A taxpayer who conducts an active trade or business can save income tax with the Section 179 deduction. Section 179 of the Internal Revenue Code allows a business to deduct immediately the cost of tangible, personal property that the business purchased and placed in service in a trade or business. Therefore, a taxpayer may claim the Section 179 deduction on business equipment, office furniture, and machinery used in the business. In addition, off-the-shelf computer software qualifies through 2007. However, if the taxpayer uses such assets in connection with rental real estate, they do not qualify for the Section 179 deduction.
A taxpayer must use the asset for more than 50-percent business use to claim any Section 179 deduction. If the usage is greater than 50 percent but less than 100 percent, the taxpayer may claim the Section 179 deduction on the percentage of the cost of the asset that is used for business. A taxpayer claims the Section 179 deduction by making the election on Form 4562.
This deduction reduces taxable income and therefore saves income tax. If the taxpayer is a self-employed individual, the Section 179 deduction also reduces self-employment income and therefore saves self-employment tax.
Vehicles purchased and placed in service in a business are eligible for the Section 179 deduction. However, the total deduction for depreciation and the Section 179 deduction on most vehicles is severely limited. Therefore, claiming the Section 179 deduction on car used in a business is usually not the best use of the Section 179 deduction.
However, if the taxpayer purchases and places in service a sport utility vehicle (SUV) that has a gross vehicle weight of more than 6,000 pounds, the taxpayer may claim a Section 179 deduction up to $25,000. In addition, the taxpayer may claim a depreciation deduction on the remaining cost. If a taxpayer purchases and places in service a pickup truck with a gross vehicle weight of more than 6,000 pounds, the taxpayer may claim all of the cost of the pickup as a Section 179 deduction, subject only to the annual limit and the taxable income limit as explained below.
The Section 179 deduction reduces the adjusted basis of the property. However, if the taxpayer has any cost remaining after subtracting the Section 179 deduction, the taxpayer may take depreciation deductions on the remaining cost, including in the year of purchase.
The maximum Section 179 deduction allowed in 2006 is $108,000 (Rev. Proc. 2005-70). This limit is the aggregate limit on the cost of all eligible property and not the limit on each item of eligible property. If a taxpayer purchases more than $430,000 of eligible property during 2006 (Rev. Proc 2005-70), the maximum Section 179 deduction is reduced by $1 for each $1 of the cost of eligible property over the $430,000 limit.
In addition, the Section 179 deduction is limited to the taxable income derived for any business before considering the Section 179 deduction. For this purpose, wages and salaries count as income from a business. Therefore, someone who is employed may start a part-time business and claim the Section 179 deduction even if the business makes little money or suffers a loss in the first year or two. The taxpayer may carry forward to the next tax year any Section 179 deduction that exceeds the taxable income limit. There are also special rules for certain kinds of property called listed property.
If a taxpayer disposes of property on which the taxpayer has claimed the Section 179 deduction, the Section 179 deduction is subject to recapture in the same manner as depreciation. A taxpayer reports the sale of such property on Form 4797. The recapture of depreciation and the recapture of the Section 179 deduction on a sale of the property are not subject to the self-employment tax (Section 1402(a)(3)(C)).
If the taxpayer converts the asset to 50-percent or less business use before the end of its depreciable life, however, the taxpayer must recapture part of the Section 179 deduction for income tax purposes and self-employment tax purposes. A taxpayer reports such recapture on the same form on which the taxpayer claimed the deduction. For a self-employed individual the form would be Schedule C of Form 1040 because the Section 179 deduction claimed on Form 4562 flows to Schedule C.
The Section 179 deduction is one of the best deductions allowed to a taxpayer who operates a business. Claiming the Section 179 deduction accelerates the deduction for depreciation that the taxpayer would have to claim over several years. Money does have a time value. In addition, a self-employed individual usually saves self-employment tax with the Section 179 deduction, but the recapture of the Section 179 deduction increases only income tax, not self-employment tax.
While claiming the Section 179 deduction is usually a good decision, in some cases it may not be wise. Therefore, a business owner would be wise to consult a competent tax professional before claiming the Section 179 deduction.