Depreciation & Recapture
This is archived information that pertains only to the 2002 Tax Year. If you
are looking for information for the current tax year, go to the Tax Prep Help Area.
What kinds of property can be depreciated for tax purposes?
Only property used in a trade or business or in an income production activity can be depreciated. Additionally, the property must be something that wears out or becomes obsolete and it must have a determinable useful life substantially beyond the tax year. The kinds of property that can be depreciated include, but are not limited to, machinery, equipment, buildings, vehicles, and furniture. Depreciation is a complex topic. For more information, refer to Tax Topic 704, Depreciation, or Publication 946 (PDF), How to Depreciate Property, or Publication 534 (PDF), Depreciating Property Placed in Service Before 1987.
References: Can the entire acquisition cost of a computer that I purchased for my business be deducted as a business expense or do I have to use depreciation?
A deduction for depreciation of a computer for business use, whether all at once or over a recovery period, is reported on Form 4562 (PDF), Depreciation and Amortization, Part V. Generally, is depreciated over a 5-year period. However, if the computer is used more than 50% for business, then you may also have an option to expense the business portion in as little as one year (as a section 179 deduction) using Form 4562 Part I (as well as Part V). Taxable income from the active conduct of any trade or business must be at least as great as the section 179 deduction claimed. Dollar limits and investment limits also apply to the section 179 deduction. For more information on depreciation and the section 179 deduction, refer to Publication 946 (PDF), How to Depreciate Property.
References: I purchased a computer last year to do online day trading part-time from home for additional income. Can I deduct or depreciate the cost of the computer or internet connection from my investment income?
You may deduct investment expenses (other than interest expenses) as miscellaneous itemized deductions on Form 1040, Schedule A (PDF), line 22, Itemized Deductions. This would include depreciation on the portion of your computer used for investment purposes, and the portion of your internet access charges used for investment purposes. These deductions must be reduced by 2% of your adjusted gross income. Use Form 4562 (PDF), Depreciation and Amortization, to compute the depreciation for the portion of your computer used for investment purposes. Unless the computer is used more than 50% for business purpose (as opposed to investment purposes), you cannot claim section 179 expensing of the computer or claim accelerated depreciation for it. For more information, refer to "Listed Property" in Publication 946 (PDF), How to Depreciate Property.
References: I purchased a computer to support my job-related activities. As an employee, can I write-off the entire allowed cost or will I have to depreciate it over a few years?
You can claim a depreciation deduction for a computer that you use in your work as an employee if its use is: - For the convenience of your employer, and
- Required as a condition of your employment.
You cannot take a section 179 deduction for the item or claim accelerated depreciation unless your use of the computer is more than 50% business or job-related use (and you meet the two conditions listed above).
Section 179 deductions and accelerated depreciation methods are explained in Publication 946 (PDF), How to Depreciate Property.
References: I need to know the maximum deduction allowed for depreciation on a passenger vehicle purchased in 2002?
The maximum deduction that can be claimed for a used passenger vehicle or one that is Liberty Zone property that was placed in service in 2002 is $3,060 for the first year, $4,900 for the second year, $2,950 for the third year, and $1,775 for the fourth and following years. For a new passenger vehicle placed in service in 2002 (and not Liberty Zone property), the maximum deduction is $4,600 for the first year. Subsequent year limits are the same as for used vehicles. Increase deductions are also available for electric vehicles see Supplement to Publication 946 (PDF), How to Depreciate Property. For more information, refer to Car Expenses in Chapter 4, Local Transportation Expenses of Publication 463 (PDF), Travel, Entertainment, Gift, and Car Expenses and Special Rule for Passenger Automobiles in Chapter 4, Listed Property, of Publication 946 (PDF), How to Depreciate Property.
References: What form and line do I deduct the 36.5 cents per mile on for my business travel and do I need to figure depreciation of the vehicle, too?
A Sole Proprietor's business use of a car or truck is claimed on line 10 of Form 1040 (PDF), Schedule C, Profit or Loss from Business or, if eligible, line 2 of Form 1040, Schedule C-EZ (PDF), Net Profit from Business. You may use either the actual expense method in calculating your car or truck expense or, if eligible, the 2002 standard mileage rate of 36.5 cents per mile. Depreciation expense is already included in this standard mileage rate. Depreciation is only calculated as a separate expense when using the actual expense method. Deductible employee business use of a car or truck may be taken on Form 2106 (PDF), Employee Business Expenses, or if, eligible, line 1 of Form 2106-EZ (PDF), Unreimbursed Employee Business Expenses. The car and truck expenses are then taken with other employee business expenses on line 22, Form 1040, Schedule A&B (PDF) Itemized Deductions. For more information, refer to Publication 463 (PDF), Travel, Entertainment, Gift, and Car Expenses, and Publication 535 (PDF), Business Expenses.
References: - Publication 535 (PDF), Business Expenses
- Publication 463 (PDF), Travel, Entertainment, Gift, and Car Expenses
- Form 1040, Schedule C (PDF), Profit or Loss from Business (Sole Proprietorship)
- Form 1040, Schedule C-EZ (PDF), Unreimbursed Employee Business Expenses.
- Form 2106 (PDF), Employee Business Expenses
- Form 2106EZ (PDF), Unreimbursed Employee Business Expenses
I have a home office. Can I deduct expenses like mortgage, utilities, etc., but not deduct depreciation so that when I sell this house, the basis won't be affected?
If you have qualified business use of your home and enough gross income from that business use to that entitle you to a depreciation deduction, you are required to reduce your basis in the home by the amount of depreciation allowed (deducted) or allowable (could have been deducted).
Whether you choose to deduct the depreciation on your current return(s) will not matter. For tax purposes, you will still be treated as if you had taken the allowable deduction, and your basis will have to be reduced. For more information, refer to Publication 946 (PDF), How to Depreciate Property, Publication 544 (PDF), Sales and Other Dispositions of Assets, and Publication 587 (PDF), Business Use of Your Home.
References: I have a rental property. Do I have to take depreciation on it?
You do not have to claim depreciation on your rental property on your tax return. However, when reporting the sale of the rental property you are required to reduce the basis of the property for allowable depreciation regardless of whether the depreciation deduction was taken or not. For more information, refer to Publication 544 (PDF), Sale or Other Dispositions of Assets, the Instructions for Form 4797, Sale of Business Property, and Publication 527 (PDF), Residential Rental Property (including vacation homes).
References: In calculating depreciation on both my rental apartment building and its furniture, what depreciation type, asset class, depreciation method, and recovery period should be used?
An apartment building rented for residential purposes is considered residential rental property. Residential rental property is depreciated, generally, over 27.5 years under the modified accelerated cost recovery system (MACRS) using the general depreciation system (GDS) straight line method with a mid-month convention. Furniture for use in residential rental property, generally, is depreciated over 5 years using the MACRS, GDS 200% double declining balance method with a half-year convention. The convention used may vary depending on when the property was placed in service. Publication 527 (PDF), Residential Rental Property, contains the appropriate depreciation tables as does Publication 946 (PDF), How to Depreciate Property. Attach Form 4562 (PDF), Depreciation and Amortization, to your individual income tax return to claim the depreciation for the year this property is placed into service and for each subsequent tax year in which you own the property.
References: We replaced the roof on a residential rental property and need to know what to use for the classification and recovery period to calculate depreciation?
Replacement of a roof on a residential rental property is a capital improvement to the structure. The roof is in the same class of property as the property to which it is attached. Since the property is residential rental property, the roof is generally depreciated over a residential rental property recovery period, of 27.5 years using the straight line method of depreciation and a mid-month convention. You cannot write off (or take a loss on) any remaining basis in the replaced roof. For more information, refer to Publication 527 (PDF), Residential Rental Property, and Publication 946 (PDF), How to Depreciate Property.
References: On residential rental property, would new windows and siding be considered a repair that could be deducted against income, or would they be capitalized as an improvement?
Replacement of windows and siding on a residential rental property is a capital improvement to the structure, provided the replacement improves the value of this property. The windows and siding, in that event, are in the same class of property as the property to which they are affixed. In this case, the windows and siding are generally depreciated over a recovery period of 27.5 years using the straight line method of depreciation and a mid-month convention. For more information, refer to Publication 527 (PDF), Residential Rental Property, and Publication 946 (PDF), How to Depreciate Property.
References: We have incurred substantial repairs to our rental property: new roof, gutters, windows, furnace, and outside paint. What are the IRS rules concerning depreciation?
Replacements of roof, rain gutters, windows, and furnace on a residential rental property are capital improvements to the structure because they materially add to the value of your property or substantially prolong its life. The items would be in the same class of property as the rental property to which to which they are attached. Since the property is residential rental property, the items are generally depreciated over 27.5 years using the straight line method of depreciation and a mid-month convention.
Repairs, such as repainting the house, are currently deductible expenses. A repair keeps your property in good operating condition. It does not materially add to the value of your property or substantially prolong its life. Repainting your property inside or out, fixing gutters or floors, fixing leaks, plastering, and replacing broken windows are examples of repairs. If you make repairs as part of an extensive remodeling or restoration of your property, the whole job is an improvement. You should capitalize and depreciate the repair costs as the same class of property that you have restored or remodeled. For more information, refer to Publication 527 (PDF), Residential Rental Property, and Publication 946 (PDF), How to Depreciate Property.
References: How many years do I depreciate a new furnace installed as an improvement on residential rental property and what method do I use to compute the depreciation?
Replacement of a furnace in a residential rental property is a capital improvement to the structure. The furnace is in the same class of property as the property in which it is installed. Since the property is residential rental property, the furnace is, generally, depreciated over a recovery period of 27.5 years using the straight line method of depreciation and a mid-month convention. For more information, refer to Publication 527 (PDF), Residential Rental Property, and Publication 946 (PDF), How to Depreciate Property.
References: I purchased a snowblower and a lawn mower strictly for use at a residential apartment building I own. Can I elect the section 179 deduction to fully deduct the costs of the snowblower and lawn mower?
You cannot claim section 179 expense for property held to produce rental income (since it is use in connection with the furnishing of lodging). These assets are classified as 5-year property and must be depreciated as directed in Publication 527 (PDF), Residential Rental Property, and Publication 946 (PDF), How to Depreciate Property.
References: I expensed equipment and furniture (not used for residential rental property) two years ago under section 179, but stopped doing business last year. Does any of this have to be recaptured and claimed as income, even though the items have not been sold?
If you claim a section 179 deduction for the cost of property in the year you place the property in service, and in a subsequent year, you do not use it more than 50 percent for business, you may have to recapture part of the section 179 deduction. This can occur in any year during the recovery period for the property even though the items have not been sold. Refer to Publication 946 (PDF), How to Depreciate Property, on how to calculate the recapture amount. The recapture amount is computed on part IV of Form 4797 (PDF), Sale of Business Property, and is included as other income on line 6 of Form 1040, Schedule C (PDF), Profit or Loss from Business (Sole Proprietorship).
References: 12.7 Small Business/Self-Employed/Other Business: Income & Expenses I gave my friend a loan to do business, but the business went bankrupt and she did not pay me back. Can I deduct this bad loan?
If someone owes you money that you cannot collect, you have a bad debt. Bad debts are deductible only if the amount owed has been previously included in your income. For a discussion of what constitutes an valid debt, see Publication 535 (PDF), Business Expenses and Publication 550 (PDF), Investment Income and Expenses. If you are a cash basis taxpayer, as most individuals are, you may not take a bad debt deduction for expected income you have not received, since it was never included in your income.There are two kinds of bad debts - business and nonbusiness.
A business bad debt, generally, is one that comes from operating your trade or business. A business deducts its bad debts from gross income when figuring its taxable income. Business bad debts may be deducted in part or in full.
All other bad debts are nonbusiness. Nonbusiness bad debts must be totally worthless to be deductible. You cannot deduct a partially worthless nonbusiness bad debt. You must establish that you have taken reasonable steps to collect the debt and that the debt is worthless. It is not necessary to go to court if you can show that a judgment from the court would be uncollectible. You may take the deduction only in the year the debt becomes worthless. A debt becomes worthless when the surrounding facts and circumstances indicate there is no longer any chance the amount owed will be paid. You do not have to wait until the debt comes due.
A nonbusiness bad debt is reported on Form 1040, Schedule D (PDF), Capital Gains and Losses, as a short-term capital loss. It is subject to the capital loss limit of $3,000 per year. This limit is $1,500 if you are married filing a separate return. A nonbusiness bad debt requires a separate detailed statement attached to the schedule D. For more information on nonbusiness bad debts, refer to Publication 550 (PDF), Investment Income and Expenses. For more information on business bad debts, refer to Publication 535 (PDF), Business Expenses.
References: How do you distinguish between a business and a hobby?
Since hobby expenses are deductible only to the extent of hobby income, it is important to distinquish hobby expenses from expenses incurred in an activity engaged in for profit. In making this distinction, all facts and circumstances with respect to the activity are taken into account and no one factor is determinative. Among the factors which should normally be taken into account are the following: - Whether you carry on the activity in a businesslike manner
- Whether the time and effort you put into the activity indicate you intend to make it profitable
- Whether you depend on income from the activity for your livelihood
- Whether your losses are due to circumstances beyond your control (or are normal in the startup phase of your type of business)
- Whether you change your methods of operation in an attempt to improve profitability
- Whether you, or your advisors, have the knowledge needed to carry on the activity as a successful business
- Whether you were successful in making a profit in similar activities in the past
- Whether the activity makes a profit in some years, and how much profit it makes
- Whether you can expect to make a future profit from the appreciation of the assets used in the activity
Additional information on this topic is available in section 1.183-2 (b) of the federal tax regulations.
References: If I pay personal expenses out of my business bank account, should I count the money used as part of my income, or can I write these expenses off?
You would include the money in income and you would not write the amounts off as expenses. Only business related expenses can be deducted from your business income. It is recommended that you not mix business and personal accounts. This makes it easier to keep records.
References: For business travel, are there limits on the amounts deductible for meals?
Meal expenses are deductible only if your trip is overnight or long enough that you need to stop for sleep or rest to properly perform your duties. The amount of the meal expenses must be substantiated, but instead of keeping records of the actual cost of your meal expenses you can generally use a standard meal allowance ranging from $30 to $46 in 2001 depending on where and when you travel.
Generally, the deduction for unreimbursed business meals is limited to 50% of the cost that would otherwise be deductible.
For more information on business travel expenses and restrictions, refer to Tax Topic 511, or Publication 463 (PDF), Travel, Entertainment, Gift, and Car Expenses, and Publication 1542, Per Diem Rates.
References: Where can I find the per diem rates for foreign countries?
The federal per diem rates for foreign locations are published monthly in the Maximum Travel Per Diem Allowances for Foreign Areas. Your employer may have these rates available, or you can purchase the publication from the: Superintendent of Documents
U.S. Government Printing Office
P.O. Box 371954
Pittsburgh, PA 15250-7954
You can also order it by calling the Government Printing Office at (202) 512-1800 (not a toll-free number) or if you have a computer and modem, you can check rates at the U.S. Department of State Office of Allowances.
References: I use my home for business. Can I deduct the expenses?
If you use part of your home exclusively and regularly, as your principal place of business or as a place where you meet or deal with customers, you may deduct expenses for use of part of your home. If you deduct your business expenses on Form 1040, Schedule C (PDF), you must figure your deduction on Form 8829 (PDF), Expenses for Business Use of Your Home, and attach it to Form 1040 with Schedule C. For more information refer to Tax Topic 509, Business Use of Home, or Publication 587 (PDF), Business Use of Your Home (Including Use by Day-Care Providers).
References: I use part of my living room as an office. Can I take a deduction for business use of my home?
In general, if you use a part of your home for both personal and business purposes, no expenses for business use of that part are deductible. Exceptions apply for qualified day-care providers and for the storage of inventory or product samples used in your business. For additional information on business use of your home, refer to Tax Topic 509, or Publication 587 (PDF), Business Use of Your Home (Including Use by Day-Care Providers).
References: If you lease a vehicle, can you deduct the cost of the lease payments plus the standard mileage rate?
No, if you lease a car you use in business, you may use either the standard mileage rate or claim actual expenses, which would include lease payments. You cannot use both the standard mileage rate and the lease payments.
References: Is the state sales tax paid on the purchase of an automobile an allowed deduction?
State and local sales tax paid on personal items is no longer an allowable itemized deduction on Form 1040, Schedule A (PDF), Itemized Deductions. If the auto is a business asset it is generally added to the basis and recovered through depreciation.
References: Are excise taxes for a vehicle deductible?
It has to be a personal property tax, not an excise tax, in order to deduct it. Deductible personal property taxes are only those based on the value of personal property such as a boat or car. The tax must be charged to you on a yearly basis, even if it is collected more than once a year or less than once a year. To be deductible, the tax must be charged to you and must have been paid during your tax year. Taxes may be claimed only as an itemized deduction on Form 1040, Schedule A (PDF), Itemized Deductions.
References: We leased an auto for a small business. How much (if any) of the down payment is tax deductible in the year the automobile is leased?
You must spread any advance lease payments over the entire lease period. You cannot deduct any payments you make to buy a car even if the payments are called lease payments. If you lease a car that you use in your business, you can deduct the part of each lease payment that is for the use of the car in your business. You cannot deduct any part of a lease payment that is for commuting to your regular job or for any other personal use of the car.
References: If I buy down the lease (pay a lump sum up-front) of a vehicle for my new business, how would this up-front payment be treated for tax purposes?
You must spread any advance lease payments over the entire lease period. You cannot deduct any payments you make to buy a car even if the payments are called lease payments. If you lease a car that you use in your business, you can deduct the part of each lease payment that is for the use of the car in your business. You cannot deduct any part of a lease payment that is for commuting to your regular job or for any other personal use of the car.
References: If you lease purchase a piece of equipment, like a forklift or boom truck, do you deduct the lease or do you depreciate it?
There may be instances in which you must determine whether your payments are for rent or for the purchase of the property. You must first determine whether your agreement is a lease or a conditional sales contract. If, under the agreement, you acquired or will acquire title to or equity in the property, you should treat the agreement as a conditional sales contract. Payments made under a conditional sales contract are not deductible as rent expense.
Whether the agreement is a conditional sales contract depends on the intent of the parties. Determine intent based on the facts and circumstances that exist when you make the agreement.
In general, an agreement may be considered a conditional sales contract rather than a lease if any of the following is true: - The agreement applies part of each payment toward an equity interest that you will receive.
- You get title to the property upon the payment of a stated amount required under the contract.
- The amount you pay to use the property for a short time is a large part of the amount you would pay to get title to the property.
- You pay much more than the current fair rental value for the property.
- You have an option to buy the property at a nominal price compared to the value of the property when you may exercise the option. Determine this value when you make the agreement.
- You have an option to buy the property at a nominal price compared to the total amount you have to pay under the lease.
- The lease designates some part of the payments as interest, or part of the payments are easy to recognize as interest.
References: If you lease office equipment and machinery with the option to buy, when do you depreciate the purchase price?
If you lease equipment with the option to later buy the equipment, you must first determine whether your agreement is a lease agreement or a conditional sales contract. If, under the agreement, you acquired or will acquire title to or equity in the property, you should treat the agreement as a conditional sales contract. Payments made under a conditional sales contract are not deductible as rent expense. You would start depreciating the equipment on the date you acquired the equipment.
Whether the agreement is a conditional sales contract depends on the intent of the parties. Determine intent based on the facts and circumstances that exist when you make the agreement
In general, an agreement may be considered a conditional sales contract rather than a lease if any of the following is true. - The agreement applies part of each payment toward an equity interest that you will receive.
- You get title to the property upon the payment of a stated amount required under the contract.
- The amount you pay to use the property for a short time is a large part of the amount you would pay to get title to the property.
- You pay much more than the current fair rental value for the property.
- You have an option to buy the property at a nominal price compared to the value of the property when you may exercise the option. Determine this value when you make the agreement.
- You have an option to buy the property at a nominal price compared to the total amount you have to pay under the lease.
- The lease designates some part of the payments as interest, or part of the payments are easy to recognize as interest.
References: Are business gifts deductible?
If you give business gifts in the course of your trade or business, you can deduct the cost subject to special limits and rules. In general, you can deduct no more than $25 for business gifts you give directly or indirectly to any one person during your tax year. Exceptions may apply. For additional information, refer to Tax Topic 512 and Chapter 28 of Publication 17 (PDF), Your Federal Income Tax.
References: Can I deduct my investment expenses as business expenses?
The proper classification of your investment activities is important to determine how income and expenses are to be reported. Investors trade solely for their own account and do not carry on a trade or business. Their securities sales result in capital gain or loss and their deductible expenses are itemized deductions. Dealers sell securities to customers in the ordinary course of trade or business. Their sales result in ordinary gain or loss and their deductible expenses are trade or business expenses. Traders buy and sell securities frequently but have no customers. Their purchases and sales result in capital gain and loss, and their deductible expenses are trade or business expenses.
Even if you engage in extensive securities activities, you are an investor, not a dealer or trader, if you do not seek profit primarily in swings in daily market movements, and do not personally engage in or direct the purchases or sales. An investor trades for profit-motivated reasons such as long-term appreciation, dividends and interest. Whether the activities of an individual constitute trade or business or investment is determined from the facts in each case. These distinctions have been established through court cases.
If your trading activity is a business, your trading expenses would be reported on Form 1040, Schedule C (PDF), Profit or Loss from Business (Sole Proprietorship) instead of Form 1040, Schedule A (PDF), Itemized Deductions. Your gains or losses, however, would be reported on Form 1040, Schedule D (PDF), Capital Gains and Losses, unless you file an election to change your method of accounting.
If your trading activity is a business and you elect to change to the mark-to-market method of accounting, you would report both your gains or losses on Part II of Form 4797 (PDF), Sales of Business Property.
A change in your method of accounting requires the consent of the Commissioner and can not be revoked without the consent of the Secretary. Though there is no publication specific to day traders, the details for traders in securities and commodities are covered in Internal Revenue Code Section 475(f) and Revenue Procedure 99-17.
References: 12.8 Small Business/Self-Employed/Other Business: Schedule C & Schedule SE I buy and sell stocks as a day trader using an online brokerage firm. Can I treat this as a business and report my gains and losses on Schedule C?
A business is generally an activity carried on for a livelihood or in good faith to make a profit. Rather than defined in the tax code, exactly what activities are considered business activities has long been the subject of court cases. The facts and circumstances of each case determine whether or not an activity is a trade or business. Basically, if your day trading activity goal is to profit from short-term swings in the market rather than from long-term capital appreciation of assets, if your income is primarily from the sale of securities rather than from dividends and interest paid on securities, and if you expect this income to be your primary income for meeting your personal living expenses, i.e. you do not have another regular job, then your trading activity might be a business.
For details about not-for-profit activities, refer to Publication 535 (PDF), Business Expenses. That chapter explains how to determine whether your activity is carried on to make a profit and how to figure the amount of loss you can deduct.
If your trading activity is a business, your trading expenses would be reported on Form 1040, Schedule C (PDF), Profit or Loss from Business (Sole Proprietorship), instead of Form 1040, Schedule A (PDF), Itemized Deductions. Your gains or losses, however, would be reported on Form 1040, Schedule D (PDF), Capital Gains and Losses, unless you file an election to change you method of accounting.
If your trading activity is a business and you elect to change to the mark-to-market method of accounting, you would report both your gains or losses and your trading expenses in Part II of Form 4797, Sale of Business Property. See Publication 550 (PDF), Investment Income and Expenses, for details.
A change in your method of accounting requires the consent of the Commissioner and can not be revoked without the consent of the Secretary. Though there is no publication specific to day traders, the details for traders in securities and commodities are covered in Internal Revenue Code Section 475(f) and Revenue Procedure 99-17.
References: If you have run a small business in the past, but this year there is no income or expenses, is it necessary to file a Schedule C?
If your sole proprietorship business is inactive during the full year, it is not necessary to file a Form 1040, Schedule C (PDF), Profit or Loss from Business, for that year.
References: 12.9 Small Business/Self-Employed/Other Business: Starting or Ending a Business I went out of business this year and still have inventory on hand. Can I take a deduction for inventory that I cannot sell?
Generally inventory losses and gains must be run through the business (shown as sold on Form 1040, Schedule C (PDF), Profit or Loss from Business) when sold even after the business closes. If you cannot sell inventory because it has become obsolete or you have formed the intent to give up possession of the inventory without passing it on to someone else and suffer a loss, you may deduct such losses. If you use any remaining inventory for personal use after you go out of business, you cannot take a deduction for that inventory. If you give the remaining inventory away to a nonprofit organization, claim your deduction on Form 1040, Schedule A (PDF), Itemized Deductions. When you have business related expenses after your business has closed, you still may deduct these expenses.
References: Which form do I use to file my business income tax return?
To determine which form you should file for your business entity, select one of the following links:
References: What deductions can I take on my partnership or S Corporation return?
In general, ordinary and necessary business expenses are deductible on business return. However, there are some items that partnership and S Corporation do not deduct at the business entity level but rather at the partner or shareholder level. These are referred to as separately stated items. For a more complete explanation of business in general, see Publication 535 (PDF) , Business Expenses Publication 541 (PDF), Partnerships, and Instructions for Form 1120S.
References: Where is a loss reported on my return and how much can I deduct?
The place where your loss is reported depends on how much is deductible, the type of loss, and the type of return you are filing. If your business deductions are more than your business income for the year, you may have a Net Operating Loss (NOL). You can use an NOL by deducting it from your income in another year or years. Partnerships and S Corporations generally cannot use an NOL. But partners or shareholders can use their separate shares of the partnership's of S Corporation's business deductions to their individual NOLs. For additional help, see Publication 541 (PDF), Partnership, Publication 542 (PDF), Corporation, Publication 925 (PDF), Passive Activities and At-Risk Rules, and Publication 536 (PDF), Net Operating Losses (NOLs) for individuals, Estates, and Trusts.
If you have a Capital Loss, it is generally from the sale or loss of investment property, a business, or a capital asset used in a business. Publication 544 (PDF), on Sales and Other Disposition of Assets, will provide additional information on this subject.
Special Situations
S Corporations
In general, if an S corporation purchases a C Corporation at the end of the year and the C Corporation has a loss, the S Corporation does not get to claim the C Corporation loss. A C Corporation is a taxable entity in itself and gains and losses do not flow through to the shareholders.
S Corporation shareholder who hold stock at any time during the year may claim their proportionate share of corporate losses on their individual tax returns subject to certain limits. For more information about the limitations, see the instruction for Instructions for Form 1120S, Schedule K-1.
Partnerships
In general, a partner loss is allocated base on his/her percentage of ownership of the year. This percentage is referred to as the partner's distributive share. The partners' distributive share of items is reported to the partner on Schedule K-1 (Form 1065). A partner's distributive share of partnership loss is allowed only to the extent of the adjusted basis of the partner's partnership interest. A loss that is more than the partner's adjusted basis is not deductible. For additional deductibility of partnership losses, see Publication 541 (PDF), Partnership, and Publication 925 (PDF), Passive Activities and At-Risk Rules.
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