What can I deduct?

What Can I Deduct?

Extracted from: https://www.irs.gov/publications/p535#en_US_2022_publink100025510 

To be deductible, a business expense must be both ordinary and necessary. An ordinary expense is one that is common and accepted in your industry. A necessary expense is one that is helpful and appropriate for your trade or business. An expense does not have to be indispensable to be considered necessary.

Removed section on Cost of Goods Sold and Start Up Expenses - see IRS website for information on these items

Business Assets

There are many different kinds of business assets, for example, land, buildings, machinery, furniture, trucks, patents, and franchise rights. You must fully capitalize the cost of these assets, including freight and installation charges.

Certain property you produce for use in your trade or business must be capitalized under the uniform capitalization rules. See Regulations section 1.263A-2 for information on these rules.

Removed section on DeMinimus Assets (under $2500 and/or useful life of w year or less). - see IRS website for information on these items

Capital Versus Deductible Expenses

To help you distinguish between capital and deductible expenses, different examples are given below.

Motor vehicles. 

You usually capitalize the cost of a motor vehicle you use in your business. You can recover its cost through annual deductions for depreciation.

There are dollar limits on the depreciation you can claim each year on passenger automobiles used in your business. See Pub. 463 for more information.

Generally, repairs you make to your business vehicle are currently deductible. However, amounts you pay to improve your business vehicle are generally capital expenditures and are recovered through depreciation.

Roads and driveways. 

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. The cost of maintaining a private road on your business property is a deductible expense.

Tools. 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 they cost $200 or less per item or invoice.

Machinery parts. 

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 to improve the machine, is a deductible expense.

Heating equipment. The cost of changing from one heating system to another is a capital expense.

Removed section on qualified business deduction. - - see IRS website for information on these items

Personal Versus Business Expenses

Generally, you cannot deduct personal, living, or family expenses. 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. You can deduct the business part.

For example, if you borrow money and use 70% of it for business and the other 30% for a family vacation, you can generally deduct 70% of the interest as a business expense. The remaining 30% is personal interest and is generally not deductible. See chapter 4 for information on deducting interest and the allocation rules.

Removed section on business use of home. If you have a totally dedicated room of your home for your business,you may be able to use this as a deduction. - see me or the IRS website for information on these items

Business expenses unrelated to the home, such as advertising, supplies, and wages paid to employees, are still fully deductible. All of the requirements discussed earlier under Business use of your home still apply.

Business use of your car. 

If you use your car exclusively in your business, you can deduct car expenses. If you use your car for both business and personal purposes, you must divide your expenses based on actual mileage. Generally, commuting expenses between your home and your business location, within the area of your tax home, are not deductible.

You can deduct actual car expenses, which include depreciation (or lease payments), gas and oil, tires, repairs, tune-ups, insurance, and registration fees. 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. For 2022, the standard mileage rate is 58.5 cents per mile before July 1, 2022, and 62.5 cents per mile on or after July 1, 2022. To find the standard mileage rate for 2023, go to IRS.gov/Tax-Professionals/Standard-Mileage-Rates.

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.

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.

Recovery of amount deducted (tax benefit rule). 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. If you have a recovery in a later year, include the recovered amount in income in that year. 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.

For more information on recoveries and the tax benefit rule, see Pub. 525.

Payments in kind. 

If you provide services to pay a business expense, the amount you can deduct is limited to your out-of-pocket costs. You cannot deduct the cost of your own labor.

Similarly, if you pay a business expense in goods or other property, you can deduct only what the property costs you. If these costs are included in the cost of goods sold, do not deduct them again as a business expense.

Limits on losses. 

If your deductions for an investment or business activity are more than the income it brings in, you have a loss. There may be limits on how much of the loss you can deduct.

Not-for-profit limits. 

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. For more information, see Not-for-Profit Activities, later.

Removed section on at-risk limitations. - see the IRS website for information on these items

Passive activities.

 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. In general, deductions for losses from passive activities only offset income from passive activities. You cannot use any excess deductions to offset other income. In addition, passive activity credits can only offset the tax on net passive income. Any excess loss or credits are carried over to later years. Suspended passive losses are fully deductible in the year you completely dispose of the activity. For more information, see Pub. 925.

Net operating loss (NOL). 

If your deductions are more than your income for the year, you may have an NOL. You can use an NOL to lower your taxes in other years. See Pub. 536 for more information.

See Pub. 542 for information about NOLs of corporations.

When Can I Deduct an Expense?

When you can deduct an expense depends on your accounting method. An accounting method is a set of rules used to determine when and how income and expenses are reported. The two basic methods are the cash method and the accrual method. Whichever method you choose must clearly reflect income.

.Regards,

Michael W. Loomis, CPA