Publication 946
How To Depreciate Property

Section 179 Deduction; Special Depreciation Allowance; MACRS Listed Property

For use in preparing 2002 Returns

Business Income Limit

The total cost you can deduct each year after you apply the dollar limit 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.

Any cost not deductible in one year under section 179 because of this limit can be carried to the next year. See Carryover of disallowed deduction, later.

Taxable income.   Figure taxable income for this purpose by totaling the net income and losses from all trades and businesses you actively conducted during the year. Net income or loss from a trade or business includes the following items.

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

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

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 unreimbursed employee business expenses.

Two different taxable income limits.   In addition to the business income limit for your section 179 deduction, you may have a taxable income limit for some other deduction. 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 business 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 business income limit. This disallowed deduction amount is shown on line 13 of Form 4562. You use the amount you carry over to determine your section 179 deduction in the next year. Enter that amount on line 10 of your Form 4562 for the next year.

If you place more than one property in service in a year, you can select the properties for which all or a part of the costs will be carried forward. Your selections must be shown in your books and records. For this purpose, treat section 179 costs allocated from a partnership or an S corporation as one item of section 179 property. 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 costs from more than one year are carried forward to a subsequent year in which only part of the total carryover can be deducted, you must deduct the costs being carried forward from the earliest year first.

If there is a sale or other disposition of your property (including a transfer at death) before you can use the full amount of any outstanding carryover of your disallowed section 179 deduction, neither you nor the new owner can deduct any of the unused amount. Instead, you must add it back to the property's basis.

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 partnerships (shown on Schedule K-1 (Form 1065), Partner's Share of Income, Credits, Deductions, etc.) to his or her nonpartnership section 179 costs and then applies the dollar limit to this total. To determine any reduction in the dollar limit for costs over $200,000, the partner does not include any of the cost of section 179 property placed in service by the partnership. After the dollar limit (and any reduction in the dollar limit due to nonpartnership section 179 costs) is applied, any remaining cost of the partnership and nonpartnership section 179 property is subject to the business income limit.

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

Partner's share of partnership's taxable income.   For purposes of the business 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.

Example.   In 2002, Beech Partnership placed in service section 179 property with a total cost of $204,000. The partnership must reduce its dollar limit by $4,000 ($204,000 - $200,000). Its maximum section 179 deduction is $20,000 ($24,000 - $4,000), and it elects to expense that amount. The partnership's taxable income from the active conduct of all its trades or businesses for the year was $30,000, so it can deduct the full $20,000. It allocates $10,000 of its section 179 deduction and $15,000 of its taxable income to Dean, one of its partners.

Dean does not have to include section 179 partnership costs to figure any reduction in his dollar limit, so his total section 179 costs for the year are not more than $200,000 and his dollar limit is not reduced. His maximum section 179 deduction is $24,000. He elects to expense all of the $17,000 in section 179 deductions allocated from the partnerships, plus $7,000 of his sole proprietorship's section 179 costs, and notes that information in his books and records. However, his deduction is limited to his business taxable income of $22,000 ($15,000 from Beech Partnership, plus $12,000 from Cedar Partnership minus $5,000 loss from his sole proprietorship). He carries over $2,000 ($24,000 - $22,000) of the elected section 179 costs to 2003. He allocates the carryover amount to the cost of section 179 property placed in service in his sole proprietorship, and notes that allocation in his books and records.

Different tax years.   For purposes of section 179, if the partner's tax year and that of the partnership differ, the partner's share of the partnership's taxable income for a tax year is determined based on the partnership tax year that ends with or within the partner's 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 it's tax year ending January 31, 2002, Oak Company's taxable income from the active conduct of its business is $80,000, of which $70,000 was earned during 2001. John and James each include $40,000 (each partner's entire share) of partnership taxable income in computing their business income limit for the 2002 tax year.

Adjustment of partner's basis in partnership.   A partner must reduce the basis of his or her partnership interest by the total amount of section 179 expenses allocated from the partnership even if the partner cannot currently deduct the total amount. If the partner disposes of his or her partnership interest, the partner's basis for determining gain or loss is increased by any outstanding carryover of disallowed section 179 expenses allocated from the partnership.

Adjustment of partnership's basis in section 179 property.   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.

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 its 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 and losses 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, or 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. In figuring the taxable income of an S corporation, disregard any limits on the amount of an S corporation item 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.

How Do You Elect the Deduction?

• Listed property
• Placed in service

You elect the section 179 deduction by completing Part I of Form 4562.

If you elect the deduction for listed property (described in chapter 5), complete Part V of Form 4562 before completing Part I.

File Form 4562 with either of the following.

• Your original tax return filed for the year the property was placed in service (whether or not you file it timely).
• An amended return filed by the due date (including extensions) for your return for the year the property was placed in service. (You cannot make an election for the section 179 deduction on an amended return filed after the due date (including extensions).)

If you timely filed your return for the year without making the election, you still can make the election by filing an amended return within six months of the due date of the return (excluding extensions). For more information, see the instructions for Part I of Form 4562.

You must keep records that show the specific identification of each piece of qualifying section 179 property. These records must show how you acquired the property, the person you acquired it from, and when you placed it in service.

Revoking an election.   Once you elect a section 179 deduction, you cannot change your selection of qualifying property or revoke your election without IRS approval. The IRS will grant approval only in extraordinary circumstances. A request to change or revoke the election is subject to a user fee.

When you file your request, you must include the following information.

• Your name.
• Your address.
• Your taxpayer identification number (TIN).
• A statement showing the year and property involved and your reasons, in detail, for the request.

The request must be signed by you or your representative.

You must file your request with the:

Commissioner of Internal Revenue
Washington, DC 20224

When Must You Recapture the Deduction?

• Disposition
• Exchange
• Recapture
• Recovery period
• Section 1245 property

You may have to recapture the section 179 deduction if, in any year during the property's recovery period, the percentage of business use drops to 50% or less. In the year the business use drops to 50% or less, you include the recapture amount as ordinary income in Part IV of Form 4797. You also increase the basis of the property by the recapture amount. Recovery periods for property are discussed under Which Recovery Period Applies? in chapter 4.

If you sell, exchange, or otherwise dispose of the property, do not figure the recapture amount under the rules explained in this discussion. Instead, use the rules for recapturing depreciation explained in chapter 3 of Publication 544 under Section 1245 Property.

If the property is listed property (described in chapter 5), do not figure the recapture amount under the rules explained in this discussion when the percentage of business use drops to 50% or less. Instead, use the rules for recapturing depreciation explained in chapter 5 under What Is the Business-Use Requirement.

Figuring the recapture amount.   To figure the amount to recapture, take the following steps.

1. Figure the depreciation that would have been allowable on the section 179 deduction you claimed. Begin with the year you placed the property in service and include the year of recapture.
2. Subtract the depreciation figured in (1) from the section 179 deduction you claimed. The result is the amount you must recapture.

Example.   In 2000, Paul Lamb, a calendar year taxpayer, bought and placed in service section 179 property costing $10,000. The property is not listed property. He elected a $5,000 section 179 deduction for the property. He used the property only for business in 2000 and 2001. In 2002, he used the property 40% for business and 60% for personal use. He figures his recapture amount as follows.

Paul must include $814.80 in income for 2002.

Qualified zone property.   If any qualified zone property placed in service during the year ceases to be used in an empowerment zone by an enterprise zone business in a later year, the benefit of the increased section 179 deduction must be reported as other income on your return. For information on the increased section 179 deduction available to enterprise zone businesses, see Enterprise Zone Businesses under How Much Can You Deduct, earlier. For an explanation of qualified zone property, see Publication 954.

Qualified Liberty Zone property.   If any qualified Liberty Zone property placed in service during the year ceases to be used in the Liberty Zone in a later year, the benefit of the increased section 179 deduction must be reported as other income on your return. For information on the increased section 179 deduction available for Liberty Zone property, see Liberty Zone Property under How Much Can You Deduct, earlier. For an explanation of qualified Liberty Zone property, see What Is Qualified Liberty Zone Property? in chapter 3.

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