Section 179 Deduction

2024-09-06The 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, for some businesses satisfying additional tax rules, $5000, then the cost can be deducted as a current expense (Deducting Capital Expenditures as Current Expenses), which reduces the bookkeeping required. The §179 deduction can be used to deduct more expensive items in the 1^st year.

Named for Section 179 of the Internal Revenue Code (IRC) allowing 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 and some other types of property up to the statutory limit for the applicable tax year. However, if the value of the §179 property exceeds a certain amount, the phaseout threshold, then the allowable §179 deduction is reduced dollar for dollar, by the amount that the total investment exceeds the phaseout threshold, thus eliminating the §179 deduction completely when the total investment reaches the §179 phaseout limit. The maximum deduction, the phaseout threshold and the phaseout limit are adjusted annually for inflation. If several eligible properties are purchased during the tax year, then the §179 deduction can be allocated among the several properties in any manner, if the total deduction does not exceed the statutory limit. The §179 deduction is claimed on Form 4562, Depreciation and Amortization.

To summarize:

• If §179 Property Value > Phaseout Threshold + Maximum Deduction,
  • then no §179 deduction.
• If §179 Property Value > Phaseout Threshold < Phaseout Threshold + Maximum Deduction,
  • then §179 Deduction
    • = Maximum Deduction
    • − Property Value Exceeding Phaseout Threshold
• Other depreciation methods must be used for any remaining property.

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.

A §179 deduction can be claimed on qualified real property expenditures, including certain improvements to the interiors of retail buildings and of leased nonresidential buildings, and certain restaurant buildings or improvements to such buildings.

Other types of property eligible for the §179 deduction include:

• tangible personal property, such as machinery and equipment, portable air conditioners and heaters, and other types of properties, such as refrigerators, office equipment, testing equipment, and signs
• livestock
• off-the-shelf computer software
• qualified §179 real property, including certain property improvements and improvements to nonresidential real property, including heating, ventilation, and air conditioning equipment, roofs, security systems, fire protection and alarm systems
• and other specialized types of property used in some manufacturing, production, or extraction, or in the furnishing of transportation, communications, gas, electricity, water, or sewage disposal services.

Without the §179 deduction, capital expenses must be depreciated over a period ranging 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 later. 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 §179-type deductions, 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:

• most intangible property, not including off-the-shelf software,
• land (which cannot be depreciated at all, under any method),
• improvements to land, such as fences, bridges, paved parking areas, and swimming pools,
• inventory,
• gifts,
• 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. (The GVWR can usually be found on the label on the inside edge, near the hinges of the driver’s door.) See Actual Expense Method for Deducting Car and Truck Expenses for more information.

For heavy vehicles, defined as those with GVWR exceeding 6000 pounds, up to the full §179 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.

The §179 deduction can be used for heavy sports utility vehicles, and other types of passenger vehicles, that weigh more than 6000 pounds but less than 14,000 pounds, but a special limit applies: the total deduction for 2024 cannot exceed $30,500 of the cost: this limit is adjusted for inflation.

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 by its business use percentage for each year in which it is used over its class life.

Listed Property

There is some property, such as vehicles, tablets, or e-book readers, that are 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 exceeds 50%.

Income Limits to using Section 179

Aside from the property value limits discussed above, 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 1^st 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.

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 exceeding her total income, since she can deduct the §179 expense from the working spouse's income if that income exceeds the 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 more income later, it is better to depreciate the property over its class life 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 use different depreciation methods for different property, then consider the class life of the property and any projections of your future profitability. For instance, if you may 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 is sensible to use the §179 deduction for assets with a longer class life for immediate deductions, 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 must repay some of the 179 deduction. The recaptured amount will equal the §179 deduction minus the amount the owner would have depreciated under the straight-line depreciation methods.

Historical Notes

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.

Bonus depreciation cannot be applied to any carryover basis of the property, such as would occur in a like-kind exchange or involuntary conversion.

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.

Farming Businesses

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.

Source: New rules and limitations for depreciation and expensing under the Tax Cuts and Jobs Act | Internal Revenue Service