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Federal 1040ezFederal 1040ez 1. Federal 1040ez Deducting Business Expenses Table of Contents What's New Introduction Topics - This chapter discusses: Useful Items - You may want to see: What Can I Deduct?Cost of Goods Sold Capital Expenses Capital versus Deductible Expenses Personal versus Business Expenses How Much Can I Deduct?Not-for-profit limits. Federal 1040ez At-risk limits. Federal 1040ez Passive activities. Federal 1040ez Net operating loss. Federal 1040ez When Can I Deduct an Expense?Economic performance. Federal 1040ez Not-for-Profit ActivitiesGross Income Limit on Deductions What's New Optional safe harbor method to determine the business use of a home deduction. Federal 1040ez Beginning in 2013, you can use the optional safe harbor method to determine the deduction for the business use of your home. Federal 1040ez See Optional safe harbor method under Business use of your home , later. Federal 1040ez Introduction This chapter covers the general rules for deducting business expenses. Federal 1040ez Business expenses are the costs of carrying on a trade or business, and they are usually deductible if the business is operated to make a profit. Federal 1040ez Topics - This chapter discusses: What you can deduct How much you can deduct When you can deduct Not-for-profit activities Useful Items - You may want to see: Publication 334 Tax Guide for Small Business 463 Travel, Entertainment, Gift, and Car Expenses 525 Taxable and Nontaxable Income 529 Miscellaneous Deductions 536 Net Operating Losses (NOLs) for Individuals, Estates, and Trusts 538 Accounting Periods and Methods 542 Corporations 547 Casualties, Disasters, and Thefts 587 Business Use of Your Home 925 Passive Activity and At-Risk Rules 936 Home Mortgage Interest Deduction 946 How To Depreciate Property Form (and Instructions) Sch A (Form 1040) Itemized Deductions 5213 Election To Postpone Determination as To Whether the Presumption Applies That an Activity Is Engaged in for Profit See chapter 12 for information about getting publications and forms. Federal 1040ez What Can I Deduct? To be deductible, a business expense must be both ordinary and necessary. Federal 1040ez An ordinary expense is one that is common and accepted in your industry. Federal 1040ez A necessary expense is one that is helpful and appropriate for your trade or business. Federal 1040ez An expense does not have to be indispensable to be considered necessary. Federal 1040ez Even though an expense may be ordinary and necessary, you may not be allowed to deduct the expense in the year you paid or incurred it. Federal 1040ez In some cases you may not be allowed to deduct the expense at all. Federal 1040ez Therefore, it is important to distinguish usual business expenses from expenses that include the following. Federal 1040ez The expenses used to figure cost of goods sold, Capital expenses, and Personal expenses. Federal 1040ez Cost of Goods Sold If your business manufactures products or purchases them for resale, you generally must value inventory at the beginning and end of each tax year to determine your cost of goods sold. Federal 1040ez Some of your business expenses may be included in figuring cost of goods sold. Federal 1040ez Cost of goods sold is deducted from your gross receipts to figure your gross profit for the year. Federal 1040ez If you include an expense in the cost of goods sold, you cannot deduct it again as a business expense. Federal 1040ez The following are types of expenses that go into figuring cost of goods sold. Federal 1040ez The cost of products or raw materials, including freight. Federal 1040ez Storage. Federal 1040ez Direct labor (including contributions to pension or annuity plans) for workers who produce the products. Federal 1040ez Factory overhead. Federal 1040ez Under the uniform capitalization rules, you must capitalize the direct costs and part of the indirect costs for certain production or resale activities. Federal 1040ez Indirect costs include rent, interest, taxes, storage, purchasing, processing, repackaging, handling, and administrative costs. Federal 1040ez This rule does not apply to personal property you acquire for resale if your average annual gross receipts (or those of your predecessor) for the preceding 3 tax years are not more than $10 million. Federal 1040ez For more information, see the following sources. Federal 1040ez Cost of goods sold—chapter 6 of Publication 334. Federal 1040ez Inventories—Publication 538. Federal 1040ez Uniform capitalization rules—Publication 538 and section 263A of the Internal Revenue Code and the related regulations. Federal 1040ez Capital Expenses You must capitalize, rather than deduct, some costs. Federal 1040ez These costs are a part of your investment in your business and are called “capital expenses. Federal 1040ez ” Capital expenses are considered assets in your business. Federal 1040ez In general, you capitalize three types of costs. Federal 1040ez Business start-up costs (See Tip below). Federal 1040ez Business assets. Federal 1040ez Improvements. Federal 1040ez You can elect to deduct or amortize certain business start-up costs. Federal 1040ez See chapters 7 and 8. Federal 1040ez Cost recovery. Federal 1040ez Although you generally cannot take a current deduction for a capital expense, you may be able to recover the amount you spend through depreciation, amortization, or depletion. Federal 1040ez These recovery methods allow you to deduct part of your cost each year. Federal 1040ez In this way, you are able to recover your capital expense. Federal 1040ez See Amortization (chapter 8) and Depletion (chapter 9) in this publication. Federal 1040ez A taxpayer can elect to deduct a portion of the costs of certain depreciable property as a section 179 deduction. Federal 1040ez A greater portion of these costs can be deducted if the property is qualified disaster assistance property. Federal 1040ez See Publication 946 for details. Federal 1040ez Going Into Business The costs of getting started in business, before you actually begin business operations, are capital expenses. Federal 1040ez These costs may include expenses for advertising, travel, or wages for training employees. Federal 1040ez If you go into business. Federal 1040ez When you go into business, treat all costs you had to get your business started as capital expenses. Federal 1040ez Usually you recover costs for a particular asset through depreciation. Federal 1040ez Generally, you cannot recover other costs until you sell the business or otherwise go out of business. Federal 1040ez However, you can choose to amortize certain costs for setting up your business. Federal 1040ez See Starting a Business in chapter 8 for more information on business start-up costs. Federal 1040ez If your attempt to go into business is unsuccessful. Federal 1040ez If you are an individual and your attempt to go into business is not successful, the expenses you had in trying to establish yourself in business fall into two categories. Federal 1040ez The costs you had before making a decision to acquire or begin a specific business. Federal 1040ez These costs are personal and nondeductible. Federal 1040ez They include any costs incurred during a general search for, or preliminary investigation of, a business or investment possibility. Federal 1040ez The costs you had in your attempt to acquire or begin a specific business. Federal 1040ez These costs are capital expenses and you can deduct them as a capital loss. Federal 1040ez If you are a corporation and your attempt to go into a new trade or business is not successful, you may be able to deduct all investigatory costs as a loss. Federal 1040ez The costs of any assets acquired during your unsuccessful attempt to go into business are a part of your basis in the assets. Federal 1040ez You cannot take a deduction for these costs. Federal 1040ez You will recover the costs of these assets when you dispose of them. Federal 1040ez Business Assets There are many different kinds of business assets; for example, land, buildings, machinery, furniture, trucks, patents, and franchise rights. Federal 1040ez You must fully capitalize the cost of these assets, including freight and installation charges. Federal 1040ez Certain property you produce for use in your trade or business must be capitalized under the uniform capitalization rules. Federal 1040ez See Regulations section 1. Federal 1040ez 263A-2 for information on these rules. Federal 1040ez Improvements Improvements are generally major expenditures. Federal 1040ez Some examples are: new electric wiring, a new roof, a new floor, new plumbing, bricking up windows to strengthen a wall, and lighting improvements. Federal 1040ez The costs of making improvements to a business asset are capital expenses if the improvements add to the value of the asset, appreciably lengthen the time you can use it, or adapt it to a different use. Federal 1040ez Beginning in 2014, you must capitalize as improvements costs that are for the betterment of a unit of property, restore the unit of property, or adapt the unit of property to a new or different use. Federal 1040ez Temporary regulations allow you to capitalize costs meeting the above criteria for tax years beginning after 2011. Federal 1040ez However, you can currently deduct repairs that keep your property in a normal efficient operating condition as a business expense. Federal 1040ez Treat as repairs amounts paid to replace parts of a machine that only keep it in a normal operating condition. Federal 1040ez Restoration plan. Federal 1040ez Capitalize the cost of reconditioning, improving, or altering your property as part of a general restoration plan to make it suitable for your business. Federal 1040ez This applies even if some of the work would by itself be classified as repairs. Federal 1040ez Capital versus Deductible Expenses To help you distinguish between capital and deductible expenses, different examples are given below. Federal 1040ez Motor vehicles. Federal 1040ez You usually capitalize the cost of a motor vehicle you use in your business. Federal 1040ez You can recover its cost through annual deductions for depreciation. Federal 1040ez There are dollar limits on the depreciation you can claim each year on passenger automobiles used in your business. Federal 1040ez See Publication 463. Federal 1040ez Generally, repairs you make to your business vehicle are currently deductible. Federal 1040ez However, amounts you pay to recondition and overhaul a business vehicle are capital expenses and are recovered through depreciation. Federal 1040ez Roads and driveways. Federal 1040ez The cost of building a private road on your business property and the cost of replacing a gravel driveway with a concrete one are capital expenses you may be able to depreciate. Federal 1040ez The cost of maintaining a private road on your business property is a deductible expense. Federal 1040ez Tools. Federal 1040ez Unless the uniform capitalization rules apply, amounts spent for tools used in your business are deductible expenses if the tools have a life expectancy of less than 1 year or their cost is minor. Federal 1040ez Machinery parts. Federal 1040ez Unless the uniform capitalization rules apply, the cost of replacing short-lived parts of a machine to keep it in good working condition, but not add to its life, is a deductible expense. Federal 1040ez Heating equipment. Federal 1040ez The cost of changing from one heating system to another is a capital expense. Federal 1040ez Personal versus Business Expenses Generally, you cannot deduct personal, living, or family expenses. Federal 1040ez However, if you have an expense for something that is used partly for business and partly for personal purposes, divide the total cost between the business and personal parts. Federal 1040ez You can deduct the business part. Federal 1040ez For example, if you borrow money and use 70% of it for business and the other 30% for a family vacation, you generally can deduct 70% of the interest as a business expense. Federal 1040ez The remaining 30% is personal interest and generally is not deductible. Federal 1040ez See chapter 4 for information on deducting interest and the allocation rules. Federal 1040ez Business use of your home. Federal 1040ez If you use part of your home for business, you may be able to deduct expenses for the business use of your home. Federal 1040ez These expenses may include mortgage interest, insurance, utilities, repairs, and depreciation. Federal 1040ez To qualify to claim expenses for the business use of your home, you must meet both of the following tests. Federal 1040ez The business part of your home must be used exclusively and regularly for your trade or business. Federal 1040ez The business part of your home must be: Your principal place of business, or A place where you meet or deal with patients, clients, or customers in the normal course of your trade or business, or A separate structure (not attached to your home) used in connection with your trade or business. Federal 1040ez You generally do not have to meet the exclusive use test for the part of your home that you regularly use either for the storage of inventory or product samples, or as a daycare facility. Federal 1040ez Your home office qualifies as your principal place of business if you meet the following requirements. Federal 1040ez You use the office exclusively and regularly for administrative or management activities of your trade or business. Federal 1040ez You have no other fixed location where you conduct substantial administrative or management activities of your trade or business. Federal 1040ez If you have more than one business location, determine your principal place of business based on the following factors. Federal 1040ez The relative importance of the activities performed at each location. Federal 1040ez If the relative importance factor does not determine your principal place of business, consider the time spent at each location. Federal 1040ez Optional safe harbor method. Federal 1040ez Beginning in 2013, individual taxpayers can use the optional safe harbor method to determine the amount of deductible expenses attributable to certain business use of a residence during the tax year. Federal 1040ez This method is an alternative to the calculation, allocation, and substantiation of actual expenses. Federal 1040ez The deduction under the optional method is limited to $1,500 per year based on $5 a square foot for up to 300 square feet. Federal 1040ez Under this method, you claim your allowable mortgage interest, real estate taxes, and casualty losses on the home as itemized deductions on Schedule A (Form 1040). Federal 1040ez You are not required to allocate these deductions between personal and business use, as is required under the regular method. Federal 1040ez If you use the optional method, you cannot depreciate the portion of your home used in a trade or business. Federal 1040ez Business expenses unrelated to the home, such as advertising, supplies, and wages paid to employees, are still fully deductible. Federal 1040ez All of the requirements discussed earlier under Business use of your home still apply. Federal 1040ez For more information on the deduction for business use of your home, including the optional safe harbor method, see Publication 587. Federal 1040ez If you were entitled to deduct depreciation on the part of your home used for business, you cannot exclude the part of the gain from the sale of your home that equals any depreciation you deducted (or could have deducted) for periods after May 6, 1997. Federal 1040ez Business use of your car. Federal 1040ez If you use your car exclusively in your business, you can deduct car expenses. Federal 1040ez If you use your car for both business and personal purposes, you must divide your expenses based on actual mileage. Federal 1040ez Generally, commuting expenses between your home and your business location, within the area of your tax home, are not deductible. Federal 1040ez You can deduct actual car expenses, which include depreciation (or lease payments), gas and oil, tires, repairs, tune-ups, insurance, and registration fees. Federal 1040ez Or, instead of figuring the business part of these actual expenses, you may be able to use the standard mileage rate to figure your deduction. Federal 1040ez Beginning in 2013, the standard mileage rate is 56. Federal 1040ez 5 cents per mile. Federal 1040ez If you are self-employed, you can also deduct the business part of interest on your car loan, state and local personal property tax on the car, parking fees, and tolls, whether or not you claim the standard mileage rate. Federal 1040ez For more information on car expenses and the rules for using the standard mileage rate, see Publication 463. Federal 1040ez How Much Can I Deduct? Generally, you can deduct the full amount of a business expense if it meets the criteria of ordinary and necessary and it is not a capital expense. Federal 1040ez Recovery of amount deducted (tax benefit rule). Federal 1040ez If you recover part of an expense in the same tax year in which you would have claimed a deduction, reduce your current year expense by the amount of the recovery. Federal 1040ez If you have a recovery in a later year, include the recovered amount in income in that year. Federal 1040ez However, if part of the deduction for the expense did not reduce your tax, you do not have to include that part of the recovered amount in income. Federal 1040ez For more information on recoveries and the tax benefit rule, see Publication 525. Federal 1040ez Payments in kind. Federal 1040ez If you provide services to pay a business expense, the amount you can deduct is limited to your out-of-pocket costs. Federal 1040ez You cannot deduct the cost of your own labor. Federal 1040ez Similarly, if you pay a business expense in goods or other property, you can deduct only what the property costs you. Federal 1040ez If these costs are included in the cost of goods sold, do not deduct them again as a business expense. Federal 1040ez Limits on losses. Federal 1040ez If your deductions for an investment or business activity are more than the income it brings in, you have a loss. Federal 1040ez There may be limits on how much of the loss you can deduct. Federal 1040ez Not-for-profit limits. Federal 1040ez If you carry on your business activity without the intention of making a profit, you cannot use a loss from it to offset other income. Federal 1040ez See Not-for-Profit Activities , later. Federal 1040ez At-risk limits. Federal 1040ez Generally, a deductible loss from a trade or business or other income-producing activity is limited to the investment you have “at risk” in the activity. Federal 1040ez You are at risk in any activity for the following. Federal 1040ez The money and adjusted basis of property you contribute to the activity. Federal 1040ez Amounts you borrow for use in the activity if: You are personally liable for repayment, or You pledge property (other than property used in the activity) as security for the loan. Federal 1040ez For more information, see Publication 925. Federal 1040ez Passive activities. Federal 1040ez Generally, you are in a passive activity if you have a trade or business activity in which you do not materially participate, or a rental activity. Federal 1040ez In general, deductions for losses from passive activities only offset income from passive activities. Federal 1040ez You cannot use any excess deductions to offset other income. Federal 1040ez In addition, passive activity credits can only offset the tax on net passive income. Federal 1040ez Any excess loss or credits are carried over to later years. Federal 1040ez Suspended passive losses are fully deductible in the year you completely dispose of the activity. Federal 1040ez For more information, see Publication 925. Federal 1040ez Net operating loss. Federal 1040ez If your deductions are more than your income for the year, you may have a “net operating loss. Federal 1040ez ” You can use a net operating loss to lower your taxes in other years. Federal 1040ez See Publication 536 for more information. Federal 1040ez See Publication 542 for information about net operating losses of corporations. Federal 1040ez When Can I Deduct an Expense? When you can deduct an expense depends on your accounting method. Federal 1040ez An accounting method is a set of rules used to determine when and how income and expenses are reported. Federal 1040ez The two basic methods are the cash method and the accrual method. Federal 1040ez Whichever method you choose must clearly reflect income. Federal 1040ez For more information on accounting methods, see Publication 538. Federal 1040ez Cash method. Federal 1040ez Under the cash method of accounting, you generally deduct business expenses in the tax year you pay them. Federal 1040ez Accrual method. Federal 1040ez Under an accrual method of accounting, you generally deduct business expenses when both of the following apply. Federal 1040ez The all-events test has been met. Federal 1040ez The test is met when: All events have occurred that fix the fact of liability, and The liability can be determined with reasonable accuracy. Federal 1040ez Economic performance has occurred. Federal 1040ez Economic performance. Federal 1040ez You generally cannot deduct or capitalize a business expense until economic performance occurs. Federal 1040ez If your expense is for property or services provided to you, or for your use of property, economic performance occurs as the property or services are provided, or the property is used. Federal 1040ez If your expense is for property or services you provide to others, economic performance occurs as you provide the property or services. Federal 1040ez Example. Federal 1040ez Your tax year is the calendar year. Federal 1040ez In December 2013, the Field Plumbing Company did some repair work at your place of business and sent you a bill for $600. Federal 1040ez You paid it by check in January 2014. Federal 1040ez If you use the accrual method of accounting, deduct the $600 on your tax return for 2013 because all events have occurred to “fix” the fact of liability (in this case the work was completed), the liability can be determined, and economic performance occurred in that year. Federal 1040ez If you use the cash method of accounting, deduct the expense on your 2014 return. Federal 1040ez Prepayment. Federal 1040ez You generally cannot deduct expenses in advance, even if you pay them in advance. Federal 1040ez This rule applies to both the cash and accrual methods. Federal 1040ez It applies to prepaid interest, prepaid insurance premiums, and any other expense paid far enough in advance to, in effect, create an asset with a useful life extending substantially beyond the end of the current tax year. Federal 1040ez Example. Federal 1040ez In 2013, you sign a 10-year lease and immediately pay your rent for the first 3 years. Federal 1040ez Even though you paid the rent for 2013, 2014, and 2015, you can only deduct the rent for 2013 on your 2013 tax return. Federal 1040ez You can deduct the rent for 2014 and 2015 on your tax returns for those years. Federal 1040ez Contested liability. Federal 1040ez Under the cash method, you can deduct a contested liability only in the year you pay the liability. Federal 1040ez Under the accrual method, you can deduct contested liabilities such as taxes (except foreign or U. Federal 1040ez S. Federal 1040ez possession income, war profits, and excess profits taxes) either in the tax year you pay the liability (or transfer money or other property to satisfy the obligation) or in the tax year you settle the contest. Federal 1040ez However, to take the deduction in the year of payment or transfer, you must meet certain conditions. Federal 1040ez See Regulations section 1. Federal 1040ez 461-2. Federal 1040ez Related person. Federal 1040ez Under an accrual method of accounting, you generally deduct expenses when you incur them, even if you have not yet paid them. Federal 1040ez However, if you and the person you owe are related and that person uses the cash method of accounting, you must pay the expense before you can deduct it. Federal 1040ez Your deduction is allowed when the amount is includible in income by the related cash method payee. Federal 1040ez See Related Persons in Publication 538. Federal 1040ez Not-for-Profit Activities If you do not carry on your business or investment activity to make a profit, you cannot use a loss from the activity to offset other income. Federal 1040ez Activities you do as a hobby, or mainly for sport or recreation, are often not entered into for profit. Federal 1040ez The limit on not-for-profit losses applies to individuals, partnerships, estates, trusts, and S corporations. Federal 1040ez It does not apply to corporations other than S corporations. Federal 1040ez In determining whether you are carrying on an activity for profit, several factors are taken into account. Federal 1040ez No one factor alone is decisive. Federal 1040ez Among the factors to consider are whether: You carry on the activity in a businesslike manner, The time and effort you put into the activity indicate you intend to make it profitable, You depend on the income for your livelihood, Your losses are due to circumstances beyond your control (or are normal in the start-up phase of your type of business), You change your methods of operation in an attempt to improve profitability, You (or your advisors) have the knowledge needed to carry on the activity as a successful business, You were successful in making a profit in similar activities in the past, The activity makes a profit in some years, and You can expect to make a future profit from the appreciation of the assets used in the activity. Federal 1040ez Presumption of profit. Federal 1040ez An activity is presumed carried on for profit if it produced a profit in at least 3 of the last 5 tax years, including the current year. Federal 1040ez Activities that consist primarily of breeding, training, showing, or racing horses are presumed carried on for profit if they produced a profit in at least 2 of the last 7 tax years, including the current year. Federal 1040ez The activity must be substantially the same for each year within this period. Federal 1040ez You have a profit when the gross income from an activity exceeds the deductions. Federal 1040ez If a taxpayer dies before the end of the 5-year (or 7-year) period, the “test” period ends on the date of the taxpayer's death. Federal 1040ez If your business or investment activity passes this 3- (or 2-) years-of-profit test, the IRS will presume it is carried on for profit. Federal 1040ez This means the limits discussed here will not apply. Federal 1040ez You can take all your business deductions from the activity, even for the years that you have a loss. Federal 1040ez You can rely on this presumption unless the IRS later shows it to be invalid. Federal 1040ez Using the presumption later. Federal 1040ez If you are starting an activity and do not have 3 (or 2) years showing a profit, you can elect to have the presumption made after you have the 5 (or 7) years of experience allowed by the test. Federal 1040ez You can elect to do this by filing Form 5213. Federal 1040ez Filing this form postpones any determination that your activity is not carried on for profit until 5 (or 7) years have passed since you started the activity. Federal 1040ez The benefit gained by making this election is that the IRS will not immediately question whether your activity is engaged in for profit. Federal 1040ez Accordingly, it will not restrict your deductions. Federal 1040ez Rather, you will gain time to earn a profit in the required number of years. Federal 1040ez If you show 3 (or 2) years of profit at the end of this period, your deductions are not limited under these rules. Federal 1040ez If you do not have 3 (or 2) years of profit, the limit can be applied retroactively to any year with a loss in the 5-year (or 7-year) period. Federal 1040ez Filing Form 5213 automatically extends the period of limitations on any year in the 5-year (or 7-year) period to 2 years after the due date of the return for the last year of the period. Federal 1040ez The period is extended only for deductions of the activity and any related deductions that might be affected. Federal 1040ez You must file Form 5213 within 3 years after the due date of your return (determined without extensions) for the year in which you first carried on the activity, or, if earlier, within 60 days after receiving written notice from the Internal Revenue Service proposing to disallow deductions attributable to the activity. Federal 1040ez Gross Income Gross income from a not-for-profit activity includes the total of all gains from the sale, exchange, or other disposition of property, and all other gross receipts derived from the activity. Federal 1040ez Gross income from the activity also includes capital gains and rents received for the use of property which is held in connection with the activity. Federal 1040ez You can determine gross income from any not-for-profit activity by subtracting the cost of goods sold from your gross receipts. Federal 1040ez However, if you determine gross income by subtracting cost of goods sold from gross receipts, you must do so consistently, and in a manner that follows generally accepted methods of accounting. Federal 1040ez Limit on Deductions If your activity is not carried on for profit, take deductions in the following order and only to the extent stated in the three categories. Federal 1040ez If you are an individual, these deductions may be taken only if you itemize. Federal 1040ez These deductions may be taken on Schedule A (Form 1040). Federal 1040ez Category 1. Federal 1040ez Deductions you can take for personal as well as for business activities are allowed in full. Federal 1040ez For individuals, all nonbusiness deductions, such as those for home mortgage interest, taxes, and casualty losses, belong in this category. Federal 1040ez Deduct them on the appropriate lines of Schedule A (Form 1040). Federal 1040ez For tax years beginning after December 31, 2008, you can deduct a casualty loss on property you own for personal use only to the extent it is more than $500 and exceeds 10% of your adjusted gross income (AGI). Federal 1040ez The 10% AGI limitation does not apply to net disaster losses resulting from federally declared disasters in 2008 and 2009, and individuals are allowed to claim the net disaster losses even if they do not itemize their deductions. Federal 1040ez The reduction amount returns to $100 for tax years beginning after December 31, 2009. Federal 1040ez See Publication 547 for more information on casualty losses. Federal 1040ez For the limits that apply to home mortgage interest, see Publication 936. Federal 1040ez Category 2. Federal 1040ez Deductions that do not result in an adjustment to the basis of property are allowed next, but only to the extent your gross income from the activity is more than your deductions under the first category. Federal 1040ez Most business deductions, such as those for advertising, insurance premiums, interest, utilities, and wages, belong in this category. Federal 1040ez Category 3. Federal 1040ez Business deductions that decrease the basis of property are allowed last, but only to the extent the gross income from the activity exceeds the deductions you take under the first two categories. Federal 1040ez Deductions for depreciation, amortization, and the part of a casualty loss an individual could not deduct in category (1) belong in this category. Federal 1040ez Where more than one asset is involved, allocate depreciation and these other deductions proportionally. Federal 1040ez Individuals must claim the amounts in categories (2) and (3) as miscellaneous deductions on Schedule A (Form 1040). Federal 1040ez They are subject to the 2%-of-adjusted-gross-income limit. Federal 1040ez See Publication 529 for information on this limit. Federal 1040ez Example. Federal 1040ez Adriana is engaged in a not-for-profit activity. Federal 1040ez The income and expenses of the activity are as follows. Federal 1040ez Gross income $3,200 Subtract: Real estate taxes $700 Home mortgage interest 900 Insurance 400 Utilities 700 Maintenance 200 Depreciation on an automobile 600 Depreciation on a machine 200 3,700 Loss $(500) Adriana must limit her deductions to $3,200, the gross income she earned from the activity. Federal 1040ez The limit is reached in category (3), as follows. Federal 1040ez Limit on deduction $3,200 Category 1: Taxes and interest $1,600 Category 2: Insurance, utilities, and maintenance 1,300 2,900 Available for Category 3 $ 300 The $800 of depreciation is allocated between the automobile and machine as follows. Federal 1040ez $600 $800 x $300 = $225 depreciation for the automobile $200 $800 x $300 = $75 depreciation for the machine The basis of each asset is reduced accordingly. Federal 1040ez Adriana includes the $3,200 of gross income on line 21 (other income) of Form 1040. Federal 1040ez The $1,600 for category (1) is deductible in full on the appropriate lines for taxes and interest on Schedule A (Form 1040). Federal 1040ez Adriana deducts the remaining $1,600 ($1,300 for category (2) and $300 for category (3)) as other miscellaneous deductions on Schedule A (Form 1040) subject to the 2%-of-adjusted-gross-income limit. Federal 1040ez Partnerships and S corporations. Federal 1040ez If a partnership or S corporation carries on a not-for-profit activity, these limits apply at the partnership or S corporation level. Federal 1040ez They are reflected in the individual shareholder's or partner's distributive shares. Federal 1040ez More than one activity. Federal 1040ez If you have several undertakings, each may be a separate activity or several undertakings may be combined. Federal 1040ez The following are the most significant facts and circumstances in making this determination. Federal 1040ez The degree of organizational and economic interrelationship of various undertakings. Federal 1040ez The business purpose that is (or might be) served by carrying on the various undertakings separately or together in a business or investment setting. Federal 1040ez The similarity of the undertakings. Federal 1040ez The IRS will generally accept your characterization if it is supported by facts and circumstances. Federal 1040ez If you are carrying on two or more different activities, keep the deductions and income from each one separate. Federal 1040ez Figure separately whether each is a not-for-profit activity. Federal 1040ez Then figure the limit on deductions and losses separately for each activity that is not for profit. Federal 1040ez Prev Up Next Home More Online Publications
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