Basic Categories of Tax Deductions
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How much you can deduct and when you can take the deduction depend on the type of expense. Below are the four basic categories of deductions. Rules for specific types of operating expenses, capital asset deductions, and treatment of inventory costs are also discussed in more detail later in this section.
Operating expenses. Once your eBay business is operating — that is, you are making sales — you can deduct your day-to-day operating expenses. These might include expenses for storage rental, office supplies, shipping costs, employee salaries, travel, professional services, advertising, interest on business loans or purchases, and other expenses incurred in operating your business. As long as you aren’t paying for something that you will use for more than a year (and you'll see that this restriction has many exceptions), you can deduct these expenses in the year you spend the money. The IRS has created special rules for operating expenses that it believes are often overstated or abused — home office, travel, vehicle, and entertainment expenses — and these are covered in more detail below.
Capital expenses. You can deduct the cost of items for your business that have a useful life of more than one year, such as a car, furniture, or machinery. You usually have the choice of either depreciating an asset’s cost (deducting a portion of the cost for each year of its useful life, the length of which is determined by the IRS) or deducting its cost all at once. See Capital Assets: Deducting the Costs of Long-Term Assets, below, for more information.
Inventory expenses. You can deduct the cost of inventory that you sell on eBay, but there are special tax rules for inventory that is not sold each year. This is why so many businesses are desperate to get rid of their inventory at the end of the year: They want to take a larger deduction, and they want to minimize their burden when it comes time to count inventory for tax purposes. We'll discuss inventory deductions in more detail later in this section.
Start-up expenses. Money that you spend before you start selling on eBay — for example, when buying computers, researching what kind of eBay business to start, or conferring with your accountant — are start-up expenses. When it comes to dealing with these expenses, you can either:
Treat them as part of your basis in the business. “Basis” is the amount of money you have invested in your business, which has not been treated as a tax deduction. If you were to sell your business, the basis would be subtracted from the sale price to determine your capital gain or loss. If you treat a start-up expense as part of basis, you cannot deduct that expense from income.
Deduct them over time. If all of your start-up expenses were incurred after October 23, 2004, you may deduct up to $5,000 of them right away. If you do so, you must then deduct the remainder of the expenses over the first 180 months you are in business. A different rule applies to start-up costs incurred before October 24, 2004: None are deductible right away. Instead, all must be spread equally over the first 60 months you are in business.
If you have already incurred start-up costs, you’ll have to follow the rules laid out above. If you are just starting to do so, and you don’t anticipate spending more than $5,000 on start-up expenses, you can simply deduct all of those expenses in the year they are incurred. However, if you believe you will spend more than $5,000 in start-up costs, there are ways to avoid spreading out part of your deduction over the next 15 years. The key is to start your business before you lay out significant amounts of money; that way, your expenses are usually immediately deductible. Your business is considered to start operating once you make items available for sale. For example, postpone major purchases until you’re up and running. Once you start selling on eBay, you can buy that fancy computer system and office furniture, or shell out thousands of dollars for advertising.