Depreciation and deduction

The Basics of Depreciation

Depreciation is the most complicated tax issue family child care providers face.

It's complicated because there are so many rules associated with it and they often change from year to year. And there's a lot of math involved! What fun.

What is depreciation?

Depreciation is the process of spreading the deduction of an item over a number of years, rather than deducting it in one year.

You must depreciate any item you purchase costing $500 or more that you use in your business. You are also entitled to depreciate any item you owned before you went into business that you start using for your business.

Here's a basic example of how depreciation works.

Let's say you bought a $1,000 refrigerator.

1) How much of the refrigerator can you depreciate?

Since you are using it in your business, you can deduct it. Since it costs more than $500 you must depreciate it. Since it's used by your family and your business, you can't depreciate the entire cost.

Therefore, you will use your Time-Space Percentage to determine the business portion of the refrigerator you can depreciate. Let's say your Time-Space Percentage is 40%.

$1,000 x 40% = $400. This is the business portion of your refrigerator.

2) How long do you depreciate the refrigerator?

All items costing more than $500 fall into one of these depreciation categories: office equipment (5 years), personal property (7 years), land improvement (15 years), home improvement (39 years), home (39 years) or car (5 years). For more information, see my article: "The Categories of Depreciation."

The refrigerator is considered "personal property" so it must be depreciated over 7 years. The phrase "personal property" here can be confusing. Essentially it means any property that's not attached to your home or land and is not office equipment. It doesn't mean property that is only personal. So, if you bought a $1,000 children's furniture set, it would be depreciated over 7 years as well.

3) How much is claimed as a depreciation deduction in the first year?

Now it gets more complicated. There are two ways you can depreciate seven year property. You can use the straight line method of depreciation or an accelerated method of depreciation.

The straight line method would give you approximately the same amount of depreciation deductions each year. You would claim 7.14% the first year; 14.29% for years 2-5; and 7.14% for year eight.

You might now say, "What is going on? Why are we depreciating the refrigerator over eight years? I thought were were using the seven year depreciation rule."

There is another rule that says you can't claim a full year's depreciation deduction in the first year, because you may have purchased the item in the middle of the year. Therefore, you only get a half a year's depreciation in the first year (no matter when you purchased it) and the other half at the end, or year eight. Aren't you glad you asked?

The accelerated method would give you higher depreciation deductions in the first few years and lower deductions in the later years. You would claim 14.29% in the first year; followed by 24.49%; 17.49%; 12.49%; 8.93%; 8.92%; 8.93%; and 4.46%.

Yes, this is also spread over eight years for the same reason as described above.

Which method should you use?

Because the accelerated method gives you deductions faster, it's almost always better to use this method. A deduction this year is worth more to you than a deduction next year, because you can use the money now or invest it.

So, using the accelerated method:

$1,000 x 40% = $400 x 14.29% = $57.16 first year depreciation deduction.

4) Where is my depreciation deduction claimed?

IRS Form 4562. In this case, seven year property is claimed on line 19c.

We're done!

Additional information

If you use personal property (or office equipment) more than 50% for your business, you can use the Section 179 rule and deduct the business portion all in one year, rather than depreciating it. So, for example, if our refrigerator was used 55% for the business, we could deduct $550 ($1,000 x 55% = $550) in the first year on IRS Form 4562, Part I. See my article, "The Section 179 Rule: A Powerful Way to Cut Your Taxes."

To use a business percentage other than your Time-Space Percentage for items used for both business and personal purposes, you must keep several months of records that show the actual business use. See my article, "How to Calculate an Actual Business Use Percent."

Is it worth it?

Some tax professionals tell providers that it's not worth depreciating a refrigerator to get only a $57 deduction the first year. This is bad advice. Over the course of eight years you will get a $400 deduction! Also, even a $57 deduction will reduce your taxes in the first year, so why not get it? It's your money. Lastly, you may have purchased other items besides a refrigerator and therefore your depreciation deduction will be higher.

My annual book Family Child Care Tax Workbook and Organizer has a long chapter explaining all of the depreciation rules in detail. It shows you how to calculate your depreciation deduction and where to put it on your tax forms.

If you use a tax preparer, let that person look at your receipt for the refrigerator and calculate your depreciation deduction.

Note for Minute Menu Kids Pro users

This software allows you to label and track items you purchase that cost more than $500. Although it won't calculate your depreciation deduction, it will organize these expenses so your tax professional (or you) may more easily fill out your tax forms.

13 Tax Questions Answered

The April 15th tax deadline is almost upon us. Here are some tax questions I've received from family child care providers recently:

1) Can I deduct my monthly mortgage payment?

-No. You can deduct your mortgage interest on IRS Form 8829 Expenses for Business Use of Your Home, line 10, column b (indirect expense). If your Time-Space Percentage is 35% you would deduct 35% of your mortgage interest on Form 8829 and 65% on Schedule A if you itemize.

You are able to capture the principle payments (that are part of your monthly mortgage payment) when you depreciate your home on Form 8829. See my article "How to Depreciate Your Home." 

2) Can I deduct 100% of my family child care union dues?

-Yes. In some states family child care providers have organized into unions and pay monthly union dues. These expenses can be deducted on IRS Form Schedule C, line 17 Legal and Professional Services. Some child care providers are not a member of a union, but are having "fair share" fees deducted from the payments they receive from the county for caring for children from subsidized families. You cannot deduct these "fair share" fees as a business expense. Instead, you are receiving less income and, as a result, you will pay less in taxes.

3) Can I deduct expenses for lawn maintenance such as a lawn mowing service or landscaping service?

-Yes. Multiply the cost by your Time-Space Percentage.

4) I bought some clothes (t-shirts, gloves, coats) for my day care children. Can I deduct this?

-It depends. If these items are given to the children for them to take home they would be considered "gifts" and are subject to a limitation of $25 per child, per year. There is a difference between a "gift" and an "activity expense." See my article on this. If these items were purchased for the children but kept in your home so they can be used by other children, then there is no $25 gift limitation and the items could be fully deducted as an activity expense.

Image credit: www.pamsclipart.com

5. If the clothes are used for daycare purposes (i.e. extra gloves for when theirs get too wet, t-shirts for extras when they get soiled, extra coats for those cold days when the parents bring them in a spring jacket etc...) wouldn't the clothing then be 100% deductible? 

 Yes, if you kept the clothes. No, if the children took home the clothes for good. I'll rewrite this section to make this point clearer.

6. We are planning on fencing on our entire front lawn, making it a nature exploration area for daycare. Can this entire expense be used as daycare since it will be used for daycare purposes only.

 It would be hard to argue that a fence in a front yard is only used for daycare, unless you have no young children of your own and you never use the front lawn area for personal purposes.

7. Will "fair share" dues be deductible if they are assessed against providers who are not receiving money from the county?
(Can the unions force us to pay these dues?)

Each state has its own rules about how they handle "fair share" payments. If the state makes you pay a "fair share" fee out of your pocket, then it's deductible. But, most states take the "fair share" payment out of the subsidy check before  the provider receives it. In this case, the provider is getting less in payments, reporting less in income and paying less taxes. There is a difference between union dues and "fair share." Unions cannot force providers to join the union or pay union dues. Fair share fees represent the costs associated with the union negotiating with the state to increase payments and provider other services and resources to all providers, those who are union members and those who are not. In most states who set up fair share fees, they are not voluntary.

8. So, for providers who are NOT taking subsidized families, is it your understanding that the union CAN make providers pay them the "fair share"? I'm in MN.

We don't know yet if the union will represent any providers in Minnesota, so I can't answer your question at this time. I don't know what the outcome will be. You can only be charged a fair share if the union is representing you. Whether or not the union will represent providers who do not care for subsidized families is not clear yet.

9. We are an small Day care for 6 children, What Document should we give to the parent to do their taxes? Should we give to them an account statement with the total that they paid for year o every three month?

Give parents an end-of-year receipt that indicates how much they paid you for the year. Give them your Employer Identification Number (EIN) and have them sign one copy that you keep for your files. There is no particular form to use when creating this receipt. You could use IRS Form W-10 and add to it how much the parent paid.

10. How will you do the deduction for a child care provider living in a movable home and paying mortgage for it, and also paying rent for the land? How many years we have to use for the movable house amortization?

You must depreciate the mobile home over 39 years. Deduct the time-space% of the rent on Form 8829.

11. Regarding Mortgage Interest on form 8829, my tax preparer - had entered it on line 16b "Excess mortgage Interest" I told her it should be on line 10b. She said it doesn't make any difference? Is that correct?

It won't make any difference since they are both multiplied by your time-space %. So, don't worry about this.

12. I pay rent where I live, am I able to deduct it with time-space%?

Yes, you can deduct the time-space% of rent, whether you rent a house or apartment.

13. Can I deduct the cost of dental insurance as a "self employed health insurance premium"? According to Turbotax, i can get a credit (as long as I show a profit) for health insurance premiums for me and my family. But, i wasn't sure if dental insurance was included. Turbotax wasn't clear on that.

Tom Copeland - www.tomcopelandblog.com