When it comes to tax deductions - some deductions require special recordkeeping. This is true with what is called “listed property”.
In 1984 Big Brother, via the Tax Reform Act of 1984, decided to restrict the depreciation deduction for the business use of items “lending themselves easily to personal use”, which were labeled “listed property”. Included on the “list” were –
* Passenger automobiles.
* Property of a type generally used for entertainment, recreation, or amusement (including photographic, phonographic, communication, and video recording equipment.
* Computers and related peripheral equipment
Computers and peripherals used 100% for business at a “regular business establishment” are not considered to be “listed property”. This includes a computer used 100% for business in a qualified home office.
In 1989 cellular telephones and “similar telecommunication equipment” were added to this “list” under Internal Revenue Code Section 280F (d)(4)(A)(v).
As a general rule, only “listed property” that is used more than 50% for business will be eligible for Section 179 expensing and “accelerated” depreciation under MACRS (Modified Accelerated Cost Recovery System). Assets with 50% or less business use must be depreciated using “Straight Line” under the ADS (Alternative Depreciation System) “class life”. The “class life” of automobiles, computers and cell phones is five (5) years under both MACRS and ADS.
In a situation where the “business use percentage” of a “listed” asset is more than 50% in the first years, but drops below 51%, or the property is either sold or removed from business use (i.e. converted to 100% personal use), in a subsequent year (before the property’s depreciation “class life” has expired), you must “recapture” the “accelerated” depreciation claimed in the early years.
In the first year that business use of the property falls below 51% you must add to the “ordinary income” of the business (as “Other Income” on Line 6 of the Schedule C) the difference between the actual depreciation, including any Section 179 expensing, claimed in the earlier years and the depreciation that would have been allowed in those years using the “Straight Line” depreciation method. No Section 179 deduction would be allowed for less than 51% business use.
Let’s say you purchased a computer for your business in 2005 for $1,000.00. You determined that you used it 95% for business in 2005 and 2006. You elected to depreciate, rather than expense under Section 179, the computer. Your depreciation deductions for 2005 and 2006 under MACRS would be $190.00 and $304.00, for a total of $494.00. In 2007 you give the computer to your son and purchase a new one for the business. You must claim $209.00 as “other income” on Line 6 of your 2007 Schedule C. Under the “Straight Line” method your depreciation deduction would only be $95.00 and $190.00, for a total of $285.00.
If you had decided to expense the computer under Section 179 in 2005, your 2007 “recapture” income would be $665.00 ($950.00 - $285.00).
Internal Revenue Code Section 274(d) (4) requires that you keep detailed records to document the business use of “listed property”. For automobiles you would keep a mileage log (to be discussed in a future posting).
For computers, cameras, audio/video equipment, etc you should keep a log noting the date, length of time, and purpose for each use of the item. Personal or family use can simply be designated "personal" but business use should show enough detail to enable you to prove the relationship to your work. For example a daily computer log entry could indicate –
1 hour reading and answering business emails.
1 hour word processing for business correspondence to Client A and Client C.
2 hour word processing business proposal for Client E.
1 hour internet research on topic C for business project A.
½ hour reading and answering personal emails.
Total Daily Useage = 5½ hours.
With a cell-phone your log would indicate the date, number called, person called, business purpose (or “personal”), and length of call. If the bill listed each call separately you would indicate the cost for each call on the log. If you pay a flat fee for unlimited minutes you would need to do a calculation for each monthly bill.
My package of SCHEDULE C FORMS AND WORKSHEETS, (available as a “word document” email attachment for only $2.00) includes Auto, Cell Phone and Computer Log forms. Click here to order.
I realize that it is a pain in the arse to have to log your computer and cell-phone use, but this is what you will need to have to substantiate your deduction if audited by “Sam”.