IRS Code Section 179 Election

Gregory J. Cook, EA, CPA+ Accredited Tax Advisor Past President Alabama Society of Enrolled Agents Past President Alabama Association of Accountants

(a) IN GENERAL

Under Code Section 179, a taxpayer (other than a trust or estate) may elect to treat the cost (subject to certain limitations) of Code Section 179 property as a currently deductible business expense. The Code Section 179 deduction is not affected by the point during the taxable year that the property was actually placed in service. Reg. Section

1.179-1(c). However, apportionment is required if Code Section 179 property is used for both business and non-business purposes. Reg.Section 1.179-1(d).

(b) CODE SECTION 179 PROPERTY

Code Section 179 property is any tangible property that is Code Section 1245 property and that is acquired by purchase for use in the active conduct of a trade or business. This definition must be met during the year in which the property is first placed in service. Property is "placed in service" when it is placed in a condition or state of readiness and available for a specifically assigned function, in a trade or business, for the production of income, in a tax-exempt activity, or in a personal activity. Reg. Section 1.179-4(e).

In general, Code Section 1245 property is depreciable personal property, such as machinery, equipment, and furniture. Code Section 1245(a)(3)(A). Code Section 1245 property also includes:

(1) depreciable tangible property (other than a building or its structural components) but only if such property (i) was used as an integral part of manufacturing, production, or extraction or of furnishing transportation, communications, electrical energy, gas, water, or sewage disposal services, or (ii) constituted a research or storage facility used in connection with the above activities, or (iii) constituted a facility used in connection with the above activities for the bulk storage of fungible commodities (including commodities in a liquid or gaseous state);

(2) so much of any real property (other than property described in Code Section 1245(a)(3)) that has an adjusted basis in which there are reflected adjustments for amortization under Code Sections 169, 179, 179A, 185, 188 (as in effect before its repeal by the Revenue Reconciliation Act of 1990), 190, 193, or 194 ;

(3) depreciable single purpose agricultural or horticultural structures;

(4) storage facilities (not including a building or its structural components) used in connection with the distribution of petroleum or any primary product of petroleum; or

(5) any railroad grading or tunnel bore (as defined in Code Section 168(e)(4)).


A purchase is any acquisition other than from a related person, from a decedent, or in any transaction in which the taxpayer's basis is determined by reference to the transferor's basis. The term "trade or business" has the same meaning as in Code Section 162. Property held for the production of income or other activity described in Code Section 212 is not eligible for the Code Section 179 election.


EXAMPLE 14: Blanche, a tailor, purchased two industrial sewing machines from her father, who is in the business of selling industrial sewing equipment, and placed these machines in service during the same year. Since Blanche and her father are related persons under Code Section 267, the sewing machines are not Code Section 179 property.

(c) LIMITATIONS ON THE CODE SECTION 179 DEDUCTION

The maximum amount that a taxpayer may elect to expense under Code Section 179 for any taxable year is set forth in the following table:

If the taxable year begins in: The applicable amount is

1997 $18,000

1998 $18,500

1999 $19,000

2000 $20,000

2001 or 2002 $24,000

2003 or thereafter $25,000

The applicable amount is reduced (but not below zero) by the amount that the total cost of all Code Section 179 property placed in service during the year exceeds $200,000. Code Section 179(b)(2). No carryover is permitted for any amount disallowed under this limitation.

EXAMPLE 15: Rod purchased and placed in service various machinery and equipment for use in his farming business in 1997. All of the property qualified for the Code Section 179 election, and the total cost was $212,000. Because the total cost of the machinery and equipment exceeded $200,000 by $12,000, the maximum amount that Rod can deduct under Code Section 179 is $6,000 ($18,000 minus $12,000).

The Code Section 179 deduction is further limited to the taxpayer's taxable income derived from the active conduct of any trade or business during the taxable year (computed before any Code Section 179 deduction). Thus, the Code Section 179 deduction cannot generate a loss for the taxpayer's trades or businesses. Any amount disallowed by this limitation may be carried over and deducted in subsequent years, subject to the maximum dollar limitations and taxable income limitations in effect for that year.

EXAMPLE 16: In 1997, Doris purchased and placed in service a machine for use in her business. The machine cost $12,000. During 1997, Doris generated taxable income from her consulting business of $9,000, after deducting all costs other than the equipment. Therefore, Doris's Code Section 179 deduction is limited to $9,000. The remaining $3,000 is carried over and may be deducted in 1998, subject to the same dollar and taxable income limitations.

EXAMPLE 17: Steve is the head accountant for a university. On the side, Steve conducts an accounting business. During 1997, Steve placed in service for his accounting business certain Code Section 179 property costing a total of $205,000. The maximum dollar amount that Steve can deduct under Code Section 179 is $13,000 ($18,000 minus $5,000). His taxable income from the accounting business for 1997 is $6,000 before the $13,000 Code Section 179 deduction is taken into account. Thus, his Code Section 179 deduction is further limited to $6,000. The remaining $7,000 of the maximum dollar amount ($13,000 minus $6,000) may be carried forward and used in a subsequent taxable year, subject to the same limitations.

A husband and wife filing a joint return are treated as one taxpayer for purposes of applying the dollar limitation, regardless of which spouse purchased the property or placed it in service. Reg. Section1.179-2(b)(5). A husband and wife filing separate returns are also treated as one taxpayer for purposes of the dollar limitation. Code Section 179(b)(4)(A). In addition, unless they elect otherwise, each spouse is treated as having purchased and placed in service 50 percent of the cost of eligible property. The taxable income limitation is applied separately to each spouse.

In the case of a partnership or S corporation, the determination of whether property constitutes Code Section 179 property is made at the partnership or S corporation level, and the Code Section 179 election is made by the partnership or S corporation. Code Section 179(d)(8). However, the maximum dollar limitation and the taxable income limitation apply to both the partnership or S corporation and the individual partners or shareholders.

The Code Section 179 deduction is a separately stated item as set forth in their respective Schedule K-1s. Each partner or shareholder must add the allocated Code Section 179 deduction to his own Code Section 179 expenses to apply the limitations. However, the partnership's or S corporation's basis in the Code Section 179 property is reduced by the amount of the allowable Code Section 179 deduction, even if a partner or shareholder cannot deduct the full amount of the Code Section 179 deduction allocated to him. Reg. Section 1.179-1(f)(2).


(d) DEPRECIABLE BASIS OF CODE SECTION 179 PROPERTY

The basis of Code Section 179 property is reduced by the amount of the Code Section 179 deduction. Reg. Section 1.179-1(f)(1). The balance constitutes the taxpayer's unrecovered basis for purposes of computing depreciation under Code Section 168. The amount expensed under Code Section 179 is not eligible for depreciation in subsequent years.

(e) RECAPTURE OF CODE SECTION 179 DEDUCTIONS

The Code Section 179 deduction is treated as depreciation for many purposes. It is subject to recapture, as depreciation, under Code Section1245 on the sale, exchange, or involuntary conversion of the property.

EXAMPLE 18: In 1997, Chris purchased and placed in service two items of Code Section 179 property for use in his lumber business: a $20,000 forklift and a $1,200 circular saw. Chris elected to deduct the entire $1,200 for the saw and $16,800 for the forklift under Code Section 179. Chris is considered to have recovered the full cost of the saw and holds it with a zero basis. The adjusted basis of the forklift for depreciation is $1,200. If Chris sells the saw for $500, he would recognize a gain of $500, the full amount of which would be ordinary income under Code Section 1245.

The Code Section 179 deduction also is added to Code Section 168 depreciation taken on a passenger automobile for purposes of applying the Code Section 280F deduction limitation and is subject to the other depreciation limits regarding listed property as well.

(f) ELECTION

A taxpayer must make a separate election for each taxable year that a Code Section 179 deduction is claimed with respect to property placed in service during that year. <83> The election to claim a Code Section 179 deduction must be made on the taxpayer's first income tax return for the taxable year to which the election applies (whether or not the return is timely filed) or on an amended return filing within the time period prescribed by law (including extensions) for filing the return for such taxable year. Reg. Section 1.179-5(a).

The Tax Court has rejected an attempt by a taxpayer to claim additional Code Section 179 expenses on an amended return filed after she received a notice of deficiency because the expenses were claimed after the due date of her return. Furthermore, the court pointed out, the original Code Section 179 election was irrevocable and binding in the absence of IRS consent to its revocation. Green v. Commissioner, T.C. Memo. 1998-356.

The election is made by showing as a separate item on the taxpayer's income tax return the following items: (1) the total Code Section 179 expense deduction claimed with respect to all Code Section 179 property selected, and (2) the portion of that deduction allocable to each specific item. <84> The taxpayer must maintain records that permit specific identification of each piece of Code Section 179 property and reflect how and from whom such property was acquired and when such property was placed in service.

Entitlement to the benefits of Code Section 179 additional first-year depreciation is not automatic: It requires an affirmative election to be attached to the original return or to a timely filed return. Starr v. Commissioner, T.C. Memo. 1995-190. If a taxpayer does not make the requisite election, the taxpayer is not entitled to the benefits or Code Section 179, even if the amount deducted as depreciation on the return does exceed the $19,000 limit as provided in Code Section 179. Therefore, the taxpayer is required to specifically note on the depreciation form, Form 4562, that she is electing to take the Code Section 179 depreciation deduction on the property that has properly been placed in service during the taxable year. Fors v. Commissioner, T.C. Memo. 1998-158.

Once made, an election is irrevocable and is binding on the taxpayer for the taxable year in which the election is made and for all subsequent taxable years, unless the Commissioner consents to the revocation of the election. Similarly, the selection of Code Section 179 property by the taxpayer to be subject to the expense deduction and apportionment scheme must be adhered to in computing the taxpayer's taxable income for the taxable year for which the election is made and for all subsequent taxable years, unless consent to change is given by the Commissioner. Such consents will be granted only in extraordinary circumstances.

(g) PROPERTY THAT CEASES TO BE PREDOMINANTLY USED IN A TRADE OR BUSINESS

If a taxpayer's Code Section 179 property is not used predominantly in the taxpayer's trade or business at any time before the end of the property's recovery period, the taxpayer must recapture in the taxable year in which the Code Section 179 property is not used predominantly in a trade or business any benefit derived from expensing such property.

<88> Property is not predominantly used in a trade or business when 50 percent or more of its use during the taxable year is for a use other than in a trade or business. Reg. Section 1.179-1(e)(2). The recaptured amount is treated as ordinary income for the taxable year in which the property is not used predominantly in a trade or business. Reg. Section

1.179-1(e)(1).


COMPLIANCE TIP: The recaptured amount is reported on Form 4797, Sales of Business Property.

The recapture amount is the difference between the Code Section 179 deduction attributable to the property and the total amount of depreciation that would have been allowable for prior taxable years and the taxable year of recapture. Reg. Section 1.179-1(e)(1). The Code Section 179 deduction subject to recapture does not include any amount disallowed by reason of the dollar limitations. In addition, the amount of depreciation allowable under Code Section 168 is determined as if the property was used for the production of income if the taxpayer does not elect to itemize deductions in the year of recapture. Reg. Section1.179-1(e)(1).

The basis in the property is increased by the amount that the taxpayer must recapture and is recovered through depreciation in future taxable years. Reg. Section 1.179-1(e)(3).

EXAMPLE 19: Linda, a calendar year taxpayer, purchased and placed in service a new computer for use in her business on February 1, 1995. The computer cost $10,000. Linda elected to expense $5,000 of the cost under Code Section 179 and depreciate the remaining $5,000 under Code Section 168. The computer is five-year property under Code Section 168(e). Linda used the computer exclusively for business in 1995 and 1996, but in 1997 used the computer only 40 percent for business and the remainder for personal use. Therefore, Linda must recapture as ordinary income $2,016, which is the Code Section 179 election of $5,000 less $2,984 of depreciation that was allowable under Code Section 168 for 1995, 1996, and 40 percent in 1997.


<ENDNOTES>


69/ Code Section 179(d)(3) ; Reg. Section 1.179-4(d).


70/ Code Section 179(d)(1). It does not include any property described in Code Section 50(b) (i.e., property used outside the United States, property used in furnishing lodging, property used by tax-exempt organizations, and property used by governments and foreign persons) and does not include air conditioning or heating units. Code Section

179(d)(1).

71/ For the definition of single purpose agricultural or horticultural structures, see Code Section 168(i)(13). In Hart v. Commissioner, T.C. Memo. 1999-236, the Tax Court held that a tobacco barn is not Code Section 179 property because it is a building rather than a

single purpose horticultural structure. The barn was a general purposes structure, not a single purpose horticultural structure, because it did not meet the "specific design" or "exclusive use" tests of Reg. Section1.48-10(c), or the "actual use" test of Reg. Section 1.48-10(e). As a farm building, the barn had a 20-year recovery period.

72/ Code Section 1245(a)(3). See Ch. 75 for a further discussion of Code Section 1245 property.

73/ A related person is defined as a person described in Code Section 267 and Code Section 707(b), except that family members include only spouses, ancestors, and lineal descendants, not siblings. Code Section 179(d)(2)(A).

74/ Code Section 179(d)(2)(C). Also excluded is an acquisition of property by one member of a controlled group of corporations from another. Code Section 179(d)(2)(B).

75/ Reg. Section 1.179-4(a). See Section 25.2 for a detailed discussion of the Code Section 162 trade or business requirement.

76/ Code Section 179(b)(1), as amended by the Small Business Job Protection Act of 1996, Section 1111(a), effective for tax years beginning after 1996.

77/ Code Section 179(b)(3)(A) and Code Section 179(b)(3)(C) ; Reg. Section 1.179-2(c).

78/ Code Section 179(b)(3)(B). If the taxable income limit applies, the taxpayer should attach a statement to her return, showing the computation of taxable income. See IRS Publication 534, Depreciation.

79/ Code Section 179(b)(4)(B) ; Reg. Section 1.179-2(b)(6). The spouses can elect to share the limitation in a proportion that is not equal. However, if the spouses do not elect a percentage, or the percentages elected do not equal 100 percent, the percentage for each

spouse is 50 percent. Reg. Section 1.179-2(b)(6).

80/ Code Section 179(b)(3)(A). Reg. Section 1.179-2(c)(2) Hayden v. Commissioner, No. 99-2520 (7th Cir. Feb. 11, 2000) (Seventh Circuit affirms the Tax Court in validating regulation).

81/ Code Section 1245(a). See Ch. 75 for a discussion of Code Section 1245 recapture.

82/ See Code Section 280F(d)(1). See Section 73.10 for a discussion of depreciation for passenger automobiles and other listed property.

83/ See Code Section 179(c) ; Reg. Section 1.179-5(a).

84/ Code Section 179(c)(1) ; Reg. Section 1.179-5(a).

85/ Reg. Section 1.179-5(a). However, for these purposes, a partner (or S corporation shareholder) treats partnership (or S corporation) Code Section 179 property for which Code Section 179 expenses are allocated from a partnership (or S corporation) as one item of Code Section 179 property.

86/ Code Section 179(c)(2) ; Reg. Section 1.179-5(a).

87/ Reg. Section 1.179-5(b). Requests for consent must be filed with the Commissioner of Internal Revenue in Washington, DC, 20224. The request must include the taxpayer's name, address, and identification number, and it must be signed by the taxpayer or his duly authorized representative. In addition, the request must include a statement showing the year and property involved, and must set forth in detail the reasons for the request. Reg. Section 1.179-5(b).

88/ Code Section 179(d)(10) ; Reg. Section 1.179-1(e)(1).