Bloggers, digital nomads, side hustlers, and business owners have more opportunities for tax savings than the average employee. One of my favorites is the ability to turn stuff you already have or were going to buy anyway into beautiful tax deductions through depreciation.
Have an extra room in your house? Write it off. That computer you once used for Facebook but now use to write blog posts and manage investments? Write it off. The smartphone you use to populate your Instagram feed? Write it off. The new SLR camera and lenses you plan to use to share details of the nomadic lifestyle? Write ’em off!
There is nothing better than having Uncle Sam help pay for the stuff you need for your business.
Naturally this ability to write it all off is a superpower that is rife for abuse, so the IRS has a whole mess of rules to follow. But as with all rules, there are always ways to optimize to your advantage. In this post I walk through the opportunities, gotchas, and strategies for depreciation write-offs using some common side hustle tools and equipment.
Depreciation for Side Hustlers
To “write it off” simply means to deduct expenses from taxable business income. Small items such as the pen and notebook I use to make notes have a short lifespan and can be expensed, meaning to write off their whole value at the time of purchase.
Tangible items with longer life span (computers, desks, cameras) must be capitalized and depreciated, meaning to write off the expense over time as its value is reduced due to wear, tear, and obsolescence. Because a computer or desk provides value over many years, and can be sold to recover some cost, we can only write off a portion of its worth each year.
The IRS provides a 114 page rule book that outlines the method and madness for calculating depreciation, called Modified Accelerated Cost Recovery System (MACRS). Underneath are two subsystems, the GDS (General Depreciation System) and the ADS (Alternative Depreciation System.)
Who reads this crap? Well… me :$. And in my mind, this is the most overly-complex / nuanced / stupid part of the whole tax code. So let me simplify it. (Part of simplification is this post does not apply to automobiles or real estate.)
To calculate depreciation you really only need to know 3 things:
- Cost / basis (lower of purchase price & fair market value)
- Asset class per IRS (from a Table)
- Date item was placed in service (1 of 3 Conventions)
An example will provide clarity:
On August 1st, we start a new blog. Yeah! We use a laptop we bought last year for $2,000, and plan to use it 60% for blogging, 20% for managing our investments, and 20% for personal use. (Hot tip, as long as the laptop is used at least 50% for business, you can depreciate time spent managing your personal investments, an “income seeking activity.”)
From Ebay and Craigslist we deduce that the fair market value is $1,250. Our depreciable basis in the laptop is thus $1,000 (80% * $1,250, personal use is not deductible.)
From the IRS asset class table we learn a laptop has a 5-year recovery period. We also learn that a default Half-Year convention applies (more on convention later.)
We can choose the method of deprecation (math here) based on our tax goals, either a Declining Balance or a Straight Line method. A DB method results in greater write-offs in the early years ($200 in Year 1 vs $100 for Straight Line.) This chart shows the possible depreciation. The numbers comes directly from another IRS provided Table, and TurboTax does all of this for you.
In Year 6, the book value is $0. Our laptop has been fully depreciated.
But wait, there is more…
The rule that a capital asset must be depreciated has two exceptions, the Section 179 Deduction and Special Depreciation (aka Special D.)
Section 179 Deduction
The Section 179 Deduction allows a complete deduction of the cost of purchasing tangible items, as long as the item is used at least 50% for business purposes.
Buying a $5,000 camera for 80% business use? You can deduct $4,000 (80% of $5k) of that purchase today. Write it off!
There are limits to total Section 179 Deductions, but most people won’t have issues (Max: $500k)
Special D allows a substantial depreciation allowance in the year an item is placed in service, currently 50%. (This is reduced to 40% in 2018, 30% in 2019, and 0% in 2020 and beyond.)
To qualify for Special Depreciation an item must be purchased NEW by you (“original use.”) An used camera from Craigslist is not eligible, but converting your old camera to business use is.
Buying a $5,000 camera for 80% business use? You can deduct $2,000 (80% of $5k x 50%) of that purchase today. Write it off!
The Section 179 Deduction, Special Depreciation, and normal MACRS Depreciation can all be used together / combined to create powerful tax optimization opportunities.
This chart shows a few different options available to us for a $1000 desk. Office Furniture has a 7-year recovery period. In Year 1 we can choose to write off anywhere from ~$100 to $1,000, depending on our tax needs and goals.
A $1,000 deduction at the 15% Federal marginal rate will reduce the tax bill by ~$300 (15% Federal, ~15% Self Employment.)
With something this powerful, it behooves us to plan in advance.
If at anytime during the recovery period we dispose of a capital asset, we must recapture any deprecation up to the point of depreciation previously allowed or allowable.
That is a mouth full. But all it means is that if we sell something for a price different than current book value, we may have to pay back (recapture) some of the depreciation.
Again, an example makes it clear:
We bought a $1,000 camera 100% for business use, and in July of the 4th year of use we sold the camera (7 year recovery period) to a stranger on Craigslist for $312.40.
If the sale price is different than the book price we have an ordinary gain or loss. The book value will be different depending on if we claimed a Section 179 deduction, Special Depreciation, or normal MACRS depreciation (or all 3.) It also depends on which depreciation method we used (1 of 4.)
If we expensed the camera entirely using a 100% Section 179 deduction, our book value is zero (the Green line.) We must recapture the entire sales price of $312.40 as ordinary income.
If we used normal 200DB/HY depreciation (Blue line), our book value and sales price are the same ($312.40.) We have no gain or loss.
If we used Straight Line depreciation (Red line), our book value is $500. We have an ordinary loss of $187.60 ($500 – $312.40.)
In all of these situations, the amount of depreciation / write-off is exactly the same. The only different is the timing. (For another good example, and more on Listed Property, see thismatter.com.)
So recapture isn’t that big of a deal, it is just something to be aware of and plan for… but in some cases it can become a big deal.
Recapture of Listed Property
Listed property (aka mixed-use) property is anything that has both personal and business use. Two examples are Computers and Cameras (but also cars.)
Because depreciation is such a powerful tool for tax avoidance, there is a tendency to overstate the amount of business use or to claim personal use items as business use. So the IRS has strict rules for Listed Property. (Special warning: Document with ridiculous level of detail the amount of usage on these items for business & personal use.)
If at any time the business use of listed property is less than 50%, immediate recapture is required, and in an almost punitive form: we must use straight line recovery under the ADS (Alternative Depreciation System.)
Expanding on the Camera example from above:
We bought a $1,000 camera 100% for business use, and in July of the 4th year of don’t travel much so our business camera use drops to 40%. This is cause for immediate recapture under the ADS system. GDS can only be used for property used at least 50% for business.
Under GDS, a camera is a 7-year property. Under ADS, the recovery period is 12 years. Twelve. And while we could use accelerated depreciation options under GDS, now we have only straight line.
Since we drop to 40% business use in the 4th year, we can claim 3 years of straight line depreciation at 100%. This is a total of $208.33. If we had used a 100% Section 179 deduction, we now add $791.67 to income for the year ($1k – $208.33.)
For the current / 4th year (and subsequent years), we can still claim straight line depreciation of $33.33 ($1k * 40% * 1/12.)
This table highlights some of the other recovery period differences for other common side hustle usage.
|Item||Asset class||Recovery period (GDS)||Recovery period (ADS)|
|Laptop & peripherals||00.12, Information Systems||5||5|
|Printer||00.13, Data Handling Equipment||5||6|
|Desk||00.11, Office Furniture||7||10|
|Camera, lens, flash||Personal Property With No Class Life||7||12|
Digital Nomads and Travelers
Now that we’ve seen the ADS subsystem at work, there is another major gotcha.
The GDS subsystem which allows Section 179 expensing, Super D, and accelerated depreciation is only allowed for items used in the United States. Any items predominantly used outside the United States (defined as more than 50% of days in tax year) must use ADS, unless you are drilling for oil in the Arctic or another obscure exception. (Isn’t lobbying great?)
So if you are in the US and buy a $1,000 camera for business use, you can immediately write off 100%. If you are like me, you can write off $41.70. (Super lame! Seriously, we need a Digital Nomad lobby group.)
Year End Shopping
The default for personal items is a Half Year Convention (only 1/2 year of depreciation is allowed in first year.)
But if at least 40% of total depreciable property is placed in service in Q4, then the first year deduction is reduced. In other words, if you buy a lot of stuff at the end of the year the normal MACRS write-offs will be smaller. And this applies to ALL property of the same recovery period.
A 5-year property like a laptop with 200DB/HY depreciation would get a 20% depreciation allowance, but under 200DB/Q4MQ the allowance is only 5%.
Section 179 deductions and Special Depreciation are still fully allowed.
Now that we have a handle on depreciation, how can we use these tools for maximum goodness?
Besides being able to turn stuff we already own and business things we were going to buy anyway into tax deductions, depreciation allows us to time shift our income.
Because some of these ideas represent buying and selling of assets, I should caution not to let the tax tail wag the dog. Don’t buy or sell something just because of the tax benefits. But be aware of the benefits if you are going to buy or sell an asset because that is what makes business sense.
Time Shift Income
Because we can choose depreciation methods under GDS, we have some control over the timing and amount of depreciation in any given year.
Maybe we expect next year’s income to be significantly higher. In which case, we can:
- Choose a slower depreciation schedule (e.g. Straight Line)
- Buy assets on Jan 1 next year and expense (Section 179)
- Sell assets that have a Fair Market Value above book value this year (gain is ordinary income)
If income next year is expected to be lower, we can:
- Choose a faster depreciation schedule (e.g. Declining Balance)
- Expense assets (Section 179)
- Take bonus depreciation (Special D)
- Sell assets with a Fair Market Value below book value this year (ordinary loss)
At a minimum, this time shift in income can be thought of as a 0% interest loan from Uncle Sam. Best case, we can reduce our average effective tax rate.
Special Depreciation has an amazing feature.
You can deduct any amount of bonus depreciation, and if the deduction creates a net operating loss (NOL), you can carry that amount back to offset previous year’s income and also carry any unused loss forward to deduct against future income.
This can be especially powerful for financially independent types who are transitioning from a high income career to a lower income side hustle. Why not carryback a NOL to an earlier tax return with a high marginal rate?
Section 179 Deductions
With Section 179 deductions, the total deduction may not exceed the net taxable income from all businesses you actively conduct.
Examples include your blog and your day job. (Don’t have a blog? Start one!) Yes, wages from a job are consider a “business you actively conduct” for the purpose of figuring your taxable income limitation. This makes Section 179 deductions a good tool to use while still working but side hustle income is low.
Converting to Personal Use
We saw in a camera example above that converting an asset to personal use requires immediate recapture. Because this can generate ordinary income, it can make sense to align this with a low income year.
Even after a business item becomes a personal item, it still retains book value in the business. When you eventually dispose (sell, recycle) that item, that generates a potential loss for the business. Be sure to document and claim that loss (perhaps at a time of high business income… But note, if you sell to a relative, you lose the ability to claim the loss.)
Other Tax Optimization
Bloggers, side hustlers, digital nomads, and business owners have the ability to deduct the cost of their tools of the trade from their taxable income.
The numerous rules and options provide the ability to time shift income and expenses. Worst case, we get a 0% interest loan from Uncle Sam. Best case, we get a reduced effective tax rate.
Overall, through depreciation we can take stuff we already own or were going to buy anyway and turn them into tax deductions for our business. Write it off! Write it all off!
NOTE: I’m just a random guy on the Internet who has no idea what he is doing. Tax laws change periodically, and you should consult with a tax professional for the most up-to-date advice. The information contained in this article is not intended as tax advice, is not a substitute for tax advice, and could just be wrong :).
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