If you recover part of an expense in the same tax year in which you would have claimed a deduction, reduce your current year expense by the amount of the recovery. If you have a recovery in a later year, include the recovered amount in income in that year. However, if part of the deduction for the expense did not reduce your tax, you do not have to include that part of the recovered amount in income.

For more information on recoveries and the tax benefit rule, see Publication 525.

If you provide services to pay a business expense, the amount you can deduct is limited to your out-of-pocket costs. You cannot deduct the cost of your own labor.

Similarly, if you pay a business expense in goods or other property, you can deduct only what the property costs you. If these costs are included in the cost of goods sold, do not deduct them as a business expense.

If your deductions for an investment or business activity are more than the income it brings in, you have a loss. There may be limits on how much of the loss you can deduct.

Under the cash method of accounting, you generally deduct business expenses in the tax year you pay them.

Under an accrual method of accounting, you generally deduct business expenses when both of the following apply.

You generally cannot deduct expenses in advance, even if you pay them in advance. This rule applies to both the cash and accrual methods. It applies to prepaid interest, prepaid insurance premiums, and any other expense paid far enough in advance to, in effect, create an asset with a useful life extending substantially beyond the end of the current tax year.

Under the cash method, you can deduct a contested liability only in the year you pay the liability. Under the accrual method, you can deduct contested liabilities such as taxes (except foreign or U.S. possession income, war profits, and excess profits taxes) either in the tax year you pay the liability (or transfer money or other property to satisfy the obligation) or in the tax year you settle the contest. However, to take the deduction in the year of payment or transfer, you must meet certain conditions. See Contested Liability in Publication 538 for more information.

Under an accrual method of accounting, you generally deduct expenses when you incur them, even if you have not yet paid them. However, if you and the person you owe are related and that person uses the cash method of accounting, you must pay the expense before you can deduct it. Your deduction is allowed when the amount is includible in income by the related cash method payee. See Related Persons in Publication 538.

An activity is presumed carried on for profit if it produced a profit in at least 3 of the last 5 tax years, including the current year. Activities that consist primarily of breeding, training, showing, or racing horses are presumed carried on for profit if they produced a profit in at least 2 of the last 7 tax years, including the current year. The activity must be substantially the same for each year within this period. You have a profit when the gross income from an activity exceeds the deductions.

If a taxpayer dies before the end of the 5-year (or 7-year) period, the test period ends on the date of the taxpayer's death.

If your business or investment activity passes this 3- (or 2-) years-of-profit test, the IRS will presume it is carried on for profit. This means the limits discussed here will not apply. You can take all your business deductions from the activity, even for the years that you have a loss. You can rely on this presumption unless the IRS later shows it to be invalid.

If you are starting an activity and do not have 3 (or 2) years showing a profit, you can elect to have the presumption made after you have the 5 (or 7) years of experience allowed by the test.

You can elect to do this by filing Form Form: 52135213. Filing this form postpones any determination that your activity is not carried on for profit until 5 (or 7) years have passed since you started the activity.

The benefit gained by making this election is that the IRS will not immediately question whether your activity is engaged in for profit. Accordingly, it will not restrict your deductions. Rather, you will gain time to earn a profit in the required number of years. If you show 3 (or 2) years of profit at the end of this period, your deductions are not limited under these rules. If you do not have 3 (or 2) years of profit, the limit can be applied retroactively to any year with a loss in the 5-year (or 7-year) period.

Filing Form 5213 automatically extends the period of limitations on any year in the 5-year (or 7-year) period to 2 years after the due date of the return for the last year of the period. The period is extended only for deductions of the activity and any related deductions that might be affected.

You may be able to use Form 5305-SEP, Simplified Employee Pension—Individual Retirement Accounts Contribution Agreement, in setting up your SEP.

To be a qualified plan, the plan must meet many requirements. They include requirements that determine the following.

If you are self-employed and also work for someone else, you can participate in retirement plans for both jobs. Generally, your participation in a retirement plan for one job does not affect your participation in a plan for the other job. However, if you have an IRA, you may not be allowed to deduct part or all of your IRA contributions. See Publication 590.

You cannot take a rental deduction for unreasonable rent. Ordinarily, the issue of reasonableness arises only if you and the lessor are related. Rent paid to a related person is reasonable if it is the same amount you would pay to a stranger for use of the same property. Rent is not unreasonable just because it is figured as a percentage of gross sales. For examples of related persons, see Related Persons in chapter 12.

If you rent your home and use part of it as your place of business, you may be able to deduct the rent you pay for that part. You must meet the requirements for business use of your home. For more information, see Business use of your home in chapter 1.

Generally, rent paid in your trade or business is deductible in the year paid or accrued. If you pay rent in advance, you can deduct only the amount that applies to your use of the rented property during the tax year. You can deduct the rest of your payment only over the period to which it applies.

You generally can deduct as rent an amount you pay to cancel a business lease.

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. Payments made under a conditional sales contract are not deductible as rent expense.

Special rules are provided for certain leases of tangible property. The rules apply if the lease calls for total payments of more than $250,000 and any of the following apply.

Generally, if the special rules apply, you must use an accrual method of accounting (and time value of money principles) for your rental expenses, regardless of your overall method of accounting. In addition, in certain cases in which the IRS has determined that a lease was designed to achieve tax avoidance, you must take rent and stated or imputed interest into account under a constant rental accrual method in which the rent is treated as accruing ratably over the entire lease term. For details, see section 467 of the Internal Revenue Code.

If you use the cash method of accounting, you can deduct the taxes as additional rent only for the tax year in which you pay them.

If you use an accrual method of accounting, you can deduct taxes as additional rent for the tax year in which you can determine all the following.

The liability and amount of taxes are determined by state or local law and the lease agreement. Economic performance occurs as you use the property.

The term of the lease for amortization includes all renewal options plus any other period for which you and the lessor reasonably expect the lease to be renewed. However, this applies only if less than 75% of the cost of getting the lease is for the term remaining on the purchase date (not including any period for which you may choose to renew, extend, or continue the lease). Allocate the lease cost to the original term and any option term based on the facts and circumstances. In some cases, it may be appropriate to make the allocation using a present value computation. For more information, see Regulations section 1.178-1(b)(5).

You may have to pay an additional rent amount over part of the lease period to change certain provisions in your lease. You must capitalize these payments and amortize them over the remaining period of the lease. You cannot deduct the payments as additional rent, even if they are described as rent in the agreement.

You must capitalize the $3,000 and amortize it over the 20-year term of the lease. Your amortization deduction each year will be $150 ($3,000 ÷ 20). You cannot deduct the $600 (12 × $50) that you will pay during each of the first 5 years as rent.

Commissions, bonuses, fees, and other amounts you pay to get a lease on property you use in your business are capital costs. You must amortize these costs over the term of the lease.

If you sell at a loss merchandise and fixtures that you bought solely to get a lease, the loss is a cost of getting the lease. You must capitalize the loss and amortize it over the remaining term of the lease.

If a long-term lessee who makes permanent improvements to land later assigns all lease rights to you for money and you pay the rent required by the lease, the amount you pay for the assignment is a capital investment. If the rental value of the leased land increased since the lease began, part of your capital investment is for that increase in the rental value. The rest is for your investment in the permanent improvements.

The part that is for the increased rental value of the land is a cost of getting a lease, and you amortize it over the remaining term of the lease. You can depreciate the part that is for your investment in the improvements over the recovery period of the property as discussed earlier, without regard to the lease term.

You may be subject to the uniform capitalization rules if you do any of the following, unless the property is produced for your use other than in a business or an activity carried on for profit.

For more information on these rules, see Uniform Capitalization Rules in Publication 538 and the regulations under Internal Revenue Code section 263A.

The allocation of loan proceeds and the related interest is not generally affected by the use of property that secures the loan.

The period for which a loan is allocated to a particular use begins on the date the proceeds are used and ends on the earlier of the following dates.

Even if the lender disburses the loan proceeds to a third party, the allocation of the loan is still based on your use of the funds. This applies whether you pay for property, services, or anything else by incurring a loan, or you take property subject to a debt.

Treat loan proceeds deposited in an account as property held for investment. It does not matter whether the account pays interest. Any interest you pay on the loan is investment interest expense. If you withdraw the proceeds of the loan, you must reallocate the loan based on the use of the funds.

When you repay any part of a loan allocated to more than one use, treat it as being repaid in the following order.

The following rules apply if you have a line of credit or similar arrangement.

Allocate the replacement loan to the same uses to which the repaid loan was allocated. Make the allocation only to the extent you use the proceeds of the new loan to repay any part of the original loan.

A debt-financed distribution occurs when a partnership or S corporation borrows funds and allocates those funds to distributions made to partners or shareholders. The manner in which you report the interest expense associated with the distributed debt proceeds depends on your use of those proceeds.

If you are liable for part of a business debt, you can deduct only your share of the total interest paid or accrued.

Generally, mortgage interest paid or accrued on real estate you own legally or equitably is deductible. However, rather than deducting the interest currently, you may have to add it to the cost basis of the property as explained later under Capitalization of Interest.

Interest charged on employment taxes assessed on your business is deductible.

OID is a form of interest. A loan (mortgage or other debt) generally has OID when its proceeds are less than its principal amount. The OID is the difference between the stated redemption price at maturity and the issue price of the loan.

A loan's stated redemption price at maturity is the sum of all amounts (principal and interest) payable on it other than qualified stated interest. Qualified stated interest is stated interest that is unconditionally payable in cash or property (other than another loan of the issuer) at least annually over the term of the loan at a single fixed rate.

The term points is used to describe certain charges paid, or treated as paid, by a borrower to obtain a loan or a mortgage. These charges are also called loan origination fees, maximum loan charges, discount points, or premium charges. If any of these charges (points) are solely for the use of money, they are interest.

Because points are prepaid interest, you generally cannot deduct the full amount in the year paid. However, you can choose to fully deduct points in the year paid if you meet certain tests. For exceptions to the general rule, see Publication 936.

If you make partial payments on a debt (other than a debt owed the IRS), the payments are applied, in general, first to interest and any remainder to principal. You can deduct only the interest. This rule does not apply when it can be inferred that the borrower and lender understood that a different allocation of the payments would be made.

If you make an installment purchase of business property, the contract between you and the seller generally provides for the payment of interest. If no interest or a low rate of interest is charged under the contract, a portion of the stated principal amount payable under the contract may be recharacterized as interest (unstated interest). The amount recharacterized as interest reduces your basis in the property and increases your interest expense. For more information on installment sales and unstated interest, see Publication 537.

If you use the cash method of accounting, you cannot deduct interest you pay with funds borrowed from the original lender through a second loan, an advance, or any other arrangement similar to a loan. You can deduct the interest expense once you start making payments on the new loan.

When you make a payment on the new loan, you first apply the payment to interest and then to the principal. All amounts you apply to the interest on the first loan are deductible, along with any interest you pay on the second loan, subject to any limits that apply.

You cannot currently deduct interest you are required to capitalize under the uniform capitalization rules. See Capitalization of Interest, later. In addition, if you buy property and pay interest owed by the seller (for example, by assuming the debt and any interest accrued on the property), you cannot deduct the interest. Add this interest to the basis of the property.

Fees you incur to have business funds available on a standby basis, but not for the actual use of the funds, are not deductible as interest payments. You may be able to deduct them as business expenses.

If the funds are for inventory or certain property used in your business, the fees are indirect costs and you generally must capitalize them under the uniform capitalization rules. See Capitalization of Interest, later.

Interest charged on income tax assessed on your individual income tax return is not a business deduction even though the tax due is related to income from your trade or business. Treat this interest as a business deduction only in figuring a net operating loss deduction.

You generally cannot deduct interest on a debt incurred with respect to any life insurance, annuity, or endowment contract that covers any individual unless that individual is a key person.

If the policy or contract covers a key person, you can deduct the interest on up to $50,000 of debt for that person. However, the deduction for any month cannot be more than the interest figured using Moody's Composite Yield on Seasoned Corporate Bonds (formerly known as Moody's Corporate Bond Yield Average-Monthly Average Corporates) (Moody's rate) for that month.

You produce property if you construct, build, install, manufacture, develop, improve, create, raise, or grow it. Treat property produced for you under a contract as produced by you up to the amount you pay or incur for the property.

Carrying charges include taxes you pay to carry or develop real estate or to carry, transport, or install personal property. You can choose to capitalize carrying charges not subject to the uniform capitalization rules if they are otherwise deductible. For more information, see chapter 8.

Treat capitalized interest as a cost of the property produced. You recover your interest when you sell or use the property. If the property is inventory, recover capitalized interest through cost of goods sold. If the property is used in your trade or business, recover capitalized interest through an adjustment to basis, depreciation, amortization, or other method.

The interest capitalization rules are applied first at the partnership or S corporation level. The rules are then applied at the partners' or shareholders' level to the extent the partnership or S corporation has insufficient debt to support the production or construction costs.

If you are a partner or a shareholder, you may have to capitalize interest you incur during the tax year for the production costs of the partnership or S corporation. You may also have to capitalize interest incurred by the partnership or S corporation for your own production costs. To properly capitalize interest under these rules, you must be given the required information in an attachment to the Schedule K-1 you receive from the partnership or S corporation.

The procedures for applying the uniform capitalization rules are beyond the scope of this publication. For more information, see sections 1.263A-8 through 1.263A-15 of the regulations and Notice 88-99. Notice 88-99 is in Cumulative Bulletin 1988-2.

Under the cash method, you can generally deduct only the interest you actually paid during the tax year. You cannot deduct a promissory note you gave as payment because it is a promise to pay and not an actual payment.

Under an accrual method, you can deduct only interest that has accrued during the tax year.

The rules for below-market loans apply to the following.

Except as noted in (5) above, these rules apply to demand loans (loans payable in full at any time upon the lender's demand) outstanding after June 6, 1984, and to term loans (loans that are not demand loans) made after that date.

If you receive a below-market gift loan or demand loan, you are treated as receiving an additional payment (as a gift, dividend, etc.) equal to the forgone interest on the loan. You are then treated as transferring this amount back to the lender as interest. These transfers are considered to occur annually, generally on December 31. If you use the loan proceeds in your trade or business, you can deduct the forgone interest each year as a business interest expense. The lender must report it as interest income.

If you receive a below-market term loan other than a gift or demand loan, you are treated as receiving an additional cash payment (as a dividend, etc.) on the date the loan is made. This payment is equal to the loan amount minus the present value, at the applicable federal rate, of all payments due under the loan. The same amount is treated as original issue discount on the loan. See Original issue discount (OID) under Interest You Can Deduct, earlier.

The rules for below-market loans do not apply to any day on which the total outstanding loans between the borrower and lender is $10,000 or less. This exception applies only to the following.

The following loans are specifically exempted from the rules for below-market loans because their interest arrangements do not have a significant effect on the federal tax liability of the borrower or the lender.

The below-market interest rules do not apply to a loan made by a lender to a qualified continuing care facility under a continuing care contract if the lender (or lender's spouse) is age 65 or older by the end of the calendar year. For 2005, this exception applies only to the part of the total outstanding loans from the lender (or lender's spouse) that does not exceed $158,100.

Different rules generally apply to a loan connected with the sale or exchange of property. If the loan does not provide adequate stated interest, part of the principal payment may be considered interest. However, there are exceptions that may require you to apply the below-market interest rate rules to these loans. See Unstated Interest and Original Issue Discount (OID) in Publication 537.

For more information on below-market loans, see section 7872 of the Internal Revenue Code and section 1.7872-5T of the regulations.

A taxing jurisdiction can require the use of a date for accruing taxes that is earlier than the date it originally required. However, if you use an accrual method, and can deduct the tax before you pay it, use the original accrual date for the year of change and all future years to determine when you can deduct the tax.

Uniform capitalization rules apply to certain taxpayers who produce real property or tangible personal property for use in a trade or business or for sale to customers. They also apply to certain taxpayers who acquire property for resale. Under these rules, you either include certain costs in inventory or capitalize certain expenses related to the property, such as taxes. For more information, see chapter 1.

Carrying charges include taxes you pay to carry or develop real estate or to carry, transport, or install personal property. You can elect to capitalize carrying charges not subject to the uniform capitalization rules if they are otherwise deductible. For more information, see chapter 8.

If you receive a refund for any taxes you deducted in an earlier year, include the refund in income to the extent the deduction reduced your federal income tax in the earlier year. For more information, see Recovery of amount deducted (tax benefit rule) in chapter 1.

Generally, you cannot deduct taxes charged for local benefits and improvements that tend to increase the value of your property. These include assessments for streets, sidewalks, water mains, sewer lines, and public parking facilities. You should increase the basis of your property by the amount of the assessment.

You can deduct taxes for these local benefits only if the taxes are for maintenance, repairs, or interest charges related to those benefits. If part of the tax is for maintenance, repairs, or interest, you must be able to show how much of the tax is for these expenses to claim a deduction for that part of the tax.

Water bills, sewerage, and other service charges assessed against your business property are not real estate taxes, but are deductible as business expenses.

If real estate is sold, the real estate taxes must be allocated between the buyer and the seller.

The buyer and seller must allocate the real estate taxes according to the number of days in the real property tax year (the period to which the tax imposed relates) that each owned the property. Treat the seller as paying the taxes up to but not including the date of sale. Treat the buyer as paying the taxes beginning with the date of sale. You can usually find this information on the settlement statement you received at closing.

If you (the seller) cannot deduct taxes until they are paid because you use the cash method and the buyer of your property is personally liable for the tax, you are considered to have paid your part of the tax at the time of the sale. This permits you to deduct the part of the tax up to (but not including) the date of sale even though you did not pay it. You must also include the amount of that tax in the selling price of the property.

If you (the seller) use an accrual method and have not elected to ratably accrue real estate taxes, you are considered to have accrued your part of the tax on the date you sell the property.

If you use an accrual method, you can elect to accrue real estate tax related to a definite period ratably over that period.

You cannot deduct federal income taxes.

A corporation or partnership can deduct state and local income taxes imposed on the corporation or partnership as business expenses. An individual can deduct state and local income taxes only as an itemized deduction on Schedule A (Form 1040).

However, an individual can deduct a state tax on gross income (as distinguished from net income) directly attributable to a trade or business as a business expense.

Generally, you can take either a deduction or a credit for income taxes imposed on you by a foreign country or a U.S. possession. However, an individual cannot take a deduction or credit for foreign income taxes paid on income that is exempt from U.S. tax under the foreign earned income exclusion or the foreign housing exclusion. For information on these exclusions, see Publication 54, Tax Guide for U.S. Citizens and Resident Aliens Abroad. For information on the foreign tax credit, see Publication 514, Foreign Tax Credit for Individuals.

As an employer, you may have to make payments to a state unemployment compensation fund or to a state disability benefit fund. Deduct these payments as taxes.

You can deduct as a business expense all excise taxes that are ordinary and necessary expenses of carrying on your trade or business. However, see Fuel taxes, later.

You can deduct corporate franchise taxes as a business expense.

Taxes on gasoline, diesel fuel, and other motor fuels that you use in your business are usually included as part of the cost of the fuel. Do not deduct these taxes as a separate item.

You may be entitled to a credit or refund for federal excise tax you paid on fuels used for certain purposes. For more information, see Publication 510.

You can deduct as a business expense an occupational tax charged at a flat rate by a locality for the privilege of working or conducting a business in the locality.

You can deduct any tax imposed by a state or local government on personal property used in your trade or business.

Treat any sales tax you pay on a service or on the purchase or use of property as part of the cost of the service or property. If the service or the cost or use of the property is a deductible business expense, you can deduct the tax as part of that service or cost. If the property is merchandise bought for resale, the sales tax is part of the cost of the merchandise. If the property is depreciable, add the sales tax to the basis for depreciation. For more information on basis, see Publication 551.

You can deduct one-half of your self-employment tax as a business expense in figuring your adjusted gross income. This deduction only affects your income tax. It does not affect your net earnings from self-employment or your self-employment tax.

To deduct the tax, enter on Form 1040, line 27, the amount shown on the Deduction for one-half of self-employment tax line of Schedule SE (Form 1040).

For more information on self-employment tax, see Publication 334.

You may be subject to the uniform capitalization rules if you do any of the following, unless the property is produced for your use other than in a business or an activity carried on for profit.

For more information on these rules, see Uniform Capitalization Rules in Publication 538 and the regulations under Internal Revenue Code section 263A.

If you use the cash method of accounting, you generally deduct insurance premiums in the tax year you actually paid them, even if you incurred them in an earlier year. However, see Prepayment, later.

If you use an accrual method of accounting, you cannot deduct insurance premiums before the tax year in which you incur a liability for them. In addition, you cannot deduct insurance premiums before the tax year in which you actually pay them (unless the exception for recurring items applies). For more information about the accrual method of accounting, see chapter 1. For information about the exception for recurring items, see Publication 538.

You cannot deduct expenses in advance, even if you pay them in advance. This rule applies to any expense paid far enough in advance to, in effect, create an asset with a useful life extending substantially beyond the end of the current tax year.

Expenses such as insurance are generally allocable to a period of time. You can deduct insurance expenses for the year to which they are allocable.

If you receive dividends from business insurance and you deducted the premiums in prior years, at least part of the dividends generally are income. For more information, see Recovery of amount deducted (tax benefit rule) in chapter 1 under How Much Can I Deduct?

To make the election to capitalize a carrying charge, write a statement saying which charges you elect to capitalize. Attach it to your original tax return for the year the election is to be effective. However, if you timely filed your return for the year without making the election, you can still make the election by filing an amended return within 6 months of the due date of the return (excluding extensions). Attach the statement to the amended return and write Filed pursuant to section 301.9100-2 on the statement. File the amended return at the same address you filed the original return.

Research and experimental costs are reasonable costs you incur in your trade or business for activities intended to provide information that would eliminate uncertainty about the development or improvement of a product. Uncertainty exists if the information available to you does not establish how to develop or improve a product or the appropriate design of a product. Whether costs qualify as research and experimental costs depends on the nature of the activity to which the costs relate rather than on the nature of the product or improvement being developed or the level of technological advancement.

The costs of obtaining a patent, including attorneys' fees paid or incurred in making and perfecting a patent application, are research and experimental costs. However, costs paid or incurred to obtain another's patent are not research and experimental costs.

You make the election to deduct research and experimental costs by deducting them on your tax return for the year in which you first pay or incur research and experimental costs. If you do not make the election to deduct research and experimental costs in the first year in which you pay or incur the costs, you can deduct the costs in a later year only with approval from the IRS.

If you pay or incur qualified research expenses, you may be able to take the research credit. For more information about the research credit, see the instructions to Form 6765, Credit for Increasing Research Activities.

Amounts paid to a contractor must be capitalized if they are either:

You elect to deduct IDCs as a current business expense by taking the deduction on your income tax return for the first tax year you have eligible costs. No formal statement is required. If you file Schedule C (Form 1040), enter these costs under Other expenses.

For oil and gas wells, your election is binding for the year it is made and for all later years. For geothermal wells, your election can be revoked by the filing of an amended return on which you do not take the deduction. You can file the amended return for the year up to the normal time of expiration for filing a claim for credit or refund, generally, within 3 years after the date you filed the original return or within 2 years after the date you paid the tax, whichever is later.

If you capitalize the drilling and development costs of geothermal wells that you place in service during the tax year, you may be able to claim a business energy credit. See the instructions for Form 3468 for more information.

If you capitalize your IDCs, you have another option if the well is nonproductive. You can deduct the IDCs of the nonproductive well as an ordinary loss. You must indicate and clearly state your election on your tax return for the year the well is completed. Once made, the election for oil and gas wells is binding for all later years. You can revoke your election for a geothermal well by filing an amended return that does not claim the loss.

You cannot deduct as a current business expense all the IDCs paid or incurred for an oil, gas, or geothermal well located outside the United States. However, you can elect to include the costs in the adjusted basis of the well to figure depletion or depreciation. If you do not make this election, you can deduct the costs over the 10-year period beginning with the tax year in which you paid or incurred them. These rules do not apply to a nonproductive well.

You elect to deduct exploration costs by taking the deduction on your income tax return, or on an amended income tax return, for the first tax year for which you wish to deduct the costs paid or incurred during the tax year. Your return must adequately describe and identify each property or mine, and clearly state how much is being deducted for each one. The election applies to the tax year you make this election and all later tax years.

A corporation (other than an S corporation) can deduct only 70% of its domestic exploration costs. It must capitalize the remaining 30% of costs and amortize them over the 60-month period starting with the month the exploration costs are paid or incurred. A corporation may also elect to capitalize and amortize mining exploration costs over a 10-year period. For more information on this method of amortization, see Internal Revenue Code section 59(e).

The 30% the corporation capitalizes cannot be added to its basis in the property to figure cost depletion. However, the amount amortized is treated as additional depreciation and is subject to recapture as ordinary income on a disposition of the property. See Section 1250 Property under Depreciation Recapture in chapter 3 of Publication 544.

These rules also apply to the deduction of development costs by corporations. See Development Costs, later.

When your mine reaches the producing stage, you must recapture any exploration costs you elected to deduct. Use either of the following methods.

You also must recapture deducted exploration costs if you receive a bonus or royalty from mine property before it reaches the producing stage. Do not claim any depletion deduction for the tax year you receive the bonus or royalty and any later tax years, until the depletion you would have deducted equals the exploration costs you deducted.

Generally, if you dispose of the mine before you have fully recaptured the exploration costs you deducted, recapture the balance by treating all or part of your gain as ordinary income.

Under these circumstances, you generally treat as ordinary income all of your gain if it is less than your adjusted exploration costs with respect to the mine. If your gain is more than your adjusted exploration costs, treat as ordinary income only a part of your gain, up to the amount of your adjusted exploration costs.

If you pay or incur exploration costs for a mine or other natural deposit located outside the United States, you cannot deduct all the costs in the current year. You can elect to include the costs (other than for an oil, gas, or geothermal well) in the adjusted basis of the mineral property to figure cost depletion. (Cost depletion is discussed in chapter 10.) If you do not make this election, you must deduct the costs over the 10-year period beginning with the tax year in which you pay or incur them. These rules also apply to foreign development costs.

The election to deduct development costs ratably as the ores or minerals are sold must be made for each mine or other natural deposit by a clear indication on your return or by a statement filed with the IRS office where you file your return. Generally, you must make the election by the due date of the return (including extensions). However, if you timely filed your return for the year without making the election, you can still make the election by filing an amended return within 6 months of the due date of the return (excluding extensions). Clearly indicate the election on your amended return and write Filed pursuant to section 301.9100-2. File the amended return at the same address you filed the original return.

The rules discussed earlier for foreign exploration costs apply to foreign development costs.

The rules discussed earlier for reduced corporate deductions for exploration costs also apply to corporate deductions for development costs.

If you do not want to deduct circulation costs as a current business expense, you can elect one of the following ways to recover these costs.

You elect to capitalize circulation costs by attaching a statement to your return for the first tax year the election applies. Your election is binding for the year it is made and for all later years, unless you get IRS approval to revoke it.

Qualified environmental cleanup costs are generally costs you pay or incur to abate or control hazardous substances at a qualified contaminated site.

You elect to deduct environmental cleanup costs by taking the deduction on the income tax return (filed by the due date including extensions) for the tax year in which the costs are paid or incurred. The costs are deducted differently depending on the type of business entity involved.

This deduction may have to be recaptured as ordinary income under section 1245 when you sell or otherwise dispose of the property that would have received an addition to basis if you had not elected to deduct the expenditure. For more information on recapturing the deduction, see Depreciation and amortization under Gain Treated as Ordinary Income in Publication 544.

For more information about the environmental cleanup cost deduction, see Internal Revenue Code section 198.

You elect to deduct the start-up or organizational costs by claiming the deduction on the income tax return (filed by the due date including extensions) for the tax year in which the active trade or business begins. However, if you timely filed your return for the year without making the election, you can still make the election by filing an amended return within 6 months of the due date of the return (excluding extensions). Clearly indicate the election on your amended return and write Filed pursuant to section 301.9100-2. File the amended return at the same address you filed the original return. The election applies when computing taxable income for the current tax year and all subsequent years.

You elect to deduct qualifying reforestation costs by claiming the deduction on your timely filed income tax return (including extensions) for the tax year the expenses were paid or incurred. However, if you timely filed your return for the year without making the election, you can still make the election by filing an amended return within 6 months of the due date of the return (excluding extensions). Clearly indicate the election on your amended return and write Filed pursuant to section 301.9100-2. File the amended return at the same address you filed the original return. The election applies when computing taxable income for the current tax year and all subsequent years.

For additional information on reforestation costs, see chapter 9.

This deduction may have to be recaptured as ordinary income under section 1245 when you sell or otherwise dispose of the property that would have received an addition to basis if you had not elected to deduct the expenditure. For more information on recapturing the deduction, see Depreciation and amortization under Gain Treated as Ordinary Income in Publication 544.

The most you can deduct as a cost of removing barriers to the disabled and the elderly for any tax year is $15,000. However, you can add any costs over this limit to the basis of the property and depreciate these excess costs.

The $15,000 limit applies to a partnership and also to each partner in the partnership. A partner can allocate the $15,000 limit in any manner among the partner's individually incurred costs and the partner's distributive share of partnership costs. If the partner cannot deduct the entire share of partnership costs, the partnership can add any costs not deducted to the basis of the improved property.

A partnership must be able to show that any amount added to basis was not deducted by the partner and that it was over a partner's $15,000 limit (as determined by the partner). If the partnership cannot show this, it is presumed that the partner was able to deduct the distributive share of the partnership's costs in full.

You can deduct your costs as a current expense only if the barrier removal meets the guidelines and requirements issued by the Architectural and Transportation Barriers Compliance Board under the Americans with Disabilities Act (ADA) of 1990. You can view the Americans with Disabilities Act at www.usdoj.gov/crt/ada/pubs/ada.txt.

The following is a list of some architectural barrier removal costs that can be deducted.

The following is a list of some deductible transportation barrier removal costs.

Also, you can access the ADA website at www.ada.gov for additional information.

If you elect to deduct your costs for removing barriers to the disabled or the elderly, claim the deduction on your income tax return (partnership return for partnerships) for the tax year the expenses were paid or incurred. Identify the deduction as a separate item. The election applies to all the qualifying costs you have during the year, up to the $15,000 limit. If you make this election, you must maintain adequate records to support your deduction.

For your election to be valid, you generally must file your return by its due date, including extensions. However, if you timely filed your return for the year without making the election, you can still make the election by filing an amended return within 6 months of the due date of the return (excluding extensions). Clearly indicate the election on your amended return and write Filed pursuant to section 301.9100-2. File the amended return at the same address you filed the original return. Your election is irrevocable after the due date, including extensions, of your return.

If you make your business accessible to persons with disabilities and your business is an eligible small business, you may be able to claim the disabled access credit. If you choose to claim the credit, you must reduce the amount you deduct or capitalize by the amount of the credit.

For more information about the disabled access credit, see Form 8826.

The amortization period for any section 197 intangible leased under a lease agreement entered into after March 12, 2004, to a tax-exempt organization, governmental unit, or foreign person or entity (other than a partnership), shall not be less than 125 percent of the lease term. See section 197(f)(10) of the Internal Revenue Code.

The rules for section 197 intangibles do not apply to any amount that is included in determining the cost of property that is not a section 197 intangible. For example, if the cost of computer software is not separately stated from the cost of hardware or other tangible property and you consistently treat it as part of the cost of the hardware or other tangible property, these rules do not apply. Similarly, none of the cost of acquiring real property held for the production of rental income is considered the cost of goodwill, going concern value, or any other section 197 intangible.

Reforestation costs are the direct costs of planting or seeding for forestation or reforestation. Qualifying costs include only those costs you must capitalize and include in the adjusted basis of the property. They include costs for the following items.

Qualified timber property is property that contains trees in significant commercial quantities. It can be a woodlot or other site that you own or lease. The property qualifies only if it meets all the following requirements.

The 84-month amortization period starts on the first day of the first month of the second half of the tax year you incur the costs (July 1 for a calendar year taxpayer), regardless of the month you actually incur the costs. You can claim amortization deductions for no more than 6 months of the first and last (eighth) tax years of the period.

If one person holds the property for life with the remainder going to another person, the life tenant is entitled to the full amortization for qualifying reforestation costs incurred by the life tenant. Any remainder interest in the property is ignored for amortization purposes.

If you dispose of qualified timber property within 10 years after the tax year you incur qualifying reforestation expenses, report any gain as ordinary income up to the amortization you took. See chapter 3 of Publication 544 for more information.

Amortizable reforestation costs qualify for the investment credit, whether or not they are amortized. See the instructions for Form 3468 for information on the investment credit.

To elect to amortize qualifying reforestation costs, complete Part VI of Form 4562 and attach a statement that contains the following information.

Generally, you must make the election on a timely filed return (including extensions) for the tax year in which you incurred the costs. However, if you timely filed your return for the year without making the election, you can still make the election by filing an amended return within 6 months of the due date of the return (excluding extensions). Attach Form 4562 and the statement to the amended return and write Filed pursuant to section 301.9100-2 on Form 4562. File the amended return at the same address you filed the original return.

The following chart shows where to report your amortization deduction for qualifying reforestation costs after you enter it on Form 4562. If you file . . . The deduction goes on . . . Schedule C (Form 1040) Line 27 Schedule F (Form 1040) Line 34 Form 1120 Line 26 Form 1120-A Line 22 Form 1120S Schedules K and K-1 Form 1065 Schedules K and K-1 None of the above Line 36 of Form 1040 (identify as RFST)You cannot report your amortization deduction on Schedule C-EZ (Form 1040).

You must get IRS approval to revoke your election to amortize qualifying reforestation costs. Your application to revoke the election must include your name, address, the years for which your election was in effect, and your reason for revoking it. You, or your duly authorized representative, must sign the application and file it at least 90 days before the due date (without extensions) for filing your income tax return for the first tax year for which your election is to end.

Certain atmospheric pollution control facilities placed in service after April 11, 2005, can be amortized over 84 months. To qualify, the following must apply.

A corporation must reduce the amortizable basis of a pollution control facility by 20% before figuring the amortization deduction.

For more information on the amortization of pollution control facilities, see section 169 of the Internal Revenue Code and the related regulations.

Rather than amortize these costs or deduct them as a current expense, you have the option of deducting (writing off) research and experimental costs ratably over a 10-year period beginning with the tax year in which you incurred the costs.

You can amortize costs chargeable to a capital account if you meet both the following requirements.

To elect to amortize research and experimental costs, complete Part VI of Form 4562 and attach it to your income tax return. Generally, you must file the return by the due date (including extensions). However, if you timely filed your return for the year without making the election, you can still make the election by filing an amended return within 6 months of the due date of the return (excluding extensions). Attach Form 4562 to the amended return and write Filed pursuant to section 301.9100-2 on Form 4562. File the amended return at the same address you filed the original return.

Your election is binding for the year it is made and for all later years unless you get IRS approval to change to a different method.

To elect to amortize qualifying costs over the optional recovery period, complete Part VI of Form 4562 and attach a statement containing the following information to your return for the tax year in which the election begins.

Generally, the election must be made on a timely filed return (including extensions) for the tax year in which you incurred the costs. However, if you timely filed your return for the year without making the election, you can still make the election by filing an amended return within 6 months of the due date of the return (excluding extensions). Attach Form 4562 to the amended return and write Filed pursuant to section 301.9100-2 on Form 4562. File the amended return at the same address you filed the original return.

You must get IRS consent to revoke your election. Your request to revoke the election must be submitted to the IRS in the form of a letter ruling before the end of the tax year in which the optional recovery period ends. The request must contain all of the information necessary to demonstrate the rare and unusual circumstances that would justify granting revocation. If the request for revocation is approved, any unamortized costs are deductible in the year the revocation is effective.

To figure your cost depletion allowance, you multiply the number of timber units cut by your depletion unit.

Claim your depletion allowance as a deduction in the year of sale or other disposition of the products cut from the timber, unless you choose to treat the cutting of timber as a sale or exchange (explained below). Include allowable depletion for timber products not sold during the tax year the timber is cut as a cost item in the closing inventory of timber products for the year. The inventory is your basis for determining gain or loss in the tax year you sell the timber products.

You can elect, under certain circumstances, to treat the cutting of timber held for more than 1 year as a sale or exchange. You must make the election on your income tax return for the tax year to which it applies. If you make this election, subtract the adjusted basis for depletion from the fair market value of the timber on the first day of the tax year in which you cut it to figure the gain or loss on the cutting. You generally report the gain as long-term capital gain. The fair market value then becomes your basis for figuring your ordinary gain or loss on the sale or other disposition of the products cut from the timber. For more information, see Timber in chapter 2 of Publication 544, Sales and Other Dispositions of Assets.

You may revoke an election to treat the cutting of timber as a sale or exchange without IRS's consent. The prior election (and revocation) is disregarded for purposes of making a subsequent election. See Form T (Timber), Forest Activities Schedule, for more information.

Complete and attach Form T (Timber) to your income tax return if you claim a deduction for timber depletion, choose to treat the cutting of timber as a sale or exchange, or make an outright sale of timber.

Business bad debts are mainly the result of credit sales to customers. Goods and services customers have not paid for are recorded in your books as either accounts receivable or notes receivable. If you are unable to collect any part of these receivables, the uncollectible part is a business bad debt.

Accounts or notes receivable valued at fair market value when received are deductible only at that value, even though the fair market value may be less than face value. If you bought an account receivable for less than its face value, the amount you can deduct if it becomes worthless is the amount you paid for it.

If you sell your business but keep its receivables, these debts are business debts since they arose out of your trade or business. If one of these debts later becomes worthless, the loss is still a business bad debt. These debts would also be business debts if sold to the new owner of the business.

If you sell your business to one person and sell your receivables to someone else, the activities of the new holder of the debts determine whether they are business or nonbusiness debts for that person. A loss from the debts is a business bad debt to the new holder if that person acquired the debts in his or her trade or business or if the debts were closely related to the new holder's trade or business when they became worthless. Otherwise, a loss from these debts is a nonbusiness bad debt.

If you receive property in partial settlement of a debt, reduce the debt by the fair market value of the property received. You can deduct the remaining debt as a bad debt if and when it becomes worthless.

If you later sell the property, any gain on the sale is due to the appreciation of the property. It is not a recovery of a bad debt. For information on the sale of an asset, see Publication 544.

Definitions: Clean-burning fuelThe following are clean-burning fuels.

A motor vehicle is any vehicle that has four or more wheels and is manufactured primarily for use on public streets, roads, and highways. It does not include a vehicle operated exclusively on a rail or rails.

This is property used in the following ways.

You can usually deduct as a business expense the cost of institutional or goodwill advertising to keep your name before the public if it relates to business you reasonably expect to gain in the future. For example, the cost of advertising that encourages people to contribute to the Red Cross, to buy U.S. Savings Bonds, or to participate in similar causes is usually deductible.

Anticipated liabilities or reserves for anticipated liabilities are not deductible. For example, assume you sold 1-year TV service contracts this year totaling $50,000. From experience, you know you will have expenses of about $15,000 in the coming year for these contracts. You cannot deduct any of the $15,000 this year by charging expenses to a reserve or liability account. You can deduct your expenses only when you actually pay or accrue them, depending on your accounting method.

Engaging in the payment of bribes or kickbacks is a serious criminal matter. Such activity could result in criminal prosecution. Any payments that appear to have been made, either directly or indirectly, to an official or employee of any government or an agency or instrumentality of any government are not deductible for tax purposes and are in violation of the law.

Payments paid directly or indirectly to a person in violation of any federal or state law (but only if that state law is generally enforced, defined below) that provides for a criminal penalty or for the loss of a license or privilege to engage in a trade or business are also not allowed as a deduction for tax purposes.

The costs of operating a car, truck, or other vehicle in your business are deductible. For more information on how to figure your deduction, see Publication 463.

Cash payments to an organization, charitable or otherwise, may be deductible as business expenses if the payments are not charitable contributions or gifts. If the payments are charitable contributions or gifts, you cannot deduct them as business expenses. However, corporations (other than S corporations) can deduct charitable contributions on their income tax returns, subject to limitations. See the Instructions for Form 1120 and 1120-A for more information. Sole proprietors, partners in a partnership, or shareholders in an S corporation may be able to deduct charitable contributions made by their business on Schedule A (Form 1040).

Generally, amounts paid or incurred for membership in any club organized for business, pleasure, recreation, or any other social purpose are not deductible. Clubs organized for business, pleasure, recreation, or other social purpose include, but are not limited to country clubs, golf and athletic clubs, hotel clubs, sporting clubs, airline clubs, and clubs operated to provide meals under circumstances generally considered to be conducive to business discussions.

Credit card companies charge a fee to businesses who accept their cards. This fee when paid or incurred by the business can be deducted as a business expense.

Special rules apply to compensation you receive for damages sustained as a result of patent infringement, breach of contract or fiduciary duty, or antitrust violations. You must include this compensation in your income. However, you may be able to take a special deduction. The deduction applies only to amounts recovered for actual injury, not any additional amount. The deduction is the smaller of the following.

Amounts paid or incurred to demolish a structure are not deductible. These amounts are added to the basis of the land where the demolished structure was located. Any loss for the remaining undepreciated basis of a demolished structure would not be recognized until the property is disposed.

Ordinary and necessary expenses paid for the cost of the education and training of your employees are deductible. See Education Expenses in chapter 2.

You may also deduct the cost of your own education (including certain related travel) related to your trade or business. You must be able to show the education maintains or improves skills required in your trade or business, or that it is required by law or regulations, for keeping your license to practice, status, or job. For example, an attorney can deduct the cost of attending Continuing Legal Education (CLE) classes that are required by the state bar association to maintain his or her license to practice law.

Education expenses you incur to meet the minimum requirements of your present trade or business, or those that qualify you for a new trade or business, are not deductible. This is true even if the education maintains or improves skills presently required in your business. For more information on education expenses, see Publication 970.

If you buy a franchise, trademark, or trade name, you can deduct the amount you pay or incur as a business expense only if your payments are part of a series of payments that are:

When determining the term of the transfer agreement, include all renewal options and any other period for which you and the transferrer reasonably expect the agreement to be renewed.

A franchise includes an agreement that gives one of the parties to the agreement the right to distribute, sell, or provide goods, services, or facilities within a specified area.

If you are disabled, you can deduct expenses necessary for you to be able to work (impairment-related expenses) as a business expense, rather than as a medical expense.

You are disabled if you have either of the following.

The expense qualifies as a business expense if all the following apply.

Reimbursements you make to job candidates for transportation or other expenses related to interviews for possible employment are not wages. You can deduct the reimbursements as a business expense. However, expenses for food, beverages, and entertainment are subject to the 50% limit discussed earlier under Meals and Entertainment.

Fees charged by accountants and attorneys that are ordinary and necessary expenses directly related to operating your business are deductible as business expenses. However, usually legal fees you pay to acquire business assets are not deductible. These costs are added to the basis of the property.

Fees that include payments for work of a personal nature (such as drafting a will, or damages arising from a personal injury), are not allowed as a business deduction on Schedule C or C-EZ. If the invoice includes both business and personal charges, compute the business portion as follows: multiply the total amount of the bill by a fraction, the numerator of which is the amount attributable to business matters, the denominator of which is the total amount paid. The result is the portion of the invoice attributable to business expenses. The portion attributable to personal matters is the difference between the total amount and the business portion (computed above).

Legal fees relating to personal tax advice may be deductible on Line 22, Schedule A (Form 1040), if you itemize deductions. However, the deduction is subject to the 2% limitation on miscellaneous itemized deductions. See Publication 529, Miscellaneous Deductions.

Licenses and regulatory fees for your trade or business paid annually to state or local governments generally are deductible. Some licenses and fees may have to be amortized. See chapter 9 for more information.

Generally, lobbying expenses are not deductible. Lobbying expenses include amounts paid or incurred for any of the following activities.

Your expenses for influencing legislation and communicating directly with a covered executive branch official include a portion of your labor costs and general and administrative costs of your business. For information on making this allocation, see section 1.162-28 of the regulations.

You cannot claim a charitable or business expense deduction for amounts paid to an organization if both of the following apply.

If a tax-exempt organization, other than a section 501(c)(3) organization, provides you with a notice on the part of dues that is allocable to nondeductible lobbying and political expenses, you cannot deduct that part of the dues.

Generally, the cost of moving machinery from one city to another is a deductible expense. So is the cost of moving machinery from one plant to another, or from one part of your plant to another. You can deduct the cost of installing the machinery in the new location. However, you must capitalize the costs of installing or moving newly purchased machinery.

The costs of outplacement services you provide to your employees to help them find new employment, such as career counseling, résumé assistance, skills assessment, etc. are deductible.

The costs of outplacement services may cover more than one deduction category. For example, deduct as a utilities expense the cost of telephone calls made under this service and deduct as rental expense the cost of renting machinery and equipment for this service.

For information on whether the value of outplacement services is includable in your employees' income, see Publication 15-B.

Penalties paid for late performance or nonperformance of a contract are generally deductible. For instance, you own and operate a construction company. You have been contracted to construct a building by a certain date. Due to construction delays, the building is not completed and ready for occupancy on the date stipulated in the contract. You are now required to pay an additional amount for each day that completion is delayed beyond the completion date stipulated in the contract. These additional costs are deductible business expenses.

On the other hand, penalties or fines paid to any government agency or instrumentality because of a violation of any law are not deductible. These fines or penalties include the following amounts.

Examples of nondeductible penalties and fines include the following.

A fine or penalty does not include any of the following.

Contributions or gifts paid to political parties or candidates are not deductible. In addition, expenses paid or incurred to take part in any political campaign of a candidate for public office are not deductible.

The cost of repairing or improving property used in your trade or business is either a deductible or capital expense. Routine maintenance that keeps your property in a normal efficient operating condition, but that does not materially increase the value or substantially prolong the useful life of the property is deductible in the year that it is incurred. Otherwise, the cost must be depreciated over the useful life of the property. See Form 4562 and its instructions for how to compute and claim the depreciation deduction.

The cost of repairs includes the costs of labor, supplies, and certain other items. The value of your own labor is not deductible. Examples of repairs include:

If you had to repay an amount you included in your income in an earlier year, you may be able to deduct the amount repaid for the year in which you repaid it. Or, if the amount you repaid is more than $3,000, you may be able to take a credit against your tax for the year in which you repaid it.

Subscriptions to professional, technical, and trade journals that deal with your business field are deductible.

Unless you have deducted the cost in any earlier year, you generally can deduct the cost of materials and supplies actually consumed and used during the tax year.

If you keep incidental materials and supplies on hand, you can deduct the cost of the incidental materials and supplies you bought during the tax year if all the following requirements are met.

You can also deduct the cost of books, professional instruments, equipment, etc., if you normally use them within a year. However, if the usefulness of these items extends substantially beyond the year they are placed in service, you generally must recover their costs through depreciation. For more information regarding depreciation see Publication 946, How to Depreciate Property.

Business expenses for heat, lights, power, telephone service, and water and sewerage are deductible. However, any part attributable to personal use is not deductible.

If you have attempted to deal with an IRS problem unsuccessfully, you should contact your Taxpayer Advocate.

The Taxpayer Advocate independently represents your interests and concerns within the IRS by protecting your rights and resolving problems that have not been fixed through normal channels. While Taxpayer Advocates cannot change the tax law or make a technical tax decision, they can clear up problems that resulted from previous contacts and ensure that your case is given a complete and impartial review.

To contact your Taxpayer Advocate:

For more information, see Publication 1546, How To Get Help With Unresolved Tax Problems (now available in Chinese, Korean, Russian, and Vietnamese, in addition to English and Spanish).

To find out what services are available, get Publication 910, IRS Guide to Free Tax Services. It contains a list of free tax publications and an index of tax topics. It also describes other free tax information services, including tax education and assistance programs and a list of TeleTax topics.