Editorial · January 23, 2016
Section 179 Deduction: What the Permanent Limit Means
The section 179 deduction now has a permanent limit. A taxpayer can generally deduct up to $500,000 of the cost of qualifying equipment and other property in the tax year it goes into service. The limit shrinks once a taxpayer places more than $2 million of qualifying property in service in one tax year. Congress gave both numbers no end date in the Protecting Americans from Tax Hikes (PATH) Act, which became law on December 18, 2015. For tax years that begin after 2015, they adjust for inflation. This is general information, not tax advice.
What the new law changed
Before the PATH Act, the tax code gave the $500,000 limit only through tax years that began in 2014. For later years it set the limit at $25,000, and the phase-out began at $200,000. The Act removes those dates, so the higher limit no longer expires. It covers tax years that begin after December 31, 2014, so 2015 returns get the higher limit. The IRS confirms this for 2015.
The Act also changes these related rules:
- Off-the-shelf computer software stays eligible, with no end date.
- A taxpayer can revoke a section 179 election without IRS approval by filing an amended return in time. That option no longer has an end date.
- The option to treat certain real property as qualifying becomes permanent for tax years that begin after 2015. The $250,000 cap on that property still applies for 2015, then ends.
- Air conditioning and heating units come off the excluded list for tax years that begin after 2015.
- For tax years that begin after 2015, the $500,000 and $2 million amounts are adjusted for inflation, with the increase rounded to the nearest $10,000.
How the limit works
A taxpayer does not have to deduct the full cost of an item. The taxpayer can expense part and generally depreciate the rest. With several items, the deduction can be split in any way, as long as the total does not pass the limit.
The phase-out generally works dollar for dollar. In one IRS example, a taxpayer placed $2,100,000 of machinery in service. That was $100,000 over the threshold, so the limit fell to $400,000. The rest is simple subtraction. Using 2015 numbers, the limit reaches zero at $2.5 million of qualifying property placed in service.
A second cap looks at income. The deduction cannot be more than the taxpayer's taxable income from businesses the taxpayer actively conducts that tax year. Generally, active means meaningful participation in management or operations. For an individual, the IRS counts wages from a job as part of that income. If the income cap blocks part of the deduction, that part generally carries over to later years, and there is no limit on how many.
The limits generally apply to each taxpayer, not to each business. For S corporations and for partnerships other than electing large partnerships, they apply to the entity and to each owner. A married couple shares one dollar limit.
What counts as qualifying property
The property must be bought for use in the active conduct of the business. It must also be used more than 50 percent for business. If use is mixed, only the business share of the cost counts. Qualifying types include:
- tangible personal property, such as machinery, office equipment, signs and cell phones
- off-the-shelf computer software
- three kinds of qualified real property, if the taxpayer elects: leasehold improvement, retail improvement and restaurant property
The property must also be placed in service during the tax year. That means it is ready and available for its specific use. In an IRS example, a machine was delivered in one year but not installed and working until the next. It counts as placed in service in the second year.
What the deduction does not cover
Some property does not qualify:
- land and land improvements, such as paved parking areas and fences
- property held for investment
- property received as a gift or inheritance, or bought from a related person, such as a parent
- property used mostly outside the United States, or mostly to furnish lodging or in connection with it, with some exceptions
- air conditioning and heating units, for tax years that begin before 2016
An estate or trust cannot make the election.
Heavy SUVs and certain other vehicles have their own cap. A taxpayer can expense no more than $25,000 of the cost of any such vehicle. The cap covers four-wheeled vehicles mainly designed or used to carry passengers on public roads and rated above 6,000 and up to 14,000 pounds gross vehicle weight, with some exceptions.
Business use must also last. If use falls to 50 percent or less before the end of the property's recovery period, the benefit of the deduction must be reported as other income.
Section 179 is separate from bonus depreciation, which the IRS calls the special depreciation allowance. That extra deduction comes after any section 179 deduction and before regular depreciation. The PATH Act extends it and steps it down in later years.
Questions to ask before you buy
These questions come from the rules above. A tax professional can check them against a real purchase.
- When will it be ready for use? The tax year it goes into service is the tax year of the deduction.
- How much will you place in service this tax year? Past the threshold ($2 million for 2015), the limit starts to fall.
- How much taxable business income will you have? The deduction cannot exceed it, though the part it blocks generally carries over.
- How much of the use is for business? It must stay above half.
The section 179 election is made on Form 4562, filed with the return for the tax year the property went into service. A timely amended return can also include it. That filing must name each item and the part of its cost to expense, and include any resulting adjustments.