Several months ago, I wrote an article describing hobby losses.
Briefly, losses in a business or investment are generally deductible unless the IRS argues it was a hobby. Whether we have a business or a hobby depends on whether we have a genuine intent to make a profit (even if that intent was not reasonable). I suspect the government has lost more of these cases than it won.
One of the greatest expenses that you generally will incur is the purchase of new equipment. For example, if you intend to race horses there is the cost of the barn, stalls, the walkers, etc. If you are racing cars, there is the expense of the car itself, tools, additional parts and accessories, trailers, etc. If you are interested in ranching and farming there may tractors, trailers, barns, etc.
The new federal tax law just passed by the Republicans and signed by President Trump significantly expands the deductions for these kinds of undertakings:
- Amount Deductible
In the past, the maximum amount of these costs that we could deduct in each year was $500,000. This was reduced to the extent it exceeded a certain threshold amount.
Under the new tax law, the maximum amount we can deduct in one year is doubled to $1 million. Also, the threshold limitation is also increased.
Many businesses may spend this much, especially in a startup year.
However, certain assets cannot be entirely written off in the first year. The most common example is a passenger automobile. Under the old law, subject to a variety of obscure rules, the first year depreciation could not exceed $3160.
Under the new tax law, this amount has increased to $10,000 per vehicle.
This particular provision may impact a great number of us.
- Real Estate Improvements
In the past, non-residential real property would be depreciated over 39 years and residential real property could be depreciated over 27.5 years. The depreciation had to be in equal annual amounts. Those provisions stay the same.
However, certain improvements made to this real property can be depreciated over 15 years instead of 39. This includes roofs, heating and air-conditioning, alarm systems and security systems, etc.
This will be a boon to owners of commercial real estate and contractors who remodel commercial real estate.
- Placed in Service
These expenses can only be claimed in the year the property was “placed in service”. This phrase is a term of art in the tax code and far too complicated to discuss here.
If you have a significant purchase and it was in any way acted on in a prior year, you need to make sure that you meet with your tax advisor and develop the proper evidence so that you don’t become vulnerable to an IRS agent attempting to reclassify this date to an earlier less beneficial year.
- Tax Code Simplicity
In my last article I argued that the new federal tax code had become more complicated but would apply to fewer people because the standard deduction had been doubled. This is still true. These provisions will not change that analysis as these expenses are claimed on a separate form within the tax return.
So regardless of your political affiliation, from a tax lawyer’s point of view these tax benefits may be a significant incentive for people to expand their businesses, increase productivity and employ more people.
And as for the hobby loss issue, if you have a risk the IRS may try to reclassify your project to a hobby, I again ask you to discuss the IRS factors with your tax adviser and develop evidence now.
Next week we will address additional tax issues arising from this new tax code and how they may impact us.
David Leeper is a Board Certified federal tax attorney with 38 years of experience. He can be reached at 915-581-8748, by email at email@example.com, or visit leepertaxlaw.com