Special business deductions, depreciation, and losses

Special deductions

Self-employed health insurance deduction is available to self-employed taxpayers with a net profit for the year (and to more-than-2% S-corporation shareholders), limited to the taxpayer’s earned income from the business under which the plan is established (for a self-employed taxpayer, net profit from that business minus the deductible part of self-employment tax and any self-employed SEP, SIMPLE, or qualified plan contributions attributable to it; wages from the S corporation for a more-than-2% shareholder). The deduction isn’t allowed for any month the taxpayer was eligible to participate in a subsidized health plan maintained by an employer of the taxpayer or the spouse (including as the employee’s spouse), or by the employer of a dependent or of a child under age 27 at the end of the year, even if the taxpayer didn’t enroll. It’s claimed as an adjustment to income on Part II, Schedule 1, and transferred to page 1 of Form 1040.

The office-in-home expense deduction is available to both homeowners and renters. The space must be used regularly and exclusively for business. See IRS Publication 587: Business Use of Your Home for details. Businesses can use either the simplified method ($5 per square foot of the business-use space, up to a maximum of 300 square feet) or the regular method (actual home expenses multiplied by the percentage of the home’s total square footage used for business). Deductible expenses include mortgage interest, insurance, utilities, repairs, maintenance, depreciation and rent (renting part of your home to your employer does not create a home office deduction). Click on link to see Form 8829.

The qualified business income (QBI) deduction is for small-business owners or self-employed taxpayers, pass-through entities such as S-corporations and partners in a partnership, to deduct up to 20% of your qualified trade or business income (QBI) from your taxes. Reported on Form 1040, line 13a. Income earned through a C corporation (which pays its own tax, with dividends taxed again to its shareholders) or as an employee isn’t QBI, so a C corporation shareholder or a W-2 employee can’t claim the deduction on it. For 2025, the deduction for income from a specified service trade or business begins to phase out once taxable income exceeds $197,300 (single filers) or $394,600 (married filing jointly), and is fully phased out at $247,300 and $494,600, respectively. See IRC §199A guidance for more details.

Definitions

Pass-through entity

A business structure in which the entity’s income, deductions, and credits flow directly to the owners’ or shareholders’ individual tax returns, rather than being taxed at the entity level. Common examples include S-corporations, partnerships, LLCs taxed as partnerships, and sole proprietorships.

Qualified business income (QBI)

The net amount of qualified items of income, gain, deduction, and loss from a qualified trade or business. It does not include investment income, reasonable compensation paid to the taxpayer, or guaranteed payments from a partnership.

Qualified trade or business

Any trade or business other than a specified service trade or business or the trade or business of performing services as an employee. Above a taxable-income threshold ($197,300, or $394,600 married filing jointly, for 2025, phased in over the next $50,000/$100,000), it excludes businesses performing services in fields such as health, law, accounting, consulting, financial services, or where the business’s principal asset is the reputation or skill of one or more owners or employees.

Net operating loss (NOL) - individuals NOLs arising in tax years after 2017 can be carried forward indefinitely and can offset up to 80% of taxable income in a carryforward year; there is generally no carryback (farming losses can be carried back 2 years). Refer to Form 172 and IRS Publication 536 for details. There are rules and exceptions for almost any circumstance.

Definitions

Net operating loss (NOL)

Occurs when a taxpayer’s allowable deductions exceed their gross income in a given tax year, resulting in negative taxable income. The IRS allows taxpayers to carry this loss forward to offset taxable income in future years, subject to applicable rules and limitations.

Depreciation and depletion

Depreciation is a deduction that is allowed for the gradual wear and tear on an asset used to help produce income. The Straight-line method spreads the depreciable amount evenly over the asset’s useful life. The 200% declining balance method is commonly used by tax professionals and front-loads deductions (for example, about 52% of the cost of 5-year property is deducted in the first two years). Under the half-year convention that generally applies to personal property, only half a year’s depreciation is allowed in the first year: 20% of the cost of 5-year property under the 200% declining balance method, but 10% under the straight-line method. The Modified accelerated cost recovery system (MACRS) provides detailed information on how to depreciate property, including tables for various asset classes. MACRS treats salvage value as zero, so the property’s entire basis is recovered over its recovery period.

Definitions

Straight-line method

A depreciation method that spreads the cost of an asset evenly over its useful life. Each year, the same fixed amount is deducted until the asset is fully depreciated.

200% declining balance method

An accelerated depreciation method that applies double the straight-line rate to the asset’s remaining book value each year, allowing larger deductions in the early years of an asset’s life.

MACRS (Modified accelerated cost recovery system)

The standard depreciation system used in the United States for tax purposes. MACRS assigns assets to specific property classes with prescribed recovery periods and depreciation methods, allowing businesses to recover the cost of qualifying property over time.

Common MACRS property classes and their recovery periods:

• 3-year: Tractor units for over-the-road use, race horses over 2 years old when placed in service.
• 5-year: Automobiles, computers, office machinery.
• 7-year: Office furniture and fixtures.
• 27.5-year: Residential rental property.
• 39-year: Nonresidential real property.

Refer to IRS Publication 946 for detailed information.

IRC Section 179 expensing and bonus depreciation IRC Section 168(k)

The Section 179 deduction and bonus depreciation (also known as the additional first-year depreciation deduction) allow businesses to take an immediate deduction rather than write them off over their useful life as in traditional depreciation for assets such as equipment, vehicles, and software. Both methods must be taken in the first year of an asset’s service. For 2025, the Section 179 maximum deduction is $2,500,000, and the phase-out begins once qualifying property placed in service during the year exceeds $4,000,000. Under the Section 168(k) rules as amended by the “One Big Beautiful Bill Act” (OBBBA), bonus depreciation is 100% for qualifying property acquired and placed in service after January 19, 2025; property acquired before January 20, 2025, and placed in service in 2025 is limited to 40%. Section 179 and bonus depreciation may both be used on the same asset in the same year, but Section 179 must be applied first. Section 179 expenses cannot be used to create a loss, but bonus depreciation can be used to create a loss. For further information visit the IRS website.

Depletion is a method of recording the gradual expense or use of natural resources over time. The IRS defines depletion as the “using up of natural resources extracted from a mineral property by mining, drilling, quarrying stone, or cutting timber”. Depletion details two methods: cost depletion (based on the property’s adjusted basis and units extracted) and percentage depletion (using a fixed percentage of gross income). Refer to the IRS website for detailed information.

Definitions

Cost depletion

A method of calculating depletion based on the property’s adjusted tax basis and the number of units extracted during the year relative to total estimated recoverable units.

Percentage depletion

A method of calculating depletion using a fixed statutory percentage of the gross income generated from the natural resource, regardless of the property’s adjusted basis.

Depreciation recapture

When depreciated property is sold at a gain, the part of the gain that comes from depreciation is taxed less favorably than other long-term gain. Depreciation here includes section 179 expensing and bonus depreciation, and it is the amount allowed or allowable: depreciation the taxpayer could have claimed but didn’t still reduces basis and is still recaptured.

• Section 1245 property (depreciable personal property such as equipment, vehicles and furniture, but not buildings or their structural components): gain is ordinary income up to the total depreciation; only gain above that is section 1231 gain.
• Section 1250 property (depreciable real property such as a rental house or an office building): only depreciation in excess of straight-line is ordinary income, and real property placed in service after 1986 under MACRS (27.5-year residential rental, 39-year nonresidential) is depreciated straight-line, so it normally has none. The gain due to depreciation is instead unrecaptured section 1250 gain, a long-term capital gain taxed at a maximum rate of 25%.

Form 4797 figures the ordinary recapture in Part III. A net section 1231 gain goes to Schedule D, except that it is ordinary income to the extent of net section 1231 losses deducted in the previous 5 years. The §121 home-sale exclusion can’t cover gain equal to depreciation allowed or allowable after May 6, 1997, for a home office or a rental period.

Example: Selling a depreciated rental house

Ana bought a rental house for $200,000 and deducted $58,000 of straight-line depreciation before selling it in 2025 for $300,000. She has no other section 1231 transactions and no section 1231 losses in earlier years.

• Adjusted basis: $200,000 − $58,000 = $142,000
• Gain: $300,000 − $142,000 = $158,000

Answer: None of the gain is ordinary income, because the house was depreciated straight-line. $58,000 is unrecaptured section 1250 gain taxed at up to 25%, and the other $100,000 is long-term capital gain taxed at 0%, 15% or 20%.

Business start-up and organizational costs

Taxpayers can deduct up to $5,000 each for organizational costs and start-up costs in the first year of business. This $5,000 first-year deduction is reduced dollar-for-dollar by the amount that the respective costs exceed $50,000, and is eliminated entirely once costs reach $55,000. Any remaining costs - including the excess over $5,000 for either type - are amortized over a 15-year (180-month) period, per IRC §195 (start-up costs) and §248 or §709 (organizational costs of corporations and partnerships).

Definitions

Amortization

The process of gradually deducting the cost of an intangible asset or deferred expense over a set number of years. For tax purposes, business start-up and organizational costs exceeding the $5,000 threshold must be spread out and deducted incrementally over a 15-year recovery period.

Nonbusiness bad debt deduction

This deduction is available to taxpayers who loan money or other assets to others in good faith but did not get repaid. To get this deduction, the debt must be totally worthless and the taxpayer must substantiate his or her efforts to recover the amount that was borrowed. Losses are deemed by the IRS as capital losses.

Example: Nonbusiness bad debt

Quinn loaned $700 to his niece in good faith, with no interest and no business relationship between them. Despite reasonable efforts to collect - repeated requests and a demand for repayment - the niece was unable to repay any part of the loan, and the debt became totally worthless this year.

Answer: Quinn can deduct the $700 as a short-term capital loss on Schedule D, Form 1040, because he can show a genuine debt existed, he made reasonable efforts to collect, and the debt is totally (not just partially) worthless.

To claim a nonbusiness bad debt deduction, the taxpayer must be able to show:

• A genuine debt existed (not a gift), ideally supported by a written, signed loan agreement.
• The debt is totally worthless - partially worthless nonbusiness bad debts aren’t deductible.
• The deduction is taken in the year the debt becomes totally worthless, even if the loan originated in an earlier year.
• Reasonable efforts were made to collect the debt, and those efforts are documented.
• A statement is attached to the return explaining the nature of the debt, the debtor’s information, the collection efforts made, and why the debt is considered worthless.

Nonbusiness bad debts are reported as a short-term capital loss on Form 8949, Part I (which flows to Schedule D, Form 1040). If the loss isn’t fully used in the year it arises, the unused amount carries forward as a short-term capital loss.

For more details see IRS topic No. 453, Bad debt deduction

Car loan interest deduction

Under the One Big Beautiful Bill Act (OBBBA), enacted in July 2025, individuals can deduct interest paid on a qualified passenger vehicle loan for tax years 2025 through 2028. The deduction is available whether or not the taxpayer itemizes, and it is claimed on Schedule 1-A (Form 1040).

To qualify, the interest must be paid on a loan that:

• Was originated after December 31, 2024, to buy a new vehicle (its original use must begin with the taxpayer)
• Is secured by a first lien on the vehicle (lease payments don’t qualify)
• Is for a vehicle bought for personal use, not for business or commercial use

A qualified vehicle is a car, minivan, van, SUV, pickup truck, or motorcycle with a gross vehicle weight rating of less than 14,000 pounds whose final assembly took place in the United States. The vehicle identification number (VIN) must be included on the return for each year the deduction is claimed.

The deduction is limited to $10,000 of interest per year. The interest deductible after that limit, not the $10,000 limit itself, is reduced by $200 for each $1,000 (or part of $1,000) by which modified AGI exceeds $100,000 ($200,000 if married filing jointly), so a full $10,000 deduction is eliminated at $150,000 ($250,000 if married filing jointly). For this deduction, modified AGI is AGI plus any excluded foreign earned income and excluded income from Puerto Rico or a U.S. territory.