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. taxmap/pubs/p535-001.htm#TXMP3aeee33b
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
(Including Use by Daycare Providers) 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.
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.
It is important to distinguish business expenses from:
- The expenses used to figure cost of goods sold,
- Capital expenses, and
- Personal expenses.
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.
- The cost of products or raw materials, including freight.
- Direct labor (including contributions to pension or annuity plans) for workers who produce the products.
- Factory overhead.
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.
- Cost of goods sold—chapter 6 of Publication 334.
- Inventories—Publication 538.
- Uniform capitalization rules—Publication 538 and section 263A of the Internal Revenue Code and the related regulations.
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. There are, in general, three types of costs you capitalize.
- Business start-up costs (See Tip below).
- Business assets.
You can elect to deduct or amortize certain business start-up costs. See chapters 7
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.
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.taxmap/pubs/p535-001.htm#en_us_publink1000208612
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.
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.
- 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.
- 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.taxmap/pubs/p535-001.htm#en_us_publink1000208614
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. taxmap/pubs/p535-001.htm#en_us_publink1000208615
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. 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.
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.taxmap/pubs/p535-001.htm#en_us_publink1000208616
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. taxmap/pubs/p535-001.htm#en_us_publink1000208617
To help you distinguish between capital and deductible expenses, different examples are given below. taxmap/pubs/p535-001.htm#en_us_publink1000208618
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. taxmap/pubs/p535-001.htm#en_us_publink1000208619
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.taxmap/pubs/p535-001.htm#en_us_publink1000208620
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. taxmap/pubs/p535-001.htm#en_us_publink1000208621
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. taxmap/pubs/p535-001.htm#en_us_publink1000208622
The cost of changing from one heating system to another is a capital expense. taxmap/pubs/p535-001.htm#en_us_publink1000208623
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.
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.
- The business part of your home must be used exclusively and regularly for your trade or business.
- 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.
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.
- You use the office exclusively and regularly for administrative or management activities of your trade or business.
- You have no other fixed location where you conduct substantial administrative or management activities of your trade or business.
If you have more than one business location, determine your principal place of business based on the following factors.
- The relative importance of the activities performed at each location.
- If the relative importance factor does not determine your principal place of business, consider the time spent at each location.
For more information, see Publication 587.taxmap/pubs/p535-001.htm#en_us_publink1000208625
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 2009, the standard mileage rate is 55 cents a mile for all business miles driven before January 1, 2010.
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.