Whether you claim a business office in the home or are simply working at home, say because of COVID-19, you likely have some former personal assets that you now use for business.
Ah, new tax deductions!
Yep. Say you don’t claim a home-office deduction but now you are working at home and sitting in the fancy chair you inherited from your grandmother.
Let’s say you use the fancy chair 85 percent for business purposes. Can you depreciate 85 percent of that chair?
Let’s say that grandma’s estate was appraised and this chair had a value of $10,000 when you inherited it about a year ago. It’s an antique, so it’s not gone down in value since you inherited it.
Depreciating a Formerly Personal Asset
When you convert the fancy chair to 85 percent business use, the law sees you as placing the item in service in your business at that time. That means you can begin depreciating the asset and claiming your tax deductions.
To determine the basis to use for depreciation, use the lesser of
- fair market value on the date of conversion from personal to business use, or
- adjusted basis of the property (generally the amount you paid for the asset plus the cost of any improvements).
With the fancy chair, your adjusted basis is the inherited value.
But say you bought the chair for $8,000. Suppose it was worth $10,000 when you converted it to personal use. You would use the $8,000 figure to determine your depreciation deductions.
Bonus Depreciation and Section 179 Expensing
Unfortunately, unlike assets directly purchased for your business, you may not use Section 179 to immediately expense assets that you convert from personal to business use.
Bonus Depreciation Is a Different Story
If you acquire bonus depreciation qualified property for personal use after September 27, 2017, and convert it to business use this year (or anytime before 2027), you must use 100 percent bonus depreciation if you don’t elect out of it.
Example. You purchased an antique clock for $9,300 in January 2018. Yesterday, you placed the clock in business service by moving the clock from your entryway to your home office. If you don’t make a formal election in your tax return to elect out of bonus depreciation, you must claim a $9,300 depreciation deduction on the antique clock this year.
Basis When You Sell
There’s a trick to basis when you sell converted property—you use a different rule for calculating losses than you do for calculating gains:
- Losses. To calculate losses, use your adjusted basis (conversion basis as discussed above minus depreciation).
- Gains. To calculate gains, use original cost basis minus post-conversion depreciation. In most cases, original cost gives you a higher basis and thus less tax. So don’t accidentally use adjusted basis.
Note. For inherited assets, your cost basis is the estate value (generally, the date of death value).
Let’s say you bought a personal use desk/credenza/bookcase set for $8,000 and then converted it to business use when its fair market value had fallen to $6,000. Here are the tax consequences for three different sales scenarios (to make the examples clear, we ignored depreciation):
- Loss. If you sell the desk/credenza/bookcase set for $4,000, you have a $2,000 deductible loss ($6,000 - $4,000). Note. This is much better than if you sold the desk/credenza/bookcase set as a personal asset, which would create a zero deductible loss.
- Gain. If you sell the desk/credenza/bookcase set for $10,000, you have a $2,000 gain ($10,000 - $8,000).
- Gray area. If you sell the set for $7,000, you have neither gain nor loss on the sale. That’s a decent result—it means no taxes for you (but no deductible losses either).
Source: Bradford Tax Institute