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
...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 the property 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:
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 market value of such items will generally be lower than their adjusted basis (your original cost) on the date of conversion.
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
Make a table like the one indicated below, which shows a description of each item and each item's adjusted basis, fair market value, and Depreciable basis.
Fair market 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 Market Value:
To determine fair market value you could check the classifieds, eBay, and other places to find out what people are willing to pay for the type of equipment you have. If you recently purchased items close to the date of conversion, your cost will probably be the same as the market value.
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.
|Item||Adjusted Basis (Original Cost)||Fair Market Value on Date of Conversion||Depreciable Basis: Lower or AB or FMV|
Determine the amount of annual depreciation for each piece of property based on the property's depreciable basis.
Once you know the depreciable basis of each piece of property, to compute the correct amount of depreciation you need to know three things:
- What depreciation method you intend to use
- The recovery period for each piece of property, and
- 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.
The American Taxpayer Relief Act of 2012 (ATRA) extended 50 percent bonus depreciation for qualified property placed in service from Jan. 1, 2013, through Dec. 31, 2013 (2014 for property with a longer production period, such as certain transportation property).
For property placed in service after Dec. 31, 2013, bonus depreciation is currently expired. While the House passed a bill to make bonus depreciation permanent, continued gridlock in Congress means the chances of the bill becoming law are uncertain. If the Senate does address bonus depreciation, as well as other tax extenders, it is more likely to happen after the November 2014 elections.
To claim bonus depreciation the property must be new when placed in service.
For example, if you purchase a used laptop on eBay and place it in service in your business, it will qualify for first-year expensing but not bonus depreciation.
On December 18, 2015 the President signed into law tax extenders legislation entitled the Protecting Americans from Tax Hikes (PATH) Act of 2015. Many items have been extended retroactively and made permanent. The 50% bonus depreciation for qualified business property is retroactively extended to 2015. The percentage will be reduced to 40% for 2018 and then 30% for 2019. After 2019, bonus depreciation will completely expire unless it is extended again.
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- See the Business Deductions Table of Contents for more information on depreciation.