TIMING RECAPTURE OF THE DEDUCTION

Taxpayers must recapture the deduction if at any point in the year within its designated depreciable life the use of the property drops to 50 percent or less. Taxpayers should include the recapture amount as ordinary income in Part IV of Form 4797 and increase the basis of the property by the re-capture amount. Rere-capture is only required if the decline in business use occurs during the MACRS recovery period used to depreciate the property or that would have been used to depreciate the property if it had not been fully expensed.

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M O D U L E 1 — C H A P T E R 3 — E l e c t i n g t h e S e c t i o n 1 7 9 E x p e n s i n g D e d u c t i o n 3.27

_EXAMPLE

Laundromat Inc. had a business use of a fully expensed machine that was placed in service in 2000. The machine has a seven-year MACRS recov-ery period. If the business use drops to 40 percent in 2008, which would be after the recovery period would have expired, Laundromat Inc. is not required to recapture any portion of the Code Sec. 179 deduction.

COMMENT

If property is sold, exchanged, or disposed of, rules for the recapture of de-preciation under Code Sec. 1245 property generally apply. The Code Sec.

179 deduction is treated like a depreciation deduction for purposes of the recapture rules when a depreciable property is sold or otherwise disposed of.

The amount of the Code Sec. 179 allowance and any regular MACRS depre-ciation deductions claimed on that expensed property will be treated under the recapture rules as ordinary income to the extent of gain recognized.

The recapture amount is equal to the difference between the amount ex-pensed and the MACRS depreciation that could have been claimed on the expensed amount through the year of recapture. The recaptured amount is added to the basis of the property so that it may be recovered through de-preciation deductions during the remaining years in the recovery period.

To calculate the recapture amount, taxpayers need to:

1. Compute the depreciation that would have been allowed on the Code Sec. 179 deduction claimed. (Begin with the year the property was placed in service and include the year of recapture);

2. Subtract the depreciation from (1) from the Code Sec. 179 deduction claimed; and

3. The result is the amount that must be recaptured.

_EXAMPLE

In January 2004 Harry, who is a calendar year taxpayer, bought and placed into service Code Sec. 179 property which cost $10,000. The property is not listed property. Harry elected $5,000 for the Code Sec. 179 deduction for the property and also elected not to claim a special depreciation allowance.

Harry only used the property for business use in 2004 and 2005. In 2006 he used the property 40 percent for business use and 60 percent for personal use. The Code Sec. 179 deduction in 2004 was $5,000. Subtracting the allowable depreciation, 2004: $1,666.50; 2005: $2,222.50; 2006: $296.20 ($740.50 × 40 percent business use) gives a total of $4,185.20. The 2006 recapture amount is $814.80, which must be included in Harry’s income.

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Listed property. If the property is listed property, taxpayers should not cal-culate the recapture amount under the rules given above when the business use drops to 50 percent or less. Special rules apply when the business use of listed property, like a passenger car or a cell phone, drops to 50 percent or less. The listed property recapture rules require recapturing as ordinary income the difference between (1) the amount expensed and any depre-ciation deductions claimed prior to the tax year of recapture and (2) the amount of depreciation that could have been claimed using the MACRS alternative depreciation system (ADS) through the tax year prior to the tax year of recapture. Beginning in the tax year of recapture and through the remaining ADS recovery period, depreciation is computed using the ADS method. Recapture does not apply if the business use has dropped to 50 percent or less in a tax year after the applicable ADS recovery period has expired.

Liberty Zone, GO Zone, and other special property. If any of the qualified zone property—including renewal property, Liberty Zone property, or GO Zone property—ceases to be used within its respective zones in a later year, the benefit of the increased Code Sec. 179 deduction must be reported as other income on the taxpayer’s return for that year.

STUDY QUESTIONS

9. The recapture amount for a previously claimed deduction on Code Sec. 179 property is:

a. The difference between the amount expensed with the deduction and MACRS depreciation that could have been claimed

b. Equal to the MACRS depreciation amount c. The basis of the property plus the total deduction d. None of the above

10. The listed property recapture rules require recapturing a prior Code Sec. 179 deduction as:

a. Ordinary income b. Long-term capital gain c. Depreciation

d. None of the above

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M O D U L E 1 — C H A P T E R 3 — E l e c t i n g t h e S e c t i o n 1 7 9 E x p e n s i n g D e d u c t i o n 3.29

CONCLUSION

Despite generous long-term benefits from accelerated methods for depre-ciating assets, many small- and medium-sized businesses find it difficult to come up with the cash necessary to purchase new assets to improve their operations. Fortunately, many of these businesses have a significant window of opportunity. From 2003 through 2009, they have the option of taking an immediate write-off of up to $100,000 (plus an inflation adjustment) each year. After 2009, the amount of the immediate write-off goes down to a $25,000 cap (unless extended again by Congress).

To take full advantage of this tax break, a business needs to think strategi-cally. Coordinating purchases of qualifying Section 179 property with business income and annual deduction limitations can make a significant difference to a small business’s after-tax bottom line. Keeping an eye on whether Congress will again extend the enhanced deduction after 2009 is also important in determining whether accelerated purchasing plans should be set in motion.

Finally, a business may need to effectively coordinate the enhanced Section 179 expensing tax break with other federal tax incentives. Despite its sometimes complicated rules, however, the Section 179 election is well worth the effort to maximize for most small businesses. Planning is essential. The right to a Section 179 deduction does not accumulate each year. Once each tax year ends, the opportunity to retrieve a missed Section 179 deduction because of a foregone purchase is lost forever.

CPE NOTE: When you have completed your study and review of chapters 1, 2 and 3 which comprise this Module, you may wish to take the Quizzer for this Module.

CPE instructions can be found on page 12.1.

The Module 1 Quizzer Questions begin on page 12.3. The Module 1 Answer Sheet can be found on pages 12.27 and 12.28. For your convenience, you can also take this Quizzer online at www.cchtestingcenter.com.

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TOP FEDERAL TAX ISSUES FOR 2007 CPE COURSE