Electing the Section 179 Expensing Deduction
HOW MUCH CAN TAXPAYERS DEDUCT?
The cost of the qualifying property is generally the amount of the deduc-tion. However, the total amount a taxpayer can deduct is subject to dollar limits, investment limits, and a business income limit.
The Code Sec. 179 deduction applies to each taxpayer and not to each busi-ness. Therefore, taxpayers with multiple businesses or sources of income must evaluate which qualifying property they will elect to expense for that year.
CAUTION
Special rules apply to married couples, partnerships, S corporations, and opportunity zones, as explained later in this chapter.
REMINDER
If a taxpayer is only able to deduct a portion of the property’s cost, the taxpayer can depreciate the remainder under normal depreciation rules to recover the cost of the property.
When a business acquires property through a trade-in of other property, the cost of the purchase will only be the cash that is paid. In other words,
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if the taxpayer buys qualifying property with cash and trades in other property, its qualifying cost, for purposes of the Code Sec. 179 deduction, is only the cash paid.
EXAMPLE
Jamie traded in his old drafting table worth $800, plus $520 in cash, for a new drafting table valued at $1,320. He also traded a used truck, with a basis of $4,500, for a new truck that cost $9,000 based on a $4,800 trade-in allowance and $4,200 cash. Because only cash qualifies when determining cost under Code Sec. 179, Jamie was only able to deduct a total cost of $4,720 ($520 + $4,200) for the qualifying property.
Dollar Limits
For each tax year, the Internal Revenue Code sets, by way of an inflation formula, the total dollar amount of Code Sec. 179 property placed in service during that particular tax year that can qualify for the Section 179 deduction. For 2006, that amount is $108,000. In addition, a taxpayer that purchases too much Section 179-type property within the course of one year (i.e., more than a certain dollar maximum) must reduce the otherwise allowable Section 179 deduction under phaseout rules, which could reduce the deduction to zero.
Table 1 shows the maximum dollar amount that can be taken as a Section 179 deduction.
Table 1. Maximum Deduction by Tax Year
Tax Year Deduction Allowed
1997 $18,000
1998 $18,500
1999 $19,000
2000 $20,000
2001 $24,000
2002 $24,000
2003 $100,000
2004 $102,000
2005 $105,000
2006 $108,000
2007–2009 $100,000 + inflation adjustment 2010 + $25,000 (no inflation adjustment)
For 2007, the inflation-adjusted deduction limit is projected to rise to
$112,000.
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NOTE
The Section 179 deduction has been extended several times in its short history. The latest extension took place in the Tax Increase Prevention and Relief Act (TIPRA), passed in 2006. Without that extension, the expensing limit would have dropped to $25,000 on a $200,000 cap after 2007. Before passage of that tax bill, the American Jobs Creation Act of 2004 (AJCA) had extended for 2006 and 2007 an increase in the deduction introduced by the Jobs and Growth Tax Relief Reconciliation Act of 2003 (JGTRRA).
Taxpayers can acquire and place into service more than one item of qualifying property during a tax year, but the maximum deduction ap-plies to the total of all qualifying property purchased. Taxpayers have the opportunity to allocate the Code Sec. 179 deduction in any way among qualifying property in reducing basis, but the deduction cannot exceed the limit. Additionally, taxpayers are not required to claim a deduction valued at the entire limit.
COMMENT
The amount that is elected to be deducted is not affected if the taxpayer places the qualifying property into service in a short tax year or if the tax-payer places the qualifying property in service for only a part of a 12-month tax year. In this instance, the full dollar limitation may be expensed (subject to investment limitation and taxable income limitation) in a short tax year.
CAUTION
Although the dollar limit is used to determine the tentative deduction, the taxpayer must also apply the investment limitation and the business income limit to determine the actual Code Sec. 179 deduction.
EXAMPLE
In 2006, Albert bought and placed into service a tractor that cost $110,000 and a circular saw that cost $2,000. He elected to deduct $106,000 of his tractor’s cost and $2,000 of the circular saw’s cost for the maximum dollar limit for 2006, equaling $108,000. Because Albert elected to deduct $2,000 for the circular saw, he was able to completely recover its cost, making its basis for depreciation zero. However, he was unable to deduct the entire cost for the tractor, so he had a remaining basis of $4,000 ($110,000 – $106,000) that he will then be able to depreciate under normal depreciation rules.
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PLANNING POINTER
Taxpayers should consider allocating the Code Sec. 179 expense to prop-erty with the longest recovery period. For example, if an item of qualifying 10-year MACRS-type depreciable property and qualifying 5-year MACRS property is placed in service, the Code Sec. 179 deduction should be al-located to the 10-year property. This will allow for the cost of property to be recovered in the shortest period of time.
Investment Limitation
Taxpayers can have too much of a good thing as far as Code Sec. 179 property is concerned.
Phaseout. The Code Sec. 179 deduction phases out as the cost of the Sec-tion 179 property purchased and placed in service for the year increase over a certain maximum dollar amount. The deduction in excess of this overall threshold is reduced on a dollar-for-dollar basis. The limitation amount was $400,000 in 2003, after which it is increased each year by an inflation amount. In 2006, that amount is $430,000. It sets the maximum for the Section 179 deduction regardless of whether the taxpayer chooses to take the full deduction.
For example, if the cost of six items of qualifying property in 2006 totals more than $430,000, the taxpayer’s maximum $108,000 Section 179 deduc-tion must be reduced dollar-for-dollar for the total dollar amount of Secdeduc-tion 179 qualifying property that exceeds $430,000. The taxpayer must reduce the dollar limit (but not below zero) by the amount of the cost exceeding $430,000.
As a result, the taxpayer’s available $108,000 Section 179 deduction is reduced to zero if the total amount of Section 179 purchased and placed in service for 2006 exceeds $538,000.
Note, further, that if the taxpayer exceeds the limit because of the acquisi-tion of several items of qualifying property during the course of the year, the taxpayer may choose how to divide among the property the total reduction of the Section 179 deduction. Generally, taxpayers chose to take the maximum deduction on the property with the shortest depreciable class life in order to accelerate overall deductions as much as possible.
Table 2 lists the investment limits for tax years 2000 and beyond.
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Table 2. Investment Limits for Claiming Full Code Sec. 179 Deduction by Year
Tax Year Investment Limit
2000 $200,000
2001 $200,000
2002 $200,000
2003 $400,000
2004 $410,000
2005 $420,000
2006 $430,000
2007–2009 $400,000 + inflation adjustment 2010 + $200,000 (no inflation adjustment)
For 2007, the inflation-adjusted investment limit is projected to rise to
$450,000.
EXAMPLE
In 2005, Karen placed into service a printer costing $495,000. Because the cost of the printer was more than $430,000, she had to compute the excess amount, which is $495,000 – $420,000 = $75,000. She then had to take the 2005 dollar limit of $105,000 and reduce it by the excess amount of $75,000, which reduced her total dollar limit for taking the Code Sec. 179 deduction in 2005 to $30,000 ($105,000 – $75,000). The rest of her otherwise qualifying costs had to be depreciated over the life of the printer (generally, five years).
The purpose of the investment limit used to reduce the dollar limit is to keep the benefits of the deduction focused primarily on the small business. The investment limitation is also adjusted for inflation. Any unused portion of the dollar limit may not be carried forward. Therefore, tax planning helps in delaying certain Section 179 property purchases into a subsequent year when the taxpayer’s expenses exceed the $400,000-plus-inflation limit for the current year.
Inflation adjustments. Both the dollar limit and the investment limit for tax years beginning after 2003 and before 2010 are adjusted for inflation.
Remember, also, that the Section 179 deduction itself is all about inflation in the sense of accelerated deductions. If the Section 179 deduction is taken, depreciation deductions for that Section 179 amount that would have otherwise been taken over the asset’s remaining useful life are lost. Based on the assump-tion that it is better to take a deducassump-tion sooner, the Secassump-tion 179 deducassump-tion is better. As with most generalizations, this is not always the case. An immediate deduction is useless (or not as useful) if the business has overall losses, if the
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business will be in a higher tax rate in future years, if a cashout through an sale of the business is anticipated or other similar circumstances are expected. In such circumstances, going against the norm might be advisable.
Special Situations
Congress has allowed for special situations that affect the dollar limits for certain taxpayers. Two of the situations relate to disasters: Liberty Zone expensing put in place after 9/11 and GO Zone expensing created after Hurricane Katrina devastated the Gulf Coast.
Liberty Zone. Legislation has increased the Code Sec. 179 deduction dol-lar limit for property that is placed in the New York Liberty Zone (Liberty Zone). The dollar limit is the lesser of:
$35,000; or
The cost of the qualified Liberty Zone property.
COMMENT
The Liberty Zone is the area proximate to the former World Trade Center, located on or south of Canal Street, East Broadway (east of its intersec-tion with Canal Street), or Grand Street (east of its intersecintersec-tion with East Broadway) in the Borough of Manhattan in New York City.
The property must be qualified Liberty Zone property. Property placed in service in the Liberty Zone before January 1, 2007, is available for this deduction. Taxpayers calculating this deduction should only include 50 percent of the cost of Liberty Zone property when calculating the invest-ment limit ($430,000 for 2006).
Enterprise zone and renewal community businesses. Congress has also allowed for the annual dollar limit to be increased for property placed in enterprise zone businesses and for renewal community businesses. To qualify, the property must be placed within these zones. Therefore, the dollar limit on Code Sec. 179 deduction will be increased if the business qualifies. It will be the lesser of:
$35,000; or
Cost of 179 property that is also qualified zone property.
In addition, only 50 percent of the cost of the qualified property placed in service by the enterprise zone or community renewal business during the tax year is taken into account for purposes of applying the inflation-adjusted investment limitation ($430,000 for 2006).
In 2002, the annual dollar limitation for Code Sec. 179 property that is enterprise or renewal zone property was $59,000 ($24,000 + $35,000). This
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amount rose in 2003 to $135,000; in 2004 to $137,000; and in 2005 to
$140,000. In 2006, it is $143,000.
Gulf Opportunity (GO) Zone property. In areas that the Federal Emergency Management Agency (FEMA) has declared to be a disaster area after Hur-ricane Katrina, Congress has designated an increased Code Sec. 179 dollar limit for property placed into service. This applies to all qualified Code Sec. 179 property that is acquired after August 27, 2005.
COMMENT
IRS Publication 4492, Information for Taxpayers Affected by Hurricanes Katrina, Rita and Wilma, contains a complete list of the areas that have been designated for assistance by FEMA.
The GO Zone increased dollar limit is the smaller of:
$100,000; or
The cost of qualified Code Sec. 179 GO Zone property placed in ser-vice during the year (including such property placed in serser-vice by your spouse, even with a separate return).
In addition to an increased dollar limit, Congress has provided for an increased investment limit for GO Zone property. As under the regular Section 179 de-duction rules, the amount a taxpayer can take under an election that includes GO Zone property is reduced if the cost of all Code Sec. 179 property placed in service exceeds that year’s investment limit. The limit will be increased by the smaller of $600,000 (adjusted for inflation) or the cost of qualified Code Sec. 179 GO Zone property placed in service during the year.
Code Sec. 1400N requires that substantially all of the property must be used in the GO Zone. The IRS clarified this requirement to mean that the property must be used at least 80 percent during each tax year in the GO Zone. The property also must be used in the active conduct of a trade or business by the taxpayer. Notice 2006-67 elaborates that “active conduct” can be determined by applying a facts and circumstances test. Active conduct requires the meaningful participation in the management or operations by the taxpayer.
Property generally restricted from the enhanced GO Zone deduction in-cludes that used in connection with a private or commercial golf course, country club, massage parlor, hot tub facility, suntan facility, liquor store, or gambling or animal racing property, with certain de minimis exceptions.
Sport utility and other vehicles. Taxpayers cannot elect to expense more than $25,000 of the cost of a sport utility vehicle (SUV) placed in service during the tax year. This limit applies to any four-wheel drive vehicle that is designed to carry passengers over public streets, roads, or highways that
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weighs more than 6,000 pounds but less than 14,000 pounds. The $25,000 limit does not apply to:
Vehicles designed to hold more than nine passengers behind the driver;
Vehicles that are equipped with a cargo area that is open or enclosed by a cap, of at least six feet in interior length that is not readily accessible from passenger compartment; or
Vehicles that have an integral enclosure fully enclosing the driver com-partment and load-carrying device, do not have seating behind the driver’s seat, and contains no body section more than 30 inches ahead of the leading edge of the windshield.
Married taxpayers. How a married individual can claim the Code Sec.
179 deduction depends on whether he or she files a joint or separate tax return. When taxpayers file jointly, the taxpayer and spouse are treated as one taxpayer for determining any reduction to the dollar limit, regardless of who purchased the property. If the married couple files separate returns, for purposes of the small business expense, the couple will still be treated as one for the dollar limit, including the investment limitation ($430,000 for 2006). The couple must allocate the dollar limit, after the reduction for the investment limitation.
Without an affirmative allocation, married taxpayers are each allocated 50 percent of the cost that can be taken into account for the Code Sec. 179 deduc-tion. This allocation occurs regardless of which taxpayer actually paid for and acquired the property. The default allocation will also happen if the sum of the percentages that had been elected by the spouses does not equal 100 percent.
EXAMPLE
Lisa and Doug are married and file separate returns. Doug bought and placed into service $430,000 of qualified farm machinery in 2006. Lisa has her own business, and she bought and placed into service $10,000 of qualified equipment. Doug and Lisa’s total cost of qualified property is $440,000 to be placed into service. To calculate their dollar limit, they first need to reduce the cost of property by the amount it exceeds the investment limit ($440,000 of qualified property – $430,000 investment limitation = $10,000). Doug and Lisa will then reduce the $108,000 dollar limit by that $10,000 excess over the investment limit. Between the two of them, they can elect to expense $98,000. If they do not choose how to allocate the $98,000, it will be split evenly; however, they have the option to allocate the $98,000 between them any way they see fit.
Married couples who file an amended joint return after filing separate returns for the same tax year are limited by the separate annual dollar limi-tation stated on their separate returns and are subject to the annual dollar limit on the joint return rather than the aggregate amount deducted on the
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original separate returns. Additionally, taxpayers who file separate returns and choose to deduct less than the maximum amount may not subsequently increase the aggregate deduction on a joint return filed for the same tax year, above the total amount originally expensed on their returns. Therefore, when married taxpayers are amending their returns after the due date, the dollar limit on the joint return is lesser of the following:
Dollar limit (after the investment deduction); or
The total cost of the Code Sec. 179 property the taxpayer and spouse elected to expense on separate returns.
EXAMPLE
Joan and Greg, who are both calendar year taxpayers, purchase and place into service $10,000 worth of Code Sec. 179 qualifying property for the direct expense deduction. Joan and Greg file separate income tax returns for 2006. Joan decided to expense $3,000 of the property on her return and Greg decided to expense $2,000 on his return and depreciate the bal-ance. After the due date of their separate returns passes, both Joan and Greg decide to file an amended return using the joint filing status. Joan and Greg, on their joint return, can only elect to expense $5,000.
COMMENT
A special rule allows a taxpayer to revoke or change an election made with respect to property placed in service in a tax year beginning in 2003 through 2009 if the limitations period for filing an amended return has not expired.
PLANNING POINTER
Presumably, Joan and Greg in the above example taxpayers could avoid the limitation result by amending their returns to claim a combined deduc-tion of $10,000.
Married taxpayers who file separate returns are treated as separate taxpay-ers for purposes of determining the taxable income limitation. However, married taxpayers who file joint returns, including those who elect to file a joint return after filing separate returns, must aggregate the taxable income of both spouses when applying the taxable income limitation.
Business Income Limit
The total cost a taxpayer can deduct each year after the dollar limit is taken into account is limited to the taxable income from the active conduct of
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any trade or business during the year. This must be from a meaningful participation in the management or operations of the trade or business.
COMMENT
Any cost not deductible in one year under Code Sec. 179 because of the business income limitation can be carried forward to the next year.
Taxable income. Taxpayers calculate their taxable income for this purpose by totaling their net income and losses from all trades and businesses the taxpayer actively conducted during the year. This total includes:
Code Sec. 1231 gains or losses (for more information see IRS Pub-lication 544);
Interest from working capital of the trade or business;
Wages, salaries, tips, or other pay earned as an employee;
Net profits from active conduct of a sole proprietorship;
Net profits from active conduct of real estate rental activity; and Net distribution profit received from passthrough entities in which the
Net profits from active conduct of real estate rental activity; and Net distribution profit received from passthrough entities in which the