"Depreciation" is a big word that intimidates many taxpayers, but it's really a simple concept. Read the rest of this article for a detailed explanation.
Be sure that depreciation schedules are provided with the tax return copy you keep for your records. These schedules document current and prior year depreciation deducted on your tax return. They might be called depreciation "worksheets" or "detail" or something else. Just make sure that whatever you have shows information similar to what is included on my sample depreciation schedule, such as cost of items depreciated, date acquired, depreciation taken, method of depreciation, etc.
Because depreciation schedules are not submitted to the IRS with your tax return, tax preparers are not required to give copies to you either, though they are crucial documentation for you to have. Form 4562 will be attached to your tax return every time you start depreciating a new asset, but the prior year information will be lost without the depreciation schedule detail.
Ask about depreciation schedules when you agree to work with a particular tax preparer. Make sure that all the schedules (both for regular tax and alternative minimum tax* purposes) will be included with your copy of the tax return. If not, find someone else to work with.
This is a strong suggestion, but having the depreciation schedules in your possession is very important. Certain tax professionals go so far as to consider them privileged work papers and will not share the information, even upon request. Many others don't print them out of habit, to save paper, or because they know it will be harder for you to switch preparers without them. Either way, you lose.
All businesses, including home daycare businesses, have depreciable business assets, meaning things you buy to use in your business that last more than one year.
A family child care business also has many depreciable personal assets that are used partially for business purposes. This category includes furniture, kitchenware, window coverings, room decorations, linens, appliances, electronics, etc.
Items are called "depreciable" because the cost of such items cannot necessarily be deducted fully on your tax return. You may be able to deduct 100% of the cost using the Section 179 Expense Election, but the normal procedure is to write such things off (depreciate them) over about 7 years. The number of years will vary with the type of asset.
Take depreciation on your home, if you own it. This will be your biggest depreciable asset--the building value, anyway. You must allocate some of the cost of your home to land value, which cannot be depreciated. Building value for a home day care, after applying your time/space percentage, is written off over 39 years. You start with an overall property value that is either the purchase price of the property or the fair market value on your first day of business, whichever is lower.
I hope the idea of depreciation makes a little bit of sense now. The question is, if you pull out last year's income tax return, will you find a page or pages that contain the kind of information shown on my sample depreciation schedule? (The format will vary.) Can't find it? You are not alone!
I am very disappointed by the fact that many of the new clients I meet with do not have their prior year depreciation schedules. It is a simple matter for tax preparers to provide these schedules with your copy of the tax return, so make sure that they do! Otherwise, you will not have all the data you need to understand your tax return or to explain your depreciation deduction to an auditor.
You will also have a problem if you decide to change tax preparers. You will have to go back to your old preparer and request the schedules. In many cases, this means waiting a long time and making mulitple requests before you finally get something. Some tax preparers never turn over the information. One client of mine went down to her former tax preparer's office and staged a sit-in. She said she would make herself at home until she got the depreciation schedules. When she put it that way, the tax preparer finally handed them over.
When new clients cannot get their hands on their depreciation schedules, I am forced to guess at what has been depreciated over the years. There is a lot of information that needs to be reconstructed, especially if the provider has been in business for a long time. Look at this sample depreciation schedule and see what I mean. The schedules provide a description of each asset, the date of first business use, the method of depreciation, the number of years the depreciation will last, and how much depreciation has been taken so far.
In addition to a regular federal depreciation schedule, your records should include a federal alternative minimum tax* schedule. If you live in California, you also need a regular state depreciation schedule and a state alternative minimum tax schedule. Many states have depreciation rules that do not match federal rules. When I reconstruct prior year depreciation, I have to reconstruct all four of these schedules. This is time consuming. New clients usually end up pestering their prior tax preparer for the information, even though it's the last thing they want to do.
Be sure your income tax return has all the depreciation schedules! Work only with tax professionals who include the schedules with your tax return every year.
P.S. I was quite surprised at the wide variety of feedback I received from other tax professionals when I brought this issue to the attention of TaxMama Eva Rosenberg a few years ago. Eva, herself, along with several of her readers were supportive and agreed that depreciation schedules should be included with the client's copy of the tax return. This is not required, however, and there are some tax pros who beg to differ and actually consider the schedules to be their own private work papers. This sounds like legal hair splitting to me, but whatever it is, you end up with incomplete records.
I firmly believe that you must have depreciation schedules for your records to be complete and to protect yourself in case of audit, in case you want to change preparers, and simply to understand and review what's being reported on your tax return. Do not count on your tax preparer being able and willing to give you the information at some later date.
*Alternative Minimum Tax (AMT) is an annoying fact of life. It is an alternate way to calculate your income tax. A good percentage of taxpayers actually have to pay some AMT every year, though many do not, and I rarely see child care providers paying it. Nevertheless, you have to do the AMT calculation every year and AMT has different depreciation rules, which means you need a separate AMT depreciation schedule.
Last updated 10 August 2013