 On December 1, 1988, you used the insurance payment to acquire and place in service replacement low-income housing property. Form 1040 Your realized gain from the involuntary conversion was $51,600 ($90,000 − $38,400). Form 1040 You chose to postpone reporting the gain under the involuntary conversion rules. Form 1040 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. Form 1040 The basis of the replacement low-income housing property was its $90,000 cost minus the $51,600 gain you postponed, or $38,400. Form 1040 The $14,932 ordinary gain you did not report is treated as additional depreciation on the replacement property. Form 1040 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. Form 1040 Example 2. Form 1040 John Adams received a $90,000 fire insurance payment for depreciable real property (office building) with an adjusted basis of $30,000. Form 1040 He uses the whole payment to buy property similar in use, spending $42,000 for depreciable real property and $48,000 for land. Form 1040 He chooses to postpone reporting the $60,000 gain realized on the involuntary conversion. Form 1040 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. Form 1040 The basis of the property bought is $30,000 ($90,000 − $60,000), allocated as follows. Form 1040 The $42,000 cost of depreciable real property minus $10,000 ordinary income not reported is $32,000. Form 1040 The $48,000 cost of other property (land) plus the $32,000 figured in (1) is $80,000. Form 1040 The $32,000 figured in (1) divided by the $80,000 figured in (2) is 0. Form 1040 4. Form 1040 The basis of the depreciable real property is $12,000. Form 1040 This is the $30,000 total basis multiplied by the 0. Form 1040 4 figured in (3). Form 1040 The basis of the other property (land) is $18,000. Form 1040 This is the $30,000 total basis minus the $12,000 figured in (4). Form 1040 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. Form 1040 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. Form 1040 Different rules may apply to the allocation of the amount realized on the sale of a business that includes a group of assets. Form 1040 See chapter 2. Form 1040 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. Form 1040 In the absence of an agreement, the allocation should be made by taking into account the appropriate facts and circumstances. Form 1040 These include, but are not limited to, a comparison between the depreciable property and all the other property being disposed of in the transaction. Form 1040 The comparison should take into account all the following facts and circumstances. Form 1040 The original cost and reproduction cost of construction, erection, or production. Form 1040 The remaining economic useful life. Form 1040 The state of obsolescence. Form 1040 The anticipated expenditures required to maintain, renovate, or modernize the properties. Form 1040 Like-kind exchanges and involuntary conversions. Form 1040   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. Form 1040 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. Form 1040 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. Form 1040   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. Form 1040 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. Form 1040 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. Form 1040 Example. Form 1040 A fire destroyed your property with a total fair market value of $50,000. Form 1040 It consisted of machinery worth $30,000 and nondepreciable property worth $20,000. Form 1040 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. Form 1040 The adjusted basis of the destroyed machinery was $5,000 and your depreciation on it was $35,000. Form 1040 You choose to postpone reporting your gain from the involuntary conversion. Form 1040 You must report $9,000 as ordinary income from depreciation arising from this transaction, figured as follows. Form 1040 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. Form 1040 The amount allocated to the machinery is 30,000/50,000 × $40,000, or $24,000. Form 1040 The amount allocated to the other property is 20,000/50,000 × $40,000, or $16,000. Form 1040 Your gain on the involuntary conversion of the machinery is $24,000 minus $5,000 adjusted basis, or $19,000. Form 1040 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. Form 1040 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. Form 1040 Your potential ordinary income from depreciation is $19,000, the gain on the machinery, because it is less than the $35,000 depreciation. Form 1040 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. Form 1040 Prev  Up  Next   Home   More Online Publications
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The Form 1040

Form 1040 Publication 587 - Main Content Table of Contents Qualifying for a DeductionExclusive Use Regular Use Trade or Business Use Principal Place of Business Place To Meet Patients, Clients, or Customers Separate Structure Figuring the DeductionUsing Actual Expenses Using the Simplified Method Daycare Facility Standard meal and snack rates. Form 1040 Sale or Exchange of Your HomeGain on Sale Depreciation Basis Adjustment Reporting the Sale More Information Business Furniture and EquipmentListed Property Property Bought for Business Use Personal Property Converted to Business Use Recordkeeping Where To DeductSelf-Employed Persons Employees Partners How To Get Tax HelpLow Income Taxpayer Clinics Worksheet To Figure the Deduction for Business Use of Your HomeInstructions for the Worksheet Worksheets To Figure the Deduction for Business Use of Your Home (Simplified Method) Instructions for the Simplified Method Worksheet Instructions for the Daycare Facility Worksheet Instructions for the Area Adjustment Worksheet Qualifying for a Deduction Generally, you cannot deduct items related to your home, such as mortgage interest, real estate taxes, utilities, maintenance, rent, depreciation, or property insurance, as business expenses. Form 1040 However, you may be able to deduct expenses related to the business use of part of your home if you meet specific requirements. Form 1040 Even then, the deductible amount of these types of expenses may be limited. Form 1040 Use this section and Figure A, later, to decide if you can deduct expenses for the business use of your home. Form 1040 To qualify to deduct expenses for business use of your home, you must use part of your home: Exclusively and regularly as your principal place of business (defined later), Exclusively and regularly as a place where you meet or deal with patients, clients, or customers in the normal course of your trade or business, In the case of a separate structure which is not attached to your home, in connection with your trade or business, On a regular basis for certain storage use (see Storage of inventory or product samples , later), For rental use (see Publication 527), or As a daycare facility (see Daycare Facility , later). Form 1040 Additional tests for employee use. Form 1040   If you are an employee and you use a part of your home for business, you may qualify for a deduction for its business use. Form 1040 You must meet the tests discussed earlier plus: Your business use must be for the convenience of your employer, and You must not rent any part of your home to your employer and use the rented portion to perform services as an employee for that employer. Form 1040 If the use of the home office is merely appropriate and helpful, you cannot deduct expenses for the business use of your home. Form 1040 Exclusive Use To qualify under the exclusive use test, you must use a specific area of your home only for your trade or business. Form 1040 The area used for business can be a room or other separately identifiable space. Form 1040 The space does not need to be marked off by a permanent partition. Form 1040 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. Form 1040 Example. Form 1040 You are an attorney and use a den in your home to write legal briefs and prepare clients' tax returns. Form 1040 Your family also uses the den for recreation. Form 1040 The den is not used exclusively in your trade or business, so you cannot claim a deduction for the business use of the den. Form 1040 Exceptions to Exclusive Use You do not have to meet the exclusive use test if either of the following applies. Form 1040 You use part of your home for the storage of inventory or product samples (discussed next). Form 1040 You use part of your home as a daycare facility, discussed later under Daycare Facility . Form 1040 Note. Form 1040 With the exception of these two uses, any portion of the home used for business purposes must meet the exclusive use test. Form 1040 Storage of inventory or product samples. Form 1040    If you use part of your home for storage of inventory or product samples, you can deduct expenses for the business use of your home without meeting the exclusive use test. Form 1040 However, you must meet all the following tests. Form 1040 You sell products at wholesale or retail as your trade or business. Form 1040 You keep the inventory or product samples in your home for use in your trade or business. Form 1040 Your home is the only fixed location of your trade or business. Form 1040 You use the storage space on a regular basis. Form 1040 The space you use is a separately identifiable space suitable for storage. Form 1040 Example. Form 1040 Your home is the only fixed location of your business of selling mechanics' tools at retail. Form 1040 You regularly use half of your basement for storage of inventory and product samples. Form 1040 You sometimes use the area for personal purposes. Form 1040 The expenses for the storage space are deductible even though you do not use this part of your basement exclusively for business. Form 1040 Regular Use To qualify under the regular use test, you must use a specific area of your home for business on a regular basis. Form 1040 Incidental or occasional business use is not regular use. Form 1040 You must consider all facts and circumstances in determining whether your use is on a regular basis. Form 1040 Trade or Business Use To qualify under the trade-or-business-use test, you must use part of your home in connection with a trade or business. Form 1040 If you use your home for a profit-seeking activity that is not a trade or business, you cannot take a deduction for its business use. Form 1040 Example. Form 1040 You use part of your home exclusively and regularly to read financial periodicals and reports, clip bond coupons, and carry out similar activities related to your own investments. Form 1040 You do not make investments as a broker or dealer. Form 1040 So, your activities are not part of a trade or business and you cannot take a deduction for the business use of your home. Form 1040 Principal Place of Business You can have more than one business location, including your home, for a single trade or business. Form 1040 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 trade or business. Form 1040 To determine whether your home is your principal place of business, you must consider: The relative importance of the activities performed at each place where you conduct business, and The amount of time spent at each place where you conduct business. Form 1040 Your home office will qualify as your principal place of business if you meet the following requirements. Form 1040 You use it exclusively and regularly for administrative or management activities of your trade or business. Form 1040 You have no other fixed location where you conduct substantial administrative or management activities of your trade or business. Form 1040 If, after considering your business locations, your home cannot be identified as your principal place of business, you cannot deduct home office expenses. Form 1040 However, see the later discussions under Place To Meet Patients, Clients, or Customers and Separate Structure for other ways to qualify to deduct home office expenses. Form 1040 Administrative or management activities. Form 1040   There are many activities that are administrative or managerial in nature. Form 1040 The following are a few examples. Form 1040 Billing customers, clients, or patients. Form 1040 Keeping books and records. Form 1040 Ordering supplies. Form 1040 Setting up appointments. Form 1040 Forwarding orders or writing reports. Form 1040 Administrative or management activities performed at other locations. Form 1040   The following activities performed by you or others will not disqualify your home office from being your principal place of business. Form 1040 You have others conduct your administrative or management activities at locations other than your home. Form 1040 (For example, another company does your billing from its place of business. Form 1040 ) You conduct administrative or management activities at places that are not fixed locations of your business, such as in a car or a hotel room. Form 1040 You occasionally conduct minimal administrative or management activities at a fixed location outside your home. Form 1040 You conduct substantial nonadministrative or nonmanagement business activities at a fixed location outside your home. Form 1040 (For example, you meet with or provide services to customers, clients, or patients at a fixed location of the business outside your home. Form 1040 ) You have suitable space to conduct administrative or management activities outside your home, but choose to use your home office for those activities instead. Form 1040 Please click here for the text description of the image. Form 1040 Can you deduct business use of the home expenses? Example 1. Form 1040 John is a self-employed plumber. Form 1040 Most of John's time is spent at customers' homes and offices installing and repairing plumbing. Form 1040 He has a small office in his home that he uses exclusively and regularly for the administrative or management activities of his business, such as phoning customers, ordering supplies, and keeping his books. Form 1040 John writes up estimates and records of work completed at his customers' premises. Form 1040 He does not conduct any substantial administrative or management activities at any fixed location other than his home office. Form 1040 John does not do his own billing. Form 1040 He uses a local bookkeeping service to bill his customers. Form 1040 John's home office qualifies as his principal place of business for deducting expenses for its use. Form 1040 He uses the home office for the administrative or managerial activities of his plumbing business and he has no other fixed location where he conducts these administrative or managerial activities. Form 1040 His choice to have his billing done by another company does not disqualify his home office from being his principal place of business. Form 1040 He meets all the qualifications, including principal place of business, so he can deduct expenses (subject to certain limitations, explained later) for the business use of his home. Form 1040 Example 2. Form 1040 Pamela is a self-employed sales representative for several different product lines. Form 1040 She has an office in her home that she uses exclusively and regularly to set up appointments and write up orders and other reports for the companies whose products she sells. Form 1040 She occasionally writes up orders and sets up appointments from her hotel room when she is away on business overnight. Form 1040 Pamela's business is selling products to customers at various locations throughout her territory. Form 1040 To make these sales, she regularly visits customers to explain the available products and take orders. Form 1040 Pamela's home office qualifies as her principal place of business for deducting expenses for its use. Form 1040 She conducts administrative or management activities there and she has no other fixed location where she conducts substantial administrative or management activities. Form 1040 The fact that she conducts some administrative or management activities in her hotel room (not a fixed location) does not disqualify her home office from being her principal place of business. Form 1040 She meets all the qualifications, including principal place of business, so she can deduct expenses (subject to certain limitations, explained later) for the business use of her home. Form 1040 Example 3. Form 1040 Paul is a self-employed anesthesiologist. Form 1040 He spends the majority of his time administering anesthesia and postoperative care in three local hospitals. Form 1040 One of the hospitals provides him with a small shared office where he could conduct administrative or management activities. Form 1040 Paul very rarely uses the office the hospital provides. Form 1040 He uses a room in his home that he has converted to an office. Form 1040 He uses this room exclusively and regularly to conduct all the following activities. Form 1040 Contacting patients, surgeons, and hospitals regarding scheduling. Form 1040 Preparing for treatments and presentations. Form 1040 Maintaining billing records and patient logs. Form 1040 Satisfying continuing medical education requirements. Form 1040 Reading medical journals and books. Form 1040 Paul's home office qualifies as his principal place of business for deducting expenses for its use. Form 1040 He conducts administrative or management activities for his business as an anesthesiologist there and he has no other fixed location where he conducts substantial administrative or management activities for this business. Form 1040 His choice to use his home office instead of the one provided by the hospital does not disqualify his home office from being his principal place of business. Form 1040 His performance of substantial nonadministrative or nonmanagement activities at fixed locations outside his home also does not disqualify his home office from being his principal place of business. Form 1040 He meets all the qualifications, including principal place of business, so he can deduct expenses (subject to certain limitations, explained later) for the business use of his home. Form 1040 Example 4. Form 1040 Kathleen is employed as a teacher. Form 1040 She is required to teach and meet with students at the school and to grade papers and tests. Form 1040 The school provides her with a small office where she can work on her lesson plans, grade papers and tests, and meet with parents and students. Form 1040 The school does not require her to work at home. Form 1040 Kathleen prefers to use the office she has set up in her home and does not use the one provided by the school. Form 1040 She uses this home office exclusively and regularly for the administrative duties of her teaching job. Form 1040 Kathleen must meet the convenience-of-the-employer test, even if her home qualifies as her principal place of business for deducting expenses for its use. Form 1040 Her employer provides her with an office and does not require her to work at home, so she does not meet the convenience-of-the-employer test and cannot claim a deduction for the business use of her home. Form 1040 More Than One Trade or Business The same home office can be the principal place of business for two or more separate business activities. Form 1040 Whether your home office is the principal place of business for more than one business activity must be determined separately for each of your trade or business activities. Form 1040 You must use the home office exclusively and regularly for one or more of the following purposes. Form 1040 As the principal place of business for one or more of your trades or businesses. Form 1040 As a place to meet or deal with patients, clients, or customers in the normal course of one or more of your trades or businesses. Form 1040 If your home office is a separate structure, in connection with one or more of your trades or businesses. Form 1040 You can use your home office for more than one business activity, but you cannot use it for any nonbusiness (i. Form 1040 e. Form 1040 , personal) activities. Form 1040 If you are an employee, any use of the home office in connection with your employment must be for the convenience of your employer. Form 1040 See Rental to employer , later, if you rent part of your home to your employer. Form 1040 Example. Form 1040 Tracy White is employed as a teacher. Form 1040 Her principal place of work is the school, which provides her office space to do her school work. Form 1040 She also has a mail order jewelry business. Form 1040 All her work in the jewelry business is done in her home office and the office is used exclusively for that business. Form 1040 If she meets all the other tests, she can deduct expenses for the business use of her home for the jewelry business. Form 1040 If Tracy also uses the office for work related to her teaching, she must meet the exclusive use test for both businesses to qualify for the deduction. Form 1040 As an employee, Tracy must also meet the convenience-of-the-employer test to qualify for the deduction. Form 1040 She does not meet this test for her work as a teacher, so she cannot claim a deduction for the business use of her home for either activity. Form 1040 Place To Meet Patients, Clients, or Customers If you meet or deal with patients, clients, or customers in your home in the normal course of your business, even though you also carry on business at another location, you can deduct your expenses for the part of your home used exclusively and regularly for business if you meet both the following tests. Form 1040 You physically meet with patients, clients, or customers on your premises. Form 1040 Their use of your home is substantial and integral to the conduct of your business. Form 1040 Doctors, dentists, attorneys, and other professionals who maintain offices in their homes generally will meet this requirement. Form 1040 Using your home for occasional meetings and telephone calls will not qualify you to deduct expenses for the business use of your home. Form 1040 The part of your home you use exclusively and regularly to meet patients, clients, or customers does not have to be your principal place of business. Form 1040 Example. Form 1040 June Quill, a self-employed attorney, works 3 days a week in her city office. Form 1040 She works 2 days a week in her home office used only for business. Form 1040 She regularly meets clients there. Form 1040 Her home office qualifies for a business deduction because she meets clients there in the normal course of her business. Form 1040 Separate Structure You can deduct expenses for a separate free-standing structure, such as a studio, workshop, garage, or barn, if you use it exclusively and regularly for your business. Form 1040 The structure does not have to be your principal place of business or a place where you meet patients, clients, or customers. Form 1040 Example. Form 1040 John Berry operates a floral shop in town. Form 1040 He grows the plants for his shop in a greenhouse behind his home. Form 1040 He uses the greenhouse exclusively and regularly in his business, so he can deduct the expenses for its use, subject to certain limitations, explained later. Form 1040 Figuring the Deduction After you determine that you meet the tests under Qualifying for a Deduction , you can begin to figure how much you can deduct. Form 1040 When figuring the amount you can deduct for the business use of your home, you will use either your actual expenses or a simplified method. Form 1040 Electing to use the simplified method. Form 1040   The simplified method is an alternative to the calculation, allocation, and substantiation of actual expenses. Form 1040 You choose whether or not to figure your deduction using the simplified method each taxable year. Form 1040 See Using the Simplified Method , later. Form 1040 Rental to employer. Form 1040   If you rent part of your home to your employer and you use the rented part in performing services for your employer as an employee, your deduction for the business use of your home is limited. Form 1040 You can deduct mortgage interest, qualified mortgage insurance premiums, real estate taxes, and personal casualty losses for the rented part, subject to any limitations. Form 1040 However, you cannot deduct otherwise allowable trade or business expenses, business casualty losses, or depreciation related to the use of your home (or use the simplified method as an alternative to deducting these actual expenses) in performing services for your employer. Form 1040 Using Actual Expenses If you do not or cannot elect to use the simplified method for a home, you will figure your deduction for that home using your actual expenses. Form 1040 You will also need to figure the percentage of your home used for business and the limit on the deduction. Form 1040 If you are an employee or a partner, or you use your home in your farming business and you file Schedule F (Form 1040), you can use the Worksheet To Figure the Deduction for Business Use of Your Home, near the end of this publication, to help you figure your deduction. Form 1040 If you use your home in a trade or business and you file Schedule C (Form 1040), you will use Form 8829 to figure your deduction. Form 1040 Part-year use. Form 1040   You cannot deduct expenses for the business use of your home incurred during any part of the year you did not use your home for business purposes. Form 1040 For example, if you begin using part of your home for business on July 1, and you meet all the tests from that date until the end of the year, consider only your expenses for the last half of the year in figuring your allowable deduction. Form 1040 Expenses related to tax-exempt income. Form 1040   Generally, you cannot deduct expenses that are related to tax-exempt allowances. Form 1040 However, if you receive a tax-exempt parsonage allowance or a tax-exempt military allowance, your expenses for mortgage interest and real estate taxes are deductible under the normal rules. Form 1040 No deduction is allowed for other expenses related to the tax-exempt allowance. Form 1040   If your housing is provided free of charge and the value of the housing is tax exempt, you cannot deduct the rental value of any portion of the housing. Form 1040 Actual Expenses You must divide the expenses of operating your home between personal and business use. Form 1040 The part of a home operating expense you can use to figure your deduction depends on both of the following. Form 1040 Whether the expense is direct, indirect, or unrelated. Form 1040 The percentage of your home used for business. Form 1040 Table 1, next, describes the types of expenses you may have and the extent to which they are deductible. Form 1040 Table 1. Form 1040 Types of Expenses  Expense  Description  Deductibility Direct Expenses only for  the business part  of your home. Form 1040 Deductible in full. Form 1040 *   Examples:  Painting or repairs  only in the area  used for business. Form 1040 Exception: May be only partially  deductible in a daycare facility. Form 1040 See Daycare Facility , later. Form 1040 Indirect Expenses for  keeping up and running your  entire home. Form 1040 Deductible based on the percentage of your home used for business. Form 1040 *   Examples:  Insurance, utilities, and  general repairs. Form 1040   Unrelated Expenses only for  the parts of your  home not used  for business. Form 1040 Not deductible. Form 1040   Examples:  Lawn care or painting  a room not used  for business. Form 1040   *Subject to the deduction limit, discussed later. Form 1040 Form 8829 and the Worksheet To Figure the Deduction for Business Use of Your Home have separate columns for direct and indirect expenses. Form 1040 Certain expenses are deductible whether or not you use your home for business. Form 1040 If you qualify to deduct business use of the home expenses, use the business percentage of these expenses to figure your total business use of the home deduction. Form 1040 These expenses include the following. Form 1040 Real estate taxes. Form 1040 Qualified mortgage insurance premiums. Form 1040 Deductible mortgage interest. Form 1040 Casualty losses. Form 1040 Other expenses are deductible only if you use your home for business. Form 1040 You can use the business percentage of these expenses to figure your total business use of the home deduction. Form 1040 These expenses generally include (but are not limited to) the following. Form 1040 Depreciation (covered under Depreciating Your Home , later). Form 1040 Insurance. Form 1040 Rent paid for the use of property you do not own but use in your trade or business. Form 1040 Repairs. Form 1040 Security system. Form 1040 Utilities and services. Form 1040 Real estate taxes. Form 1040   To figure the business part of your real estate taxes, multiply the real estate taxes paid by the percentage of your home used for business. Form 1040   For more information on the deduction for real estate taxes, see Publication 530, Tax Information for Homeowners. Form 1040 Deductible mortgage interest. Form 1040   To figure the business part of your deductible mortgage interest, multiply this interest by the percentage of your home used for business. Form 1040 You can include interest on a second mortgage in this computation. Form 1040 If your total mortgage debt is more than $1,000,000 or your home equity debt is more than $100,000, your deduction may be limited. Form 1040 For more information on what interest is deductible, see Publication 936, Home Mortgage Interest Deduction. Form 1040 Qualified mortgage insurance premiums. Form 1040   To figure the business part of your qualified mortgage insurance premiums, multiply the premiums by the percentage of your home used for business. Form 1040 You can include premiums for insurance on a second mortgage in this computation. Form 1040 If your adjusted gross income is more than $100,000 ($50,000 if your filing status is married filing separately), your deduction may be limited. Form 1040 For more information, see Publication 936, and Line 13 in the Instructions for Schedule A (Form 1040). Form 1040 Casualty losses. Form 1040    If you have a casualty loss on your home that you use for business, treat the casualty loss as a direct expense, an indirect expense, or an unrelated expense, depending on the property affected. Form 1040 A direct expense is the loss on the portion of the property you use only in your business. Form 1040 Use the entire loss to figure the business use of the home deduction. Form 1040 An indirect expense is the loss on property you use for both business and personal purposes. Form 1040 Use only the business portion to figure the deduction. Form 1040 An unrelated expense is the loss on property you do not use in your business. Form 1040 Do not use any of the loss to figure the deduction. Form 1040 Example. Form 1040 You meet the rules to take a deduction for an office in your home that is 10% of the total area of your house. Form 1040 A storm damages your roof. Form 1040 This is an indirect expense as the roof is part of the whole house and is considered to be used both for business and personal purposes. Form 1040 You would complete Form 4684, Casualties and Thefts, to report your loss. Form 1040 You complete both section A (Personal Use Property) and section B (Business and Income-Producing Property) as your home is used both for business and personal purposes. Form 1040 Since you use 90% of your home for personal purposes, use 90% of the cost or adjusted basis of your home, insurance or other reimbursement, and fair market value, both before and after the storm, to figure the amounts to enter on lines 2, 3, 5, and 6 of Form 4684. Form 1040 Since you use 10% of your home for business purposes, use 10% of the cost or adjusted basis of your home, insurance or other reimbursement, and fair market value, both before and after the storm, to figure the amounts to enter on lines 20, 21, 23, and 24 of Form 4684. Form 1040 Forms and worksheets to use. Form 1040   If you are filing Schedule C (Form 1040), get Form 8829 and follow the instructions for casualty losses. Form 1040 If you are an employee or a partner, or you file Schedule F (Form 1040), use the Worksheet To Figure the Deduction for Business Use of Your Home, near the end of this publication. Form 1040 You will also need to get Form 4684. Form 1040 More information. Form 1040   For more information on casualty losses, see Publication 547, Casualties, Disasters, and Thefts. Form 1040 Insurance. Form 1040   You can deduct the cost of insurance that covers the business part of your home. Form 1040 However, if your insurance premium gives you coverage for a period that extends past the end of your tax year, you can deduct only the business percentage of the part of the premium that gives you coverage for your tax year. Form 1040 You can deduct the business percentage of the part that applies to the following year in that year. Form 1040 Rent. Form 1040   If you rent the home you occupy and meet the requirements for business use of the home, you can deduct part of the rent you pay. Form 1040 To figure your deduction, multiply your rent payments by the percentage of your home used for business. Form 1040   If you own your home, you cannot deduct the fair rental value of your home. Form 1040 However, see Depreciating Your Home , later. Form 1040 Repairs. Form 1040   The cost of repairs that relate to your business, including labor (other than your own labor), is a deductible expense. Form 1040 For example, a furnace repair benefits the entire home. Form 1040 If you use 10% of your home for business, you can deduct 10% of the cost of the furnace repair. Form 1040   Repairs keep your home in good working order over its useful life. Form 1040 Examples of common repairs are patching walls and floors, painting, wallpapering, repairing roofs and gutters, and mending leaks. Form 1040 However, repairs are sometimes treated as a permanent improvement and are not deductible. Form 1040 See Permanent improvements , later, under Depreciating Your Home. Form 1040 Security system. Form 1040   If you install a security system that protects all the doors and windows in your home, you can deduct the business part of the expenses you incur to maintain and monitor the system. Form 1040 You also can take a depreciation deduction for the part of the cost of the security system relating to the business use of your home. Form 1040 Utilities and services. Form 1040   Expenses for utilities and services, such as electricity, gas, trash removal, and cleaning services, are primarily personal expenses. Form 1040 However, if you use part of your home for business, you can deduct the business part of these expenses. Form 1040 Generally, the business percentage for utilities is the same as the percentage of your home used for business. Form 1040 Telephone. Form 1040   The basic local telephone service charge, including taxes, for the first telephone line into your home (i. Form 1040 e. Form 1040 , landline) is a nondeductible personal expense. Form 1040 However, charges for business long-distance phone calls on that line, as well as the cost of a second line into your home used exclusively for business, are deductible business expenses. Form 1040 Do not include these expenses as a cost of using your home for business. Form 1040 Deduct these charges separately on the appropriate form or schedule. Form 1040 For example, if you file Schedule C (Form 1040), deduct these expenses on line 25, Utilities (instead of line 30, Expenses for business use of your home). Form 1040 Depreciating Your Home If you own your home and qualify to deduct expenses for its business use, you can claim a deduction for depreciation. Form 1040 Depreciation is an allowance for the wear and tear on the part of your home used for business. Form 1040 You cannot depreciate the cost or value of the land. Form 1040 You recover its cost when you sell or otherwise dispose of the property. Form 1040 Before you figure your depreciation deduction, you need to know the following information. Form 1040 The month and year you started using your home for business. Form 1040 The adjusted basis and fair market value of your home (excluding land) at the time you began using it for business. Form 1040 The cost of any improvements before and after you began using the property for business. Form 1040 The percentage of your home used for business. Form 1040 See Business Percentage , later. Form 1040 Adjusted basis defined. Form 1040   The adjusted basis of your home is generally its cost, plus the cost of any permanent improvements you made to it, minus any casualty losses or depreciation deducted in earlier tax years. Form 1040 For a discussion of adjusted basis, see Publication 551. Form 1040 Permanent improvements. Form 1040   A permanent improvement increases the value of property, adds to its life, or gives it a new or different use. Form 1040 Examples of improvements are replacing electric wiring or plumbing, adding a new roof or addition, paneling, or remodeling. Form 1040    You must carefully distinguish between repairs and improvements. Form 1040 See Repairs , earlier, under Actual Expenses. Form 1040 You also must keep accurate records of these expenses. Form 1040 These records will help you decide whether an expense is a deductible or a capital (added to the basis) expense. Form 1040 However, if you make repairs as part of an extensive remodeling or restoration of your home, the entire job is an improvement. Form 1040 Example. Form 1040 You buy an older home and fix up two rooms as a beauty salon. Form 1040 You patch the plaster on the ceilings and walls, paint, repair the floor, install an outside door, and install new wiring, plumbing, and other equipment. Form 1040 Normally, the patching, painting, and floor work are repairs and the other expenses are permanent improvements. Form 1040 However, because the work gives your property a new use, the entire remodeling job is a permanent improvement and its cost is added to the basis of the property. Form 1040 You cannot deduct any portion of it as a repair expense. Form 1040 Adjusting for depreciation deducted in earlier years. Form 1040   Decrease the basis of your property by the depreciation you deducted, or could have deducted, on your tax returns under the method of depreciation you properly selected. Form 1040 If you deducted less depreciation than you could have under the method you selected, decrease the basis by the amount you could have deducted under that method. Form 1040 If you did not deduct any depreciation, decrease the basis by the amount you could have deducted. Form 1040   If you deducted more depreciation than you should have, decrease your basis by the amount you should have deducted, plus the part of the excess depreciation you deducted that actually decreased your tax liability for any year. Form 1040   If you deducted the incorrect amount of depreciation, see Publication 946. Form 1040 Fair market value defined. Form 1040   The fair market value of your home is the price at which the property would change hands between a buyer and a seller, neither having to buy or sell, and both having reasonable knowledge of all necessary facts. Form 1040 Sales of similar property, on or about the date you begin using your home for business, may be helpful in determining the property's fair market value. Form 1040 Figuring the depreciation deduction for the current year. Form 1040   If you began using your home for business before 2013, continue to use the same depreciation method you used in past tax years. Form 1040   If you began using your home for business for the first time in 2013, depreciate the business part as nonresidential real property under the modified accelerated cost recovery system (MACRS). Form 1040 Under MACRS, nonresidential real property is depreciated using the straight line method over 39 years. Form 1040 For more information on MACRS and other methods of depreciation, see Publication 946. Form 1040   To figure the depreciation deduction, you must first figure the part of the cost of your home that can be depreciated (depreciable basis). Form 1040 The depreciable basis is figured by multiplying the percentage of your home used for business by the smaller of the following. Form 1040 The adjusted basis of your home (excluding land) on the date you began using your home for business. Form 1040 The fair market value of your home (excluding land) on the date you began using your home for business. Form 1040 Depreciation table. Form 1040   If 2013 was the first year you used your home for business, you can figure your 2013 depreciation for the business part of your home by using the appropriate percentage from the following table. Form 1040 Table 2. Form 1040 MACRS Percentage Table for 39-Year Nonresidential Real Property Month First Used for Business Percentage To Use 1 2. Form 1040 461% 2 2. Form 1040 247% 3 2. Form 1040 033% 4 1. Form 1040 819% 5 1. Form 1040 605% 6 1. Form 1040 391% 7 1. Form 1040 177% 8 0. Form 1040 963% 9 0. Form 1040 749% 10 0. Form 1040 535% 11 0. Form 1040 321% 12 0. Form 1040 107%   Multiply the depreciable basis of the business part of your home by the percentage from the table for the first month you use your home for business. Form 1040 See Publication 946 for the percentages for the remaining tax years of the recovery period. Form 1040 Example. Form 1040 In May, George Miller began to use one room in his home exclusively and regularly to meet clients. Form 1040 This room is 8% of the square footage of his home. Form 1040 He bought the home in 2003 for $125,000. Form 1040 He determined from his property tax records that his adjusted basis in the house (exclusive of land) is $115,000. Form 1040 In May, the house had a fair market value of $165,000. Form 1040 He multiplies his adjusted basis of $115,000 (which is less than the fair market value) by 8%. Form 1040 The result is $9,200, his depreciable basis for the business part of the house. Form 1040 George files his return based on the calendar year. Form 1040 May is the 5th month of his tax year. Form 1040 He multiplies his depreciable basis of $9,200 by 1. Form 1040 605% (. Form 1040 01605), the percentage from the table for the 5th month. Form 1040 His depreciation deduction is $147. Form 1040 66. Form 1040 Depreciating permanent improvements. Form 1040   Add the costs of permanent improvements made before you began using your home for business to the basis of your property. Form 1040 Depreciate these costs as part of the cost of your home as explained earlier. Form 1040 The costs of improvements made after you begin using your home for business (that affect the business part of your home, such as a new roof) are depreciated separately. Form 1040 Multiply the cost of the improvement by the business-use percentage and depreciate the result over the recovery period that would apply to your home if you began using it for business at the same time as the improvement. Form 1040 For improvements made this year, the recovery period is 39 years. Form 1040 For the percentage to use for the first year, see Table 2, earlier. Form 1040 For more information on recovery periods, see Publication 946. Form 1040 Business Percentage To find the business percentage, compare the size of the part of your home that you use for business to your whole house. Form 1040 Use the resulting percentage to figure the business part of the expenses for operating your entire home. Form 1040 You can use any reasonable method to determine the business percentage. Form 1040 The following are two commonly used methods for figuring the percentage. Form 1040 Divide the area (length multiplied by the width) used for business by the total area of your home. Form 1040 If the rooms in your home are all about the same size, you can divide the number of rooms used for business by the total number of rooms in your home. Form 1040 Example 1. Form 1040 Your office is 240 square feet (12 feet × 20 feet). Form 1040 Your home is 1,200 square feet. Form 1040 Your office is 20% (240 ÷ 1,200) of the total area of your home. Form 1040 Your business percentage is 20%. Form 1040 Example 2. Form 1040 You use one room in your home for business. Form 1040 Your home has 10 rooms, all about equal size. Form 1040 Your office is 10% (1 ÷ 10) of the total area of your home. Form 1040 Your business percentage is 10%. Form 1040 Use lines 1-7 of Form 8829, or lines 1-3 on the Worksheet To Figure the Deduction for Business Use of Your Home (near the end of this publication) to figure your business percentage. Form 1040 Deduction Limit 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. Form 1040 If your gross income from the business use of your home is less than your total business expenses, your deduction for certain expenses for the business use of your home is limited. Form 1040 Your deduction of otherwise nondeductible expenses, such as insurance, utilities, and depreciation of your home (with depreciation of your home taken last), that are allocable to the business, is limited to the gross income from the business use of your home minus the sum of the following. Form 1040 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)). Form 1040 These expenses are discussed in detail under Actual Expenses , earlier. Form 1040 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. Form 1040 If you are self-employed, do not include in (2) above your deduction for one-half of your self-employment tax. Form 1040 Carryover of unallowed expenses. Form 1040   If your deductions are greater than the current year's limit, you can carry over the excess to the next year in which you use actual expenses. Form 1040 They are subject to the deduction limit for that year, whether or not you live in the same home during that year. Form 1040 Figuring the deduction limit and carryover. Form 1040   If you are an employee or a partner, or you file Schedule F (Form 1040), use the Worksheet To Figure the Deduction for Business Use of Your Home, near the end of this publication. Form 1040 If you file Schedule C (Form 1040), figure your deduction limit and carryover on Form 8829. Form 1040 Example. Form 1040 You meet the requirements for deducting expenses for the business use of your home. Form 1040 You use 20% of your home for business. Form 1040 In 2013, your business expenses and the expenses for the business use of your home are deducted from your gross income in the following order. Form 1040    Gross income from business $6,000 Minus:   Deductible mortgage interest and real estate taxes (20%) 3,000 Business expenses not related to the use of your home (100%) (business phone, supplies, and depreciation on equipment) 2,000 Deduction limit $1,000 Minus other expenses allocable to business use of home:   Maintenance, insurance, and utilities (20%) 800 Depreciation allowed (20% = $1,600 allowable, but subject to balance of deduction limit) 200 Other expenses up to the deduction limit $1,000 Depreciation carryover to 2014 ($1,600 − $200) (subject to deduction limit in 2014) $1,400   You can deduct all of the business part of your deductible mortgage interest and real estate taxes ($3,000). Form 1040 You also can deduct all of your business expenses not related to the use of your home ($2,000). Form 1040 Additionally, you can deduct all of the business part of your expenses for maintenance, insurance, and utilities, because the total ($800) is less than the $1,000 deduction limit. Form 1040 Your deduction for depreciation for the business use of your home is limited to $200 ($1,000 minus $800) because of the deduction limit. Form 1040 You can carry over the $1,400 balance and add it to your depreciation for 2014, subject to your deduction limit in 2014. Form 1040 More than one place of business. Form 1040   If part of the gross income from your trade or business is from the business use of part of your home and part is from a place other than your home, you must determine the part of your gross income from the business use of your home before you figure the deduction limit. Form 1040 In making this determination, consider the time you spend at each location, the business investment in each location, and any other relevant facts and circumstances. Form 1040 If your home office qualifies as your principal place of business, you can deduct your daily transportation costs between your home and another work location in the same trade or business. Form 1040 For more information on transportation costs, see Publication 463, Travel, Entertainment, Gift, and Car Expenses. Form 1040 Using the Simplified Method The simplified method is an alternative to the calculation, allocation, and substantiation of actual expenses. Form 1040 In most cases, you will figure your deduction by multiplying $5, the prescribed rate, by the area of your home used for a qualified business use. Form 1040 The area you use to figure your deduction is limited to 300 square feet. Form 1040 See Simplified Amount , later, for information about figuring the amount of the deduction. Form 1040 For more information about the simplified method, see Revenue Procedure 2013-13, 2013-06 I. Form 1040 R. Form 1040 B. Form 1040 478, available at www. Form 1040 irs. Form 1040 gov/irb/2013-06_IRB/ar09. Form 1040 html. Form 1040 Actual expenses and depreciation of your home. Form 1040   If you elect to use the simplified method, you cannot deduct any actual expenses for the business except for business expenses that are not related to the use of the home. Form 1040 You also cannot deduct any depreciation (including any additional first-year depreciation) or section 179 expense for the portion of the home that is used for a qualified business use. Form 1040 The depreciation deduction allowable for that portion of the home is deemed to be zero for a year you use the simplified method. Form 1040 If you figure your deduction for business use of the home using actual expenses in a subsequent year, you will have to use the appropriate optional depreciation table for MACRS to figure your depreciation. Form 1040 More information. Form 1040   For more information about claiming depreciation in a subsequent year, see Revenue Procedure 2013-13, 2013-06 I. Form 1040 R. Form 1040 B. Form 1040 478, available at www. Form 1040 irs. Form 1040 gov/irb/2013-06_IRB/ar09. Form 1040 html. Form 1040 See Publication 946 for the optional depreciation tables Although you cannot deduct any depreciation or section 179 expense for the portion of your home used for a qualified business use, you may still claim depreciation or the section 179 expense deduction on other assets used in the business (for example, furniture and equipment). Form 1040 Expenses deductible without regard to business use. Form 1040   When using the simplified method, treat as personal expenses those business expenses related to the use of the home that are deductible without regard to whether there is a qualified business use of the home. Form 1040 These expenses include mortgage interest, real estate taxes, and casualty losses, subject to any limitations. Form 1040 See Where To Deduct , later. Form 1040 If you also rent part of your home, you must still allocate these expenses between rental use and personal use (for this purpose, personal use includes business use reported using the simplified method). Form 1040 No deduction of carryover of actual expenses. Form 1040   If you used actual expenses to figure your deduction for business use of the home in a prior year and your deduction was limited, you cannot deduct the disallowed amount carried over from the prior year during a year you figure your deduction using the simplified method. Form 1040 Instead, you will continue to carry over the disallowed amount to the next year that you use actual expenses to figure your deduction. Form 1040 Electing the Simplified Method You choose whether or not to figure your deduction using the simplified method each taxable year. Form 1040 Make the election for a home by using the simplified method to figure the deduction for the qualified business use of that home on a timely filed, original federal income tax return. Form 1040 An election for a taxable year, once made, is irrevocable. Form 1040 A change from using the simplified method in one year to actual expenses in a succeeding taxable year, or vice-versa, is not a change in method of accounting and does not require the consent of the Commissioner. Form 1040 Shared use. Form 1040   If you share your home with someone else who also uses the home in a business that qualifies for this deduction, each of you make your own election. Form 1040 More than one qualified business use. Form 1040   If you conduct more than one business that qualifies for this deduction in your home, your election to use the simplified method applies to all your qualified business uses of that home. Form 1040 More than one home. Form 1040   If you used more than one home during the year (for example, you moved during the year), you can elect to use the simplified method for only one of the homes. Form 1040 You must figure the deduction for any other home using actual expenses. Form 1040 Simplified Amount Your deduction for the qualified business use of a home is the sum of each amount you figure for a separate qualified business use of your home. Form 1040 To figure your deduction for the business use of a home using the simplified method, you will need to know the following information for each qualified business use of the home. Form 1040 The allowable area of your home used in conducting the business. Form 1040 If you did not conduct the business for the entire year in the home or the area changed during the year, you will need to know the allowable area you used and the number of days you conducted the business for each month. Form 1040 The gross income from the business use of your home. Form 1040 The amount of the business expenses that are not related to the use of your home. Form 1040 If the qualified business use is for a daycare facility that uses space in your home on a regular (but not exclusive) basis, you will also need to know the percentage of time that part of your home is used for daycare. Form 1040 To figure the amount you can deduct for qualified business use of your home using the simplified method, follow these 3 steps. Form 1040 Multiply the allowable area by $5 (or less than $5 if the qualified business use is for a daycare that uses space in your home on a regular, but not exclusive, basis). Form 1040 See Allowable area and Space used regularly for daycare , later. Form 1040 Subtract the expenses from the business that are not related to the use of the home from the gross income related to the business use of the home. Form 1040 If these expenses are greater than the gross income from the business use of the home, then you cannot take a deduction for this business use of the home. Form 1040 See Gross income limitation , later. Form 1040 Take the smaller of the amounts from (1) and (2). Form 1040 This is the amount you can deduct for this qualified business use of your home using the simplified method. Form 1040 If you are an employee or a partner, or you use your home in your farming business and file Schedule F (Form 1040), you can use the Simplified Method Worksheet, near the end of this publication, to help you figure your deduction. Form 1040 If you use your home in a trade or business and you file Schedule C (Form 1040), you will use the Simplified Method Worksheet in your Instructions for Schedule C to figure your deduction. Form 1040 Allowable area. Form 1040   In most cases, the allowable area is the smaller of the actual area (in square feet) of your home used in conducting the business and 300 square feet. Form 1040 Your allowable area may be smaller if you conducted the business as a qualified joint venture with your spouse, the area used by the business was shared with another qualified business use, you used the home for the business for only part of the year, or the area used by the business changed during the year. Form 1040 You can use the Area Adjustment Worksheet (for simplified method), near the end of this publication, to help you figure your allowable area for a qualified business use. Form 1040 Area used by a qualified joint venture. Form 1040   If the qualified business use of the home is also a qualified joint venture, you and your spouse will figure the deduction for the business use separately. Form 1040 Split the actual area used in conducting business between you and your spouse in the same manner you split your other tax attributes. Form 1040 Then, each spouse will figure the allowable area separately. Form 1040 For more information about qualified joint ventures, see Qualified Joint Venture in the Instructions for Schedule C. Form 1040 Shared use. Form 1040   If you share your home with someone else who uses the home to conduct business that also qualifies for this deduction, you may not include the same square feet to figure your deduction as the other person. Form 1040 You must allocate the shared space between you and the other person in a reasonable manner. Form 1040 Example. Form 1040 Kristin and Lindsey are roommates. Form 1040 Kristin uses 300 square feet of their home for a qualified business use. Form 1040 Lindsey uses 200 square feet of their home for a separate qualified business use. Form 1040 The qualified business uses share 100 square feet. Form 1040 In addition to the portion that they do not share, Kristin and Lindsey can both claim 50 of the 100 square feet or divide the 100 square feet between them in any reasonable manner. Form 1040 If divided evenly, Kristin could claim 250 square feet using the simplified method and Lindsey could claim 150 square feet. Form 1040 More than one qualified business use. Form 1040   If you conduct more than one business qualifying for the deduction, you are limited to a maximum of 300 square feet for all of the businesses. Form 1040 Allocate the actual square footage used (up to the maximum of 300 square feet) among your qualified business uses in a reasonable manner. Form 1040 However, do not allocate more square feet to a qualified business use than you actually use for that business. Form 1040 Rental use. Form 1040   The simplified method does not apply to rental use. Form 1040 A rental use that qualifies for the deduction must be figured using actual expenses. Form 1040 If the rental use and a qualified business use share the same area, you will have to allocate the actual area used between the two uses. Form 1040 You cannot use the same area to figure a deduction for the qualified business use as you are using to figure the deduction for the rental use. Form 1040 Part-year use or area changes. Form 1040   If your qualified business use was for a portion of the taxable year (for example, a seasonal business or a business that begins during the taxable year) or you changed the square footage of your qualified business use, your deduction is limited to the average monthly allowable square footage. Form 1040 You calculate the average monthly allowable square footage by adding the amount of allowable square feet you used in each month and dividing the sum by 12. Form 1040 When determining the average monthly allowable square footage, you cannot take more than 300 square feet into account for any one month. Form 1040 Additionally, if your qualified business use was less than 15 days in a month, you must use -0- for that month. Form 1040 Example 1. Form 1040 Andy files his federal income tax return on a calendar year basis. Form 1040 On July 20, he began using 420 square feet of his home for a qualified business use. Form 1040 He continued to use the 420 square feet until the end of the year. Form 1040 His average monthly allowable square footage is 125 square feet, which is figured using 300 square feet for each month August through December divided by the number of months in the taxable year ((0 + 0 + 0 + 0 + 0 + 0 + 0 + 300 + 300 + 300 + 300 + 300)/12). Form 1040 Example 2. Form 1040 Amy files her federal income tax return on a calendar year basis. Form 1040 On April 20, she began using 100 square feet of her home for a qualified business use. Form 1040 On August 5, she expanded the area of her qualified use to 330 square feet. Form 1040 Amy continued to use the 330 square feet until the end of the year. Form 1040 Her average monthly allowable square footage is 150 square feet, which is figured using 100 square feet for May through July and 300 square feet for August through December divided by the number of months in the taxable year ((0 + 0 + 0 + 0 + 100 + 100 +100 + 300 + 300 + 300 + 300 + 300)/12). Form 1040 Gross income limitation. Form 1040   Your deduction for business use of the home is limited to an amount equal to the gross income derived from the qualified business use of the home reduced by the business deductions that are unrelated to the use of your home. Form 1040 If the business deductions that are unrelated to the use of your home are greater than the gross income derived from the qualified business use of your home, then you cannot take a deduction for this qualified business use of your home. Form 1040 Business expenses not related to use of the home. Form 1040   These expenses relate to the business activity in the home, but not to the use of the home itself. Form 1040 You can still deduct business expenses that are unrelated to the use of the home. Form 1040 See Where To Deduct , later. Form 1040 Examples of business expenses that are unrelated to the use of the home are advertising, wages, supplies, dues, and depreciation for equipment. Form 1040 Space used regularly for daycare. Form 1040   If you do not use the area of your home exclusively for daycare, you must reduce the prescribed rate (maximum $5 per square foot) before figuring your deduction. Form 1040 The reduced rate will equal the prescribed rate times a fraction. Form 1040 The numerator of the fraction is the number of hours that the space was used during the year for daycare and the denominator is the total number of hours during the year that the space was available for all uses. Form 1040 You can use the Daycare Facility Worksheet (for simplified method), near the end of this publication, to help you figure the reduced rate. Form 1040    If you used at least 300 square feet for daycare regularly and exclusively during the year, then you do not need to reduce the prescribed rate or complete the Daycare Facility Worksheet. Form 1040 Daycare Facility If you use space in your home on a regular basis for providing daycare, you may be able to claim a deduction for that part of your home even if you use the same space for nonbusiness purposes. Form 1040 To qualify for this exception to the exclusive use rule, you must meet both of the following requirements. Form 1040 You must be in the trade or business of providing daycare for children, persons age 65 or older, or persons who are physically or mentally unable to care for themselves. Form 1040 You must have applied for, been granted, or be exempt from having, a license, certification, registration, or approval as a daycare center or as a family or group daycare home under state law. Form 1040 You do not meet this requirement if your application was rejected or your license or other authorization was revoked. Form 1040 Figuring the deduction. Form 1040   If you elect to use the simplified method for your home, figure your deduction as described earlier in Using the Simplified Method under Figuring the Deduction. Form 1040    If you are figuring your deduction using actual expenses and you regularly use part of your home for daycare, figure what part is used for daycare, as explained in Business Percentage , earlier, under Figuring the Deduction. Form 1040 If you also use that part exclusively for daycare, deduct all the allocable expenses, subject to the deduction limit, as explained earlier. Form 1040   If the use of part of your home as a daycare facility is regular, but not exclusive, you must figure the percentage of time that part of your home is used for daycare. Form 1040 A room that is available for use throughout each business day and that you regularly use in your business is considered to be used for daycare throughout each business day. Form 1040 You do not have to keep records to show the specific hours the area was used for business. Form 1040 You can use the area occasionally for personal reasons. Form 1040 However, a room you use only occasionally for business does not qualify for the deduction. Form 1040 To find the percentage of time you actually use your home for business, compare the total time used for business to the total time that part of your home can be used for all purposes. Form 1040 You can compare the hours of business use in a week with the number of hours in a week (168). Form 1040 Or you can compare the hours of business use for the year with the number of hours in the year (8,760 in 2013). Form 1040 If you started or stopped using your home for daycare in 2013, you must prorate the number of hours based on the number of days the home was available for daycare. Form 1040 Example 1. Form 1040 Mary Lake used her basement to operate a daycare business for children. Form 1040 She figures the business percentage of the basement as follows. Form 1040 Square footage of the basement Square footage of her home = 1,600 3,200 = 50%           She used the basement for daycare an average of 12 hours a day, 5 days a week, for 50 weeks a year. Form 1040 During the other 12 hours a day, the family could use the basement. Form 1040 She figures the percentage of time the basement was used for daycare as follows. Form 1040 Number of hours used for daycare (12 x 5 x 50) Total number of hours in the year (24 x 365) = 3,000 8,760 = 34. Form 1040 25%           Mary can deduct 34. Form 1040 25% of any direct expenses for the basement. Form 1040 However, because her indirect expenses are for the entire house, she can deduct only 17. Form 1040 13% of the indirect expenses. Form 1040 She figures the percentage for her indirect expenses as follows. Form 1040 Business percentage of the basement 50% Multiplied by: Percentage of time used for daycare × 34. Form 1040 25% Percentage for indirect expenses 17. Form 1040 13% Mary completes Form 8829, Part I, figuring the percentage of her home used for business, including the percentage of time the basement was used. Form 1040 In Part II, Mary figures her deductible expenses. Form 1040 She uses the following information to complete Part II. Form 1040 Gross income from her daycare business $50,000 Expenses not related to the business use of the home $25,000 Tentative profit $25,000 Rent $8,400 Utilities $850 Painting the basement $500 Mary enters her tentative profit, $25,000, on line 8. Form 1040 (This figure is the same as the amount on line 29 of her Schedule C (Form 1040). Form 1040 ) The expenses she paid for rent and utilities relate to her entire home. Form 1040 Therefore, she enters the amount paid for rent on line 18, column (b), and the amount paid for utilities on line 20, column (b). Form 1040 She shows the total of these expenses on line 22, column (b). Form 1040 For line 23, she multiplies the amount on line 22, column (b) by the percentage on line 7 and enters the result, $1,585. Form 1040 Mary paid $500 to have the basement painted. Form 1040 The painting is a direct expense. Form 1040 However, because she did not use the basement exclusively for daycare, she must multiply $500 by the percentage of time the basement was used for daycare (34. Form 1040 25% – line 6). Form 1040 She enters $171 (34. Form 1040 25% × $500) on line 19, column (a). Form 1040 She adds line 22, column (a), and line 23 and enters $1,756 ($171 + $1,585) on line 25. Form 1040 This is less than her deduction limit (line 15), so she can deduct the entire amount. Form 1040 She follows the instructions to complete the rest of Part II and enters $1,756 on lines 33 and 35. Form 1040 She then carries the $1,756 to line 30 of her Schedule C (Form 1040). Form 1040 Example 2. Form 1040 Assume the same facts as in Example 1 except that Mary also has another room that was available each business day for children to take naps in. Form 1040 Although she did not keep a record of the number of hours the room was actually used for naps, it was used for part of each business day. Form 1040 Since the room was available for business use during regular operating hours each business day and was used regularly in the business, it is considered used for daycare throughout each business day. Form 1040 The basement and room are 60% of the total area of her home. Form 1040 In figuring her expenses, 34. Form 1040 25% of any direct expenses for the basement and room are deductible. Form 1040 In addition, 20. Form 1040 55% (34. Form 1040 25% × 60%) of her indirect expenses are deductible. Form 1040 Example 3. Form 1040 Assume the same facts as in Example 1 except that Mary stopped using her home for a daycare facility on June 24, 2013. Form 1040 She used the basement for daycare an average of 12 hours a day, 5 days a week, but for only 25 weeks of the year. Form 1040 During the other 12 hours a day, the family could still use the basement. Form 1040 She figures the percentage of time the basement was used for business as follows. Form 1040 Number of hours used for daycare (12 x 5 x 25) Total number of hours during period used (24 x 175) = 1,500 4,200 = 35. Form 1040 71%           Mary can deduct 35. Form 1040 71% of any direct expenses for the basement. Form 1040 However, because her indirect expenses are for the entire house, she can deduct only 17. Form 1040 86% of the indirect expenses. Form 1040 She figures the percentage for her indirect expenses as follows. Form 1040 Business percentage of the basement 50% Multiplied by: Percentage of time used for daycare × 35. Form 1040 71% Percentage for indirect expenses 17. Form 1040 86% Meals. Form 1040   If you provide food for your daycare recipients, do not include the expense as a cost of using your home for business. Form 1040 Claim it as a separate deduction on your Schedule C (Form 1040). Form 1040 You can never deduct the cost of food consumed by you or your family. Form 1040 You can deduct as a business expense 100% of the actual cost of food consumed by your daycare recipients (see Standard meal and snack rates , later, for an optional method for eligible children) and generally only 50% of the cost of food consumed by your employees. Form 1040 However, you can deduct 100% of the cost of food consumed by your employees if its value can be excluded from their wages as a de minimis fringe benefit. Form 1040 For more information on meals that meet these requirements, see Meals in chapter 2 of Publication 15-B, Employer's Tax Guide to Fringe Benefits. Form 1040   If you deduct the actual cost of food for your daycare business, keep a separate record (with receipts) of your family's food costs. Form 1040   Reimbursements you receive from a sponsor under the Child and Adult Care Food Program of the Department of Agriculture are taxable only to the extent they exceed your expenses for food for eligible children. Form 1040 If your reimbursements are more than your expenses for food, show the difference as income in Part I of Schedule C (Form 1040). Form 1040 If your food expenses are greater than the reimbursements, show the difference as an expense in Part V of Schedule C (Form 1040). Form 1040 Do not include payments or expenses for your own children if they are eligible for the program. Form 1040 Follow this procedure even if you receive a Form 1099-MISC, Miscellaneous Income, reporting a payment from the sponsor. Form 1040 Standard meal and snack rates. Form 1040   If you qualify as a family daycare provider, you can use the standard meal and snack rates, instead of actual costs, to compute the deductible cost of meals and snacks provided to eligible children. Form 1040 For these purposes: A family daycare provider is a person engaged in the business of providing family daycare. Form 1040 Family daycare is childcare provided to eligible children in the home of the family daycare provider. Form 1040 The care must be non-medical, not involve a transfer of legal custody, and generally last less than 24 hours each day. Form 1040 Eligible children are minor children receiving family daycare in the home of the family daycare provider. Form 1040 Eligible children do not include children who are full-time or part-time residents in the home where the childcare is provided or children whose parents or guardians are residents of the same home. Form 1040 Eligible children do not include children who receive daycare services for personal reasons of the provider. Form 1040 For example, if a provider provides daycare services for a relative as a favor to that relative, that child is not an eligible child. Form 1040   You can compute the deductible cost of each meal and snack you actually purchased and served to an eligible child during the time period you provided family daycare using the standard meal and snack rates shown in Table 3, later. Form 1040 You can use the standard meal and snack rates for a maximum of one breakfast, one lunch, one dinner, and three snacks per eligible child per day. Form 1040 If you receive reimbursement for a particular meal or snack, you can deduct only the portion of the applicable standard meal or snack rate that is more than the amount of the reimbursement. Form 1040   You can use either the standard meal and snack rates or actual costs to calculate the deductible cost of food provided to eligible children in the family daycare for any particular tax year. Form 1040 If you choose to use the standard meal and snack rates for a particular tax year, you must use the rates for all your deductible food costs for eligible children during that tax year. Form 1040 However, if you use the standard meal and snack rates in any tax year, you can use actual costs to compute the deductible cost of food in any other tax year. Form 1040   If you use the standard meal and snack rates, you must maintain records to substantiate the computation of the total amount deducted for the cost of food provided to eligible children. Form 1040 The records kept should include the name of each child, dates and hours of attendance in the daycare, and the type and quantity of meals and snacks served. Form 1040 This information can be recorded in a log similar to the one shown in Exhibit A, near the end of this publication. Form 1040   The standard meal and snack rates include beverages, but do not include non-food supplies used for food preparation, service, or storage, such as containers, paper products, or utensils. Form 1040 These expenses can be claimed as a separate deduction on your Schedule C (Form 1040). Form 1040     Table 3. Form 1040 Standard Meal and Snack Rates1 Location of Family Daycare Provider Breakfast Lunch Dinner Snack States other than Alaska an