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How to Convert Personal Use Property to Business Use
Determining Depreciable Basis
If you start a business, you probably have furniture and equipment that you used for personal reasons that can be used in your business (e.g., chairs, desk, computer, printer, fax machine, etc.).
When you convert personal-use property to business use or to produce investment income, you're allowed to claim a deduction for depreciation on the equipment.
The question is...
What value do you assign to each piece of equipment for depreciation purposes?
In other words, what should the depreciable basis be for each piece of equipment?
IRS rules say, when you convert personal use property to business use, the value assigned to the property for depreciation purposes is:
The LESSER of...
- the adjusted basis of the property, or
- its fair market value (FMV)
on the date of conversion.
The next question you may have is...
What is the adjusted basis of the property?
The adjusted basis of the property you purchased for personal use is generally what you originally paid for it on the date of purchase. For example, if you bought a computer for personal use two years ago for $950, the adjusted basis of the computer is $950, your original cost.
Fair market value (FMV):
Generally, except for real estate, which may increase in value, things like computers, printers and furniture will generally decline in value over time. Therefore, the fair marke value of such items will generally be lower than their adjusted basis (your original cost) on the date of conversion to business use.
Example:
You started a consulting business and intend to convert the following personal-use items to business use:
- One computer
- One printer
- One desk
- One chair
- One file cabinet
Step 1:
Make a table like the one indicated below, which shows a description of each item and each item's adjusted basis, fair marke value and Depreciable basis.
Fair marke value is established when willing parties, unrelated to each other, having adverse interests in the transaction and having all material facts in connection with the transaction, agree on a price for an item. This is referred to as an arm's length transaction. Tax rules do not consider transactions between related parties to be arm's length transactions.
How to Determine fair marke value:
To determine fair marke value you could check the classifieds, eBay, and other sources to find out what people are willing to pay for the type of equipment you have. However, if you recently purchased items close to the date of conversion, your cost will probably be the same as the fair market value.
Step 2:
Compare the adjusted basis of each item to its fair market value and use the lower value for its depreciable basis.
Note that in the following table, the depreciable basis of each item is its fair market value. As mentioned earlier, the items listed tend to decline over time.
Items to be Converted to Business Use:
Date of Conversion: August 1, 20xx
| Item | Adjusted Basis | Fair Market Value | Depreciable Basis |
|---|---|---|---|
| Computer | $1,500 | $400 | $400 |
| Printer | $175 | $50 | $50 |
| Desk | $250 | $75 | $75 |
| Chair | $100 | $25 | $25 |
| File cabinet | $125 | $55 | $55 |
Step 3:
Determine the amount of annual depreciation for each piece of property based on the property's depreciable basis.
Figuring Depreciation:
Once you know the depreciable basis of each piece of property, you need to know three things to compute the correct amount of depreciation:
- What depreciation method you intend to use
- The recovery period for each piece of property
- the depreciation convention to be used
First-Year Expensing Deduction
Property converted from personal use to business use does not qualify for the first-year expensing deduction (also called the Section 179 deduction, which is the section of the Internal Revenue Code).
Related Party Transactions:
Property purchased from a related party does not qualify for the first-year expensing deduction.
To qualify for the first-year expensing deduction, the property must be both purchased and placed in service in the year the first-year expensing deduction is claimed. The property does not have to be new when purchased.
Bonus Depreciation:
The new law (TCJA)increased the bonus depreciation percentage from 50 percent to 100 percent for qualified property acquired and placed in service after Sept. 27, 2017, and before Jan. 1, 2023. The new law allows bonus depreciation for used vehicles. Under the old law, the vehicle had to be new when placed in service to claim the special bonus allowance.
For passenger automobiles that qualify for bonus depreciation, the TCJA increased the first-year limitation amount by $8,000 to $18,000.