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Form 4868

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Form 4868

Form 4868 Publication 537 - Main Content Table of Contents What Is an Installment Sale?Special rule. Form 4868 General RulesFiguring Installment Sale Income Reporting Installment Sale Income Other RulesElecting Out of the Installment Method Payments Received or Considered Received Escrow Account Depreciation Recapture Income Sale to a Related Person Like-Kind Exchange Contingent Payment Sale Single Sale of Several Assets Sale of a Business Unstated Interest and Original Issue Discount (OID) Disposition of an Installment Obligation Repossession Interest on Deferred Tax Reporting an Installment SaleRelated person. Form 4868 Several assets. Form 4868 Special situations. Form 4868 Schedule D (Form 1040). Form 4868 Form 4797. Form 4868 How To Get Tax Help What Is an Installment Sale? An installment sale is a sale of property where you receive at least one payment after the tax year of the sale. Form 4868 The rules for installment sales do not apply if you elect not to use the installment method (see Electing Out of the Installment Method under Other Rules, later) or the transaction is one for which the installment method may not apply. Form 4868 The installment sales method cannot be used for the following. Form 4868 Sale of inventory. Form 4868   The regular sale of inventory of personal property does not qualify as an installment sale even if you receive a payment after the year of sale. Form 4868 See Sale of a Business under Other Rules, later. Form 4868 Dealer sales. Form 4868   Sales of personal property by a person who regularly sells or otherwise disposes of the same type of personal property on the installment plan are not installment sales. Form 4868 This rule also applies to real property held for sale to customers in the ordinary course of a trade or business. Form 4868 However, the rule does not apply to an installment sale of property used or produced in farming. Form 4868 Special rule. Form 4868   Dealers of time-shares and residential lots can treat certain sales as installment sales and report them under the installment method if they elect to pay a special interest charge. Form 4868 For more information, see section 453(l). Form 4868 Stock or securities. Form 4868   You cannot use the installment method to report gain from the sale of stock or securities traded on an established securities market. Form 4868 You must report the entire gain on the sale in the year in which the trade date falls. Form 4868 Installment obligation. Form 4868   The buyer's obligation to make future payments to you can be in the form of a deed of trust, note, land contract, mortgage, or other evidence of the buyer's debt to you. Form 4868 General Rules If a sale qualifies as an installment sale, the gain must be reported under the installment method unless you elect out of using the installment method. Form 4868 See Electing Out of the Installment Method under Other Rules, later, for information on recognizing the entire gain in the year of sale. Form 4868 Sale at a loss. Form 4868   If your sale results in a loss, you cannot use the installment method. Form 4868 If the loss is on an installment sale of business or investment property, you can deduct it only in the tax year of sale. Form 4868 Unstated interest. Form 4868   If your sale calls for payments in a later year and the sales contract provides for little or no interest, you may have to figure unstated interest, even if you have a loss. Form 4868 See Unstated Interest and Original Issue Discount (OID) under Other Rules, later. Form 4868 Figuring Installment Sale Income You can use the following discussions or Form 6252 to help you determine gross profit, contract price, gross profit percentage, and installment sale income. Form 4868 Each payment on an installment sale usually consists of the following three parts. Form 4868 Interest income. Form 4868 Return of your adjusted basis in the property. Form 4868 Gain on the sale. Form 4868 In each year you receive a payment, you must include in income both the interest part and the part that is your gain on the sale. Form 4868 You do not include in income the part that is the return of your basis in the property. Form 4868 Basis is the amount of your investment in the property for installment sale purposes. Form 4868 Interest Income You must report interest as ordinary income. Form 4868 Interest is generally not included in a down payment. Form 4868 However, you may have to treat part of each later payment as interest, even if it is not called interest in your agreement with the buyer. Form 4868 Interest provided in the agreement is called stated interest. Form 4868 If the agreement does not provide for enough stated interest, there may be unstated interest or original issue discount. Form 4868 See Unstated Interest and Original Issue Discount (OID) under Other Rules, later. Form 4868 Adjusted Basis and Installment Sale Income (Gain on Sale) After you have determined how much of each payment to treat as interest, you treat the rest of each payment as if it were made up of two parts. Form 4868 A tax-free return of your adjusted basis in the property, and Your gain (referred to as installment sale income on Form 6252). Form 4868 Figuring adjusted basis for installment sale purposes. Form 4868   You can use Worksheet A to figure your adjusted basis in the property for installment sale purposes. Form 4868 When you have completed the worksheet, you will also have determined the gross profit percentage necessary to figure your installment sale income (gain) for this year. Form 4868 Worksheet A. Form 4868 Figuring Adjusted Basis and Gross Profit Percentage 1. Form 4868 Enter the selling price for the property   2. Form 4868 Enter your adjusted basis for the property     3. Form 4868 Enter your selling expenses     4. Form 4868 Enter any depreciation recapture     5. Form 4868 Add lines 2, 3, and 4. Form 4868  This is your adjusted basis for installment sale purposes   6. Form 4868 Subtract line 5 from line 1. Form 4868 If zero or less, enter -0-. Form 4868  This is your gross profit     If the amount entered on line 6 is zero, stop here. Form 4868 You cannot use the installment method. Form 4868   7. Form 4868 Enter the contract price for the property   8. Form 4868 Divide line 6 by line 7. Form 4868 This is your gross profit percentage   Selling price. Form 4868   The selling price is the total cost of the property to the buyer and includes any of the following. Form 4868 Any money you are to receive. Form 4868 The fair market value (FMV) of any property you are to receive (FMV is discussed in Property Used As a Payment under Other Rules, later). Form 4868 Any existing mortgage or other debt the buyer pays, assumes, or takes (a note, mortgage, or any other liability, such as a lien, accrued interest, or taxes you owe on the property). Form 4868 Any of your selling expenses the buyer pays. Form 4868   Do not include stated interest, unstated interest, any amount recomputed or recharacterized as interest, or original issue discount. Form 4868 Adjusted basis for installment sale purposes. Form 4868   Your adjusted basis is the total of the following three items. Form 4868 Adjusted basis. Form 4868 Selling expenses. Form 4868 Depreciation recapture. Form 4868 Adjusted basis. Form 4868   Basis is your investment in the property for installment sale purposes. Form 4868 The way you figure basis depends on how you acquire the property. Form 4868 The basis of property you buy is generally its cost. Form 4868 The basis of property you inherit, receive as a gift, build yourself, or receive in a tax-free exchange is figured differently. Form 4868   While you own property, various events may change your original basis. Form 4868 Some events, such as adding rooms or making permanent improvements, increase basis. Form 4868 Others, such as deductible casualty losses or depreciation previously allowed or allowable, decrease basis. Form 4868 The result is adjusted basis. Form 4868   For more information on how to figure basis and adjusted basis, see Publication 551. Form 4868 For more information regarding your basis in property you inherited from someone who died in 2010 and whose executor filed Form 8939, Allocation of Increase In Basis for Property Acquired From a Decedent, see Publication 4895. Form 4868 Selling expenses. Form 4868   Selling expenses relate to the sale of the property. Form 4868 They include commissions, attorney fees, and any other expenses paid on the sale. Form 4868 Selling expenses are added to the basis of the sold property. Form 4868 Depreciation recapture. Form 4868   If the property you sold was depreciable property, you may need to recapture part of the gain on the sale as ordinary income. Form 4868 See Depreciation Recapture Income under Other Rules, later. Form 4868 Gross profit. Form 4868   Gross profit is the total gain you report on the installment method. Form 4868   To figure your gross profit, subtract your adjusted basis for installment sale purposes from the selling price. Form 4868 If the property you sold was your home, subtract from the gross profit any gain you can exclude. Form 4868 See Sale of Your Home , later, under Reporting Installment Sale Income. Form 4868 Contract price. Form 4868   Contract price equals: The selling price, minus The mortgages, debts, and other liabilities assumed or taken by the buyer, plus The amount by which the mortgages, debts, and other liabilities assumed or taken by the buyer exceed your adjusted basis for installment sale purposes. Form 4868 Gross profit percentage. Form 4868   A certain percentage of each payment (after subtracting interest) is reported as installment sale income. Form 4868 This percentage is called the gross profit percentage and is figured by dividing your gross profit from the sale by the contract price. Form 4868   The gross profit percentage generally remains the same for each payment you receive. Form 4868 However, see the Example under Selling Price Reduced, later, for a situation where the gross profit percentage changes. Form 4868 Example. Form 4868 You sell property at a contract price of $6,000 and your gross profit is $1,500. Form 4868 Your gross profit percentage is 25% ($1,500 ÷ $6,000). Form 4868 After subtracting interest, you report 25% of each payment, including the down payment, as installment sale income from the sale for the tax year you receive the payment. Form 4868 The remainder (balance) of each payment is the tax-free return of your adjusted basis. Form 4868 Amount to report as installment sale income. Form 4868   Multiply the payments you receive each year (less interest) by the gross profit percentage. Form 4868 The result is your installment sale income for the tax year. Form 4868 In certain circumstances, you may be treated as having received a payment, even though you received nothing directly. Form 4868 A receipt of property or the assumption of a mortgage on the property sold may be treated as a payment. Form 4868 For a detailed discussion, see Payments Received or Considered Received under Other Rules, later. Form 4868 Selling Price Reduced If the selling price is reduced at a later date, the gross profit on the sale also will change. Form 4868 You then must refigure the gross profit percentage for the remaining payments. Form 4868 Refigure your gross profit using Worksheet B. Form 4868 You will spread any remaining gain over future installments. Form 4868 Worksheet B. Form 4868 New Gross Profit Percentage — Selling Price Reduced 1. Form 4868 Enter the reduced selling  price for the property   2. Form 4868 Enter your adjusted  basis for the  property     3. Form 4868 Enter your selling  expenses     4. Form 4868 Enter any depreciation  recapture     5. Form 4868 Add lines 2, 3, and 4. Form 4868   6. Form 4868 Subtract line 5 from line 1. Form 4868  This is your adjusted  gross profit   7. Form 4868 Enter any installment sale  income reported in  prior year(s)   8. Form 4868 Subtract line 7 from line 6   9. Form 4868 Future installments   10. Form 4868 Divide line 8 by line 9. Form 4868  This is your new gross profit percentage*   * Apply this percentage to all future payments to determine how much of each of those payments is installment sale income. Form 4868 Example. Form 4868 In 2011, you sold land with a basis of $40,000 for $100,000. Form 4868 Your gross profit was $60,000. Form 4868 You received a $20,000 down payment and the buyer's note for $80,000. Form 4868 The note provides for four annual payments of $20,000 each, plus 8% interest, beginning in 2012. Form 4868 Your gross profit percentage is 60%. Form 4868 You reported a gain of $12,000 on each payment received in 2011 and 2012. Form 4868 In 2013, you and the buyer agreed to reduce the purchase price to $85,000 and payments during 2013, 2014, and 2015 are reduced to $15,000 for each year. Form 4868 The new gross profit percentage, 46. Form 4868 67%, is figured on Example—Worksheet B. Form 4868 You will report a gain of $7,000 (46. Form 4868 67% of $15,000) on each of the $15,000 installments due in 2013, 2014, and 2015. Form 4868 Example — Worksheet B. Form 4868 New Gross Profit Percentage — Selling Price Reduced 1. Form 4868 Enter the reduced selling  price for the property 85,000 2. Form 4868 Enter your adjusted  basis for the  property 40,000   3. Form 4868 Enter your selling  expenses -0-   4. Form 4868 Enter any depreciation  recapture -0-   5. Form 4868 Add lines 2, 3, and 4. Form 4868 40,000 6. Form 4868 Subtract line 5 from line 1. Form 4868  This is your adjusted  gross profit 45,000 7. Form 4868 Enter any installment sale  income reported in  prior year(s) 24,000 8. Form 4868 Subtract line 7 from line 6 21,000 9. Form 4868 Future installments 45,000 10. Form 4868 Divide line 8 by line 9. Form 4868  This is your new gross profit percentage* 46. Form 4868 67% * Apply this percentage to all future payments to determine how much of each of those payments is installment sale income. Form 4868 Reporting Installment Sale Income Generally, you will use Form 6252 to report installment sale income from casual sales of real or personal property during the tax year. Form 4868 You also will have to report the installment sale income on Schedule D (Form 1040), Capital Gains and Losses, or Form 4797, or both. Form 4868 See Schedule D (Form 1040) and Form 4797 , later. Form 4868 If the property was your main home, you may be able to exclude part or all of the gain. Form 4868 See Sale of Your Home , later. Form 4868 Form 6252 Use Form 6252 to report an installment sale in the year it takes place and to report payments received, or considered received because of related party resales, in later years. Form 4868 Attach it to your tax return for each year. Form 4868 Form 6252 will help you determine the gross profit, contract price, gross profit percentage, and installment sale income. Form 4868 Which parts to complete. Form 4868   Which part to complete depends on whether you are filing the form for the year of sale or a later year. Form 4868 Year of sale. Form 4868   Complete lines 1 through 4, Part I, and Part II. Form 4868 If you sold property to a related party during the year, also complete Part III. Form 4868 Later years. Form 4868   Complete lines 1 through 4 and Part II for any year in which you receive a payment from an installment sale. Form 4868   If you sold a marketable security to a related party after May 14, 1980, and before January 1, 1987, complete Form 6252 for each year of the installment agreement, even if you did not receive a payment. Form 4868 (After December 31, 1986, the installment method is not available for the sale of marketable securities. Form 4868 ) Complete lines 1 through 4 and Part II for any year in which you receive a payment from the sale. Form 4868 Complete Part III unless you received the final payment during the tax year. Form 4868   If you sold property other than a marketable security to a related party after May 14, 1980, complete Form 6252 for the year of sale and for 2 years after the year of sale, even if you did not receive a payment. Form 4868 Complete lines 1 through 4 and Part II for any year during this 2-year period in which you receive a payment from the sale. Form 4868 Complete Part III for the 2 years after the year of sale unless you received the final payment during the tax year. Form 4868 Schedule D (Form 1040) Enter the gain figured on Form 6252 (line 26) for personal-use property (capital assets) on Schedule D (Form 1040), as a short-term gain (line 4) or long-term gain (line 11). Form 4868 If your gain from the installment sale qualifies for long-term capital gain treatment in the year of sale, it will continue to qualify in later tax years. Form 4868 Your gain is long-term if you owned the property for more than 1 year when you sold it. Form 4868 Form 4797 An installment sale of property used in your business or that earns rent or royalty income may result in a capital gain, an ordinary gain, or both. Form 4868 All or part of any gain from the disposition of the property may be ordinary gain from depreciation recapture. Form 4868 For trade or business property held for more than 1 year, enter the amount from line 26 of Form 6252 on Form 4797, line 4. Form 4868 If the property was held 1 year or less or you have an ordinary gain from the sale of a noncapital asset (even if the holding period is more than 1 year), enter this amount on Form 4797, line 10, and write “From Form 6252. Form 4868 ” Sale of Your Home If you sell your home, you may be able to exclude all or part of the gain on the sale. Form 4868 See Publication 523 for information about excluding the gain. Form 4868 If the sale is an installment sale, any gain you exclude is not included in gross profit when figuring your gross profit percentage. Form 4868 Seller-financed mortgage. Form 4868   If you finance the sale of your home to an individual, both you and the buyer may have to follow special reporting procedures. Form 4868   When you report interest income received from a buyer who uses the property as a personal residence, write the buyer's name, address, and social security number (SSN) on line 1 of Schedule B (Form 1040A or 1040), Interest and Ordinary Dividends. Form 4868   When deducting the mortgage interest, the buyer must write your name, address, and SSN on line 11 of Schedule A (Form 1040), Itemized Deductions. Form 4868   If either person fails to include the other person's SSN, a $50 penalty will be assessed. Form 4868 Other Rules The rules discussed in this part of the publication apply only in certain circumstances or to certain types of property. Form 4868 The following topics are discussed. Form 4868 Electing out of the installment method. Form 4868 Payments received or considered received. Form 4868 Escrow account. Form 4868 Depreciation recapture income. Form 4868 Sale to a related person. Form 4868 Like-kind exchange. Form 4868 Contingent payment sale. Form 4868 Single sale of several assets. Form 4868 Sale of a business. Form 4868 Unstated interest and original issue discount. Form 4868 Disposition of an installment obligation. Form 4868 Repossession. Form 4868 Interest on deferred tax. Form 4868 Electing Out of the Installment Method If you elect not to use the installment method, you generally report the entire gain in the year of sale, even though you do not receive all the sale proceeds in that year. Form 4868 To figure the amount of gain to report, use the fair market value (FMV) of the buyer's installment obligation that represents the buyer's debt to you. Form 4868 Notes, mortgages, and land contracts are examples of obligations that are included at FMV. Form 4868 You must figure the FMV of the buyer's installment obligation, whether or not you would actually be able to sell it. Form 4868 If you use the cash method of accounting, the FMV of the obligation will never be considered to be less than the FMV of the property sold (minus any other consideration received). Form 4868 Example. Form 4868 You sold a parcel of land for $50,000. Form 4868 You received a $10,000 down payment and will receive the balance over the next 10 years at $4,000 a year, plus 8% interest. Form 4868 The buyer gave you a note for $40,000. Form 4868 The note had an FMV of $40,000. Form 4868 You paid a commission of 6%, or $3,000, to a broker for negotiating the sale. Form 4868 The land cost $25,000, and you owned it for more than one year. Form 4868 You decide to elect out of the installment method and report the entire gain in the year of sale. Form 4868 Gain realized:     Selling price $50,000 Minus: Property's adj. Form 4868 basis $25,000     Commission 3,000 28,000 Gain realized $22,000 Gain recognized in year of sale:   Cash $10,000 Market value of note 40,000 Total realized in year of sale $50,000 Minus: Property's adj. Form 4868 basis $25,000     Commission 3,000 28,000 Gain recognized $22,000 The recognized gain of $22,000 is long-term capital gain. Form 4868 You include the entire gain in income in the year of sale, so you do not include in income any principal payments you receive in later tax years. Form 4868 The interest on the note is ordinary income and is reported as interest income each year. Form 4868 How to elect out. Form 4868   To make this election, do not report your sale on Form 6252. Form 4868 Instead, report it on Form 8949, Sales and Other Dispositions of Capital Assets, Form 4797, or both. Form 4868 When to elect out. Form 4868   Make this election by the due date, including extensions, for filing your tax return for the year the sale takes place. Form 4868 Automatic six-month extension. Form 4868   If you timely file your tax return without making the election, you still can make the election by filing an amended return within 6 months of the due date of your return (excluding extensions). Form 4868 Write “Filed pursuant to section 301. Form 4868 9100-2” at the top of the amended return and file it where the original return was filed. Form 4868 Revoking the election. Form 4868   Once made, the election can be revoked only with IRS approval. Form 4868 A revocation is retroactive. Form 4868 You will not be allowed to revoke the election if either of the following applies. Form 4868 One of the purposes is to avoid federal income tax. Form 4868 The tax year in which any payment was received has closed. Form 4868 Payments Received or Considered Received You must figure your gain each year on the payments you receive, or are treated as receiving, from an installment sale. Form 4868 In certain situations, you are considered to have received a payment, even though the buyer does not pay you directly. Form 4868 These situations occur when the buyer assumes or pays any of your debts, such as a loan, or pays any of your expenses, such as a sales commission. Form 4868 However, as discussed later, the buyer's assumption of your debt is treated as a recovery of your basis rather than as a payment in many cases. Form 4868 Buyer Pays Seller's Expenses If the buyer pays any of your expenses related to the sale of your property, it is considered a payment to you in the year of sale. Form 4868 Include these expenses in the selling and contract prices when figuring the gross profit percentage. Form 4868 Buyer Assumes Mortgage If the buyer assumes or pays off your mortgage, or otherwise takes the property subject to the mortgage, the following rules apply. Form 4868 Mortgage not more than basis. Form 4868   If the buyer assumes a mortgage that is not more than your installment sale basis in the property, it is not considered a payment to you. Form 4868 It is considered a recovery of your basis. Form 4868 The contract price is the selling price minus the mortgage. Form 4868 Example. Form 4868 You sell property with an adjusted basis of $19,000. Form 4868 You have selling expenses of $1,000. Form 4868 The buyer assumes your existing mortgage of $15,000 and agrees to pay you $10,000 (a cash down payment of $2,000 and $2,000 (plus 12% interest) in each of the next 4 years). Form 4868 The selling price is $25,000 ($15,000 + $10,000). Form 4868 Your gross profit is $5,000 ($25,000 − $20,000 installment sale basis). Form 4868 The contract price is $10,000 ($25,000 − $15,000 mortgage). Form 4868 Your gross profit percentage is 50% ($5,000 ÷ $10,000). Form 4868 You report half of each $2,000 payment received as gain from the sale. Form 4868 You also report all interest you receive as ordinary income. Form 4868 Mortgage more than basis. Form 4868   If the buyer assumes a mortgage that is more than your installment sale basis in the property, you recover your entire basis. Form 4868 The part of the mortgage greater than your basis is treated as a payment received in the year of sale. Form 4868   To figure the contract price, subtract the mortgage from the selling price. Form 4868 This is the total amount (other than interest) you will receive directly from the buyer. Form 4868 Add to this amount the payment you are considered to have received (the difference between the mortgage and your installment sale basis). Form 4868 The contract price is then the same as your gross profit from the sale. Form 4868    If the mortgage the buyer assumes is equal to or more than your installment sale basis, the gross profit percentage always will be 100%. Form 4868 Example. Form 4868 The selling price for your property is $9,000. Form 4868 The buyer will pay you $1,000 annually (plus 8% interest) over the next 3 years and assume an existing mortgage of $6,000. Form 4868 Your adjusted basis in the property is $4,400. Form 4868 You have selling expenses of $600, for a total installment sale basis of $5,000. Form 4868 The part of the mortgage that is more than your installment sale basis is $1,000 ($6,000 − $5,000). Form 4868 This amount is included in the contract price and treated as a payment received in the year of sale. Form 4868 The contract price is $4,000: Selling price $9,000 Minus: Mortgage (6,000) Amount actually received $3,000 Add difference:   Mortgage $6,000   Minus: Installment sale basis 5,000 1,000 Contract price $4,000       Your gross profit on the sale is also $4,000: Selling price $9,000 Minus: Installment sale basis (5,000) Gross profit $4,000 Your gross profit percentage is 100%. Form 4868 Report 100% of each payment (less interest) as gain from the sale. Form 4868 Treat the $1,000 difference between the mortgage and your installment sale basis as a payment and report 100% of it as gain in the year of sale. Form 4868 Mortgage Canceled If the buyer of your property is the person who holds the mortgage on it, your debt is canceled, not assumed. Form 4868 You are considered to receive a payment equal to the outstanding canceled debt. Form 4868 Example. Form 4868 Mary Jones loaned you $45,000 in 2009 in exchange for a note and a mortgage in a tract of land you owned. Form 4868 On April 4, 2013, she bought the land for $70,000. Form 4868 At that time, $30,000 of her loan to you was outstanding. Form 4868 She agreed to forgive this $30,000 debt and to pay you $20,000 (plus interest) on August 1, 2013, and $20,000 on August 1, 2014. Form 4868 She did not assume an existing mortgage. Form 4868 She canceled the $30,000 debt you owed her. Form 4868 You are considered to have received a $30,000 payment at the time of the sale. Form 4868 Buyer Assumes Other Debts If the buyer assumes any other debts, such as a loan or back taxes, it may be considered a payment to you in the year of sale. Form 4868 If the buyer assumes the debt instead of paying it off, only part of it may have to be treated as a payment. Form 4868 Compare the debt to your installment sale basis in the property being sold. Form 4868 If the debt is less than your installment sale basis, none of it is treated as a payment. Form 4868 If it is more, only the difference is treated as a payment. Form 4868 If the buyer assumes more than one debt, any part of the total that is more than your installment sale basis is considered a payment. Form 4868 These rules are the same as the rules discussed earlier under Buyer Assumes Mortgage . Form 4868 However, they apply only to the following types of debt the buyer assumes. Form 4868 Those acquired from ownership of the property you are selling, such as a mortgage, lien, overdue interest, or back taxes. Form 4868 Those acquired in the ordinary course of your business, such as a balance due for inventory you purchased. Form 4868 If the buyer assumes any other type of debt, such as a personal loan or your legal fees relating to the sale, it is treated as if the buyer had paid off the debt at the time of the sale. Form 4868 The value of the assumed debt is then considered a payment to you in the year of sale. Form 4868 Property Used As a Payment If you receive property other than money from the buyer, it is still considered a payment in the year received. Form 4868 However, see Like-Kind Exchange , later. Form 4868 Generally, the amount of the payment is the property's FMV on the date you receive it. Form 4868 Exception. Form 4868   If the property the buyer gives you is payable on demand or readily tradable, the amount you should consider as payment in the year received is: The FMV of the property on the date you receive it if you use the cash method of accounting, The face amount of the obligation on the date you receive it if you use the accrual method of accounting, or The stated redemption price at maturity less any original issue discount (OID) or, if there is no OID, the stated redemption price at maturity appropriately discounted to reflect total unstated interest. Form 4868 See Unstated Interest and Original Issue Discount (OID) , later. Form 4868 Debt not payable on demand. Form 4868   Any evidence of debt you receive from the buyer not payable on demand is not considered a payment. Form 4868 This is true even if the debt is guaranteed by a third party, including a government agency. Form 4868 Fair market value (FMV). Form 4868   This is the price at which property would change hands between a willing buyer and a willing seller, neither being under any compulsion to buy or sell and both having a reasonable knowledge of all the necessary facts. Form 4868 Third-party note. Form 4868   If the property the buyer gives you is a third-party note (or other obligation of a third party), you are considered to have received a payment equal to the note's FMV. Form 4868 Because the FMV of the note is itself a payment on your installment sale, any payments you later receive from the third party are not considered payments on the sale. Form 4868 The excess of the note's face value over its FMV is interest. Form 4868 Exclude this interest in determining the selling price of the property. Form 4868 However, see Exception under Property Used As a Payment, earlier. Form 4868 Example. Form 4868 You sold real estate in an installment sale. Form 4868 As part of the down payment, the buyer assigned to you a $50,000, 8% interest third-party note. Form 4868 The FMV of the third-party note at the time of the sale was $30,000. Form 4868 This amount, not $50,000, is a payment to you in the year of sale. Form 4868 The third-party note had an FMV equal to 60% of its face value ($30,000 ÷ $50,000), so 60% of each principal payment you receive on this note is a nontaxable return of capital. Form 4868 The remaining 40% is interest taxed as ordinary income. Form 4868 Bond. Form 4868   A bond or other evidence of debt you receive from the buyer that is payable on demand or readily tradable in an established securities market is treated as a payment in the year you receive it. Form 4868 For more information on the amount you should treat as a payment, see Exception under Property Used As a Payment, earlier. Form 4868    If you receive a government or corporate bond for a sale before October 22, 2004, and the bond has interest coupons attached or can be readily traded in an established securities market, you are considered to have received payment equal to the bond's FMV. Form 4868 However, see Exception under Property Used As a Payment, earlier. Form 4868 Buyer's note. Form 4868   The buyer's note (unless payable on demand) is not considered payment on the sale. Form 4868 However, its full face value is included when figuring the selling price and the contract price. Form 4868 Payments you receive on the note are used to figure your gain in the year received. Form 4868 Installment Obligation Used as Security (Pledge Rule) If you use an installment obligation to secure any debt, the net proceeds from the debt may be treated as a payment on the installment obligation. Form 4868 This is known as the pledge rule, and it applies if the selling price of the property is over $150,000. Form 4868 It does not apply to the following dispositions. Form 4868 Sales of property used or produced in farming. Form 4868 Sales of personal-use property. Form 4868 Qualifying sales of time-shares and residential lots. Form 4868 The net debt proceeds are the gross debt minus the direct expenses of getting the debt. Form 4868 The amount treated as a payment is considered received on the later of the following dates. Form 4868 The date the debt becomes secured. Form 4868 The date you receive the debt proceeds. Form 4868 A debt is secured by an installment obligation to the extent that payment of principal or interest on the debt is directly secured (under the terms of the loan or any underlying arrangement) by any interest in the installment obligation. Form 4868 For sales after December 16, 1999, payment on a debt is treated as directly secured by an interest in an installment obligation to the extent an arrangement allows you to satisfy all or part of the debt with the installment obligation. Form 4868 Limit. Form 4868   The net debt proceeds treated as a payment on the pledged installment obligation cannot be more than the excess of item (1) over item (2), below. Form 4868 The total contract price on the installment sale. Form 4868 Any payments received on the installment obligation before the date the net debt proceeds are treated as a payment. Form 4868 Installment payments. Form 4868   The pledge rule accelerates the reporting of the installment obligation payments. Form 4868 Do not report payments received on the obligation after it has been pledged until the payments received exceed the amount reported under the pledge rule. Form 4868 Exception. Form 4868   The pledge rule does not apply to pledges made after December 17, 1987, to refinance a debt under the following circumstances. Form 4868 The debt was outstanding on December 17, 1987. Form 4868 The debt was secured by that installment sale obligation on that date and at all times thereafter until the refinancing occurred. Form 4868   A refinancing as a result of the creditor's calling of the debt is treated as a continuation of the original debt so long as a person other than the creditor or a person related to the creditor provides the refinancing. Form 4868   This exception applies only to refinancing that does not exceed the principal of the original debt immediately before the refinancing. Form 4868 Any excess is treated as a payment on the installment obligation. Form 4868 Escrow Account In some cases, the sales agreement or a later agreement may call for the buyer to establish an irrevocable escrow account from which the remaining installment payments (including interest) are to be made. Form 4868 These sales cannot be reported on the installment method. Form 4868 The buyer's obligation is paid in full when the balance of the purchase price is deposited into the escrow account. Form 4868 When an escrow account is established, you no longer rely on the buyer for the rest of the payments, but on the escrow arrangement. Form 4868 Example. Form 4868 You sell property for $100,000. Form 4868 The sales agreement calls for a down payment of $10,000 and payment of $15,000 in each of the next 6 years to be made from an irrevocable escrow account containing the balance of the purchase price plus interest. Form 4868 You cannot report the sale on the installment method because the full purchase price is considered received in the year of sale. Form 4868 You report the entire gain in the year of sale. Form 4868 Escrow established in a later year. Form 4868   If you make an installment sale and in a later year an irrevocable escrow account is established to pay the remaining installments plus interest, the amount placed in the escrow account represents payment of the balance of the installment obligation. Form 4868 Substantial restriction. Form 4868   If an escrow arrangement imposes a substantial restriction on your right to receive the sale proceeds, the sale can be reported on the installment method, provided it otherwise qualifies. Form 4868 For an escrow arrangement to impose a substantial restriction, it must serve a bona fide purpose of the buyer, that is, a real and definite restriction placed on the seller or a specific economic benefit conferred on the buyer. Form 4868 Depreciation Recapture Income If you sell property for which you claimed or could have claimed a depreciation deduction, you must report any depreciation recapture income in the year of sale, whether or not an installment payment was received that year. Form 4868 Figure your depreciation recapture income (including the section 179 deduction and the section 179A deduction recapture) in Part III of Form 4797. Form 4868 Report the recapture income in Part II of Form 4797 as ordinary income in the year of sale. Form 4868 The recapture income is also included in Part I of Form 6252. Form 4868 However, the gain equal to the recapture income is reported in full in the year of the sale. Form 4868 Only the gain greater than the recapture income is reported on the installment method. Form 4868 For more information on depreciation recapture, see chapter 3 in Publication 544. Form 4868 The recapture income reported in the year of sale is included in your installment sale basis in determining your gross profit on the installment sale. Form 4868 Determining gross profit is discussed under General Rules , earlier. Form 4868 Sale to a Related Person If you sell depreciable property to a related person and the sale is an installment sale, you may not be able to report the sale using the installment method. Form 4868 If you sell property to a related person and the related person disposes of the property before you receive all payments with respect to the sale, you may have to treat the amount realized by the related person as received by you when the related person disposes of the property. Form 4868 These rules are explained under Sale of Depreciable Property and under Sale and Later Disposition , later. Form 4868 Sale of Depreciable Property If you sell depreciable property to certain related persons, you generally cannot report the sale using the installment method. Form 4868 Instead, all payments to be received are considered received in the year of sale. Form 4868 However, see Exception , below. Form 4868 Depreciable property for this rule is any property the purchaser can depreciate. Form 4868 Payments to be received include the total of all noncontingent payments and the FMV of any payments contingent as to amount. Form 4868 In the case of contingent payments for which the FMV cannot be reasonably determined, your basis in the property is recovered proportionately. Form 4868 The purchaser cannot increase the basis of the property acquired in the sale before the seller includes a like amount in income. Form 4868 Exception. Form 4868   You can use the installment method to report a sale of depreciable property to a related person if no significant tax deferral benefit will be derived from the sale. Form 4868 You must show to the satisfaction of the IRS that avoidance of federal income tax was not one of the principal purposes of the sale. Form 4868 Related person. Form 4868   Related persons include the following. Form 4868 A person and all controlled entities with respect to that person. Form 4868 A taxpayer and any trust in which such taxpayer (or his spouse) is a beneficiary, unless that beneficiary's interest in the trust is a remote contingent interest. Form 4868 Except in the case of a sale or exchange in satisfaction of a pecuniary bequest, an executor of an estate and a beneficiary of that estate. Form 4868 Two or more partnerships in which the same person owns, directly or indirectly, more than 50% of the capital interests or the profits interests. Form 4868   For information about which entities are controlled entities, see section 1239(c). Form 4868 Sale and Later Disposition Generally, a special rule applies if you sell or exchange property to a related person on the installment method (first disposition) who then sells, exchanges, or gives away the property (second disposition) under the following circumstances. Form 4868 The related person makes the second disposition before making all payments on the first disposition. Form 4868 The related person disposes of the property within 2 years of the first disposition. Form 4868 This rule does not apply if the property involved is marketable securities. Form 4868 Under this rule, you treat part or all of the amount the related person realizes (or the FMV if the disposed property is not sold or exchanged) from the second disposition as if you received it at the time of the second disposition. Form 4868 See Exception , later. Form 4868 Related person. Form 4868   Related persons include the following. Form 4868 Members of a family, including only brothers and sisters (either whole or half), husband and wife, ancestors, and lineal descendants. Form 4868 A partnership or estate and a partner or beneficiary. Form 4868 A trust (other than a section 401(a) employees trust) and a beneficiary. Form 4868 A trust and an owner of the trust. Form 4868 Two corporations that are members of the same controlled group as defined in section 267(f). Form 4868 The fiduciaries of two different trusts, and the fiduciary and beneficiary of two different trusts, if the same person is the grantor of both trusts. Form 4868 A tax-exempt educational or charitable organization and a person (if an individual, including members of the individual's family) who directly or indirectly controls such an organization. Form 4868 An individual and a corporation when the individual owns, directly or indirectly, more than 50% of the value of the outstanding stock of the corporation. Form 4868 A fiduciary of a trust and a corporation when the trust or the grantor of the trust owns, directly or indirectly, more than 50% in value of the outstanding stock of the corporation. Form 4868 The grantor and fiduciary, and the fiduciary and beneficiary, of any trust. Form 4868 Any two S corporations if the same persons own more than 50% in value of the outstanding stock of each corporation. Form 4868 An S corporation and a corporation that is not an S corporation if the same persons own more than 50% in value of the outstanding stock of each corporation. Form 4868 A corporation and a partnership if the same persons own more than 50% in value of the outstanding stock of the corporation and more than 50% of the capital or profits interest in the partnership. Form 4868 An executor and a beneficiary of an estate unless the sale is in satisfaction of a pecuniary bequest. Form 4868 Example 1. Form 4868 In 2012, Harvey Green sold farm land to his son Bob for $500,000, which was to be paid in five equal payments over 5 years, plus adequate stated interest on the balance due. Form 4868 His installment sale basis for the farm land was $250,000 and the property was not subject to any outstanding liens or mortgages. Form 4868 His gross profit percentage is 50% (gross profit of $250,000 ÷ contract price of $500,000). Form 4868 He received $100,000 in 2012 and included $50,000 in income for that year ($100,000 × 0. Form 4868 50). Form 4868 Bob made no improvements to the property and sold it to Alfalfa Inc. Form 4868 , in 2013 for $600,000 after making the payment for that year. Form 4868 The amount realized from the second disposition is $600,000. Form 4868 Harvey figures his installment sale income for 2013 as follows: Lesser of: 1) Amount realized on second disposition, or 2) Contract price on first disposition $500,000 Subtract: Sum of payments from Bob in 2012 and 2013 - 200,000 Amount treated as received because of second disposition $300,000 Add: Payment from Bob in 2013 + 100,000 Total payments received and treated as received for 2013 $400,000 Multiply by gross profit % × . Form 4868 50 Installment sale income for 2013 $200,000 Harvey will not include in his installment sale income any principal payments he receives on the installment obligation for 2014, 2015, and 2016 because he has already reported the total payments of $500,000 from the first disposition ($100,000 in 2012 and $400,000 in 2013). Form 4868 Example 2. Form 4868 Assume the facts are the same as Example 1 except that Bob sells the property for only $400,000. Form 4868 The gain for 2013 is figured as follows: Lesser of: 1) Amount realized on second disposition, or 2) Contract price on first disposition $400,000 Subtract: Sum of payments from Bob in 2012 and 2013 − 200,000 Amount treated as received because of second disposition $200,000 Add: Payment from Bob in 2013 + 100,000 Total payments received and treated as received for 2013 $300,000 Multiply by gross profit % × . Form 4868 50 Installment sale income for 2013 $150,000     Harvey receives a $100,000 payment in 2014 and another in 2015. Form 4868 They are not taxed because he treated the $200,000 from the disposition in 2013 as a payment received and paid tax on the installment sale income. Form 4868 In 2016, he receives the final $100,000 payment. Form 4868 He figures the installment sale income he must recognize in 2016 as follows: Total payments from the first disposition received by the end of 2016 $500,000 Minus the sum of:     Payment from 2012 $100,000   Payment from 2013 100,000   Amount treated as received in 2013 200,000   Total on which gain was previously recognized  − 400,000 Payment on which gain is recognized for 2016  $100,000 Multiply by gross profit % × . Form 4868 50 Installment sale income for 2016 $ 50,000 Exception. Form 4868   This rule does not apply to a second disposition, and any later transfer, if you can show to the satisfaction of the IRS that neither the first disposition (to the related person) nor the second disposition had as one of its principal purposes the avoidance of federal income tax. Form 4868 Generally, an involuntary second disposition will qualify under the nontax avoidance exception, such as when a creditor of the related person forecloses on the property or the related person declares bankruptcy. Form 4868   The nontax avoidance exception also applies to a second disposition that is also an installment sale if the terms of payment under the installment resale are substantially equal to or longer than those for the first installment sale. Form 4868 However, the exception does not apply if the resale terms permit significant deferral of recognition of gain from the first sale. Form 4868   In addition, any sale or exchange of stock to the issuing corporation is not treated as a first disposition. Form 4868 An involuntary conversion is not treated as a second disposition if the first disposition occurred before the threat of conversion. Form 4868 A transfer after the death of the person making the first disposition or the related person's death, whichever is earlier, is not treated as a second disposition. Form 4868 Like-Kind Exchange If you trade business or investment property solely for the same kind of property to be held as business or investment property, you can postpone reporting the gain. Form 4868 These trades are known as like-kind exchanges. Form 4868 The property you receive in a like-kind exchange is treated as if it were a continuation of the property you gave up. Form 4868 You do not have to report any part of your gain if you receive only like-kind property. Form 4868 However, if you also receive money or other property (boot) in the exchange, you must report your gain to the extent of the money and the FMV of the other property received. Form 4868 For more information on like-kind exchanges, see Like-Kind Exchanges in chapter 1 of Publication 544. Form 4868 Installment payments. Form 4868   If, in addition to like-kind property, you receive an installment obligation in the exchange, the following rules apply to determine the installment sale income each year. Form 4868 The contract price is reduced by the FMV of the like-kind property received in the trade. Form 4868 The gross profit is reduced by any gain on the trade that can be postponed. Form 4868 Like-kind property received in the trade is not considered payment on the installment obligation. Form 4868 Example. Form 4868 In 2013, George Brown trades personal property with an installment sale basis of $400,000 for like-kind property having an FMV of $200,000. Form 4868 He also receives an installment note for $800,000 in the trade. Form 4868 Under the terms of the note, he is to receive $100,000 (plus interest) in 2014 and the balance of $700,000 (plus interest) in 2015. Form 4868 George's selling price is $1,000,000 ($800,000 installment note + $200,000 FMV of like-kind property received). Form 4868 His gross profit is $600,000 ($1,000,000 − $400,000 installment sale basis). Form 4868 The contract price is $800,000 ($1,000,000 − $200,000). Form 4868 The gross profit percentage is 75% ($600,000 ÷ $800,000). Form 4868 He reports no gain in 2013 because the like-kind property he receives is not treated as a payment for figuring gain. Form 4868 He reports $75,000 gain for 2014 (75% of $100,000 payment received) and $525,000 gain for 2015 (75% of $700,000 payment received). Form 4868 Deferred exchanges. Form 4868   A deferred exchange is one in which you transfer property you use in business or hold for investment and receive like-kind property later that you will use in business or hold for investment. Form 4868 Under this type of exchange, the person receiving your property may be required to place funds in an escrow account or trust. Form 4868 If certain rules are met, these funds will not be considered a payment until you have the right to receive the funds or, if earlier, the end of the exchange period. Form 4868 See Regulations section 1. Form 4868 1031(k)-1(j)(2) for these rules. Form 4868 Contingent Payment Sale A contingent payment sale is one in which the total selling price cannot be determined by the end of the tax year of sale. Form 4868 This happens, for example, if you sell your business and the selling price includes a percentage of its profits in future years. Form 4868 If the selling price cannot be determined by the end of the tax year, you must use different rules to figure the contract price and the gross profit percentage than those you use for an installment sale with a fixed selling price. Form 4868 For rules on using the installment method for a contingent payment sale, see Regulations section 15a. Form 4868 453-1(c). Form 4868 Single Sale of Several Assets If you sell different types of assets in a single sale, you must identify each asset to determine whether you can use the installment method to report the sale of that asset. Form 4868 You also have to allocate part of the selling price to each asset. Form 4868 If you sell assets that constitute a trade or business, see Sale of a Business , later. Form 4868 Unless an allocation of the selling price has been agreed to by both parties in an arm's-length transaction, you must allocate the selling price to an asset based on its FMV. Form 4868 If the buyer assumes a debt, or takes the property subject to a debt, you must reduce the FMV of the property by the debt. Form 4868 This becomes the net FMV. Form 4868 A sale of separate and unrelated assets of the same type under a single contract is reported as one transaction for the installment method. Form 4868 However, if an asset is sold at a loss, its disposition cannot be reported on the installment method. Form 4868 It must be reported separately. Form 4868 The remaining assets sold at a gain are reported together. Form 4868 Example. Form 4868 You sold three separate and unrelated parcels of real property (A, B, and C) under a single contract calling for a total selling price of $130,000. Form 4868 The total selling price consisted of a cash payment of $20,000, the buyer's assumption of a $30,000 mortgage on parcel B, and an installment obligation of $80,000 payable in eight annual installments, plus interest at 8% a year. Form 4868 Your installment sale basis for each parcel was $15,000. Form 4868 Your net gain was $85,000 ($130,000 − $45,000). Form 4868 You report the gain on the installment method. Form 4868 The sales contract did not allocate the selling price or the cash payment received in the year of sale among the individual parcels. Form 4868 The FMV of parcels A, B, and C were $60,000, $60,000, and $10,000, respectively. Form 4868 The installment sale basis for parcel C was more than its FMV, so it was sold at a loss and must be treated separately. Form 4868 You must allocate the total selling price and the amounts received in the year of sale between parcel C and the remaining parcels. Form 4868 Of the total $130,000 selling price, you must allocate $120,000 to parcels A and B together and $10,000 to parcel C. Form 4868 You should allocate the cash payment of $20,000 received in the year of sale and the note receivable on the basis of their proportionate net FMV. Form 4868 The allocation is figured as follows:   Parcels   A and B Parcel C FMV $120,000 $10,000 Minus: Mortgage assumed 30,000 -0- Net FMV $ 90,000 $10,000 Proportionate net FMV:     Percentage of total 90% 10% Payments in year of sale:     $20,000 × 90% $18,000   $20,000 × 10%   $2,000 Excess of parcel B mortgage over installment sale basis 15,000 -0- Allocation of payments  received (or considered  received) in year of sale $ 33,000 $ 2,000 You cannot report the sale of parcel C on the installment method because the sale results in a loss. Form 4868 You report this loss of $5,000 ($10,000 selling price − $15,000 installment sale basis) in the year of sale. Form 4868 However, if parcel C was held for personal use, the loss is not deductible. Form 4868 You allocate the installment obligation of $80,000 to the properties sold based on their proportionate net FMVs (90% to parcels A and B, 10% to parcel C). Form 4868 Sale of a Business The installment sale of an entire business for one overall price under a single contract is not the sale of a single asset. Form 4868 Allocation of Selling Price To determine whether any of the gain on the sale of the business can be reported on the installment method, you must allocate the total selling price and the payments received in the year of sale between each of the following classes of assets. Form 4868 Assets sold at a loss. Form 4868 Real and personal property eligible for the installment method. Form 4868 Real and personal property ineligible for the installment method, including: Inventory, Dealer property, and Stocks and securities. Form 4868 Inventory. Form 4868   The sale of inventories of personal property cannot be reported on the installment method. Form 4868 All gain or loss on their sale must be reported in the year of sale, even if you receive payment in later years. Form 4868   If inventory items are included in an installment sale, you may have an agreement stating which payments are for inventory and which are for the other assets being sold. Form 4868 If you do not, each payment must be allocated between the inventory and the other assets sold. Form 4868   Report the amount you receive (or will receive) on the sale of inventory items as ordinary business income. Form 4868 Use your basis in the inventory to figure the cost of goods sold. Form 4868 Deduct the part of the selling expenses allocated to inventory as an ordinary business expense. Form 4868 Residual method. Form 4868   Except for assets exchanged under the like-kind exchange rules, both the buyer and seller of a business must use the residual method to allocate the sale price to each business asset sold. Form 4868 This method determines gain or loss from the transfer of each asset and the buyer's basis in the assets. Form 4868   The residual method must be used for any transfer of a group of assets that constitutes a trade or business and for which the buyer's basis is determined only by the amount paid for the assets. Form 4868 This applies to both direct and indirect transfers, such as the sale of a business or the sale of a partnership interest in which the basis of the buyer's share of the partnership assets is adjusted for the amount paid under section 743(b). Form 4868   A group of assets constitutes a trade or business if goodwill or going concern value could, under any circumstances, attach to the assets or if the use of the assets would constitute an active trade or business under section 355. Form 4868   The residual method provides for the consideration to be reduced first by cash and general deposit accounts (including checking and savings accounts but excluding certificates of deposit). Form 4868 The consideration remaining after this reduction must be allocated among the various business assets in a certain order. Form 4868   For asset acquisitions occurring after March 15, 2001, make the allocation among the following assets in proportion to (but not more than) their fair market value on the purchase date in the following order. Form 4868 Certificates of deposit, U. Form 4868 S. Form 4868 Government securities, foreign currency, and actively traded personal property, including stock and securities. Form 4868 Accounts receivable, other debt instruments, and assets that you mark to market at least annually for federal income tax purposes. Form 4868 However, see Regulations section 1. Form 4868 338-6(b)(2)(iii) for exceptions that apply to debt instruments issued by persons related to a target corporation, contingent debt instruments, and debt instruments convertible into stock or other property. Form 4868 Property of a kind that would properly be included in inventory if on hand at the end of the tax year or property held by the taxpayer primarily for sale to customers in the ordinary course of business. Form 4868 All other assets except section 197 intangibles. Form 4868 Section 197 intangibles except goodwill and going concern value. Form 4868 Goodwill and going concern value (whether or not they qualify as section 197 intangibles). Form 4868   If an asset described in (1) through (6) is includible in more than one category, include it in the lower number category. Form 4868 For example, if an asset is described in both (4) and (6), include it in (4). Form 4868 Agreement. Form 4868   The buyer and seller may enter into a written agreement as to the allocation of any consideration or the fair market value of any of the assets. Form 4868 This agreement is binding on both parties unless the IRS determines the amounts are not appropriate. Form 4868 Reporting requirement. Form 4868   Both the buyer and seller involved in the sale of business assets must report to the IRS the allocation of the sales price among section 197 intangibles and the other business assets. Form 4868 Use Form 8594, Asset Acquisition Statement Under Section 1060, to provide this information. Form 4868 The buyer and seller should each attach Form 8594 to their federal income tax return for the year in which the sale occurred. Form 4868 Sale of Partnership Interest A partner who sells a partnership interest at a gain may be able to report the sale on the installment method. Form 4868 The sale of a partnership interest is treated as the sale of a single capital asset. Form 4868 The part of any gain or loss from unrealized receivables or inventory items will be treated as ordinary income. Form 4868 (The term “unrealized receivables” includes depreciation recapture income, discussed earlier. Form 4868 ) The gain allocated to the unrealized receivables and the inventory cannot be reported under the installment method. Form 4868 The gain allocated to the other assets can be reported under the installment method. Form 4868 For more information on the treatment of unrealized receivables and inventory, see Publication 541. Form 4868 Example — Sale of a Business On June 4, 2013, you sold the machine shop you had operated since 2005. Form 4868 You received a $100,000 down payment and the buyer's note for $120,000. Form 4868 The note payments are $15,000 each, plus 10% interest, due every July 1 and January 1, beginning in 2014. Form 4868 The total selling price is $220,000. Form 4868 Your selling expenses are $11,000. Form 4868 The selling expenses are divided among all the assets sold, including inventory. Form 4868 Your selling expense for each asset is 5% of the asset's selling price ($11,000 selling expense ÷ $220,000 total selling price). Form 4868 The FMV, adjusted basis, and depreciation claimed on each asset sold are as follows:     Depre- ciation Adj. Form 4868 Asset FMV Claimed Basis Inventory $ 10,000 -0- $ 8,000 Land 42,000 -0- 15,000 Building 48,000 $9,000 36,000 Machine A 71,000 27,200 63,800 Machine B 24,000 12,960 22,040 Truck 6,500 18,624 5,376   $201,500 $67,784 $150,216         Under the residual method, you allocate the selling price to each of the assets based on their FMV ($201,500). Form 4868 The remaining $18,500 ($220,000 - $201,500) is allocated to your section 197 intangible, goodwill. Form 4868 The assets included in the sale, their selling prices based on their FMVs, the selling expense allocated to each asset, the adjusted basis, and the gain for each asset are shown in the following chart. Form 4868   Sale  Price Sale   Exp. Form 4868 Adj. Form 4868   Basis Gain Inventory $ 10,000 $ 500 $ 8,000 $ 1,500 Land 42,000 2,100 15,000 24,900 Building 48,000 2,400 36,000 9,600 Mch. Form 4868 A 71,000 3,550 63,800 3,650 Mch. Form 4868 B 24,000 1,200 22,040 760 Truck 6,500 325 5,376 799 Goodwill 18,500 925 -0- 17,575   $220,000 $11,000 $150,216 $58,784 The building was acquired in 2005, the year the business began, and it is section 1250 property. Form 4868 There is no depreciation recapture income because the building was depreciated using the straight line method. Form 4868 All gain on the truck, machine A, and machine B is depreciation recapture income since it is the lesser of the depreciation claimed or the gain on the sale. Form 4868 Figure depreciation recapture in Part III of Form 4797. Form 4868 The total depreciation recapture income reported in Part II of Form 4797 is $5,209. Form 4868 This consists of $3,650 on machine A, $799 on the truck, and $760 on machine B (the gain on each item because it was less than the depreciation claimed). Form 4868 These gains are reported in full in the year of sale and are not included in the installment sale computation. Form 4868 Of the $220,000 total selling price, the $10,000 for inventory assets cannot be reported using the installment method. Form 4868 The selling prices of the truck and machines are also removed from the total selling price because gain on these items is reported in full in the year of sale. Form 4868 The selling price equals the contract price for the installment sale ($108,500). Form 4868 The assets included in the installment sale, their selling price, and their installment sale bases are shown in the following chart. Form 4868   Selling  Price Install- ment  Sale  Basis Gross  Profit Land $ 42,000 $17,100 $24,900 Building 48,000 38,400 9,600 Goodwill 18,500 925 17,575 Total $108,500 $56,425 $52,075         The gross profit percentage (gross profit ÷ contract price) for the installment sale is 48% ($52,075 ÷ $108,500). Form 4868 The gross profit percentage for each asset is figured as follows: Percentage Land— $24,900 ÷ $108,500 22. Form 4868 95 Building— $9,600 ÷ $108,500 8. Form 4868 85 Goodwill— $17,575 ÷ $108,500 16. Form 4868 20 Total 48. Form 4868 00 The sale includes assets sold on the installment method and assets for which the gain is reported in full in the year of sale, so payments must be allocated between the installment part of the sale and the part reported in the year of sale. Form 4868 The selling price for the installment sale is $108,500. Form 4868 This is 49. Form 4868 3% of the total selling price of $220,000 ($108,500 ÷ $220,000). Form 4868 The selling price of assets not reported on the installment method is $111,500. Form 4868 This is 50. Form 4868 7% ($111,500 ÷ $220,000) of the total selling price. Form 4868 Multiply principal payments by 49. Form 4868 3% to determine the part of the payment for the installment sale. Form 4868 The balance, 50. Form 4868 7%, is for the part reported in the year of the sale. Form 4868 The gain on the sale of the inventory, machines, and truck is reported in full in the year of sale. Form 4868 When you receive principal payments in later years, no part of the payment for the sale of these assets is included in gross income. Form 4868 Only the part for the installment sale (49. Form 4868 3%) is used in the installment sale computation. Form 4868 The only payment received in 2013 is the down payment of $100,000. Form 4868 The part of the payment for the installment sale is $49,300 ($100,000 × 49. Form 4868 3%). Form 4868 This amount is used in the installment sale computation. Form 4868 Installment income for 2013. Form 4868   Your installment income for each asset is the gross profit percentage for that asset times $49,300, the installment income received in 2013. Form 4868 Income Land—22. Form 4868 95% of $49,300 $11,314 Building—8. Form 4868 85% of $49,300 4,363 Goodwill—16. Form 4868 2% of $49,300 7,987 Total installment income for 2013 $23,664 Installment income after 2013. Form 4868   You figure installment income for years after 2013 by applying the same gross profit percentages to 49. Form 4868 3% of the total payments you receive on the buyer's note during the year. Form 4868 Unstated Interest and Original Issue Discount (OID) An installment sale contract may provide that each deferred payment on the sale will include interest or that there will be an interest payment in addition to the principal payment. Form 4868 Interest provided in the contract is called stated interest. Form 4868 If an installment sale contract does not provide for adequate stated interest, part of the stated principal amount of the contract may be recharacterized as interest. Form 4868 If section 483 applies to the contract, this interest is called unstated interest. Form 4868 If section 1274 applies to the contract, this interest is called original issue discount (OID). Form 4868 An installment sale contract does not provide for adequate stated interest if the stated interest rate is lower than the test rate (defined later). Form 4868 Treatment of unstated interest and OID. Form 4868   Generally, if a buyer gives a debt in consideration for personal use property, the unstated interest rules do not apply. Form 4868 As a result, the buyer cannot deduct the unstated interest. Form 4868 The seller must report the unstated interest as income. Form 4868   Personal-use property is any property in which substantially all of its use by the buyer is not in connection with a trade or business or an investment activity. Form 4868   If the debt is subject to the section 483 rules and is also subject to the below-market loan rules, such as a gift loan, compensation-related loan, or corporation-shareholder loan, then both parties are subject to the below-market loan rules rather than the unstated interest rules. Form 4868 Rules for the seller. Form 4868   If either section 1274 or section 483 applies to the installment sale contract, you must treat part of the installment sale price as interest, even though interest is not called for in the sales agreement. Form 4868 If either section applies, you must reduce the stated selling price of the property and increase your interest income by this unstated interest. Form 4868   Include the unstated interest in income based on your regular method of accounting. Form 4868 Include OID in income over the term of the contract. Form 4868   The OID includible in income each year is based on the constant yield method described in section 1272. Form 4868 (In some cases, the OID on an installment sale contract also may include all or part of the stated interest, especially if the stated interest is not paid at least annually. Form 4868 )   If you do not use the installment method to report the sale, report the entire gain under your method of accounting in the year of sale. Form 4868 Reduce the selling price by any stated principal treated as interest to determine the gain. Form 4868   Report unstated interest or OID on your tax return, in addition to stated interest. Form 4868 Rules for the buyer. Form 4868   Any part of the stated selling price of an installment sale contract treated by the buyer as interest reduces the buyer's basis in the property and increases the buyer's interest expense. Form 4868 These rules do not apply to personal-use property (for example, property not used in a trade or business). Form 4868 Adequate stated interest. Form 4868   An installment sale contract generally provides for adequate stated interest if the contract's stated principal amount is at least equal to the sum of the present values of all principal and interest payments called for under the contract. Form 4868 The present value of a payment is determined based on the test rate of interest, defined next. Form 4868 (If section 483 applies to the contract, payments due within six months after the sale are taken into account at face value. Form 4868 ) In general, an installment sale contract provides for adequate stated interest if the stated interest rate (based on an appropriate compounding period) is at least equal to the test rate of interest. Form 4868 Test rate of interest. Form 4868   The test rate of interest for a contract is the 3-month rate. Form 4868 The 3-month rate is the lower of the following applicable federal rates (AFRs). Form 4868 The lowest AFR (based on the appropriate compounding period) in effect during the 3-month period ending with the first month in which there is a binding written contract that substantially provides the terms under which the sale or exchange is ultimately completed. Form 4868 The lowest AFR (based on the appropriate compounding period) in effect during the 3-month period ending with the month in which the sale or exchange occurs. Form 4868 Applicable federal rate (AFR). Form 4868   The AFR depends on the month the binding
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The Form 4868

Form 4868 Publication 587 - Main Content Table of Contents Qualifying for a DeductionExclusive Use Regular Use Trade or Business Use Principal Place of Business Place To Meet Patients, Clients, or Customers Separate Structure Figuring the DeductionUsing Actual Expenses Using the Simplified Method Daycare Facility Standard meal and snack rates. Form 4868 Sale or Exchange of Your HomeGain on Sale Depreciation Basis Adjustment Reporting the Sale More Information Business Furniture and EquipmentListed Property Property Bought for Business Use Personal Property Converted to Business Use Recordkeeping Where To DeductSelf-Employed Persons Employees Partners How To Get Tax HelpLow Income Taxpayer Clinics Worksheet To Figure the Deduction for Business Use of Your HomeInstructions for the Worksheet Worksheets To Figure the Deduction for Business Use of Your Home (Simplified Method) Instructions for the Simplified Method Worksheet Instructions for the Daycare Facility Worksheet Instructions for the Area Adjustment Worksheet Qualifying for a Deduction Generally, you cannot deduct items related to your home, such as mortgage interest, real estate taxes, utilities, maintenance, rent, depreciation, or property insurance, as business expenses. Form 4868 However, you may be able to deduct expenses related to the business use of part of your home if you meet specific requirements. Form 4868 Even then, the deductible amount of these types of expenses may be limited. Form 4868 Use this section and Figure A, later, to decide if you can deduct expenses for the business use of your home. Form 4868 To qualify to deduct expenses for business use of your home, you must use part of your home: Exclusively and regularly as your principal place of business (defined later), Exclusively and regularly as a place where you meet or deal with patients, clients, or customers in the normal course of your trade or business, In the case of a separate structure which is not attached to your home, in connection with your trade or business, On a regular basis for certain storage use (see Storage of inventory or product samples , later), For rental use (see Publication 527), or As a daycare facility (see Daycare Facility , later). Form 4868 Additional tests for employee use. Form 4868   If you are an employee and you use a part of your home for business, you may qualify for a deduction for its business use. Form 4868 You must meet the tests discussed earlier plus: Your business use must be for the convenience of your employer, and You must not rent any part of your home to your employer and use the rented portion to perform services as an employee for that employer. Form 4868 If the use of the home office is merely appropriate and helpful, you cannot deduct expenses for the business use of your home. Form 4868 Exclusive Use To qualify under the exclusive use test, you must use a specific area of your home only for your trade or business. Form 4868 The area used for business can be a room or other separately identifiable space. Form 4868 The space does not need to be marked off by a permanent partition. Form 4868 You do not meet the requirements of the exclusive use test if you use the area in question both for business and for personal purposes. Form 4868 Example. Form 4868 You are an attorney and use a den in your home to write legal briefs and prepare clients' tax returns. Form 4868 Your family also uses the den for recreation. Form 4868 The den is not used exclusively in your trade or business, so you cannot claim a deduction for the business use of the den. Form 4868 Exceptions to Exclusive Use You do not have to meet the exclusive use test if either of the following applies. Form 4868 You use part of your home for the storage of inventory or product samples (discussed next). Form 4868 You use part of your home as a daycare facility, discussed later under Daycare Facility . Form 4868 Note. Form 4868 With the exception of these two uses, any portion of the home used for business purposes must meet the exclusive use test. Form 4868 Storage of inventory or product samples. Form 4868    If you use part of your home for storage of inventory or product samples, you can deduct expenses for the business use of your home without meeting the exclusive use test. Form 4868 However, you must meet all the following tests. Form 4868 You sell products at wholesale or retail as your trade or business. Form 4868 You keep the inventory or product samples in your home for use in your trade or business. Form 4868 Your home is the only fixed location of your trade or business. Form 4868 You use the storage space on a regular basis. Form 4868 The space you use is a separately identifiable space suitable for storage. Form 4868 Example. Form 4868 Your home is the only fixed location of your business of selling mechanics' tools at retail. Form 4868 You regularly use half of your basement for storage of inventory and product samples. Form 4868 You sometimes use the area for personal purposes. Form 4868 The expenses for the storage space are deductible even though you do not use this part of your basement exclusively for business. Form 4868 Regular Use To qualify under the regular use test, you must use a specific area of your home for business on a regular basis. Form 4868 Incidental or occasional business use is not regular use. Form 4868 You must consider all facts and circumstances in determining whether your use is on a regular basis. Form 4868 Trade or Business Use To qualify under the trade-or-business-use test, you must use part of your home in connection with a trade or business. Form 4868 If you use your home for a profit-seeking activity that is not a trade or business, you cannot take a deduction for its business use. Form 4868 Example. Form 4868 You use part of your home exclusively and regularly to read financial periodicals and reports, clip bond coupons, and carry out similar activities related to your own investments. Form 4868 You do not make investments as a broker or dealer. Form 4868 So, your activities are not part of a trade or business and you cannot take a deduction for the business use of your home. Form 4868 Principal Place of Business You can have more than one business location, including your home, for a single trade or business. Form 4868 To qualify to deduct the expenses for the business use of your home under the principal place of business test, your home must be your principal place of business for that trade or business. Form 4868 To determine whether your home is your principal place of business, you must consider: The relative importance of the activities performed at each place where you conduct business, and The amount of time spent at each place where you conduct business. Form 4868 Your home office will qualify as your principal place of business if you meet the following requirements. Form 4868 You use it exclusively and regularly for administrative or management activities of your trade or business. Form 4868 You have no other fixed location where you conduct substantial administrative or management activities of your trade or business. Form 4868 If, after considering your business locations, your home cannot be identified as your principal place of business, you cannot deduct home office expenses. Form 4868 However, see the later discussions under Place To Meet Patients, Clients, or Customers and Separate Structure for other ways to qualify to deduct home office expenses. Form 4868 Administrative or management activities. Form 4868   There are many activities that are administrative or managerial in nature. Form 4868 The following are a few examples. Form 4868 Billing customers, clients, or patients. Form 4868 Keeping books and records. Form 4868 Ordering supplies. Form 4868 Setting up appointments. Form 4868 Forwarding orders or writing reports. Form 4868 Administrative or management activities performed at other locations. Form 4868   The following activities performed by you or others will not disqualify your home office from being your principal place of business. Form 4868 You have others conduct your administrative or management activities at locations other than your home. Form 4868 (For example, another company does your billing from its place of business. Form 4868 ) You conduct administrative or management activities at places that are not fixed locations of your business, such as in a car or a hotel room. Form 4868 You occasionally conduct minimal administrative or management activities at a fixed location outside your home. Form 4868 You conduct substantial nonadministrative or nonmanagement business activities at a fixed location outside your home. Form 4868 (For example, you meet with or provide services to customers, clients, or patients at a fixed location of the business outside your home. Form 4868 ) You have suitable space to conduct administrative or management activities outside your home, but choose to use your home office for those activities instead. Form 4868 Please click here for the text description of the image. Form 4868 Can you deduct business use of the home expenses? Example 1. Form 4868 John is a self-employed plumber. Form 4868 Most of John's time is spent at customers' homes and offices installing and repairing plumbing. Form 4868 He has a small office in his home that he uses exclusively and regularly for the administrative or management activities of his business, such as phoning customers, ordering supplies, and keeping his books. Form 4868 John writes up estimates and records of work completed at his customers' premises. Form 4868 He does not conduct any substantial administrative or management activities at any fixed location other than his home office. Form 4868 John does not do his own billing. Form 4868 He uses a local bookkeeping service to bill his customers. Form 4868 John's home office qualifies as his principal place of business for deducting expenses for its use. Form 4868 He uses the home office for the administrative or managerial activities of his plumbing business and he has no other fixed location where he conducts these administrative or managerial activities. Form 4868 His choice to have his billing done by another company does not disqualify his home office from being his principal place of business. Form 4868 He meets all the qualifications, including principal place of business, so he can deduct expenses (subject to certain limitations, explained later) for the business use of his home. Form 4868 Example 2. Form 4868 Pamela is a self-employed sales representative for several different product lines. Form 4868 She has an office in her home that she uses exclusively and regularly to set up appointments and write up orders and other reports for the companies whose products she sells. Form 4868 She occasionally writes up orders and sets up appointments from her hotel room when she is away on business overnight. Form 4868 Pamela's business is selling products to customers at various locations throughout her territory. Form 4868 To make these sales, she regularly visits customers to explain the available products and take orders. Form 4868 Pamela's home office qualifies as her principal place of business for deducting expenses for its use. Form 4868 She conducts administrative or management activities there and she has no other fixed location where she conducts substantial administrative or management activities. Form 4868 The fact that she conducts some administrative or management activities in her hotel room (not a fixed location) does not disqualify her home office from being her principal place of business. Form 4868 She meets all the qualifications, including principal place of business, so she can deduct expenses (subject to certain limitations, explained later) for the business use of her home. Form 4868 Example 3. Form 4868 Paul is a self-employed anesthesiologist. Form 4868 He spends the majority of his time administering anesthesia and postoperative care in three local hospitals. Form 4868 One of the hospitals provides him with a small shared office where he could conduct administrative or management activities. Form 4868 Paul very rarely uses the office the hospital provides. Form 4868 He uses a room in his home that he has converted to an office. Form 4868 He uses this room exclusively and regularly to conduct all the following activities. Form 4868 Contacting patients, surgeons, and hospitals regarding scheduling. Form 4868 Preparing for treatments and presentations. Form 4868 Maintaining billing records and patient logs. Form 4868 Satisfying continuing medical education requirements. Form 4868 Reading medical journals and books. Form 4868 Paul's home office qualifies as his principal place of business for deducting expenses for its use. Form 4868 He conducts administrative or management activities for his business as an anesthesiologist there and he has no other fixed location where he conducts substantial administrative or management activities for this business. Form 4868 His choice to use his home office instead of the one provided by the hospital does not disqualify his home office from being his principal place of business. Form 4868 His performance of substantial nonadministrative or nonmanagement activities at fixed locations outside his home also does not disqualify his home office from being his principal place of business. Form 4868 He meets all the qualifications, including principal place of business, so he can deduct expenses (subject to certain limitations, explained later) for the business use of his home. Form 4868 Example 4. Form 4868 Kathleen is employed as a teacher. Form 4868 She is required to teach and meet with students at the school and to grade papers and tests. Form 4868 The school provides her with a small office where she can work on her lesson plans, grade papers and tests, and meet with parents and students. Form 4868 The school does not require her to work at home. Form 4868 Kathleen prefers to use the office she has set up in her home and does not use the one provided by the school. Form 4868 She uses this home office exclusively and regularly for the administrative duties of her teaching job. Form 4868 Kathleen must meet the convenience-of-the-employer test, even if her home qualifies as her principal place of business for deducting expenses for its use. Form 4868 Her employer provides her with an office and does not require her to work at home, so she does not meet the convenience-of-the-employer test and cannot claim a deduction for the business use of her home. Form 4868 More Than One Trade or Business The same home office can be the principal place of business for two or more separate business activities. Form 4868 Whether your home office is the principal place of business for more than one business activity must be determined separately for each of your trade or business activities. Form 4868 You must use the home office exclusively and regularly for one or more of the following purposes. Form 4868 As the principal place of business for one or more of your trades or businesses. Form 4868 As a place to meet or deal with patients, clients, or customers in the normal course of one or more of your trades or businesses. Form 4868 If your home office is a separate structure, in connection with one or more of your trades or businesses. Form 4868 You can use your home office for more than one business activity, but you cannot use it for any nonbusiness (i. Form 4868 e. Form 4868 , personal) activities. Form 4868 If you are an employee, any use of the home office in connection with your employment must be for the convenience of your employer. Form 4868 See Rental to employer , later, if you rent part of your home to your employer. Form 4868 Example. Form 4868 Tracy White is employed as a teacher. Form 4868 Her principal place of work is the school, which provides her office space to do her school work. Form 4868 She also has a mail order jewelry business. Form 4868 All her work in the jewelry business is done in her home office and the office is used exclusively for that business. Form 4868 If she meets all the other tests, she can deduct expenses for the business use of her home for the jewelry business. Form 4868 If Tracy also uses the office for work related to her teaching, she must meet the exclusive use test for both businesses to qualify for the deduction. Form 4868 As an employee, Tracy must also meet the convenience-of-the-employer test to qualify for the deduction. Form 4868 She does not meet this test for her work as a teacher, so she cannot claim a deduction for the business use of her home for either activity. Form 4868 Place To Meet Patients, Clients, or Customers If you meet or deal with patients, clients, or customers in your home in the normal course of your business, even though you also carry on business at another location, you can deduct your expenses for the part of your home used exclusively and regularly for business if you meet both the following tests. Form 4868 You physically meet with patients, clients, or customers on your premises. Form 4868 Their use of your home is substantial and integral to the conduct of your business. Form 4868 Doctors, dentists, attorneys, and other professionals who maintain offices in their homes generally will meet this requirement. Form 4868 Using your home for occasional meetings and telephone calls will not qualify you to deduct expenses for the business use of your home. Form 4868 The part of your home you use exclusively and regularly to meet patients, clients, or customers does not have to be your principal place of business. Form 4868 Example. Form 4868 June Quill, a self-employed attorney, works 3 days a week in her city office. Form 4868 She works 2 days a week in her home office used only for business. Form 4868 She regularly meets clients there. Form 4868 Her home office qualifies for a business deduction because she meets clients there in the normal course of her business. Form 4868 Separate Structure You can deduct expenses for a separate free-standing structure, such as a studio, workshop, garage, or barn, if you use it exclusively and regularly for your business. Form 4868 The structure does not have to be your principal place of business or a place where you meet patients, clients, or customers. Form 4868 Example. Form 4868 John Berry operates a floral shop in town. Form 4868 He grows the plants for his shop in a greenhouse behind his home. Form 4868 He uses the greenhouse exclusively and regularly in his business, so he can deduct the expenses for its use, subject to certain limitations, explained later. Form 4868 Figuring the Deduction After you determine that you meet the tests under Qualifying for a Deduction , you can begin to figure how much you can deduct. Form 4868 When figuring the amount you can deduct for the business use of your home, you will use either your actual expenses or a simplified method. Form 4868 Electing to use the simplified method. Form 4868   The simplified method is an alternative to the calculation, allocation, and substantiation of actual expenses. Form 4868 You choose whether or not to figure your deduction using the simplified method each taxable year. Form 4868 See Using the Simplified Method , later. Form 4868 Rental to employer. Form 4868   If you rent part of your home to your employer and you use the rented part in performing services for your employer as an employee, your deduction for the business use of your home is limited. Form 4868 You can deduct mortgage interest, qualified mortgage insurance premiums, real estate taxes, and personal casualty losses for the rented part, subject to any limitations. Form 4868 However, you cannot deduct otherwise allowable trade or business expenses, business casualty losses, or depreciation related to the use of your home (or use the simplified method as an alternative to deducting these actual expenses) in performing services for your employer. Form 4868 Using Actual Expenses If you do not or cannot elect to use the simplified method for a home, you will figure your deduction for that home using your actual expenses. Form 4868 You will also need to figure the percentage of your home used for business and the limit on the deduction. Form 4868 If you are an employee or a partner, or you use your home in your farming business and you file Schedule F (Form 1040), you can use the Worksheet To Figure the Deduction for Business Use of Your Home, near the end of this publication, to help you figure your deduction. Form 4868 If you use your home in a trade or business and you file Schedule C (Form 1040), you will use Form 8829 to figure your deduction. Form 4868 Part-year use. Form 4868   You cannot deduct expenses for the business use of your home incurred during any part of the year you did not use your home for business purposes. Form 4868 For example, if you begin using part of your home for business on July 1, and you meet all the tests from that date until the end of the year, consider only your expenses for the last half of the year in figuring your allowable deduction. Form 4868 Expenses related to tax-exempt income. Form 4868   Generally, you cannot deduct expenses that are related to tax-exempt allowances. Form 4868 However, if you receive a tax-exempt parsonage allowance or a tax-exempt military allowance, your expenses for mortgage interest and real estate taxes are deductible under the normal rules. Form 4868 No deduction is allowed for other expenses related to the tax-exempt allowance. Form 4868   If your housing is provided free of charge and the value of the housing is tax exempt, you cannot deduct the rental value of any portion of the housing. Form 4868 Actual Expenses You must divide the expenses of operating your home between personal and business use. Form 4868 The part of a home operating expense you can use to figure your deduction depends on both of the following. Form 4868 Whether the expense is direct, indirect, or unrelated. Form 4868 The percentage of your home used for business. Form 4868 Table 1, next, describes the types of expenses you may have and the extent to which they are deductible. Form 4868 Table 1. Form 4868 Types of Expenses  Expense  Description  Deductibility Direct Expenses only for  the business part  of your home. Form 4868 Deductible in full. Form 4868 *   Examples:  Painting or repairs  only in the area  used for business. Form 4868 Exception: May be only partially  deductible in a daycare facility. Form 4868 See Daycare Facility , later. Form 4868 Indirect Expenses for  keeping up and running your  entire home. Form 4868 Deductible based on the percentage of your home used for business. Form 4868 *   Examples:  Insurance, utilities, and  general repairs. Form 4868   Unrelated Expenses only for  the parts of your  home not used  for business. Form 4868 Not deductible. Form 4868   Examples:  Lawn care or painting  a room not used  for business. Form 4868   *Subject to the deduction limit, discussed later. Form 4868 Form 8829 and the Worksheet To Figure the Deduction for Business Use of Your Home have separate columns for direct and indirect expenses. Form 4868 Certain expenses are deductible whether or not you use your home for business. Form 4868 If you qualify to deduct business use of the home expenses, use the business percentage of these expenses to figure your total business use of the home deduction. Form 4868 These expenses include the following. Form 4868 Real estate taxes. Form 4868 Qualified mortgage insurance premiums. Form 4868 Deductible mortgage interest. Form 4868 Casualty losses. Form 4868 Other expenses are deductible only if you use your home for business. Form 4868 You can use the business percentage of these expenses to figure your total business use of the home deduction. Form 4868 These expenses generally include (but are not limited to) the following. Form 4868 Depreciation (covered under Depreciating Your Home , later). Form 4868 Insurance. Form 4868 Rent paid for the use of property you do not own but use in your trade or business. Form 4868 Repairs. Form 4868 Security system. Form 4868 Utilities and services. Form 4868 Real estate taxes. Form 4868   To figure the business part of your real estate taxes, multiply the real estate taxes paid by the percentage of your home used for business. Form 4868   For more information on the deduction for real estate taxes, see Publication 530, Tax Information for Homeowners. Form 4868 Deductible mortgage interest. Form 4868   To figure the business part of your deductible mortgage interest, multiply this interest by the percentage of your home used for business. Form 4868 You can include interest on a second mortgage in this computation. Form 4868 If your total mortgage debt is more than $1,000,000 or your home equity debt is more than $100,000, your deduction may be limited. Form 4868 For more information on what interest is deductible, see Publication 936, Home Mortgage Interest Deduction. Form 4868 Qualified mortgage insurance premiums. Form 4868   To figure the business part of your qualified mortgage insurance premiums, multiply the premiums by the percentage of your home used for business. Form 4868 You can include premiums for insurance on a second mortgage in this computation. Form 4868 If your adjusted gross income is more than $100,000 ($50,000 if your filing status is married filing separately), your deduction may be limited. Form 4868 For more information, see Publication 936, and Line 13 in the Instructions for Schedule A (Form 1040). Form 4868 Casualty losses. Form 4868    If you have a casualty loss on your home that you use for business, treat the casualty loss as a direct expense, an indirect expense, or an unrelated expense, depending on the property affected. Form 4868 A direct expense is the loss on the portion of the property you use only in your business. Form 4868 Use the entire loss to figure the business use of the home deduction. Form 4868 An indirect expense is the loss on property you use for both business and personal purposes. Form 4868 Use only the business portion to figure the deduction. Form 4868 An unrelated expense is the loss on property you do not use in your business. Form 4868 Do not use any of the loss to figure the deduction. Form 4868 Example. Form 4868 You meet the rules to take a deduction for an office in your home that is 10% of the total area of your house. Form 4868 A storm damages your roof. Form 4868 This is an indirect expense as the roof is part of the whole house and is considered to be used both for business and personal purposes. Form 4868 You would complete Form 4684, Casualties and Thefts, to report your loss. Form 4868 You complete both section A (Personal Use Property) and section B (Business and Income-Producing Property) as your home is used both for business and personal purposes. Form 4868 Since you use 90% of your home for personal purposes, use 90% of the cost or adjusted basis of your home, insurance or other reimbursement, and fair market value, both before and after the storm, to figure the amounts to enter on lines 2, 3, 5, and 6 of Form 4684. Form 4868 Since you use 10% of your home for business purposes, use 10% of the cost or adjusted basis of your home, insurance or other reimbursement, and fair market value, both before and after the storm, to figure the amounts to enter on lines 20, 21, 23, and 24 of Form 4684. Form 4868 Forms and worksheets to use. Form 4868   If you are filing Schedule C (Form 1040), get Form 8829 and follow the instructions for casualty losses. Form 4868 If you are an employee or a partner, or you file Schedule F (Form 1040), use the Worksheet To Figure the Deduction for Business Use of Your Home, near the end of this publication. Form 4868 You will also need to get Form 4684. Form 4868 More information. Form 4868   For more information on casualty losses, see Publication 547, Casualties, Disasters, and Thefts. Form 4868 Insurance. Form 4868   You can deduct the cost of insurance that covers the business part of your home. Form 4868 However, if your insurance premium gives you coverage for a period that extends past the end of your tax year, you can deduct only the business percentage of the part of the premium that gives you coverage for your tax year. Form 4868 You can deduct the business percentage of the part that applies to the following year in that year. Form 4868 Rent. Form 4868   If you rent the home you occupy and meet the requirements for business use of the home, you can deduct part of the rent you pay. Form 4868 To figure your deduction, multiply your rent payments by the percentage of your home used for business. Form 4868   If you own your home, you cannot deduct the fair rental value of your home. Form 4868 However, see Depreciating Your Home , later. Form 4868 Repairs. Form 4868   The cost of repairs that relate to your business, including labor (other than your own labor), is a deductible expense. Form 4868 For example, a furnace repair benefits the entire home. Form 4868 If you use 10% of your home for business, you can deduct 10% of the cost of the furnace repair. Form 4868   Repairs keep your home in good working order over its useful life. Form 4868 Examples of common repairs are patching walls and floors, painting, wallpapering, repairing roofs and gutters, and mending leaks. Form 4868 However, repairs are sometimes treated as a permanent improvement and are not deductible. Form 4868 See Permanent improvements , later, under Depreciating Your Home. Form 4868 Security system. Form 4868   If you install a security system that protects all the doors and windows in your home, you can deduct the business part of the expenses you incur to maintain and monitor the system. Form 4868 You also can take a depreciation deduction for the part of the cost of the security system relating to the business use of your home. Form 4868 Utilities and services. Form 4868   Expenses for utilities and services, such as electricity, gas, trash removal, and cleaning services, are primarily personal expenses. Form 4868 However, if you use part of your home for business, you can deduct the business part of these expenses. Form 4868 Generally, the business percentage for utilities is the same as the percentage of your home used for business. Form 4868 Telephone. Form 4868   The basic local telephone service charge, including taxes, for the first telephone line into your home (i. Form 4868 e. Form 4868 , landline) is a nondeductible personal expense. Form 4868 However, charges for business long-distance phone calls on that line, as well as the cost of a second line into your home used exclusively for business, are deductible business expenses. Form 4868 Do not include these expenses as a cost of using your home for business. Form 4868 Deduct these charges separately on the appropriate form or schedule. Form 4868 For example, if you file Schedule C (Form 1040), deduct these expenses on line 25, Utilities (instead of line 30, Expenses for business use of your home). Form 4868 Depreciating Your Home If you own your home and qualify to deduct expenses for its business use, you can claim a deduction for depreciation. Form 4868 Depreciation is an allowance for the wear and tear on the part of your home used for business. Form 4868 You cannot depreciate the cost or value of the land. Form 4868 You recover its cost when you sell or otherwise dispose of the property. Form 4868 Before you figure your depreciation deduction, you need to know the following information. Form 4868 The month and year you started using your home for business. Form 4868 The adjusted basis and fair market value of your home (excluding land) at the time you began using it for business. Form 4868 The cost of any improvements before and after you began using the property for business. Form 4868 The percentage of your home used for business. Form 4868 See Business Percentage , later. Form 4868 Adjusted basis defined. Form 4868   The adjusted basis of your home is generally its cost, plus the cost of any permanent improvements you made to it, minus any casualty losses or depreciation deducted in earlier tax years. Form 4868 For a discussion of adjusted basis, see Publication 551. Form 4868 Permanent improvements. Form 4868   A permanent improvement increases the value of property, adds to its life, or gives it a new or different use. Form 4868 Examples of improvements are replacing electric wiring or plumbing, adding a new roof or addition, paneling, or remodeling. Form 4868    You must carefully distinguish between repairs and improvements. Form 4868 See Repairs , earlier, under Actual Expenses. Form 4868 You also must keep accurate records of these expenses. Form 4868 These records will help you decide whether an expense is a deductible or a capital (added to the basis) expense. Form 4868 However, if you make repairs as part of an extensive remodeling or restoration of your home, the entire job is an improvement. Form 4868 Example. Form 4868 You buy an older home and fix up two rooms as a beauty salon. Form 4868 You patch the plaster on the ceilings and walls, paint, repair the floor, install an outside door, and install new wiring, plumbing, and other equipment. Form 4868 Normally, the patching, painting, and floor work are repairs and the other expenses are permanent improvements. Form 4868 However, because the work gives your property a new use, the entire remodeling job is a permanent improvement and its cost is added to the basis of the property. Form 4868 You cannot deduct any portion of it as a repair expense. Form 4868 Adjusting for depreciation deducted in earlier years. Form 4868   Decrease the basis of your property by the depreciation you deducted, or could have deducted, on your tax returns under the method of depreciation you properly selected. Form 4868 If you deducted less depreciation than you could have under the method you selected, decrease the basis by the amount you could have deducted under that method. Form 4868 If you did not deduct any depreciation, decrease the basis by the amount you could have deducted. Form 4868   If you deducted more depreciation than you should have, decrease your basis by the amount you should have deducted, plus the part of the excess depreciation you deducted that actually decreased your tax liability for any year. Form 4868   If you deducted the incorrect amount of depreciation, see Publication 946. Form 4868 Fair market value defined. Form 4868   The fair market value of your home is the price at which the property would change hands between a buyer and a seller, neither having to buy or sell, and both having reasonable knowledge of all necessary facts. Form 4868 Sales of similar property, on or about the date you begin using your home for business, may be helpful in determining the property's fair market value. Form 4868 Figuring the depreciation deduction for the current year. Form 4868   If you began using your home for business before 2013, continue to use the same depreciation method you used in past tax years. Form 4868   If you began using your home for business for the first time in 2013, depreciate the business part as nonresidential real property under the modified accelerated cost recovery system (MACRS). Form 4868 Under MACRS, nonresidential real property is depreciated using the straight line method over 39 years. Form 4868 For more information on MACRS and other methods of depreciation, see Publication 946. Form 4868   To figure the depreciation deduction, you must first figure the part of the cost of your home that can be depreciated (depreciable basis). Form 4868 The depreciable basis is figured by multiplying the percentage of your home used for business by the smaller of the following. Form 4868 The adjusted basis of your home (excluding land) on the date you began using your home for business. Form 4868 The fair market value of your home (excluding land) on the date you began using your home for business. Form 4868 Depreciation table. Form 4868   If 2013 was the first year you used your home for business, you can figure your 2013 depreciation for the business part of your home by using the appropriate percentage from the following table. Form 4868 Table 2. Form 4868 MACRS Percentage Table for 39-Year Nonresidential Real Property Month First Used for Business Percentage To Use 1 2. Form 4868 461% 2 2. Form 4868 247% 3 2. Form 4868 033% 4 1. Form 4868 819% 5 1. Form 4868 605% 6 1. Form 4868 391% 7 1. Form 4868 177% 8 0. Form 4868 963% 9 0. Form 4868 749% 10 0. Form 4868 535% 11 0. Form 4868 321% 12 0. Form 4868 107%   Multiply the depreciable basis of the business part of your home by the percentage from the table for the first month you use your home for business. Form 4868 See Publication 946 for the percentages for the remaining tax years of the recovery period. Form 4868 Example. Form 4868 In May, George Miller began to use one room in his home exclusively and regularly to meet clients. Form 4868 This room is 8% of the square footage of his home. Form 4868 He bought the home in 2003 for $125,000. Form 4868 He determined from his property tax records that his adjusted basis in the house (exclusive of land) is $115,000. Form 4868 In May, the house had a fair market value of $165,000. Form 4868 He multiplies his adjusted basis of $115,000 (which is less than the fair market value) by 8%. Form 4868 The result is $9,200, his depreciable basis for the business part of the house. Form 4868 George files his return based on the calendar year. Form 4868 May is the 5th month of his tax year. Form 4868 He multiplies his depreciable basis of $9,200 by 1. Form 4868 605% (. Form 4868 01605), the percentage from the table for the 5th month. Form 4868 His depreciation deduction is $147. Form 4868 66. Form 4868 Depreciating permanent improvements. Form 4868   Add the costs of permanent improvements made before you began using your home for business to the basis of your property. Form 4868 Depreciate these costs as part of the cost of your home as explained earlier. Form 4868 The costs of improvements made after you begin using your home for business (that affect the business part of your home, such as a new roof) are depreciated separately. Form 4868 Multiply the cost of the improvement by the business-use percentage and depreciate the result over the recovery period that would apply to your home if you began using it for business at the same time as the improvement. Form 4868 For improvements made this year, the recovery period is 39 years. Form 4868 For the percentage to use for the first year, see Table 2, earlier. Form 4868 For more information on recovery periods, see Publication 946. Form 4868 Business Percentage To find the business percentage, compare the size of the part of your home that you use for business to your whole house. Form 4868 Use the resulting percentage to figure the business part of the expenses for operating your entire home. Form 4868 You can use any reasonable method to determine the business percentage. Form 4868 The following are two commonly used methods for figuring the percentage. Form 4868 Divide the area (length multiplied by the width) used for business by the total area of your home. Form 4868 If the rooms in your home are all about the same size, you can divide the number of rooms used for business by the total number of rooms in your home. Form 4868 Example 1. Form 4868 Your office is 240 square feet (12 feet × 20 feet). Form 4868 Your home is 1,200 square feet. Form 4868 Your office is 20% (240 ÷ 1,200) of the total area of your home. Form 4868 Your business percentage is 20%. Form 4868 Example 2. Form 4868 You use one room in your home for business. Form 4868 Your home has 10 rooms, all about equal size. Form 4868 Your office is 10% (1 ÷ 10) of the total area of your home. Form 4868 Your business percentage is 10%. Form 4868 Use lines 1-7 of Form 8829, or lines 1-3 on the Worksheet To Figure the Deduction for Business Use of Your Home (near the end of this publication) to figure your business percentage. Form 4868 Deduction Limit If your gross income from the business use of your home equals or exceeds your total business expenses (including depreciation), you can deduct all your business expenses related to the use of your home. Form 4868 If your gross income from the business use of your home is less than your total business expenses, your deduction for certain expenses for the business use of your home is limited. Form 4868 Your deduction of otherwise nondeductible expenses, such as insurance, utilities, and depreciation of your home (with depreciation of your home taken last), that are allocable to the business, is limited to the gross income from the business use of your home minus the sum of the following. Form 4868 The business part of expenses you could deduct even if you did not use your home for business (such as mortgage interest, real estate taxes, and casualty and theft losses that are allowable as itemized deductions on Schedule A (Form 1040)). Form 4868 These expenses are discussed in detail under Actual Expenses , earlier. Form 4868 The business expenses that relate to the business activity in the home (for example, business phone, supplies, and depreciation on equipment), but not to the use of the home itself. Form 4868 If you are self-employed, do not include in (2) above your deduction for one-half of your self-employment tax. Form 4868 Carryover of unallowed expenses. Form 4868   If your deductions are greater than the current year's limit, you can carry over the excess to the next year in which you use actual expenses. Form 4868 They are subject to the deduction limit for that year, whether or not you live in the same home during that year. Form 4868 Figuring the deduction limit and carryover. Form 4868   If you are an employee or a partner, or you file Schedule F (Form 1040), use the Worksheet To Figure the Deduction for Business Use of Your Home, near the end of this publication. Form 4868 If you file Schedule C (Form 1040), figure your deduction limit and carryover on Form 8829. Form 4868 Example. Form 4868 You meet the requirements for deducting expenses for the business use of your home. Form 4868 You use 20% of your home for business. Form 4868 In 2013, your business expenses and the expenses for the business use of your home are deducted from your gross income in the following order. Form 4868    Gross income from business $6,000 Minus:   Deductible mortgage interest and real estate taxes (20%) 3,000 Business expenses not related to the use of your home (100%) (business phone, supplies, and depreciation on equipment) 2,000 Deduction limit $1,000 Minus other expenses allocable to business use of home:   Maintenance, insurance, and utilities (20%) 800 Depreciation allowed (20% = $1,600 allowable, but subject to balance of deduction limit) 200 Other expenses up to the deduction limit $1,000 Depreciation carryover to 2014 ($1,600 − $200) (subject to deduction limit in 2014) $1,400   You can deduct all of the business part of your deductible mortgage interest and real estate taxes ($3,000). Form 4868 You also can deduct all of your business expenses not related to the use of your home ($2,000). Form 4868 Additionally, you can deduct all of the business part of your expenses for maintenance, insurance, and utilities, because the total ($800) is less than the $1,000 deduction limit. Form 4868 Your deduction for depreciation for the business use of your home is limited to $200 ($1,000 minus $800) because of the deduction limit. Form 4868 You can carry over the $1,400 balance and add it to your depreciation for 2014, subject to your deduction limit in 2014. Form 4868 More than one place of business. Form 4868   If part of the gross income from your trade or business is from the business use of part of your home and part is from a place other than your home, you must determine the part of your gross income from the business use of your home before you figure the deduction limit. Form 4868 In making this determination, consider the time you spend at each location, the business investment in each location, and any other relevant facts and circumstances. Form 4868 If your home office qualifies as your principal place of business, you can deduct your daily transportation costs between your home and another work location in the same trade or business. Form 4868 For more information on transportation costs, see Publication 463, Travel, Entertainment, Gift, and Car Expenses. Form 4868 Using the Simplified Method The simplified method is an alternative to the calculation, allocation, and substantiation of actual expenses. Form 4868 In most cases, you will figure your deduction by multiplying $5, the prescribed rate, by the area of your home used for a qualified business use. Form 4868 The area you use to figure your deduction is limited to 300 square feet. Form 4868 See Simplified Amount , later, for information about figuring the amount of the deduction. Form 4868 For more information about the simplified method, see Revenue Procedure 2013-13, 2013-06 I. Form 4868 R. Form 4868 B. Form 4868 478, available at www. Form 4868 irs. Form 4868 gov/irb/2013-06_IRB/ar09. Form 4868 html. Form 4868 Actual expenses and depreciation of your home. Form 4868   If you elect to use the simplified method, you cannot deduct any actual expenses for the business except for business expenses that are not related to the use of the home. Form 4868 You also cannot deduct any depreciation (including any additional first-year depreciation) or section 179 expense for the portion of the home that is used for a qualified business use. Form 4868 The depreciation deduction allowable for that portion of the home is deemed to be zero for a year you use the simplified method. Form 4868 If you figure your deduction for business use of the home using actual expenses in a subsequent year, you will have to use the appropriate optional depreciation table for MACRS to figure your depreciation. Form 4868 More information. Form 4868   For more information about claiming depreciation in a subsequent year, see Revenue Procedure 2013-13, 2013-06 I. Form 4868 R. Form 4868 B. Form 4868 478, available at www. Form 4868 irs. Form 4868 gov/irb/2013-06_IRB/ar09. Form 4868 html. Form 4868 See Publication 946 for the optional depreciation tables Although you cannot deduct any depreciation or section 179 expense for the portion of your home used for a qualified business use, you may still claim depreciation or the section 179 expense deduction on other assets used in the business (for example, furniture and equipment). Form 4868 Expenses deductible without regard to business use. Form 4868   When using the simplified method, treat as personal expenses those business expenses related to the use of the home that are deductible without regard to whether there is a qualified business use of the home. Form 4868 These expenses include mortgage interest, real estate taxes, and casualty losses, subject to any limitations. Form 4868 See Where To Deduct , later. Form 4868 If you also rent part of your home, you must still allocate these expenses between rental use and personal use (for this purpose, personal use includes business use reported using the simplified method). Form 4868 No deduction of carryover of actual expenses. Form 4868   If you used actual expenses to figure your deduction for business use of the home in a prior year and your deduction was limited, you cannot deduct the disallowed amount carried over from the prior year during a year you figure your deduction using the simplified method. Form 4868 Instead, you will continue to carry over the disallowed amount to the next year that you use actual expenses to figure your deduction. Form 4868 Electing the Simplified Method You choose whether or not to figure your deduction using the simplified method each taxable year. Form 4868 Make the election for a home by using the simplified method to figure the deduction for the qualified business use of that home on a timely filed, original federal income tax return. Form 4868 An election for a taxable year, once made, is irrevocable. Form 4868 A change from using the simplified method in one year to actual expenses in a succeeding taxable year, or vice-versa, is not a change in method of accounting and does not require the consent of the Commissioner. Form 4868 Shared use. Form 4868   If you share your home with someone else who also uses the home in a business that qualifies for this deduction, each of you make your own election. Form 4868 More than one qualified business use. Form 4868   If you conduct more than one business that qualifies for this deduction in your home, your election to use the simplified method applies to all your qualified business uses of that home. Form 4868 More than one home. Form 4868   If you used more than one home during the year (for example, you moved during the year), you can elect to use the simplified method for only one of the homes. Form 4868 You must figure the deduction for any other home using actual expenses. Form 4868 Simplified Amount Your deduction for the qualified business use of a home is the sum of each amount you figure for a separate qualified business use of your home. Form 4868 To figure your deduction for the business use of a home using the simplified method, you will need to know the following information for each qualified business use of the home. Form 4868 The allowable area of your home used in conducting the business. Form 4868 If you did not conduct the business for the entire year in the home or the area changed during the year, you will need to know the allowable area you used and the number of days you conducted the business for each month. Form 4868 The gross income from the business use of your home. Form 4868 The amount of the business expenses that are not related to the use of your home. Form 4868 If the qualified business use is for a daycare facility that uses space in your home on a regular (but not exclusive) basis, you will also need to know the percentage of time that part of your home is used for daycare. Form 4868 To figure the amount you can deduct for qualified business use of your home using the simplified method, follow these 3 steps. Form 4868 Multiply the allowable area by $5 (or less than $5 if the qualified business use is for a daycare that uses space in your home on a regular, but not exclusive, basis). Form 4868 See Allowable area and Space used regularly for daycare , later. Form 4868 Subtract the expenses from the business that are not related to the use of the home from the gross income related to the business use of the home. Form 4868 If these expenses are greater than the gross income from the business use of the home, then you cannot take a deduction for this business use of the home. Form 4868 See Gross income limitation , later. Form 4868 Take the smaller of the amounts from (1) and (2). Form 4868 This is the amount you can deduct for this qualified business use of your home using the simplified method. Form 4868 If you are an employee or a partner, or you use your home in your farming business and file Schedule F (Form 1040), you can use the Simplified Method Worksheet, near the end of this publication, to help you figure your deduction. Form 4868 If you use your home in a trade or business and you file Schedule C (Form 1040), you will use the Simplified Method Worksheet in your Instructions for Schedule C to figure your deduction. Form 4868 Allowable area. Form 4868   In most cases, the allowable area is the smaller of the actual area (in square feet) of your home used in conducting the business and 300 square feet. Form 4868 Your allowable area may be smaller if you conducted the business as a qualified joint venture with your spouse, the area used by the business was shared with another qualified business use, you used the home for the business for only part of the year, or the area used by the business changed during the year. Form 4868 You can use the Area Adjustment Worksheet (for simplified method), near the end of this publication, to help you figure your allowable area for a qualified business use. Form 4868 Area used by a qualified joint venture. Form 4868   If the qualified business use of the home is also a qualified joint venture, you and your spouse will figure the deduction for the business use separately. Form 4868 Split the actual area used in conducting business between you and your spouse in the same manner you split your other tax attributes. Form 4868 Then, each spouse will figure the allowable area separately. Form 4868 For more information about qualified joint ventures, see Qualified Joint Venture in the Instructions for Schedule C. Form 4868 Shared use. Form 4868   If you share your home with someone else who uses the home to conduct business that also qualifies for this deduction, you may not include the same square feet to figure your deduction as the other person. Form 4868 You must allocate the shared space between you and the other person in a reasonable manner. Form 4868 Example. Form 4868 Kristin and Lindsey are roommates. Form 4868 Kristin uses 300 square feet of their home for a qualified business use. Form 4868 Lindsey uses 200 square feet of their home for a separate qualified business use. Form 4868 The qualified business uses share 100 square feet. Form 4868 In addition to the portion that they do not share, Kristin and Lindsey can both claim 50 of the 100 square feet or divide the 100 square feet between them in any reasonable manner. Form 4868 If divided evenly, Kristin could claim 250 square feet using the simplified method and Lindsey could claim 150 square feet. Form 4868 More than one qualified business use. Form 4868   If you conduct more than one business qualifying for the deduction, you are limited to a maximum of 300 square feet for all of the businesses. Form 4868 Allocate the actual square footage used (up to the maximum of 300 square feet) among your qualified business uses in a reasonable manner. Form 4868 However, do not allocate more square feet to a qualified business use than you actually use for that business. Form 4868 Rental use. Form 4868   The simplified method does not apply to rental use. Form 4868 A rental use that qualifies for the deduction must be figured using actual expenses. Form 4868 If the rental use and a qualified business use share the same area, you will have to allocate the actual area used between the two uses. Form 4868 You cannot use the same area to figure a deduction for the qualified business use as you are using to figure the deduction for the rental use. Form 4868 Part-year use or area changes. Form 4868   If your qualified business use was for a portion of the taxable year (for example, a seasonal business or a business that begins during the taxable year) or you changed the square footage of your qualified business use, your deduction is limited to the average monthly allowable square footage. Form 4868 You calculate the average monthly allowable square footage by adding the amount of allowable square feet you used in each month and dividing the sum by 12. Form 4868 When determining the average monthly allowable square footage, you cannot take more than 300 square feet into account for any one month. Form 4868 Additionally, if your qualified business use was less than 15 days in a month, you must use -0- for that month. Form 4868 Example 1. Form 4868 Andy files his federal income tax return on a calendar year basis. Form 4868 On July 20, he began using 420 square feet of his home for a qualified business use. Form 4868 He continued to use the 420 square feet until the end of the year. Form 4868 His average monthly allowable square footage is 125 square feet, which is figured using 300 square feet for each month August through December divided by the number of months in the taxable year ((0 + 0 + 0 + 0 + 0 + 0 + 0 + 300 + 300 + 300 + 300 + 300)/12). Form 4868 Example 2. Form 4868 Amy files her federal income tax return on a calendar year basis. Form 4868 On April 20, she began using 100 square feet of her home for a qualified business use. Form 4868 On August 5, she expanded the area of her qualified use to 330 square feet. Form 4868 Amy continued to use the 330 square feet until the end of the year. Form 4868 Her average monthly allowable square footage is 150 square feet, which is figured using 100 square feet for May through July and 300 square feet for August through December divided by the number of months in the taxable year ((0 + 0 + 0 + 0 + 100 + 100 +100 + 300 + 300 + 300 + 300 + 300)/12). Form 4868 Gross income limitation. Form 4868   Your deduction for business use of the home is limited to an amount equal to the gross income derived from the qualified business use of the home reduced by the business deductions that are unrelated to the use of your home. Form 4868 If the business deductions that are unrelated to the use of your home are greater than the gross income derived from the qualified business use of your home, then you cannot take a deduction for this qualified business use of your home. Form 4868 Business expenses not related to use of the home. Form 4868   These expenses relate to the business activity in the home, but not to the use of the home itself. Form 4868 You can still deduct business expenses that are unrelated to the use of the home. Form 4868 See Where To Deduct , later. Form 4868 Examples of business expenses that are unrelated to the use of the home are advertising, wages, supplies, dues, and depreciation for equipment. Form 4868 Space used regularly for daycare. Form 4868   If you do not use the area of your home exclusively for daycare, you must reduce the prescribed rate (maximum $5 per square foot) before figuring your deduction. Form 4868 The reduced rate will equal the prescribed rate times a fraction. Form 4868 The numerator of the fraction is the number of hours that the space was used during the year for daycare and the denominator is the total number of hours during the year that the space was available for all uses. Form 4868 You can use the Daycare Facility Worksheet (for simplified method), near the end of this publication, to help you figure the reduced rate. Form 4868    If you used at least 300 square feet for daycare regularly and exclusively during the year, then you do not need to reduce the prescribed rate or complete the Daycare Facility Worksheet. Form 4868 Daycare Facility If you use space in your home on a regular basis for providing daycare, you may be able to claim a deduction for that part of your home even if you use the same space for nonbusiness purposes. Form 4868 To qualify for this exception to the exclusive use rule, you must meet both of the following requirements. Form 4868 You must be in the trade or business of providing daycare for children, persons age 65 or older, or persons who are physically or mentally unable to care for themselves. Form 4868 You must have applied for, been granted, or be exempt from having, a license, certification, registration, or approval as a daycare center or as a family or group daycare home under state law. Form 4868 You do not meet this requirement if your application was rejected or your license or other authorization was revoked. Form 4868 Figuring the deduction. Form 4868   If you elect to use the simplified method for your home, figure your deduction as described earlier in Using the Simplified Method under Figuring the Deduction. Form 4868    If you are figuring your deduction using actual expenses and you regularly use part of your home for daycare, figure what part is used for daycare, as explained in Business Percentage , earlier, under Figuring the Deduction. Form 4868 If you also use that part exclusively for daycare, deduct all the allocable expenses, subject to the deduction limit, as explained earlier. Form 4868   If the use of part of your home as a daycare facility is regular, but not exclusive, you must figure the percentage of time that part of your home is used for daycare. Form 4868 A room that is available for use throughout each business day and that you regularly use in your business is considered to be used for daycare throughout each business day. Form 4868 You do not have to keep records to show the specific hours the area was used for business. Form 4868 You can use the area occasionally for personal reasons. Form 4868 However, a room you use only occasionally for business does not qualify for the deduction. Form 4868 To find the percentage of time you actually use your home for business, compare the total time used for business to the total time that part of your home can be used for all purposes. Form 4868 You can compare the hours of business use in a week with the number of hours in a week (168). Form 4868 Or you can compare the hours of business use for the year with the number of hours in the year (8,760 in 2013). Form 4868 If you started or stopped using your home for daycare in 2013, you must prorate the number of hours based on the number of days the home was available for daycare. Form 4868 Example 1. Form 4868 Mary Lake used her basement to operate a daycare business for children. Form 4868 She figures the business percentage of the basement as follows. Form 4868 Square footage of the basement Square footage of her home = 1,600 3,200 = 50%           She used the basement for daycare an average of 12 hours a day, 5 days a week, for 50 weeks a year. Form 4868 During the other 12 hours a day, the family could use the basement. Form 4868 She figures the percentage of time the basement was used for daycare as follows. Form 4868 Number of hours used for daycare (12 x 5 x 50) Total number of hours in the year (24 x 365) = 3,000 8,760 = 34. Form 4868 25%           Mary can deduct 34. Form 4868 25% of any direct expenses for the basement. Form 4868 However, because her indirect expenses are for the entire house, she can deduct only 17. Form 4868 13% of the indirect expenses. Form 4868 She figures the percentage for her indirect expenses as follows. Form 4868 Business percentage of the basement 50% Multiplied by: Percentage of time used for daycare × 34. Form 4868 25% Percentage for indirect expenses 17. Form 4868 13% Mary completes Form 8829, Part I, figuring the percentage of her home used for business, including the percentage of time the basement was used. Form 4868 In Part II, Mary figures her deductible expenses. Form 4868 She uses the following information to complete Part II. Form 4868 Gross income from her daycare business $50,000 Expenses not related to the business use of the home $25,000 Tentative profit $25,000 Rent $8,400 Utilities $850 Painting the basement $500 Mary enters her tentative profit, $25,000, on line 8. Form 4868 (This figure is the same as the amount on line 29 of her Schedule C (Form 1040). Form 4868 ) The expenses she paid for rent and utilities relate to her entire home. Form 4868 Therefore, she enters the amount paid for rent on line 18, column (b), and the amount paid for utilities on line 20, column (b). Form 4868 She shows the total of these expenses on line 22, column (b). Form 4868 For line 23, she multiplies the amount on line 22, column (b) by the percentage on line 7 and enters the result, $1,585. Form 4868 Mary paid $500 to have the basement painted. Form 4868 The painting is a direct expense. Form 4868 However, because she did not use the basement exclusively for daycare, she must multiply $500 by the percentage of time the basement was used for daycare (34. Form 4868 25% – line 6). Form 4868 She enters $171 (34. Form 4868 25% × $500) on line 19, column (a). Form 4868 She adds line 22, column (a), and line 23 and enters $1,756 ($171 + $1,585) on line 25. Form 4868 This is less than her deduction limit (line 15), so she can deduct the entire amount. Form 4868 She follows the instructions to complete the rest of Part II and enters $1,756 on lines 33 and 35. Form 4868 She then carries the $1,756 to line 30 of her Schedule C (Form 1040). Form 4868 Example 2. Form 4868 Assume the same facts as in Example 1 except that Mary also has another room that was available each business day for children to take naps in. Form 4868 Although she did not keep a record of the number of hours the room was actually used for naps, it was used for part of each business day. Form 4868 Since the room was available for business use during regular operating hours each business day and was used regularly in the business, it is considered used for daycare throughout each business day. Form 4868 The basement and room are 60% of the total area of her home. Form 4868 In figuring her expenses, 34. Form 4868 25% of any direct expenses for the basement and room are deductible. Form 4868 In addition, 20. Form 4868 55% (34. Form 4868 25% × 60%) of her indirect expenses are deductible. Form 4868 Example 3. Form 4868 Assume the same facts as in Example 1 except that Mary stopped using her home for a daycare facility on June 24, 2013. Form 4868 She used the basement for daycare an average of 12 hours a day, 5 days a week, but for only 25 weeks of the year. Form 4868 During the other 12 hours a day, the family could still use the basement. Form 4868 She figures the percentage of time the basement was used for business as follows. Form 4868 Number of hours used for daycare (12 x 5 x 25) Total number of hours during period used (24 x 175) = 1,500 4,200 = 35. Form 4868 71%           Mary can deduct 35. Form 4868 71% of any direct expenses for the basement. Form 4868 However, because her indirect expenses are for the entire house, she can deduct only 17. Form 4868 86% of the indirect expenses. Form 4868 She figures the percentage for her indirect expenses as follows. Form 4868 Business percentage of the basement 50% Multiplied by: Percentage of time used for daycare × 35. Form 4868 71% Percentage for indirect expenses 17. Form 4868 86% Meals. Form 4868   If you provide food for your daycare recipients, do not include the expense as a cost of using your home for business. Form 4868 Claim it as a separate deduction on your Schedule C (Form 1040). Form 4868 You can never deduct the cost of food consumed by you or your family. Form 4868 You can deduct as a business expense 100% of the actual cost of food consumed by your daycare recipients (see Standard meal and snack rates , later, for an optional method for eligible children) and generally only 50% of the cost of food consumed by your employees. Form 4868 However, you can deduct 100% of the cost of food consumed by your employees if its value can be excluded from their wages as a de minimis fringe benefit. Form 4868 For more information on meals that meet these requirements, see Meals in chapter 2 of Publication 15-B, Employer's Tax Guide to Fringe Benefits. Form 4868   If you deduct the actual cost of food for your daycare business, keep a separate record (with receipts) of your family's food costs. Form 4868   Reimbursements you receive from a sponsor under the Child and Adult Care Food Program of the Department of Agriculture are taxable only to the extent they exceed your expenses for food for eligible children. Form 4868 If your reimbursements are more than your expenses for food, show the difference as income in Part I of Schedule C (Form 1040). Form 4868 If your food expenses are greater than the reimbursements, show the difference as an expense in Part V of Schedule C (Form 1040). Form 4868 Do not include payments or expenses for your own children if they are eligible for the program. Form 4868 Follow this procedure even if you receive a Form 1099-MISC, Miscellaneous Income, reporting a payment from the sponsor. Form 4868 Standard meal and snack rates. Form 4868   If you qualify as a family daycare provider, you can use the standard meal and snack rates, instead of actual costs, to compute the deductible cost of meals and snacks provided to eligible children. Form 4868 For these purposes: A family daycare provider is a person engaged in the business of providing family daycare. Form 4868 Family daycare is childcare provided to eligible children in the home of the family daycare provider. Form 4868 The care must be non-medical, not involve a transfer of legal custody, and generally last less than 24 hours each day. Form 4868 Eligible children are minor children receiving family daycare in the home of the family daycare provider. Form 4868 Eligible children do not include children who are full-time or part-time residents in the home where the childcare is provided or children whose parents or guardians are residents of the same home. Form 4868 Eligible children do not include children who receive daycare services for personal reasons of the provider. Form 4868 For example, if a provider provides daycare services for a relative as a favor to that relative, that child is not an eligible child. Form 4868   You can compute the deductible cost of each meal and snack you actually purchased and served to an eligible child during the time period you provided family daycare using the standard meal and snack rates shown in Table 3, later. Form 4868 You can use the standard meal and snack rates for a maximum of one breakfast, one lunch, one dinner, and three snacks per eligible child per day. Form 4868 If you receive reimbursement for a particular meal or snack, you can deduct only the portion of the applicable standard meal or snack rate that is more than the amount of the reimbursement. Form 4868   You can use either the standard meal and snack rates or actual costs to calculate the deductible cost of food provided to eligible children in the family daycare for any particular tax year. Form 4868 If you choose to use the standard meal and snack rates for a particular tax year, you must use the rates for all your deductible food costs for eligible children during that tax year. Form 4868 However, if you use the standard meal and snack rates in any tax year, you can use actual costs to compute the deductible cost of food in any other tax year. Form 4868   If you use the standard meal and snack rates, you must maintain records to substantiate the computation of the total amount deducted for the cost of food provided to eligible children. Form 4868 The records kept should include the name of each child, dates and hours of attendance in the daycare, and the type and quantity of meals and snacks served. Form 4868 This information can be recorded in a log similar to the one shown in Exhibit A, near the end of this publication. Form 4868   The standard meal and snack rates include beverages, but do not include non-food supplies used for food preparation, service, or storage, such as containers, paper products, or utensils. Form 4868 These expenses can be claimed as a separate deduction on your Schedule C (Form 1040). Form 4868     Table 3. Form 4868 Standard Meal and Snack Rates1 Location of Family Daycare Provider Breakfast Lunch Dinner Snack States other than Alaska an