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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.
Alan D. Campbell is a CPA in Arkansas and Florida and is
self-employed primarily as an author of tax publications. He
earned a Ph.D. in accounting with an emphasis in taxation
from the University of North Texas. He is also admitted to
practice before the United States Tax Court. He has
published numerous articles on tax topics in professional
journals. He is the co-author of the book Tax Strategies for
the Self-Employed and the revision editor of CCH Financial
and Estate Planning Guide, 15th edition. For more tax
savings strategies, please see his blog:
http://taxsavingsstrategies.blogspot.com
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