Should I Claim Depreciation if it Creates a Loss for My Business?

One of the best financial benefits of being a family child care provider is the ability to claim many expenses associated with your home.

This includes claiming depreciation deductions for the following:

  • All items purchased before you thought about going into business that are later used in your business
  • Personal property: furniture, appliances, playground equipment, computers, carpeting
  • Land improvements: fence, driveway, patio
  • Home improvements: remodeling, new roof, new furnace, house siding, replacement windows, wood/tile floors
  • House

These expenses can represent hundreds, even thousands of dollars in depreciation deductions, and claiming them can significantly reduce your taxes.

However, what happens if by claiming depreciation expenses you show a business loss on your tax return? Are there any circumstances in which you should not claim all the depreciation deductions you are entitled to?  The short answer is no.

To better understand this, let’s separate house depreciation from all other depreciation deductions.

All other depreciation expenses are claimed on IRS Form 4562 Depreciation and Amortization. These expenses are then transferred onto your IRS Schedule C Profit or Loss From Business where they will either reduce your profit or create/increase a loss.

Let’s look at an example: Your Schedule C income is $40,000. Your Schedule C expenses before claiming depreciation are $35,000. If your Form 4562 depreciation expenses are $6,000 you will show a $1,000 loss on Schedule C.

What are the tax consequences of a $1,000 Schedule C loss? If you are married, the $1,000 loss will reduce your spouse’s federal taxable income and thus save you some taxes. It will also reduce your state taxable income as well. If you are single and don’t have any other source of income, the $1,000 loss will not reduce your taxes because you won’t owe any taxes with a loss.

As you can see, as your depreciation expenses rise (assuming you are married and your spouse has income), this will continue to reduce your federal and state income taxes. Therefore, it’s always better to claim these depreciation expenses.

House Depreciation

Now let’s look at the tax consequences of claiming house deprecation. Family child care providers should always depreciate their home because it represents a significant deduction.

Here’s a simplified example: If you bought your house for $200,000 and had a Time-Space Percentage of 40%, the business basis of your house would be $80,000. Houses must be depreciated over 39 years, so your annual house depreciation deduction would be about $2,050 a year ($200,000 divided by 39 years). Depending on your family’s tax bracket, this represents a tax savings of about $600-$800 a year. Not bad!

House depreciation is claimed on IRS Form 8829 Expenses for Business Use of Your Home. Other expenses on this form include property tax, mortgage interest, rent, utilities, house repairs, and house insurance. These expenses are transferred to Schedule C.

Let’s say that the total of these expenses in our example is $3,000 and of this amount $2,000 represents house depreciation. Expenses on Form 8829 cannot create or increase a business loss. So, using our previous example, if you are claiming a $1,000 loss on Schedule C, you cannot claim any of the $3,000 expenses on Form 8829.

Now what?

You are entitled to roll over any unclaimed expenses on Form 8829 (including house depreciation) to the next tax year. So, you could roll over your $3,000 expenses to next year’s Form 8829 and claim them then. If you cannot claim them next year (because you continue to show a loss on Schedule C), you can continue to roll them forward until you are entitled to claim them.

Should you roll over your house depreciation? Yes! IRS rules say that when you sell your home you must pay taxes on any house depreciation you claimed, or were entitled to claim, after 1997. So, each year you claim $2,000 in house depreciation you will owe taxes on it when you sell your home. This is true regardless of how many years you have quit your business before the sale.

If you are never entitled to claim house depreciation, you will never owe taxes on it. However, let’s say you can’t claim the $2,000 in depreciation in 2013, but you roll it over to 2014. In 2014 you do have a profit and claim the $2,000 from 2013 as well as the $2,000 you are entitled to claim for 2014. If you sold your home at the end of 2014 you would owe taxes on $4,000

What if you didn’t roll over your 2013 house depreciation? You would still owe taxes on it because IRS rules say that if you are entitled to depreciate your home you will be treated as if you did when you sell it! That means paying taxes on the $2,000 from 2013.

Therefore, you are always better off claiming house depreciation, even if it means rolling it over into a future tax year.

A Word About Claiming Losses

It’s not unusual to claim a loss when doing family child care. This is particularly true in the first year or two of your business. However, it’s always best to try to show a profit three out of every five years. By doing so, you will greatly reduce the chances that the IRS might audit you.

What should you do if you have shown a loss for two years in a row and it looks like you will show a loss for your third year? I would recommend reducing some of your Schedule C expenses (not your depreciation expenses) until you show at least a $1 profit. Roll over your Form 8829 expenses to the next year.

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Tom Copeland

I've been the nation's leading trainer, author, and advocate on the business of family child care since 1981. I'm a licensed attorney and have presented hundreds of business workshops for family child care providers across the country. I answer thousands of calls and emails each year to help providers, tax professionals and trainers understand complex business and tax issues. Call me at 651-280-5991. Email me at Visit me on Facebook. From 1981 to 2009 I worked at Resources for Child Caring in Minnesota (now called Think Small), where I was director of Redleaf National Institute for 15 years. I've written nine books on the business of family child care published by Redleaf Press, a division of Resources for Child Caring. I was on the board of directors of First Children's Finance, a non-profit organization providing low interest loans and consulting and technical assistance to help family child care providers suceed as a business. They operate in Minnesota, Iowa, Michigan, North and South Dakota, Kansas, Missouri, and Texas. Here are some YouTube videos of me talking about my work with this organization and the business of family child care. I graduated from Macalester College (BA) in 1972 and from William Mitchell College of Law (JD) in 1980. I live in St. Paul, Minnesota with my wife Diane and two cats, Duke and Ella.