Small businesses benefit from
Section 179 deduction
By Luis I. Ingles III • Bankrate.com

Typically, if property for business has a useful life of more than one year, the entire cost can't be deducted as a business expense in the year acquired. Taxpayers must spread the cost across more than one tax year and deduct part of it each year.

Would you like to immediately receive these income tax benefits? This tax tip outlines the provisions of Internal Revenue Code Section 179. It allows a sole proprietor, partnership or corporation to fully expense tangible property in the year it is purchased. Property eligible for the Section 179 deduction is listed. This tip also explains the process for electing to use the deduction. Examples are included to demonstrate the three limits affecting this deduction: the maximum dollar limit, the investment limit, and the taxable income limit.

Eligible property
Eligible property includes:

• Machinery and equipment
• Furniture and fixtures
• Most storage facilities
• Single-purpose agricultural or horticultural structures

Ineligible property includes:

• Buildings and their structural components
• Income-producing property (investment or rental property)
• Property held by an estate or trust
• Property acquired by gift or inheritance
• Property used in a passive activity
• Property purchased from related parties
• Property used outside of the United States

How and when do you elect to use this deduction?
The Section 179 election is made on an item by item basis for eligible property. You don't have to use it on all eligible property bought in that year. The election must be made in the tax year the property is first placed in service.

The Section 179 deduction isn't automatic. Taxpayers who want to take the deduction must elect to do so. You make the election by taking your deduction on Form 4562. When you file this form, attach it to either of the following:

• Your original tax return filed for the tax year the property was placed in service, regardless of whether you file it timely.
• An amended return filed by the due date, including extensions, for your return for the tax year the property was placed in service.

Make sure you make the election when you file your original income tax return for that year. You can't later amend your return to elect Section 179. The only exception to this is if you amend your return before the actual due date, including extensions, of your original return.

For example, the extended due date to file your original return is Oct. 15, 1999. You file your return on Sept. 1, 1999. After filing you realize you didn't use the Section 179 deduction. You have until Oct. 15, 1999, to file an amended tax return to claim the deduction.

Taxpayers interested in more information should consult IRS Publication 946: How To Depreciate Property. Chapter Two discusses the Section 179 deduction.

Maximum Section 179 deduction increased
The 1996 Small Business Job Protection Act increased the maximum annual Section 179 deduction. For many years, the annual maximum was $10,000. For tax years 1993 through 1996, the maximum was $17,500. Future annual maximums are as follows:

Limitation on annual amount of property purchased
If investment in Section 179 property exceed $200,000 in a tax year, you can't take the full deduction. Excess investment is the amount by which the investment exceeds $200,000. It phases out the deduction on a dollar for dollar basis. As the table and examples that follow demonstrate, the entire deduction is phased out for that year once the excess equals or exceeds the maximum deduction for that year.

Example 1: A taxpayer places in service $210,000 of Section 179 property in 1998. His excess investment for 1998 is $10,000:
Total Investment in Section 179 Property: $210,000
Investment in Section 179 Property Limit: $200,000
Excess Investment in Section 179 Property: $10,000
His allowable Section 179 deduction for 1998 is $8,500
Maximum Deduction for 1998: $18,500
Excess Investment: $10,000
Allowable Deduction: $8,500

Example 2: A taxpayer placed in service $220,000 of Section 179 property in 1998. Her excess investment is the difference between $220,000 and $200,000, $20,000. Since her excess investment of $20,000 exceeds the $18,500 maximum deduction, she can't take any Section 179 deduction for 1998.

Deduction limited to taxable income
You have now determined the maximum deduction based on the amount of property purchased during the year. You must now pass the aggregate income hurdle. Your deduction is limited to your aggregate taxable income from the active conduct of any trade or business. Active trade or business includes employee and spouse's wages, sole proprietorships, partnerships, and S-corporations. Unless you have other sources of business income, your Section 179 deduction can't create a taxable loss for your business.

The inclusion of employee and spouse's wages allows more taxpayers to employ the deduction. For example, you are someone else's employee for most of the year. Your wages exceed the Section 179 deduction. You start your own business at the end of the year and purchase equipment and furniture. Even if your new business doesn't generate gross income that year, you can still take the Section 179 deduction on the new equipment and furniture. Why? Your wages exceed the Section 179 deduction.

This aspect of inclusion also applies to a spouse. For example, you earn annual wages of $60,000 as an employee. Your spouse doesn't work during the year but begins a new business at the end of the year. Your spouse purchases and places in service $15,000 of Section 179 property at the end of the year. Your spouse's business doesn't generate gross income at the end of the year. Even though your spouse hasn't earned trade or business income for the year, the Section 179 deduction of $15,000 is still allowed in full since your wages count as trade or business income.

Any amounts disallowed by the trade or business taxable income limit are carried over to the next year and added to the cost of any eligible property placed in service in that year. The same rules for maximum deduction, maximum annual investment and taxable income apply to the next tax year as well. Note that there isn't carryover for deductions disallowed by the $200,000 investment limit.

Conclusion: Advantages of Section 179 deduction
The tax tip explains the process for using Section 179 to fully expense certain business expenses immediately instead of depreciating them across a period of several years. You should also be aware of less obvious advantages of the Section 179 deduction:

• Lowers adjusted gross income (AGI), which can help you qualify for various deductions which are limited by AGI
• Lowers earned income, which can increase your earned income credit
• Allowed in full even if the eligible property is placed in service on the last day of the year

This tip also includes examples that demonstrate the three limits: the maximum dollar limit, the investment limit, and the taxable income limit. Including employment and spousal wages allows more taxpayers than ever to take advantage of this provision.

Are you interested in more information? Refer to Chapter Two of IRS Publication 946: How To Depreciate Property.

Luis I. Ingles III is a certified public accountant based in Louisiana

-- Posted: March 19, 1999