By: Nikolajs Gaikis
I want to pay more taxes . . . said no entrepreneur ever! Paying taxes is an unavoidable part of entrepreneurship. After all, the Internal Revenue Service (”IRS”) is essentially a partner in your business. Unlike your actual partners, you would like to pay the IRS as little as possible. Fortunately, an easy legal solution exists! 
Most entrepreneurs start their businesses using their personal property, like their cars, homes, or office furniture. These entrepreneurs may be eligible for depreciation deductions that lower their businesses’ taxable income over many years. This blog post will explain what property conversion is and depreciation deductions are, how to convert your property, how to determine the fair market value of your converted property, and how to determine depreciation deduction eligibility.
What is Conversion and Depreciation?
Conversion is the process in which a taxpayer changes the tax classification of their property from personal use to business use or vice versa. After converting your property to business use, a taxpayer may claim various deductions, if they meet certain requirements. Deductions reduce a taxpayer’s taxable income.
Depreciation deductions are a type of deduction that spreads the cost of your property purchase over time by lowering your taxable income. With depreciation, a taxpayer deducts a set amount of the property’s total cost each year until their deductions equal their cost.
Converting Your Personal Property to Business Use
Converting property from personal use to business use requires two steps. First, your property must be a capital asset. Capital assets are property for which the normal utility is longer than one year. Second, your use of the property must be motivated by profit. That’s it, your property is converted! Taxpayers may also partially convert their property to business use. A common example is a taxpayer’s partial use of their home for business.
Let’s focus on homes for a bit. Generally, a taxpayer must use part of their home (which includes separate structures) exclusively and regularly as their principal place of their trade or business. Alternatively, a taxpayer 
must use part of their home exclusively and regularly as a place to meet and deal with clients in the normal course of their trade or business. Meeting either of these requirements can convert a part of your home to business use.
Determining the Fair Market Value of Your Property at Conversion
Once an entrepreneur converts their property to business use, they must determine the property’s value at the time of conversion. The IRS requires the entrepreneur to estimate in good faith the fair market value (“FMV”) of their property at the time of conversion. You could easily estimate the FMV of a car by searching on appraisal websites, like Kelly Blue Book. However, if you’re converting your fancy office chair or something unique, a good-faith FMV estimate will suffice.
For your home, you could use Zillow to estimate its FMV. Next, determine the square footage (“SQFT”) for both your home and the room(s) you are using for business. Divide the room(s)’s SQFT by the SQFT of the home. Next, multiply that number by your home’s FMV.
$100,000 Zillow FMV of your home.
100 SQFT business room ÷ 1000 SQFT home = 0.1
0.1 x $100,000 = $10,000
$10,000 is the FMV of the business room. You may be eligible to depreciate this.
Determining Whether Your Business Property is Eligible for Depreciation
Great, now you’ve converted your property to business use. Determining whether your property is depreciable is the fun part where you pay less tax!
First, you must identify whether the property is a capital asset. Remember, capital assets are property for which the useful life is longer than one year. Second, you must use your capital property in your trade or business. This step should be easy because if you are following this blog, you have already begun exclusively using your property for your business. Finally, your property must wear and tear. Broadly speaking, anything you physically use as an entrepreneur wears and tears, including buildings.
Determining the exact depreciation deduction for your taxes is complicated. It merits its own blog post. Luckily, the IRS had already created a helpful step-by-step guide. When determining your exact depreciation deduction, a tax professional can be very helpful.
Other Important Things to Note
Entrepreneurs that take advantage of property conversion and depreciation deductions should keep careful records. First, you should document the FMV of the property at the time you converted it. Furthermore, you should always record the time when you abandoned the personal use of your property. 
Along this same vein, entrepreneurs should never use their converted property for personal use. If you are audited, your failure to comply with depreciation requirements or maintain records could result in the IRS demanding back tax payments, interest, and penalties on the income you deducted.
If your business is organized as anything other than a sole proprietorship, you may need to officially transfer the title of the converted property over to your business. This is because you own the property and your LLC, partnership, or corporation doesn’t unless it holds the title. This is the case even if you are the sole member of an LLC or the sole owner of a corporation.
Finally, perhaps you previously converted your property to business use and you failed to claim depreciation deductions. The IRS allows taxpayers to amend their returns for refunds for up to three prior taxable years. You better get on it!
Take Away for Entrepreneurs
Converting personal property to business use and claiming depreciation deductions is an awesome way to lower your taxable income without expense purchases for your new business. Remember, you must follow all the rules. Hiring a tax professional is always a good idea. Good luck, and happy depreciating!
Sources
See 26 C.F.R. § 1.168(i)-4 (2021).
https://www.inc.com/jana-kasperkevic/us-entrepreneurs-keep-businesses-close-to-home.html https://www.irs.gov/taxtopics/tc509
https://www.irs.gov/publications/p946
https://www.irs.gov/taxtopics/tc704
https://www.irs.gov/filing/amended-return-frequently-asked-questions
Images
https://pixabay.com/photos/house-architecture-front-yard-1836070/
https://pixabay.com/photos/tax-forms-income-business-468440/
https://pixabay.com/photos/dollars-currency-money-us-dollars-499481/
https://pixabay.com/photos/journal-write-blank-pages-notes-2850091/
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Hi Nikolajs,
At first glance I thought your blog was aimed at more sophisticated business owners, but you have really simplified the topic for almost anyone to follow along! I think your blog will be really helpful for new business owners, and your caution regarding transferring title and the 3-year grace period is helpful to even existing business owners. The Zillow example was a nice touch!
I could not figure out from your blog alone if conversion requires some type of filing, or if you’re good to go based on business use alone. However, I understand that the word limit is a constraint, and readers should be consulting a tax professional anyways, like you recommend.
Overall, I enjoyed reading your blog. It has just the right tone and flow for small business owners.
-Pranita
This is a beneficial topic. I enjoyed reading your post and believe entrepreneurs will find it very relevant. Many people don’t understand taxes, especially since most businesses are small home businesses. This topic will be beneficial in easing a lot of anxiety relating to cost and expense. Great Job.
Nikolajs,
I really enjoyed reading your post!
Your friendly tone and simplified explanations made a difficult subject such as tax much more approachable for the average person. I appreciated your use of an umbrella paragraph at the beginning as it was helpful to know what the post would be discussing. Another thing I liked was how you broke down the topics into digestible sections. It made the post very easy to follow. The example you provided also helped solidify the material in my mind.
Overall, great job!
Abbie Britton