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method. If you use the optional method, you cannot depreciate the portion of your home used in a trade or business. Business expenses unrelated to the home, such as advertising, supplies, and wages paid to employees, are still fully deductible. All of the requirements discussed earlier under Business use of your home still apply. For more information on the deduction for business use of your home, including the op- tional safe harbor method, see Pub. 587. If you were entitled to deduct deprecia- tion on the part of your home used for business, you cannot exclude the part of the gain from the sale of your home that equals any depreciation you deducted (or could have deducted) for periods after May 6, 1997. Business use of your car. If you use your car exclusively in your business, you can deduct car expenses. If you use your car for both busi- ness and personal purposes, you must divide your expenses based on actual mileage. Gen- erally, commuting expenses between your home and your business location, within the area of your tax home, are not deductible. You can deduct actual car expenses, which include depreciation (or lease payments), gas and oil, tires, repairs, tune-ups, insurance, and registration fees. Or, instead of figuring the business part of these actual expenses, you may be able to use the standard mileage rate to figure your deduction. For 2018, the standard mileage rate is 54.5 cents per mile. Beginning in 2019, the standard mileage rate increases to 58 cents per mile. If you are self-employed, you can also de- duct the business part of interest on your car loan, state and local personal property tax on the car, parking fees, and tolls, whether or not you claim the standard mileage rate. For more information on car expenses and the rules for using the standard mileage rate, see Pub. 463. How Much Can I Deduct? Generally, you can deduct the full amount of a business expense if it meets the criteria of ordi- nary and necessary and it is not a capital ex- pense. Recovery of amount deducted (tax benefit rule). If you recover part of an expense in the same tax year in which you would have claimed a deduction, reduce your current year expense by the amount of the recovery. If you have a re- covery in a later year, include the recovered amount in income in that year. However, if part of the deduction for the expense did not reduce your tax, you do not have to include that part of the recovered amount in income. For more information on recoveries and the tax benefit rule, see Pub. 525. Payments in kind. If you provide services to pay a business expense, the amount you can deduct is limited to your out-of-pocket costs. You cannot deduct the cost of your own labor. CAUTION ! Similarly, if you pay a business expense in goods or other property, you can deduct only what the property costs you. If these costs are included in the cost of goods sold, do not de- duct them again as a business expense. Limits on losses. If your deductions for an in- vestment or business activity are more than the income it brings in, you have a loss. There may be limits on how much of the loss you can de- duct. Not-for-profit limits. If you carry on your business activity without the intention of making a profit, you cannot use a loss from it to offset other income. For more information, see Not-for-Profit Activities, later. At-risk limits. Generally, a deductible loss from a trade or business or other income-pro- ducing activity is limited to the investment you have “at risk” in the activity. You are at risk in any activity for the following. 1. The money and adjusted basis of property you contribute to the activity. 2. Amounts you borrow for use in the activity if: a. You are personally liable for repay- ment, or b. You pledge property (other than prop- erty used in the activity) as security for the loan. For more information, see Pub. 925. Passive activities. Generally, you are in a passive activity if you have a trade or business activity in which you do not materially partici- pate, or a rental activity. In general, deductions for losses from passive activities only offset in- come from passive activities. You cannot use any excess deductions to offset other income. In addition, passive activity credits can only off- set the tax on net passive income. Any excess loss or credits are carried over to later years. Suspended passive losses are fully deductible in the year you completely dispose of the activ- ity. For more information, see Pub. 925. Net operating loss (NOL). If your deduc- tions are more than your income for the year, you may have an NOL. You can use an NOL to lower your taxes in other years. See Pub. 536 for more information. See Pub. 542 for information about NOLs of corporations. When Can I Deduct an Expense? When you can deduct an expense depends on your accounting method. An accounting method is a set of rules used to determine when and how income and expenses are reported. The two basic methods are the cash method and the accrual method. Whichever method you choose must clearly reflect income. For more information on accounting meth- ods, see Pub. 538. Cash method. Under the cash method of ac- counting, you generally deduct business expen- ses in the tax year you pay them. Accrual method. Under an accrual method of accounting, you generally deduct business ex- penses when both of the following apply. 1. The all-events test has been met. The test is met when: a. All events have occurred that fix the fact of liability, and b. The liability can be determined with reasonable accuracy. 2. Economic performance has occurred. Economic performance. You generally cannot deduct or capitalize a business expense until economic performance occurs. If your ex- pense is for property or services provided to you, or for your use of property, economic per- formance occurs as the property or services are provided, or the property is used. If your ex- pense is for property or services you provide to others, economic performance occurs as you provide the property or services. Example. Your tax year is the calendar year. In December 2018, the Field Plumbing Company did some repair work at your place of business and sent you a bill for $600. You paid it by check in January 2019. If you use the ac- crual method of accounting, deduct the $600 on your tax return for 2018 because all events have occurred to “fix” the fact of liability (in this case, the work was completed), the liability can be determined, and economic performance oc- curred in that year. If you use the cash method of accounting, deduct the expense on your 2019 tax return. Prepayment. You generally cannot deduct ex- penses in advance, even if you pay them in ad- vance. This applies to prepaid interest, prepaid insurance premiums, and any other prepaid ex- pense that creates an intangible asset. If you pay an amount that creates an intangible asset, then you must capitalize the amounts paid and begin to amortize the payment over the appro- priate period. However, you do not have to capitalize amounts for creating an intangible asset if the right or benefit created does not extend beyond the earlier of 12 months after the date that you first receive the right or benefit or the end of the tax year following the year in which you made the advance payment. If you are a cash method taxpayer and your advance payment qualifies for this exception, then you can generally de- duct the amount when paid. If you are an ac- crual method taxpayer, you cannot deduct the amount until the all-events test has been met and economic performance has occurred. Example 1. In 2018, you sign a 10-year lease and immediately pay your rent for the first 3 years. Even though you paid the rent for 2018, 2019, and 2020, you can only deduct the rent for 2018 on your 2018 tax return. You can deduct the rent for 2019 and 2020 on your tax returns for those years. Page 6 Chapter 1 Deducting Business Expenses