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Named for Section 179 of the Internal Revenue Code (IRC) that allows this type of expensing, a small business owner can deduct capital expenses of up to $500,000 in one year under §179. Without this deduction, capital expenses would have to written off over a period that can range from 3 years for off-the-shelf software to 39 years for commercial buildings, depending on the type of property.
There are other sections of the Internal Revenue Code that allow special deductions similar to §179, including IRC §174 for research, §175 for soil and water conservation or endangered species recovery expenditures, §180 for fertilizer, and §193 tertiary injectants, §173 for publishing (circulation expenditures), and §616 for mining. IRC §263 provides more information on capital expenditures.
Some property cannot be deducted under §179, including:
There is an over 50% business use requirement for the asset to be expensed under §179. Not only does the asset have to be used for at least 50% of the time in the year that it is expensed, but it must also be used more than 50% of the time for business for each succeeding year over its class life — in other words, over the time period in which it would ordinarily be depreciated.
If the asset is used 50% or less, then it must be depreciated according to the amount of business use for each year in which it is used over its class life.
You buy a computer for $1,000, which has a 5 year class life.
Case 1: You use the computer 40% of the time for business over the 5 years. You cannot claim a §179 deduction, because you did not use a computer more than 50% of the time in any year. However, you can depreciate 40% of its value over 5 years.
Case 2: You use a computer 60% of the time during the year it was placed in service, and you claimed a $600 deduction (60% x $1000) under §179 for that year. However, in subsequent years, you used it only 40% of the time. Consequently, you must recapture some of the deduction that you took in the first year and depreciate the cost according to the percentage of usage for each year.
There is some property, such as vehicles, cellular phones, tablets or e-book readers, and computers and other peripherals, that is often used for either business or personal use. Because many taxpayers attempt to deduct these items even when their use is mostly personal, the IRS has strict rules regarding recordkeeping for such property. If the business use is documented, then the listed property will qualify for the deduction if the business use is greater than 50%.
There is no §179 deduction for motor vehicles that weigh 6000 pounds or less. If the vehicle weighs more than 6,000 pounds gross weight when loaded, then there is a special limit of $25,000 under §179.
Generally, the total amount deducted under §179 cannot be greater than the taxpayer's total working income for that year. This includes not only income from the business itself for which the 179 deduction has been taken, but it can also include earnings as an employee or from operating another business. Any unused portion of the deduction can be carried forward to future tax years until the deduction is used up.
Because the 179 deduction can only be used to lower taxes on working income, earned from either a business or as an employee, passive investors are not entitled to the §179 deduction even if they are a partner in a business that can take the deduction. So if a partner becomes disabled, and is not able to work for the entire year, then he cannot take any 179 deduction, since any income received from the business will be considered to be passive income.
Because the §179 deduction was intended for small businesses, the deduction is only available to businesses that purchase less than $2,500,000 worth of depreciable assets. If the value of the purchased assets is more than $2 million but less than $2,500,000, then the deduction limit is equal to $500,000 minus the amount over $2 million of purchased depreciable assets. Hence, if the business buys $2,300,000 worth of depreciable assets in 2010, then that business can deduct only $200,000 [$500,000 - ($2,500,000 - $2,300,000)] under §179.
A disadvantage for married couples is that they are limited to the §179 limits of a single taxpayer, even if they have separate businesses or if they filed taxes separately. However, marriage can be an advantage if the business-owning spouse has losses that are greater than her total income, since she can deduct the §179 expense from the working spouse's income as long as that income is greater than the amount of the deduction.
There is also only one §179 deduction maximum for a partnership, limited liability company, or an S corporation. The partners, members, or shareholders of these business entities can only claim the §179 deduction in proportion to their ownership interest. For a C corporation, only the corporation can use the §179 deduction, not the shareholders.
The §179 deduction is limited to the actual amount of the purchase. If there is any trade-in allowance, then that must be deducted from the cost of the equipment to determine the maximum §179 deduction. Example: you purchase a professional camera for $5000, and the dealer gives you a trade-in allowance of $1000 for your own camera. You are only entitled to a $4000 §179 deduction.
Whether the §179 deduction should be taken depends on the profitability of the business in the current year and in future years. If the business owner projects that she will make a lot more money in the future, then it may be better to depreciate the property over the class life of the property rather than expensing it under §179.
Purchases can be made at the end of the year to reduce taxes that will be due shortly by April of the following year. However, the assets must be placed in service in the year in which the deduction is claimed.
When buying a business asset, the §179 deduction can be combined with other depreciation methods. This allows better planning depending on the profitability of the business in the current year and the expected profitability of the business in future years. So, for a $10,000 asset, $4000 can be deducted under §179 and the other $6000 can be deducted in future years using other depreciation methods.
The §179 deduction can also be taken on assets bought with credit, even if the equipment will not be fully paid for over several years. The full §179 deduction can be taken when the asset is placed in service and any interest that is paid on the loan can be deducted in the years when they are incurred.
If any §179 deduction is taken on equipment that is not use at least 50% of the time over the class life of the equipment, then the owner will have to pay back some of the 179 deduction. The amount that would have to be recaptured would be the amount of the §179 deduction minus the amount that the owner could have depreciated under allowable depreciation methods.