Home day care depreciation is a term you need to be familiar with when operating a day care business, especially during tax season. The term "depreciation" refers to the type of expense the IRS allows you to claim for long-term assets used in business operations.
Depreciation
Depreciation is an expense method used to recover the cost of long-term assets over time, rather than taking an expense deduction for the asset in full in the year of purchase. By recovering the cost of an asset over time, you'll get to deduct a little bit of your purchase price each year and prevent large losses from appearing on your tax returns and financial statements in the year of purchase. This will be beneficial when applying for loans or business credit, plus you'll have a more accurate idea of what your daycare's assets are worth should you decide to sell any of them.
Expense Versus Depreciation
Deciding if an item used in your day care business should be expensed or depreciated can be tricky. In general, the IRS requires that most long-term assets expected to be in service longer than one year be depreciated. However, this does not apply to repairs performed to the asset. For example, if you paint the day care building, the cost is considered an expense that should not be depreciated, even though the paint may last longer than one year.
Expenses are 100 percent deductible in the year the cost is paid, rather than deducted a little bit each year through depreciation. Depreciation is only used to recover the cost of assets the business owns, or is making payments toward to own (such as through a vehicle loan or mortgage). Leased assets are not depreciated, but the lease payments can be deducted as "rent" expense.
Building
If you own the building where the daycare operates, the cost of the building is depreciated. The expenses used to calculate your depreciation expense will depend on whether your daycare is run from your home (residential property), or whether your daycare is run from a stand-alone business building (commercial property).
Regardless of the type of property the daycare is in, the base cost used for depreciation calculation is the purchase price of the building, plus any fees incurred to secure legal title to the building, such as title fees, survey fees, the cost of assessments for local utility lines or sidewalks and zoning costs. The IRS allows you to recover the cost of your building over a period of 39 years.
Residential Property
When a daycare provider's home is also a place of business, the IRS generally only allows you to depreciate the portion of your home that is used 100 percent for daycare purposes only, unless you have an active daycare license, certification or approved daycare registration from the state, or you are exempt from having a state license or registration.
If you are licensed by the state, then you may also include areas of your home that are also used for personal activities in addition to daycare activities. Examples of rooms that may be considered daycare-only include spare bedrooms used only for nap or playrooms, or a finished basement used strictly for day care operations. Examples of split-use rooms may include a living room that is also used as a playroom, the kitchen and dining room and outdoor play areas that are also used for your personal leisure.
After you have determined whether you can depreciate daycare-only or split-use sections of your home, you'll need to calculate the business percentage of the home you qualify to use toward your depreciation calculation. To do this, you'll need to perform the following steps:
- Calculate the total square footage of the house. The square footage of your whole house may be listed in your property assessment records or purchase paperwork.
- Determine the square feet used for business purposes. To measure a room or area, measure the length and width of the area and multiply the numbers together.
- Add the square footage results from all rooms or areas you measure. This is your total business-use square footage.
- Divide your business-use square footage number by your total house square footage. The result is your business-use percentage.
- Apply the business-use percentage to your cost calculation for depreciation. The result is the cost you may apply to the 39-year building depreciation rate.
Commercial Property
Commercial daycare property is much easier to calculate than residential daycare property. This is because commercial property is used strictly for business, so there is no need to account for areas of the building which may be used for personal activities. 100 percent of commercial property costs may be applies to the 39-year building depreciation rates.
Capital Improvements
Capital improvements --which must be depreciated -- are easily confused with repairs, which must be expensed. A capital improvement adds value to an asset, rather than simply maintaining its normal functioning.
For example, if you make additions to your daycare building that allow handicap access, you have made a capital improvement. The cost of your additions are depreciated according to the same residential or commercial classification of your main building.
Office Equipment and Furniture
The cost of office equipment and furniture used by the daycare may be recovered over five or seven years, depending on the type of office fixture you're depreciating. Office machines such as computers, printers and copiers are recovered over five years, and office furniture such as desks, chairs and filing cabinets will be recovered over seven years.
When depreciating office equipment, usually the full cost is used to calculate depreciation, unless the asset is split between personal and business use. In this instance, you will need to estimate the percentage the asset is used for business.
Toys and Playsets
Toys, playsets and other daycare assets, such as cribs, playpens and highchairs do not have a specific cost recovery period listed by the IRS. Since these items are unspecified, the recovery period for these assets is seven years. The IRS uses a seven-year period for all items that do not have a different recovery classification period listed.
Vehicles
If the daycare owns less than five vehicles for business use, the cost of each vehicle may be recovered over a period of five years. When calculating depreciation for a vehicle, you may include the purchase price of the vehicle, plus any taxes and legal fees paid to secure title to the car.
You may also have the option of deducting mileage on the vehicle instead. If you choose the mileage expense method, you will get a flat rate deduction for each business mile you drive on the vehicle during the year. It is important to know that you can either use the depreciation method (Actual Expense method), or the Standard Mileage rate when you claim daycare vehicle expenses, but not both.
Paperwork and Calculations
Advances in technology and software have made it much easier for business owners to keep track of depreciation information. For all daycare assets, keep track of the following:
- Date of Purchase
- Purchase Price
- Additional Costs to Acquire or Improve the Asset
- Business-Use Percentage (if applicable)
- Any Prior (Accumulated) Depreciation Taken in the Past (if applicable)
With this information, your tax preparer or your tax software program can accurately calculate your depreciation expense for each asset. The IRS does publish depreciation tables you can use if you choose to calculate depreciation yourself by hand. If you choose to do this, visit the IRS website and view the Form 4562 instructions for tables.
Whether you choose to calculate your depreciation on your own, or use a tax professional or software, remember to keep records of your depreciation deductions each year. These show any accumulated depreciation for assets you have started to depreciate, plus provide information about your purchase dates and prices. These are shown on a depreciation worksheet and may not appear on Form 4562 itself. This worksheet will contain all the information you need to depreciate your assets on future tax returns in the event your records are ever lost or destroyed.
