What Are the Tax Rules for Dual Use Property?

An asset that serves both a business and a personal function is known as dual-use property. This classification is common, as many individuals use personal assets to support their trade or business activities, such as a vehicle for client visits or a home computer for managing a business. When an asset is used for both generating income and personal enjoyment, the Internal Revenue Service (IRS) requires a clear division between the two uses. Only the portion of an asset’s cost attributable to business activity is eligible for tax deductions. To claim these deductions, you must substantiate the split with proper documentation, as the rules prevent the deduction of personal living costs.

Calculating the Business Use Portion

To handle dual-use property taxes, you must accurately calculate the percentage of business use. For vehicles, this involves tracking mileage in a log that details:

• The date of each business trip
• The destination
• The specific business purpose of the travel
• The starting and ending odometer readings for the trip

At the end of the year, the total business miles are divided by the total miles driven to determine the business-use percentage.

For a home office, the calculation is based on physical space using the square footage method, which involves dividing the area used exclusively for business by the home’s total square footage. An alternative is the simplified method, which allows a standard deduction per square foot of business space. Other assets, like computers or cameras, require a time-based log to track total hours of use versus business hours. For all methods, the IRS requires that records be kept contemporaneously, and the taxpayer has the burden of proof to provide these records.

Deducting Costs and Depreciation

Once the business-use percentage is established, it can be applied to the property’s costs. Expenses are categorized as either direct or indirect. Direct expenses apply solely to the business portion of the asset and are 100% deductible, such as a repair to a machine used only for business.

Indirect expenses benefit the entire property and must be allocated using the business-use percentage. For a home office with a 10% business use, 10% of costs like mortgage interest and utility bills can be deducted. Similarly, for a vehicle used 60% for business, 60% of the total costs for fuel and insurance can be deducted.

Beyond immediate expenses, the cost of the business portion of the asset can be recovered over time through depreciation. The Modified Accelerated Cost Recovery System (MACRS) is the standard depreciation framework, allowing for the recovery of an asset’s cost over a predetermined number of years. For a more immediate tax benefit, Section 179 allows taxpayers to expense the business cost of qualifying property in the year it is placed in service, subject to limits. Another accelerated option is bonus depreciation, which provides an additional first-year deduction, but this tax break is being phased out. The bonus rate is 40% for property placed in service in 2025 and is scheduled to drop to 20% in 2026.

Certain dual-use assets are subject to stricter “listed property” rules, including passenger automobiles under 6,000 pounds, computers, and photographic equipment. To use accelerated depreciation methods like Section 179 or bonus depreciation for these items, business use must exceed 50%. If business use is 50% or less, the taxpayer is restricted to a slower, straight-line depreciation method. Should business use fall to 50% or below in a future year, any excess depreciation claimed in prior years must be recaptured and reported as income.

Tax Consequences Upon Sale or Disposal

When a dual-use asset is sold, the transaction is treated as if two separate properties were sold. First, you must calculate the adjusted basis for the business portion of the asset. The basis begins with the original cost and is then reduced by all depreciation deductions claimed while the property was in service. This final figure is the adjusted basis for the business portion.

The sale price must also be allocated between the personal and business portions using the business-use percentage from the year of the sale. For example, if a computer used 40% for business is sold for $1,000, then $400 of the proceeds are allocated to the business portion. The gain or loss on the business part is calculated by subtracting its adjusted basis from its share of the sale proceeds.

A key concept in the sale of business assets is depreciation recapture. Any gain on the sale of the business portion is first treated as ordinary income up to the amount of depreciation previously deducted. For example, an asset’s business portion had an original cost of $3,000, and $2,000 in depreciation was claimed, reducing the adjusted basis to $1,000. If this business portion is sold for $2,500, the total gain is $1,500, all of which is recaptured and taxed at ordinary income rates because it is less than the total depreciation taken.

This recapture rule ensures the tax benefit from depreciation is paid back upon the sale of the asset. Any gain above the recaptured amount is treated as a capital gain. Losses on the business portion are generally deductible, while losses on the personal portion are not.