How To Figure the Deduction

Words you may need to know (see Glossary):

• Active conduct of a trade/business
• Adjusted basis
• Basis
• Placed in service

The total business cost you can elect to deduct under section 179 for 2000 cannot be more than $20,000. This maximum dollar limit applies to each taxpayer, not to each business. You do not have to claim the full $20,000. You can decide how much of the business cost of your qualifying property you want to deduct under section 179. You may be able to depreciate any cost you do not deduct under section 179. For information on how to figure depreciation, see chapter 3.

If you acquire and place in service more than one item of qualifying property during the year, you can divide the deduction among the items in any way, as long as the total deduction is not more than $20,000. If you have only one item of qualifying property and it costs less than $20,000, your deduction is limited to the lesser of the following.

• Your taxable income from your trade or business. (This limit is discussed later.)
• The cost of the item.

You must figure your section 179 deduction before figuring your depreciation deduction.

You must subtract the amount you elect to deduct under section 179 from the business/investment cost of the qualifying property. The result is called your unadjusted basis and is the amount you use to figure any depreciation deduction.

Example. In 2000, you bought and placed in service a $21,000 forklift and a $1,500 circular saw for your business. You elect to deduct $18,500 for the forklift and the entire $1,500 for the saw, a total of $20,000. This is the maximum dollar limit you can deduct. Your $1,500 deduction for the saw completely recovered its cost. Your unadjusted basis is zero. The unadjusted basis of your forklift is $2,500. You figure this by subtracting your section 179 deduction for the forklift, $18,500, from the cost of the forklift, $21,000.

Deduction Limits

Your section 179 deduction cannot be more than the business cost of the qualifying property. In addition, in figuring your section 179 deduction, you must apply the following limits.

• Maximum dollar limit.
• Investment limit.
• Taxable income limit.

Maximum Dollar Limit

The total cost of section 179 property you can elect to deduct for 2000 cannot be more than $20,000. This maximum dollar limit is reduced if you go over the investment limit (discussed later) in any year.

The total cost of section 179 property you can deduct increases in later years as shown below.
  

Passenger automobiles. For passenger automobiles placed in service in 2000, the total of the section 179 and depreciation deductions cannot be more than $3,060 for 2000. For more information, see Special Rule for Passenger Automobiles, later.

Increased section 179 deduction for enterprise zone businesses. You may be able to claim an increased section 179 deduction if your business qualifies as an enterprise zone business. The increase can be as much as $20,000, but it cannot be more than the cost of qualified zone property which is section 179 property placed in service during the year.

For information, see Publication 954, Tax Incentives for Empowerment Zones and Other Distressed Communities.

Investment Limit

If the cost of your qualifying section 179 property placed in service in a year is over $200,000, reduce the maximum dollar limit for each dollar over $200,000 (but not below zero). If the cost of your section 179 property placed in service during 2000 is $220,000 or more, you cannot take a section 179 deduction and you cannot carry over the cost that is more than $220,000.

Example. This year, Jane Ash placed in service machinery costing $207,000. Because this cost is $7,000 more than $200,000, she must reduce her maximum dollar limit of $20,000 by $7,000. If her taxable income is $13,000 or more, she can claim a $13,000 section 179 deduction for this year.

Taxable Income Limit

The total cost you can deduct each year is limited to the taxable income from the active conduct of any trade or business during the year. Generally, you are considered to actively conduct a trade or business if you meaningfully participate in the management or operations of the trade or business.

Figure taxable income for this purpose by totaling the net income (or loss) from all trades and businesses you actively conducted during the year. Items of income derived from a trade or business actively conducted by you include the following.

• Section 1231 gains (or losses).
• Interest from working capital of your trade or business.
• Wages, salaries, tips, or other pay earned as an employee.

When figuring taxable income, do not take into account any unreimbursed employee business expenses you may have as an employee.

In addition, figure taxable income without regard to any of the following.

• The section 179 deduction.
• The self-employment tax deduction.
• Any net operating loss carryback or carryforward.

Any cost not deductible in one year under section 179 because of this limit can be carried to the next year.

Section 1231 gains and losses. Any recognized gains or losses from the following types of transactions are section 1231 gains or losses.

1. The sale or exchange of real property or depreciable personal property used in a trade or business if you held it for more than 1 year.
2. The sale or exchange of cattle or horses held for draft, breeding, dairy, or sporting purposes if you held them for 2 years or more.
3. The sale or exchange of livestock (other than cattle, horses, and poultry) held for draft, breeding, dairy, or sporting purposes if you held it for 1 year or more.
4. The sale, exchange, or involuntary conversion of unharvested crops on land used in farming if you meet both the following requirements.
   1. You sold, exchanged, or involuntarily converted the crop and land at the same time and to the same person.
   2. You held the land for more than 1 year.

5. The cutting of timber for sale or for use in your trade or business if you meet both the following requirements.
   1. You elect to treat the cutting as a sale or exchange.
   2. You either owned the timber for more than 1 year or held a contract right to cut the timber for more than 1 year.

6. The disposal of timber held for more than 1 year under a cutting contract if you treat the disposal as a sale or exchange and you retain an economic interest in the timber.
7. The disposal of coal (including lignite) or iron ore (mined in the United States) owned for more than 1 year under a contract in which you retain an economic interest in the coal or iron ore.

As this publication was being prepared for print, Congress was considering legislation that would change number (6), above. For more information about this and other important tax changes, see Publication 553, Highlights of 2000 Tax Changes.

For more information about section 1231 gains and losses, see chapter 3 in Publication 544.

Two different taxable income limits. The section 179 deduction is subject to a taxable income limit. You also may have to figure some other deduction that has a limit based on taxable income. You may have to figure the limit for this other deduction taking into account the section 179 deduction. If so, complete the following steps.

Example. During the year, the XYZ corporation purchased and placed in service qualifying section 179 property that cost $10,000. It elects to expense as much as possible under section 179. The XYZ corporation also gave a charitable contribution of $1,000 during the year. A corporation's deduction for charitable contributions cannot be more than 10% of its taxable income, figured after subtracting any section 179 deduction. The taxable income limit for the section 179 deduction is figured after subtracting any allowable charitable contributions. XYZ's taxable income figured without the section 179 deduction or the deduction for charitable contributions is $12,000. XYZ figures its section 179 deduction and its deduction for charitable contributions as follows.

• Step 1- Taxable income figured without either deduction is $12,000.
• Step 2- Using $12,000 as taxable income, XYZ's hypothetical section 179 deduction is $10,000.
• Step 3- $2,000 ($12,000 - $10,000).
• Step 4- Using $2,000 (from Step 3) as taxable income, XYZ's hypothetical charitable contribution (limited to 10% of taxable income) is $200.
• Step 5- $11,800 ($12,000 - $200).
• Step 6- Using $11,800 (from Step 5) as taxable income, XYZ figures the actual section 179 deduction. Because the taxable income is at least $10,000, XYZ can take a $10,000 section 179 deduction.
• Step 7- $2,000 ($12,000 - $10,000).
• Step 8- Using $2,000 (from Step 7) as taxable income, XYZ's actual charitable contribution (limited to 10% of taxable income) is $200.

Carryover of disallowed deduction. You can carry over the cost of any section 179 property you elected to expense but were unable to because of the taxable income limit. You use the amount you carry over to determine your section 179 deduction in the next year.

In the year you place more than one property in service, you can select the properties for which all or a part of the costs will be carried forward. For this purpose, treat section 179 costs allocated from a partnership or an S corporation as one item of section 179 property. You can do this provided your decisions are shown in your books and records.

If you do not make a selection, the total carryover will be allocated equally among the properties you elected to expense for the year. If you can deduct all or a part of your total carryover in a subsequent year, you must deduct the costs being carried from the earliest year first.

Basis adjustment. Generally, you must increase the basis of any section 179 property by any unused carryover of disallowed section 179 deduction before you do either of the following.

• Sell or otherwise dispose of the section 179 property.
• Transfer section 179 property in a transaction in which gain or loss is not recognized in whole or in part (including transfers at death).

Neither the old nor the new owner can deduct any of the disallowed amount that is added to the basis of the property.

Married Filing Joint or Separate Returns

If you are married, how you figure your section 179 deduction depends on whether you file jointly or separately.

Joint returns. If you file a joint return, you and your spouse are treated as one taxpayer in determining any reduction to the maximum dollar limit, regardless of which of you purchased the property or placed it in service.

Separate returns. If you and your spouse file separate returns, you are treated as one taxpayer for the maximum dollar limit and the $200,000 investment limit. Unless you elect otherwise, 50% of the maximum dollar limit (after applying the investment limit) will be allocated to each of you. If the percentages elected by each of you do not total 100%, 50% will be allocated to each of you.

Example 1. Jack Elm is married. He and his wife file separate returns. Jack bought and placed in service $200,000 of qualified farm machinery in 2000. His wife has her own business and she bought and placed in service $5,000 of qualified business equipment. Their combined maximum dollar limit is $15,000. This is because they must figure the limit based on filing a joint return. If they filed a joint return for 2000, they would reduce the maximum dollar limit ($20,000) by the excess over the investment limit ($5,000).

They elect to allocate $15,000 as follows.

• $11,250 (75%) to Mr. Elm's machinery.
• $3,750 (25%) to Mrs. Elm's equipment.

If they did not make an election to allocate their costs, they would each be limited to $7,500 ($15,000 x 50%).

Joint return after filing separate returns. If you and your spouse elect to file a joint return after the due date for filing the return, the maximum dollar limit on the joint return is the lesser of the following.

• The maximum dollar limit (after applying the investment limit).
• The total cost of section 179 property you and your spouse elected to expense on your separate returns.

Example 2. Assume Jack from Example 1 elected to expense $4,000 on his separate return and his wife elected to expense $2,000. If they subsequently file a joint return after the due date for that return, their maximum dollar limit for the section 179 deduction is $6,000. This is the lesser of the following.

• $15,000 -- The maximum dollar limit less the excess over the investment limit.
• $6,000 -- The total they elected to expense on their separate returns.

Partnerships and Partners

The section 179 deduction limits apply both to the partnership and to each partner. The partnership determines its section 179 deduction subject to the limits. It then allocates the deduction among its partners.

Each partner adds the amount allocated from the partnership (shown on Schedule K-1) to his or her other nonpartnership section 179 costs and then applies the maximum dollar limit to this total. To determine if a partner has exceeded the $200,000 investment limit, the partner does not include any of the cost of section 179 property placed in service by the partnership. After the maximum dollar limit and investment limit are applied, the remaining cost of the partnership and nonpartnership section 179 property is subject to the taxable income limit.

Figuring taxable income for a partnership. For purposes of the taxable income limit, figure the partnership's taxable income by adding together the net income (or loss) from all trades or businesses actively conducted by the partnership during the year. See Publication 541, Partnerhips, for information on how to figure partnership net income (or loss).

Partner's share of partnership taxable income. For purposes of the taxable income limit, the taxable income of a partner engaged in the active conduct of one or more of a partnership's trades or businesses includes his or her allocable share of taxable income derived from the partnership's active conduct of any trade or business.

For purposes of section 179, if your tax year and that of the partnership differ, the amount of the partnership's taxable income attributable to you for a tax year is determined based on the partnership tax year that ends with or within your tax year.

Example. John and James Oak are equal partners in Oak Company. Oak Company uses a tax year ending January 31. John and James both use a tax year ending December 31. For Oak Company's tax year ending January 31, 2000, it has taxable income from the active conduct of its business of $80,000, of which $70,000 was earned during 1999. John and James each include $40,000 of partnership taxable income in computing their taxable income limit for the 2000 tax year.

Basis adjustment. You must reduce the basis of your partnership interest by the total amount of section 179 expenses allocated from the partnership regardless of whether you can currently deduct the full amount of allocated section 179 expenses. If you dispose of your interest in a partnership, your basis for determining gain or loss is increased by any outstanding carryover of disallowed section 179 expenses allocated from the partnership.

The basis of a partnership's section 179 property must be reduced by the section 179 deduction elected by the partnership. This reduction of basis must be made even if a partner cannot deduct all or part of the section 179 deduction allocated to that partner by the partnership because of the limits.

Example. In 2000, Beech Partnership placed in service section 179 property with a total cost of $204,000. The partnership's taxable income for the year was $30,000. The partnership must reduce its maximum dollar limit ($20,000) by $4,000 ($204,000 - $200,000). The maximum section 179 deduction for the partnership is $16,000. The partnership allocates this $16,000 equally to its two partners, Ann and Dean.

Ann had no other section 179 property placed in service this year. In addition to being a partner in the Beech Partnership, she also operates a business as a sole proprietorship. If her taxable income is $8,000 or more she can claim the $8,000 allocated to her by Beech as a section 179 deduction.

In addition to being a partner in Beech Partnership, Dean also operates a business as a sole proprietorship. This year he placed $15,500 of qualifying section 179 property in service in his sole proprietorship business. This business had taxable income of $20,000. He is also a partner in the Cedar Partnership, which allocated him a section 179 amount of $7,000. Because he has a total section 179 deduction allocated from the partnerships of $15,000 ($8,000 from Beech and $7,000 from Cedar), he can elect a section 179 deduction of only $5,000 ($20,000 - $15,000) for the property from his sole proprietorship because his maximum section 179 deduction is $20,000.

S Corporations

Generally, the rules that apply to a partnership and its partners also apply to an S corporation and its shareholders. The deduction limits apply to an S corporation and to each shareholder. The S corporation allocates the deduction to the shareholders who then take their section 179 deduction subject to the limits.

Figuring taxable income for an S corporation. To figure taxable income (or loss) from the active conduct by an S corporation of any trade or business, you total the net income (or loss) from all trades or businesses actively conducted by the S corporation during the year.

To figure the net income (or loss) from a trade or business actively conducted by an S corporation, you take into account the items from that trade or business that are passed through to the shareholders and used in determining each shareholder's tax liability. However, you do not take into account any credits, tax-exempt income, and deductions for compensation paid to shareholder-employees. For purposes of determining the total amount of S corporation items, treat deductions and losses as negative income. When figuring the amount of each item, disregard any limits that must be taken into account when figuring a shareholder's taxable income.

Other Corporations

A corporation's taxable income from its active conduct of any trade or business is its taxable income figured with the following changes.

• It is figured before deducting any net operating loss deduction or special deductions (as reported on the corporation's income tax return).
• It is adjusted for items of income or deduction not derived from a trade or business actively conducted by the corporation during the tax year.

Part I of Form 4562

Use Part I of Form 4562 to figure your section 179 deduction and any carryover. If you elect the section 179 deduction, you must attach Form 4562 to your return.

If you have listed property (explained in chapter 4) you are electing to deduct under section 179, complete Part V of Form 4562 before completing Part I.

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