Tax Deduction Strategies For Home-Based Businesses

IRS Form 4562 is used to claim deductions for depreciation and amortization of tangible or intangible assets. It is also used to expense certain property under Section 179 and to provide information on the business or investment use of vehicles and other property.

The form is required for each year that a business client is depreciating or amortizing any assets and deducting that expense on their tax return.

The safe harbour method

The IRS may update the $5 allowance from time to time, but it is not inflation-adjusted. The safe harbour method can be used by taxpayers who continue to satisfy all the other requirements for a home office deduction, including the requirement that the space in the residence used as an office be used exclusively for that purpose and the limitation that an employee qualifies for the home office deduction only if the office is for the convenience of the taxpayer's employer.

A taxpayer who itemizes deductions and uses the safe harbour method for a tax year may deduct, to the extent allowable, any expense related to the home that is deductible without regard to whether there is a qualified business use of the home for that tax year (e.g., deductions for qualified residence interest, property taxes, and casualty losses). Taxpayers using the safe harbour method deduct these expenses as itemized deductions and cannot deduct any portion of these expenses from the gross income derived from the qualified business use of the home, either for purposes of determining the net income derived from the business or for purposes of determining the gross income limitation.

Like the actual-expense method, the deduction under the safe harbour method is subject to a gross income limitation. The amount of the deduction computed using the safe harbour method cannot exceed the gross income derived from the qualified business use of the home for the tax year reduced by the business deductions unrelated to the qualified business use of a home. Unlike the actual-expense method, however, taxpayers cannot carry over any excess to another tax year. If a taxpayer uses the actual-expense method for calculating the deduction and has had their deduction limited by the gross income limitation in that year, the taxpayer can deduct this amount in the next year they use the actual-expense method, but they cannot use the disallowed amount in a year they elect the safe harbour method. This limit on carryovers for the safe harbour method means taxpayers must be careful before electing it to be sure they will not lose any of their deductions.

Section 179 deductions

Section 179 is a tax deduction that allows businesses to write off all or part of the cost of qualified property and equipment, up to a limit, during the first year it was purchased and placed into service. This is a deduction specifically designed to help small businesses invest in themselves and the American economy.

For a property to qualify for Section 179, it must meet the requirements established by the IRS. Any piece of property claimed as Section 179 must be used for business purposes at least 50% of the time during the first year it was put into service.

Tangible Personal Property

Many types of property purchased for a business can qualify for Section 179 as long as it counts as tangible personal property. Examples of eligible property include machinery, office equipment and furniture, computers and software, vehicles, and eligible improvements to non-residential buildings.

Acquired by Purchase

In order to claim Section 179, the property must have been acquired by a company via an exchange of money. Inherited property and gifts do not qualify for Section 179.

"Placed into Service"

The point of Section 179 is to deduct the cost of equipment the same year it was placed into service. The IRS defines "placed into service" as the moment when a piece of property is ready and available for a specific use. That means that any equipment purchased during a calendar year but not put in service before the end of the year is not eligible for Section 179.

How to Claim Section 179 Deductions

Claiming Section 179 for eligible property is relatively straightforward, as long as you've maintained proper records for all purchases made during a tax year. Before you file your taxes, you may want to take time to understand how much you may be eligible for in Section 179 deductions.

Once you're ready to file your taxes, the first step is to understand your business's taxable income. Doing so will help you understand the upper limits of what you are eligible to claim as Section 179. In order to write off eligible property in the first year it was purchased, you must include Form 4562 with your taxes and elect the Section 179 deduction.

Section 179 Deduction Limits

The IRS institutes yearly limits on how much one business can claim as Section 179. For tax year 2023, companies can deduct no more than $1.16 million in the total cost of eligible property, and this will be reduced by any amount more than $2.89 million. These limits are adjusted for inflation each year.

A company cannot take a Section 179 deduction on more than their total annual taxable income. For example, if a company reports $100,000 as their net income, they can only claim $100,000 for Section 179. However, any qualifying amounts beyond the limit can be carried forward to future years.

Special depreciation allowance

The special depreciation allowance is an additional deduction you can take after any section 179 expense deduction and before you figure regular depreciation under MACRS for the year you place the property in service. The special depreciation allowance applies only for the first year the property is placed in service. The allowance is an additional deduction you can take after any section 179 expense deduction and before you figure regular depreciation under MACRS.

You can take the special depreciation allowance for certain qualified property acquired after September 27, 2017, qualified reuse and recycling property, and certain plants bearing fruits and nuts.

To figure the special depreciation allowance, multiply the depreciable basis of the property by the applicable percentage.

For qualified property other than listed property, enter the special depreciation allowance on Form 4562, Part II, line 14. For qualified property that is listed property, enter the special depreciation allowance on Form 4562, Part V, line 25.

MACRS depreciation

The Modified Accelerated Cost Recovery System (MACRS) is a method of depreciation used to recover the cost of business or income-producing property through annual tax deductions. It is an allowance for the wear and tear, deterioration, or obsolescence of the property.

MACRS consists of two depreciation systems, the General Depreciation System (GDS) and the Alternative Depreciation System (ADS). Generally, these systems provide different methods and recovery periods to use in figuring depreciation deductions.

You must use GDS unless you are specifically required by law to use ADS or you elect to use ADS.

If you placed your property in service in 2023, complete Part III of Form 4562 to report depreciation using MACRS. Complete Section B of Part III to report depreciation using GDS, and complete Section C of Part III to report depreciation using ADS. If you placed your property in service before 2023 and are required to file Form 4562, report depreciation using either GDS or ADS on line 17 in Part III.

The nontaxable transfers covered by this rule include the following.

A distribution in complete liquidation of a subsidiary.

A transfer to a corporation controlled by the transferor.

An exchange of property solely for corporate stock or securities in a reorganization.

A contribution of property to a partnership in exchange for a partnership interest.

A partnership distribution of property to a partner.

Amortization

The Internal Revenue Service (IRS) allows taxpayers to take a deduction for certain expenses: geological and geophysical expenses incurred in oil and natural gas exploration, atmospheric pollution control facilities, bond premiums, research and development (R&D), lease acquisition, forestation and reforestation, and intangibles, such as goodwill, patents, copyrights, and trademarks.

When it comes to loans, amortization is the gradual reduction of the debt through the repayments agreed with the lender. Loan amortization only considers the principal and doesn't include interest. There are three common ways to calculate loan amortization: the French method (paying back the same amount each month), the increasing balance method (instalments begin lower but increase over time), and the declining balance method (the borrower pays off some of the debt at the start to lower the interest and reduce instalments further down the line).

Frequently asked questions