What is Depreciation?

Depreciation is probably one of the most feared tax topics for family child care providers.

The rules of depreciation are complicated. There are many exceptions to the general rules. There is a lot of math involved. As a result, many child care providers don't want anything to do with it.

Do you own a home? Did you buy furniture, appliances, equipment, fence, or a deck? Did you do remodeling of a room that is now used for your business? Did you own furniture or appliances before you went into business?

If you answered "yes" to any of these questions, you will want to understand the basics of depreciation. This is because claiming depreciation expenses can significantly lower your taxes.

Here's an introduction to the topic of depreciation:

Before you can claim an expense for your business, you need to answer three questions:

1) Is the expense deductible?

2) How much of the expense is deductible?

3) When can I deduct it?

You can deduct expenses if they are "ordinary and necessary" for your business. This includes hundreds of expenses associated with maintaining your home. How much of an item is deductible is based on how it's used. If it's used 100% for your business, you can deduct 100% of the cost. If it's used by your business and your family, you can deduct the Time-Space Percentage of the cost.

When you can deduct an item depends on how much it cost. The general rule is that if an item costs less than $100, you can deduct it in one year (the year you bought it). If it costs more than $100, you must depreciate it. The $100 number is a rough rule of thumb.

There are exceptions to this general rule:

1) If the item doesn't last one year, you can deduct it in one year. 

2) Repairs and maintenance items can be deducted in one year (furnace cleaning, painting, etc.)

3) Items you owned before you went into business (that were not purchased for your business), are depreciated based on their fair market value at the time your business began. Such items don't have to be worth $100, but still must be depreciated.

4) Certain items used more than 50% of the time in your business can be deducted in one year, rather than being depreciated. This is called the Section 179 rule.

Keep receipts of all items you purchase, especially if they cost more than $100. Tell your tax professional that you want them depreciated as a business expense. If you do your own taxes, you can follow the instructions in my 2011 Family Child Care Tax Workbook and Organizer and calculate your depreciation deduction yourself.

See my other articles on the categories of depreciation expenses and the Section 179 rule.

When you are done reading them, you should feel much more comfortable with this complex topic of depreciation.

Image credit: agrability.missouri.edu

Comments

[Almond Tree]

If it wasnt for depreciation I'd probably do my taxes myself.I could never wrap my mind around this which is the reason I have a tax professional do my taxes. Thank you though Tom, for simplifying it for the layman's understanding...still confusing.