Within our "Accounting for Assets" miniseries, we've examined various textbook definitions of depreciation. We also reviewed the differences between "book value" and "tax value" depreciation.
This week, we wanted to start the first of our articles regarding "tax value" depreciation by looking at Section 179 Expense Deduction. For purposes of clarification, this article is intended to be a discussion of the subject matter. It's not intended to be a definitive guide concerning Section 179 Expense Deduction or to provide any actual tax advice.
IRS Section 179 Deduction
Section 179 Expense Deduction
If you've been in business very long, you most certainly have heard the term "Section 179." You probably thought it was a form of depreciation, since it may appear to accomplish the same goal.
But is Section 179 really even depreciation in the eyes of the Internal Revenue Service?
From a tax standpoint, the IRS describes depreciation as an annual income tax deduction that allows you to recover the cost or other basis of certain property over the time you use the property. It is an allowance for the wear and tear, deterioration or obsolescence of the property.
Under strict application of that description, Section 179 cannot be considered as depreciation, because it has nothing to do with "the time you use the property." So, even though Section 179 is prominently featured within IRS Publication 946 “How to Depreciate Property,” and in many ways is treated like depreciation, it really is the section of the IRS Code that permits you to elect to deduct certain property purchases as an expense rather than depreciate them normally.
Under Section 179, the IRS says you "can elect to recover all or part of the cost of certain qualifying property, up to a limit, by deducting it in the year you place the property in service…You can elect the Section 179 deduction instead of recovering the cost by taking depreciation deductions.”
Section 179 Property Qualification
To qualify for Section 179, your property must meet these requirements:
- It must be eligible property
- It must be acquired for business use
- It must have been acquired by purchase
- It must not be "non-qualified" property
Eligible Property
To be eligible property, your property must be tangible personal property like machinery and equipment or other tangible property (not including real estate) used in your trade or business. Off-the-shelf computer software, and certain "qualified" real property also may be subject to Section 179 deduction.
Qualified real property is limited to "qualified leasehold improvements, restaurant property and retail improvements." They all have additional qualifications to be eligible. Additional rules apply, see IRS Publication 946 or the IRS Code, for additional information.
Acquired for Business Use
To qualify for the Section 179 deduction, your property must have been acquired for use in your trade or business. Property you acquire only to production of income, such as investment property, rental property (if renting property is not your trade or business). Properties that produce royalties do not qualify.
When you use property for both business and non-business purposes, you can elect the Section 179 deduction, only if you use the property more than 50 percent for business in the year you place it in service.
Purchased Property
To qualify for the Section 179 deduction, your property must have been acquired by purchase. Property acquired by gift or inheritance does not qualify. Certain exceptions and definitions apply to the provisions governing "acquired by purchase," consult IRS Publication 946 or the IRS Code, for additional information.
Non-Qualified Property
Certain property does not qualify for the Section 179 deduction. This includes Land and Improvements, as well as the following Exempted Property:
- Certain property you lease to others (if you are a non-corporate lessor)
- Certain property used predominantly to furnish lodging or in connection with the furnishing of lodging
- Air conditioning or heating units placed in service in tax years before 2016
- Property used predominantly outside the United States, except property described in section 168(g)(4) of the Internal Revenue Code
- Property used by certain tax-exempt organizations, except property used in connection with the production of income subject to the tax on unrelated trade or business income
Section 179 Deduction Limitations
Your Section 179 deduction generally is the cost of the qualifying property. But the total amount you can elect to deduct under Section 179 is subject to a dollar limit and a business income limit. These limits apply to each taxpayer, not to each business.
Dollar Limits
The total amount you can elect to deduct under Section 179 for most property placed in service in tax years beginning in 2016 generally cannot be more than $500,000. If you acquire and place in service more than one item of qualifying property during the year, you can allocate the Section 179 deduction among the items in any way, if the total deduction is not more than $500,000. However, you do not have to claim the full $500,000.
Qualified real property (described earlier) that you elected to treat as Section 179 real property is limited to $250,000 of the maximum deduction of $500,000 for tax years beginning in 2015.
Under certain circumstances, the general dollar limits on the Section 179 deduction may be reduced or increased, or there may be additional dollar limits. The general dollar limit is affected by any of the following situations:
- The cost of your Section 179 property placed in service beginning in 2016 exceeds $2,010,000. If the cost of your qualifying Section 179 property placed in service in a year is more than $2,010,000, you generally must reduce the dollar limit (but not below zero) by the amount of cost more than $2,010,000. If the cost of your Section 179 property is $2,500,000 or more, you cannot take a Section 179 deduction.
- Your business is an enterprise zone business. An increased Section 179 deduction ($535,000 for 2016) is available to enterprise zone businesses for qualified zone property placed in service during the tax year, in an empowerment zone. For more information, including the definitions of “enterprise zone business” and “qualified zone property,” see sections 1397A, 1397C and 1397D of the Internal Revenue Code.
- You placed in service a sport utility or certain other vehicles. You cannot elect to expense more than $25,000 of the cost of any heavy sport utility vehicle (SUV) and certain other vehicles placed in service during the tax year. This rule applies to any 4-wheel vehicle primarily designed or used to carry passengers over public streets, roads or highways, that is rated at more than 6,000 pounds gross vehicle weight and not more than 14,000 pounds gross vehicle weight. However, the $25,000 limit does not apply in certain situations. For more information on these situations, see IRS Publication 946 or the IRS Code.
- You are married filing a joint or separate return. If you are married, how you figure your Section 179 deduction depends on whether you file jointly or separately. If you file a joint return, you and your spouse are treated as one taxpayer in determining any reduction to the dollar limit, regardless of which of you purchased the property or placed it in service. If you and your spouse file separate returns, you are treated as one taxpayer for the dollar limit, including the reduction for costs over $2,010,000. You must allocate the dollar limit (after any reduction) between you equally, unless you both elect a different allocation. If the percentages elected by each of you do not total 100 percent, 50 percent will be allocated to each of you.
Business Income Limits
The total cost you can deduct each year after you apply the dollar limit is limited to the taxable income from the active conduct of any trade or business during the year. Generally, you are considered to actively conduct a trade or business if you meaningfully participate in the management or operations of the trade or business.
Any cost not deductible in one year under Section 179 because of this limit can be carried to the next year. Special rules apply to a deduction of qualified Section 179 real property that is disallowed because of the business income limit. For more information on these rules, see IRS Publication 946 or the IRS Code.
If your business is an S corporation, partnership or multi-member LLC, it cannot pass the Section 179 deduction on to shareholders, partners or members unless the business has income. The individual also must have earned income to take the deduction.
Section 179 Election
Section 179 election may be made only for the year the equipment is placed in use and is waived if not taken for that year. Section 179 election is optional. The eligible property may be depreciated over several years through MACRS depreciation per section 167 and 168 of the IRS Code. But if you elect Section 179, your election is irrevocable unless special permission is granted by the IRS. For more information on election or revocation, see IRS Publication 946 or the IRS Code.
- Special rules for qualified section 179 real property – You can carry over to 2015 a 2014 deduction attributable to qualified section 179 real property that you elected to expense, but were unable to take because of the business income limitation. Any such 2014 carryover amounts that are not deducted in 2015, plus any 2015 disallowed section 179 expense deductions attributable to qualified real property, are not carried over to 2016. Instead, these amounts are treated as property placed in service on the first day of 2015 for purposes of computing depreciation (including the special depreciation allowance, if applicable). See section 179(f) of the Internal Revenue Code, for more information. Also see, Notice 2013-59, and Section 5 of Revenue Procedure 2015-48 and Election for certain qualified section 179 real property, for information on these matters. Additional guidance regarding applicable carryover amounts may be available in other Internal Revenue Bulletins at www.irs.gov.
Applying Section 179 - A Practical Example
In 2016, you purchased a new Master Dongle-maker brand high-output Dongle Maker for your Dongle Making business at a cost of $350,000. At the same time, you purchased $250,000 in specialized dies for your new Dongle Maker. Since the total of your Section 179 property placed in service in 2016 did not exceed $2,010,000, and your taxable income from the Dongle Making business for 2016 exceeds $500,000, you're limited in the total amount of Section 179 you may elect by the 2016 annual limit of $500,000.
Based upon these facts, you choose to elect to deduct the entire cost of $350,000 for the new Dongle Maker, and to deduct $150,000 of the cost of the specialized dies.
Thus, your $350,000 Section 179 deduction for the Dongle Maker completely recovers its cost, leaving your depreciation basis as $0.00 for the Dongle Maker. In relationship to the specialized dongle dyes, your $150,000 Section 179 deduction leaves you with a $100,000 depreciation basis for the dongle dyes. This depreciation basis is computed by subtracting your $150,000 Section 179 deduction from the $250,000 cost of the specialized dongle dyes.
Next time, our Accounting for Assets feature will look at MACRS for tax depreciation purposes.