Section 179 Deduction
The acquisition or improvement of business property and other capital expenditures can be deducted as a business expense in several ways:
- through depreciation
- as a current expense, and
- through first-year expensing, either as bonus depreciation or as a section 179 deduction
Depreciation is deducting the cost over several years, depending on the class life of the property. If the acquisition or improvement cost of the item does not exceed $2500, or, in some cases, $5000, then the cost can be deducted as a current expense (Deducting Capital Expenditures as Current Expenses), which reduces the amount of bookkeeping required. The §179 deduction can be used to deduct more expensive items in the 1st year.
Named for Section 179 of the Internal Revenue Code (IRC) that allows this type of first-year expensing, an individual small business owner or a business entity — but not estates or trusts — can deduct capital expenses on tangible property up to the statutory limit for the applicable tax year, but only if the total investment in depreciable property is less than the investment threshold; if the investment is greater than the investment threshold, then the allowable §179 deduction is reduced dollar for dollar, by the amount that the total investment exceeds the investment threshold, thus eliminating the §179 deduction completely when the total investment reaches the §179 phaseout limit:
|2014 - 2016||$500,000||$2,000,000||$2,500,000|
|2010 - 2011||$500,000||$2,000,000||$2,500,000|
|2008 - 2009||$250,000|
However, for tax years starting in 2015, the $500,000 deduction limit has been made permanent and will be indexed for inflation, starting in 2016. Additionally, a §179 deduction can be claimed on qualified real property expenditures for up to $250,000 in 2015 and up to $500,000 in 2016 and afterwards. Qualified real property expenditures include certain improvements to the interiors of retail buildings and of leased nonresidential buildings, and certain restaurant buildings or improvements to such buildings. The §179 deduction is claimed on Form 4562, Depreciation and Amortization.
New Rules for Depreciation for 2018 and Afterwards
Under the Tax Cuts and Jobs Act, for property placed in service for tax years after 2017, the maximum §179 deduction is increased from $500,000 to $1 million, and the phaseout threshold is increased from $2 million to $2.5 million.
The new law expands what constitutes qualified improvement property to include any improvement to roofs, HVAC, fire protection systems, alarm and security systems, and a building's interior, except if the interior improvements are attributable to the enlargement of the building, the internal structural framework, or any elevator or escalator.
The first-year bonus depreciation has been temporarily increased from 50% to 100%, for certain business assets, if those assets were acquired and placed in service after September 27, 2017, but before 2023. This bonus depreciation may only be applied to property if:
- the taxpayer did not use the property before acquiring it;
- the property was not acquired from a related-party or from a related member of a controlled group of corporations; and
- the taxpayer's basis in the used property does not depend on an adjusted basis of the property of the seller or transferor or from a decedent.
Qualified property also includes qualified film, television, and live theatrical productions.
Some property types are not eligible for bonus depreciation, including property used for a business furnishing or selling:
- electrical energy,
- water or sewage disposal services, or
- the distribution of gas or steam through a local system or by pipeline.
This exclusion only applies if the rates for the furnishing or sale must be approved by a federal, state, or local government agency, a public service or utility commission, or an electric cooperative. Also excluded from bonus depreciation is any property used by a business with floor-plan financing, such as financing secured by motor vehicle inventory commonly used by retail car dealers.
For a farming business, the recovery period for machinery and equipment — except grain bins, cotton ginning assets, fences, or other land improvements — is shortened from 7 to 5 years. The date of original use and when placed in service must be after 2017. Also, this property is not required to use the 150% declining balance method, except if it is 15-year or 20-year property.
Starting for tax years after 2017, any farming businesses that elect not to use the interest deduction limit must use an alternative depreciation system for property with a recovery period of at least 10 years, such as trees or vines bearing fruit or nuts, single-purpose horticultural or agricultural structures, farm buildings, and certain land improvements.
Without the §179 deduction, capital expenses would have to be depreciated over a period that can range from 3 years for tools and devices to 7 years for office furniture and fixtures, cell phones, and fax machines, depending on the type of property — most tangible business property is 5-year property. Depreciation, however, may be preferable if the business owner expects to be in a higher tax bracket in the future. Additionally, the §179 deduction, unlike bonus depreciation, can also be used to deduct the purchase of used items. However, only the amount paid in cash can be deducted under §179 — the credit received for a trade-in does not qualify.
There are other sections of the IRC 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,
- §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:
- intangible property, including software from 2014 onward,
- land (which cannot be depreciated at all, under any method),
- heaters and air conditioners,
- gifts, or
- anything bought from a close relative or from another business in which the business owner has an ownership interest,
- any property converted from personal use to business use, which must be depreciated.
Special, complex rules apply to the deduction of motor vehicles. The deduction for light vehicles — those whose gross vehicle weight rating (GVWR) does not exceed 6000 pounds — is much lower than the §179 deduction limit. For 2016, the maximum first-year depreciation deduction is limited to $11,560 for new light trucks and vans $11,160 for new cars. If the motor vehicle is bought used, then the 1st year deduction limits are $3560 and $3160, respectively. (The GVWR can usually be found on the label on the inside edge, near the hinges of the driver’s door.)
For heavy vehicles, defined as those with GVWR exceeding 6000 pounds, up to the full $500,000 limit can be claimed for new or used heavy vehicles that are used more than 50% for business. If the vehicle is new, then an additional 50% first-year bonus depreciation can also be claimed.
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.
Example — 50% Business Use Requirement
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 using the straight-line method.
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% × $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.
Limits to using Section 179
Generally, the total amount deducted under §179 cannot exceed 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 passive income.
There is 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. Each pass-through entity is subject to the same §179 deduction rules as individuals. The pass-through entity must 1st calculate what §179 deduction it is entitled to, then the deduction is allocated to the active owners of the entity in proportion to their ownership interest. If the pass-through entity cannot claim the deduction because of insufficient income, then none of the owners can claim the deduction from that entity, even if they have adequate income from other pass-through entities or from a sole proprietorship or from wages as an employee.
For a C corporation, only the corporation can use the §179 deduction, not the shareholders.
Because the §179 deduction was intended for small businesses, there is an investment limit where 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 2013, then that business can deduct only $200,000 [$500,000 - ($2,500,000 - $2,300,000)] under §179. Other depreciation methods will have to be used for the remaining property.
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 exceed her total income, since she can deduct the §179 expense from the working spouse's income as long as that income exceeds the amount of the deduction.
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 old camera. Therefore, you can only claim $4000 as a §179 deduction.
When to Claim the Section 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 for a business on a calendar 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 applied to 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 paid on the loan can be deducted in the years when they are incurred.
Tax Tip: If you decide to use different depreciation methods for different property, then take into consideration the class life of the property and any projections of your future profitability. For instance, if you think that you will be more profitable 5 years hence, then it may be better to claim the §179 deduction for 3- or 5-year property, then use other depreciation methods for longer life assets when the deduction will be more valuable. On the other hand, if the business is already very profitable, then it may make sense to use the §179 deduction for assets with a longer class life, so that they can be immediately deducted, then deducting the short-life assets over the next few years.
Recapture When Business Use Falls to 50% or Less
If any §179 deduction taken on equipment not used 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 recaptured amount will equal the §179 deduction minus the amount that the owner would have depreciated under the straight-line depreciation methods.