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IRS.gov Website
Publication 535
taxmap/pubs/p535-003.htm#en_us_publink1000208634

When Can I Deduct an Expense?(p6)

rule
When you can deduct an expense depends on your accounting method. An accounting method is a set of rules used to determine when and how income and expenses are reported. The two basic methods are the cash method and the accrual method. Whichever method you choose must clearly reflect income.
For more information on accounting methods, see Pub. 538.
taxmap/pubs/p535-003.htm#en_us_publink1000208635

Cash method.(p6)

rule
Under the cash method of accounting, you generally deduct business expenses in the tax year you pay them.
taxmap/pubs/p535-003.htm#en_us_publink1000208636

Accrual method.(p6)

rule
Under an accrual method of accounting, you generally deduct business expenses when both of the following apply.
  1. The all-events test has been met. The test is met when:
    1. All events have occurred that fix the fact of liability, and
    2. The liability can be determined with reasonable accuracy.
  2. Economic performance has occurred.
taxmap/pubs/p535-003.htm#en_us_publink1000208637
Economic performance.(p6)
You generally cannot deduct or capitalize a business expense until economic performance occurs. If your expense is for property or services provided to you, or for your use of property, economic performance occurs as the property or services are provided, or the property is used. If your expense is for property or services you provide to others, economic performance occurs as you provide the property or services.
taxmap/pubs/p535-003.htm#en_us_publink1000208638

Example.(p6)

Your tax year is the calendar year. In December 2017, the Field Plumbing Company did some repair work at your place of business and sent you a bill for $600. You paid it by check in January 2018. If you use the accrual method of accounting, deduct the $600 on your tax return for 2017 because all events have occurred to "fix" the fact of liability (in this case, the work was completed), the liability can be determined, and economic performance occurred in that year.
If you use the cash method of accounting, deduct the expense on your 2018 tax return.
taxmap/pubs/p535-003.htm#en_us_publink1000208639

Prepayment.(p6)

rule
You generally cannot deduct expenses in advance, even if you pay them in advance. This applies to prepaid interest, prepaid insurance premiums, and any other prepaid expense that creates an intangible asset. If you pay an amount that creates an intangible asset, then you must capitalize the amounts paid and begin to amortize the payment over the appropriate period.
However, you do not have to capitalize amounts for creating an intangible asset if the right or benefit created does not extend beyond the earlier of 12 months after the date that you first receive the right or benefit or the end of the tax year following the year in which you made the advance payment. If you are a cash method taxpayer and your advance payment qualifies for this exception, then you can generally deduct the amount when paid. If you are an accrual method taxpayer, you cannot deduct the amount until the all-events test has been met and economic performance has occurred.
taxmap/pubs/p535-003.htm#en_us_publink1000208640

Example 1.(p6)

In 2017, you sign a 10-year lease and immediately pay your rent for the first 3 years. Even though you paid the rent for 2017, 2018, and 2019, you can only deduct the rent for 2017 on your 2017 tax return. You can deduct the rent for 2018 and 2019 on your tax returns for those years.
taxmap/pubs/p535-003.htm#en_us_publink100075811

Example 2.(p6)

You are a cash method calendar year taxpayer. On December 1, 2017, you sign a 12-month lease, effective beginning January 1, 2018, and immediately pay your rent for the entire 12-month period that begins on January 1, 2018. The right or benefit attributable to the payment neither extends more than 12 months beyond January 1, 2018 (the first day that you are entitled to use the property) nor beyond the tax year ending December 31, 2018 (the year following the year in which you made the advance payment). Therefore, your prepayment does not have to be capitalized, and you can deduct the entire payment in the year you pay it.
taxmap/pubs/p535-003.htm#en_us_publink1000208641

Contested liability.(p6)

rule
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 Regulations section 1.461-2.
taxmap/pubs/p535-003.htm#en_us_publink1000208642

Related person.(p6)

rule
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. For more information, see Related Persons in Pub. 538.