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IRS.gov Website
Publication 535
taxmap/pubs/p535-001.htm#en_us_publink1000208605

Chapter 1
Deducting Business Expenses(p2)

What's New(p2)


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Optional safe harbor method to determine the business use of a home deduction.(p2)
Beginning in 2013, you can use the optional safe harbor method to determine the deduction for the business use of your home. See Optional safe harbor method under Business use of your home, later.

taxmap/pubs/p535-001.htm#en_us_publink1000272096Introduction

This chapter covers the general rules for deducting business expenses. 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.

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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.
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What Can I Deduct?(p3)

rule
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.
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. In some cases you may not be allowed to deduct the expense at all. Therefore, it is important to distinguish usual business expenses from expenses that include the following.
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Cost of Goods Sold(p3)

rule
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. Some of your business expenses may be included in figuring cost of goods sold. Cost of goods sold is deducted from your gross receipts to figure your gross profit for the year. If you include an expense in the cost of goods sold, you cannot deduct it again as a business expense.
The following are types of expenses that go into figuring cost of goods sold.
Under the uniform capitalization rules, you must capitalize the direct costs and part of the indirect costs for certain production or resale activities. Indirect costs include rent, interest, taxes, storage, purchasing, processing, repackaging, handling, and administrative costs.
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.
For more information, see the following sources.
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Capital Expenses(p3)

rule
You must capitalize, rather than deduct, some costs. These costs are a part of your investment in your business and are called "capital expenses." Capital expenses are considered assets in your business. In general, you capitalize three types of costs.
Deposit
You can elect to deduct or amortize certain business start-up costs. See chapters 7 and 8.
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Cost recovery.(p3)

rule
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. These recovery methods allow you to deduct part of your cost each year. In this way, you are able to recover your capital expense. See Amortization (chapter 8) and Depletion (chapter 9) in this publication. A taxpayer can elect to deduct a portion of the costs of certain depreciable property as a section 179 deduction. A greater portion of these costs can be deducted if the property is qualified disaster assistance property. See Publication 946 for details.
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Going Into Business(p3)

rule
The costs of getting started in business, before you actually begin business operations, are capital expenses. These costs may include expenses for advertising, travel, or wages for training employees.
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If you go into business.(p3)

rule
When you go into business, treat all costs you had to get your business started as capital expenses.
Usually you recover costs for a particular asset through depreciation. Generally, you cannot recover other costs until you sell the business or otherwise go out of business. However, you can choose to amortize certain costs for setting up your business. See Starting a Business in chapter 8 for more information on business start-up costs.
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If your attempt to go into business is unsuccessful.(p3)

rule
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.
  1. The costs you had before making a decision to acquire or begin a specific business. These costs are personal and nondeductible. They include any costs incurred during a general search for, or preliminary investigation of, a business or investment possibility.
  2. The costs you had in your attempt to acquire or begin a specific business. These costs are capital expenses and you can deduct them as a capital loss.
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.
The costs of any assets acquired during your unsuccessful attempt to go into business are a part of your basis in the assets. You cannot take a deduction for these costs. You will recover the costs of these assets when you dispose of them.
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Business Assets(p3)

rule
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.
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Improvements(p3)

rule
Improvements are generally major expenditures. Some examples are: new electric wiring, a new roof, a new floor, new plumbing, bricking up windows to strengthen a wall, and lighting improvements.
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.
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. Temporary regulations allow you to capitalize costs meeting the above criteria for tax years beginning after 2011.
However, you can currently deduct repairs that keep your property in a normal efficient operating condition as a business expense. Treat as repairs amounts paid to replace parts of a machine that only keep it in a normal operating condition.
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Restoration plan.(p3)

rule
Capitalize the cost of reconditioning, improving, or altering your property as part of a general restoration plan to make it suitable for your business. This applies even if some of the work would by itself be classified as repairs.
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Capital versus Deductible Expenses(p3)

rule
To help you distinguish between capital and deductible expenses, different examples are given below.
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Motor vehicles.(p3)

rule
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 Publication 463.
Generally, repairs you make to your business vehicle are currently deductible. However, amounts you pay to recondition and overhaul a business vehicle are capital expenses and are recovered through depreciation.
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Roads and driveways.(p4)

rule
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.
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Tools.(p4)

rule
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.
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Machinery parts.(p4)

rule
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.
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Heating equipment.(p4)

rule
The cost of changing from one heating system to another is a capital expense.
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Personal versus Business Expenses(p4)

rule
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 generally can deduct 70% of the interest as a business expense. The remaining 30% is personal interest and generally is not deductible. See chapter 4 for information on deducting interest and the allocation rules.
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Business use of your home.(p4)

rule
If you use part of your home for business, you may be able to deduct expenses for the business use of your home. These expenses may include mortgage interest, insurance, utilities, repairs, and depreciation.
To qualify to claim expenses for the business use of your home, you must meet both of the following tests.
  1. The business part of your home must be used exclusively and regularly for your trade or business.
  2. The business part of your home must be:
    1. Your principal place of business, or
    2. A place where you meet or deal with patients, clients, or customers in the normal course of your trade or business, or
    3. A separate structure (not attached to your home) used in connection with your trade or business.
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.
Your home office qualifies as your principal place of business if you meet the following requirements.
If you have more than one business location, determine your principal place of business based on the following factors.
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Optional safe harbor method.(p4)
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. This method is an alternative to the calculation, allocation, and substantiation of actual expenses.
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. 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). You are not required to allocate these deductions between personal and business use, as is required under the regular method. If you use the optional method, you cannot depreciate the portion of your home used in a trade or business.
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.
For more information on the deduction for business use of your home, including the optional safe harbor method, see Publication 587.
EIC
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.
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Business use of your car.(p4)

rule
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. Beginning in 2013, the standard mileage rate is 56.5 cents per mile.
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.
For more information on car expenses and the rules for using the standard mileage rate, see Publication 463.