Keyword: Computer

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Can the entire acquisition cost of a computer that I purchased for my business be deducted as a business expense or do I have to use depreciation?

The entire acquisition cost of a computer purchased for business use can be expensed under Code section 179 in the first year if qualified, or depreciated over a 5-year recovery period. Under section 179, you can elect to recover all or part of the cost of certain qualifying property, up to a dollar limit, by deducting it in the year you place the property in service. You can elect to expense the cost of qualifying property instead of recovering the cost by taking depreciation. To claim the expense in the first year, the property must be used more than 50% for business use, and meet the other requirements for expensing. One of those requirements is that the total cost of qualifying property you can deduct after you apply the dollar limit is limited to the taxable income from the active conduct of any trade or business during the year. Any cost not deductible in one year under section 179 because of the business income limit can be carried to the next year.

For any taxable year beginning after 2002 and before 2006, a new law raised the aggregate cost that can be expensed under section 179 to $100,000 and also expanded the definition of Code section 179 property to include off-the-shelf computer software. See IRS site for Code Section 179 for the expanded definition.

If you make a choice to depreciate the property you can claim in the placed-in service year of the property a special depreciation allowance for eligible property you acquired after September 10, 2001 and before January 1, 2005. The special depreciation is figured before you calculate your regular depreciation. To qualify for the special depreciation the property must:

Be property that is depreciated generally under MACRS (Modified Accelerated Cost Recovery System) and that has a recovery period of 20 years or less. Property required to be depreciated under the straight-line method of the alternative depreciation system of MACRS generally is not eligible.
Be property that is acquired by you after September 10, 2001 and before January 1, 2005.
Be property that is placed in service by you before January 1, 2005.
Be property the original use of which began with you after September 10, 2001. This means that the property is new property.

For eligible property acquired after September 10, 2001, and before May 6, 2003, the special depreciation deduction is equal to 30% of the property's depreciable basis. For eligible property acquired after May 5, 2003 and before January 1, 2005, the special depreciation deduction is equal to 50% of the property's depreciable basis. If the property is acquired after May 5, 2003, but there was a written binding contract to acquire the property in effect before May 6, 2003, the property is not eligible for the 50% special depreciation. Also, if the property is acquired after May 5, 2003, but the original use of the property began before May 6, 2003, the property is not eligible for the 50% special depreciation. And, if you acquired the property before May 6, 2003, but placed the property in service after May 5, 2003, the property is not eligible for the 50% special depreciation.

If the property is eligible for the 50% special depreciation deduction and you claim this 50% depreciation, you cannot claim the 30% special depreciation deduction for the property. However, you can elect to deduct the 30% (instead of 50%) special depreciation for property eligible for the 50% special depreciation deduction. These elections are made for an entire class of property (for example, 5-year property) instead of for each property.

If your property is located within the New York Liberty Zone, there are different rules for special depreciation deduction.

See Publication 946, How to Depreciate Property for additional information on the special deduction.

What kinds of property can be depreciated for tax purposes?

Only property used in a trade or business or in an income producing activity can be depreciated. Additionally, the property must be something that wears out or becomes obsolete and it must have a determinable useful life substantially beyond the tax year. The kinds of property that can be depreciated include, but are not limited to, machinery, equipment, buildings, vehicles, and furniture. Some intangible property may also be depreciable (e.g. patents). Depreciation is a complex topic. For more information, refer to Tax Topic 704, Depreciation, or Publication 946, How to Depreciate Property , or Publication 534 (PDF) , Depreciating Property Placed in Service Before 1987.

I purchased a computer last year to do online day trading part-time from home for additional income. Can I deduct or depreciate the cost of the computer or internet connection from my investment income?

You may deduct investment expenses (other than interest expenses) as miscellaneous itemized deductions on Form 1040, Schedule A (PDF), line 22, Itemized Deductions. This would include depreciation on the portion of your computer used for investment purposes, and the portion of your internet access charges used for investment purposes.

The entire acquisition cost of a computer purchased for business use can be expensed under Code section 179 in the first year if qualified, or depreciated over a 5-year recovery period. Under section 179, you can elect to recover all or part of the cost of certain qualifying property, up to a dollar limit, by deducting it in the year you place the property in service. You can elect to expense the cost of qualifying property instead of recovering the cost by taking depreciation. To claim the expense in the first year, the property must be used more than 50% for business use (as opposed to investment use), and meet the other requirements for expensing. One of those requirements is that the total cost of qualifying property you can deduct after you apply the dollar limit is limited to the taxable income from the active conduct of any trade or business during the year. Any cost not deductible in one year under section 179 because of the business income limit can be carried to the next year.

The 2003 Jobs and Growth Act raised the aggregate cost that can be expensed for any tax year beginning after 2002 and before 2006 to $100,000. The new law also expanded the definition of Code Section 179 property to include off-the-shelf computer software. See Code Section 179 for the expanded definition. If the business use falls to 50% or less in a later year, these tax benefits may be subject to recapture. See Publication 946 , How to Depreciate Property for additional information on the section 179 deduction.

Because these deductions are for investment expenses rather than for business expenses, these deductions must be reduced by 2% of your adjusted gross income. Use Form 4562 (PDF), Depreciation and Amortization, to compute the depreciation for the portion of your computer used for investment purposes.

Note: Unless the computer is used more than 50% for business purpose (as opposed to investment purposes), you cannot claim section 179 expensing of the computer or claim accelerated depreciation (including the special depreciation) for it. For more information, refer to "Listed Property" in Publication 946, How to Depreciate Property.

Can I deduct my investment expenses as business expenses?

In order to properly determine the correct treatment income and expenses, it is first necessary to classify the type of investment activity occurring.

An Investor buys and sells securities solely for their own account. They are not engaged in a trade or business. An investor's investment expenses are taken as miscellaneous itemized deductions on Form 1040, Schedule A (PDF), subject to the 2% AGI limitations (with the exception of investment interest which is not a miscellaneous deduction but subject to its own special limitations). An investor's sale of securities results in capital gains and losses.

A Dealer in securities has inventories of securities that they hold for sale to customers in the ordinary course of their trade or business. Their business expenses are deductible as ordinary business expenses. A dealer doing business as a sole proprietor would deduct their expenses on Form 1040 Schedule C. A Dealer's sale of securities is reported as ordinary income.

A third classification is Trade. A Trader is in the trade or business of buying and selling securities for their own account. You are a trader in securities if you meet all of the following conditions:

You must seek to profit from daily market movements in the prices of securities and not from dividends, interest, or capital appreciation.
Your activity must be substantial.
You must carry on the activity with continuity and regularity.

The following facts and circumstances should be considered in determining if your activity is a securities trading business:

Typical holding periods for securities bought and sold.
The frequency and dollar amount of your trades during the year.
The extent to which you pursue the activity to produce income for a livelihood
The amount of time you devote to the activity.

A trader's business expense are reported on Form 1040, Schedule C (PDF), not as itemized deductions on Form 1040 Schedule A. The deductions are not subject to the limitations that apply to Schedule A (2% AGI limitation and special limits on investment interest). A trader gain or loss on sale of securities is reported as capital gain or loss on Form 1040, Schedule D (PDF) unless they have made the mark-to-market election.

If a trader has made a mark-to-market election, gains and losses are reported on Part II of Form 4797 (PDF) as ordinary income. For information regarding the manner and timing of making the mark-to-market election, see Publication 550, Investment Income and Expense or Revenue Procedure 99-17, 1999-1 CB 503.

The proper classification of your investment activities is important to determine how income and expenses are to be reported. Investors trade solely for their own account and do not carry on a trade or business. Their securities sales result in capital gain or loss and their deductible expenses are itemized deductions. Dealers sell securities to customers in the ordinary course of trade or business. Their sales result in ordinary gain or loss and their deductible expenses are trade or business expenses. Traders buy and sell securities frequently but have no customers. Their purchases and sales result in capital gain and loss, and their deductible expenses are trade or business expenses.

Even if you engage in extensive securities activities, you are an investor, not a dealer or trader, if you do not seek profit primarily in swings in daily market movements, and do not personally engage in or direct the purchases or sales. An investor trades for profit-motivated reasons such as long-term appreciation, dividends and interest. Whether the activities of an individual constitute trade or business or investment is determined from the facts in each case. These distinctions have been established through court cases.

If your trading activity is a business, your trading expenses would be reported on Form 1040, Schedule C (PDF), Profit or Loss from Business (Sole Proprietorship) instead of Form 1040, Schedule A (PDF), Itemized Deductions. Your gains or losses, however, would be reported on Form 1040, Schedule D (PDF), Capital Gains and Losses, unless you file an election to change your method of accounting.

If your trading activity is a business and you elect to change to the mark-to-market method of accounting, you would report both your gains or losses on Part II of Form 4797 (PDF), Sales of Business Property .

A change in your method of accounting requires the consent of the Commissioner and cannot be revoked without the consent of the Secretary. Though there is no publication specific to day traders, the details for traders in securities and commodities are covered in Internal Revenue Code Section 475 (f) and Revenue Procedure 99-17.

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