The Start-Up Rule: How to Claim Expenses Before Your Business Began

One of the most commonly overlooked business deductions for family child care providers is claiming expenses for items you owned before you went into business.

On the day your business began, you had a house full of items: tables, chairs, beds, play equipment, washer, dryer, freezer, lawn mower, pots and pans, beds, rugs, toys, snow blower, and so on. Most of these items you bought before you thought about becoming a family child care provider. But, you probably used them in your business once you started caring for children.

This article describes how to deduct some of the cost of these items if your business began within the last two years. A forthcoming article will describe how to deduct these items if your business began more than two years ago.

The Start-Up Rule

The IRS Start-Up Rule allows you to deduct, in your first year of business, up to $5,000 of items you owned before you went into business. The $5,000 rule applies to the business portion of your items (usually your Time-Space Percentage). It doesn’t matter if you bought the item specifically for your business or had it before you thought about becoming a provider.

Here’s how to claim these expenses if you went into business this year or last year.

First, conduct an inventory of all the items in your home. Take pictures of everything. Estimate the fair market value of each item at the time you first started using it in your business. Compare it to its original price. Use the lower number. Don't worry if you don't have receipts for these items.

List your items with their individual cost/value under one of following three categories:

I. Individual items costing/valued at $200 or less (called “Materials and Supplies” by the IRS)

Total up the number of items in this category. For example: washer $150 + dryer $100 + freezer $75 = $325.You can deduct up to $5,000 of these items in one year. If you have more than $5,000 of these items, you must amortize the amount above $5,000 over 180 months (15 years).For example, let’s say your inventory shows you have 150 items, each valued at less than $200, with a total value of $14,000. Your Time-Space Percentage is 40% ($14,000 x 40% = $5,600). You can deduct $5,000 this year and amortize the additional $600 over 180 months, for an additional deduction of $40 this year.

II. Individual items costing/valued from $201 to $2,500

Total up the number of items in this category. If the total value of these items falls under $5,000, you can elect to use the De Minimis Safe Harbor Election (IRS Section 1.263(a)-1(f)) Rule. When you elect to use this rule, these items become categorized as “Materials and Supplies” and you can deduct them in one year, using the Start-Up Rule. You must include any items costing $200 or less in this calculation.

For example, if you have $3,000 worth of items individually valued at $200 or less and $1,500 of items individually valued at $201 to $2,500, you can deduct the total ($4,500) in one year under the Start-Up Rule. If the total is more than $5,000, you must amortize over 180 months the amount over $5,000. However, you can also choose not to elect the De Minimis Safe Harbor Rule. If you do so, you can choose to apply the 100% bonus depreciation rule. This rule allows you to deduct the business portion of these items without a limit on how much you can deduct in the first year.

This rule applies to items purchased or first put into business use September 28, 2017 or after. For items purchased before September 28, 2017, you must apply earlier bonus depreciation rules. For 2017, it was a 50% bonus depreciation rule.

For example, you started your business in 2018 and your inventory shows you have $4,000 of items valued individually at $200 or less. You have another $3,000 of items valued individually at $201 to $2,500, for a total of $7,000. If you applied the De Minimis Safe Harbor Rule you could deduct $5,000 in the first year and amortize the additional $2,000 over 180 months.

If you chose not to apply the Safe Harbor Rule, you could deduct both the $4,000 (under the Start-Up Rule) and the $3,000 (under the 100% bonus depreciation rule) in the first year.

III. Individual items costing/valued at more than $2,500

These items are not subject to the Start-Up Rule and the business portion can be deducted in one year using the 100% bonus depreciation rule.

For example, let’s say your inventory includes $4,000 of items individually valued at $200 or less, $2,000 of items individually valued between $201 and $2,500 and a fence valued at $8,000 and a swing set valued at $3,000. You can deduct up to $4,000 of items costing/valued at $200 or less under the Start-Up Rule. You can then not choose the De Minimis Safe Harbor Rule and deduct the remaining $2,000 worth items costing/valued between $201 and $2,500 or less in one year using the 100% bonus depreciation rule. You can also deduct in one year the fence and swing set under the 100% bonus depreciation rule.

Summary

Conduct an inventory of everything in your home that you owned before you went into business and then used in your business. List the items under one of the three categories described above.

• If the total cost/value of these items is less than $5,000, use the Start-Up Rule and deduct them in one year.

• If the total cost/value of these items is more than $5,000, apply the Start-Up Rule to items costing/valued at $200 or less. Don’t choose the DeMinimis Safe Harbor Rule for items costing/valued from $201 to $2,500. Instead, deduct them in one year using the 100% bonus depreciation rule. Use the same bonus depreciation rule for items costing/valued at more than $2,500.

Is this complicated? Yes! But, claiming these items can significantly reduce your taxes. Give your inventory list to your tax preparer. Don’t let anyone tell you that you can’t apply these rules as a family child care provider.

If you started your business in 2017 or 2018, use the above explanation to deduct items you owned before you went into business. If you went into business in 2017 and didn’t claim these expenses, you can amend your 2017 tax return using IRS Form 1040X.

If your business began before 2017, it’s not too late to deduct expenses for items you owned before your business began. See my forthcoming article: “How to Recapture Previously Unclaimed Expenses.”

All of these rules are explained in detail in my Family Child Care Tax Workbook and Organizer.

Many thinks to Bill Porter for helping me to understand the Start-Up Rule.

Tom Copeland - www.tomcopelandblog.com

Image credit: https://childcare.gov/consumer-education/family-child-care-homes