Converting hobby to business tax question
I converted my home based hobby to an official business this past year. My question is how do I account for the tools and inventory that I already had? I make quilts, custom drapes, and other items. For example I brought my sewing machine from home to the business. Fabrics, threads, scissors etc. I know what do do with what I have acquired since, like my long arm machine, but not sure how to include what I already had.
If you use property in your business that was used previously for personal purposes, you cannot take a section 179 deduction for the property. You also cannot take a special depreciation allowance for the property. You can depreciate it, however. The method of depreciation you use depends on when you first used the property for personal purposes.
If you began using the property for personal purposes after 1986 and change it to business use in 2016, depreciate the property under modified accelerated cost recovery system (MACRS). You can find the MACRS tables using a search engin
The basis for depreciation of property changed from personal to business use is the lesser of the following.
- The adjusted basis of the property on the date of change.
- The fair market value of the property on the date of change.
Here is an example. You bought a sewing machine in 2015 for $1,000 and converted it to business use on January 1, 2016. Let's assume the sewing machine is 5 year property for MACRS (I didn't check; there is also 7 year property). The MACRS deduction in 2015 using the half year convention would be 20% ($200) so your adjusted basis in the sewing machine on 1-1-2016 was $800. If a used sewing machine like yours had a fair market value of at least $800, then your depreciable basis for the property in your business would $800. If the fair market value of the used sewing machine was less than $800 on 1-1-2016, then you would need to use the fair market value as the basis for computing your depreciation.
A similar rule would apply to consumables like thread except there is no adjustment for depreciation in the value of inventory. Contributing thread that you purchased for $100 and had a value of at least $100 would be included in your inventory at cost. If the fair market value had dropped, then the thread would be included in your inventory at the lower fair market value. As you incorporate the thread and fabric into finished products, the character changes from raw material inventory to finished goods inventory but there is no change from a tax standpoint. When you sell the products, you deduct the "cost" of the inventory (the lower of actual cost or fair market value at the time it was contributed to the business).
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