How Much Can You Deduct? Words you may need to know (see Glossary): Adjusted basis Basis Placed in service Your section 179 deduction is generally the cost of the qualifying property. However, the total amount you can elect to deduct under section 179 is subject to a dollar limit and a business income limit. These limits apply to each taxpayer, not to each business. However, see Married Individuals under Dollar Limit, later. Use Part I of Form 4562 to figure your section 179 deduction. Trade-in of other property. If you buy qualifying property with cash and a trade-in, its cost for purposes of the section 179 deduction includes only the cash you paid. Example. Silver Leaf, a retail bakery, traded two ovens having a total adjusted basis of $680 for a new oven costing $1,320. They received an $800 trade-in for the old ovens and paid $520 in cash for the new oven. The bakery also traded a used van with an adjusted basis of $4,500 for a new van costing $9,000. They received a $4,800 trade-in on the used van and paid $4,200 in cash for the new van. Silver Leaf's basis in the new property includes both the adjusted basis of the property traded and the cash paid. However, only the portion of the new property's basis paid by cash qualifies for the section 179 deduction. Therefore, Silver Leaf's qualifying costs for the section 179 deduction are $4,720 ($520 + $4,200). Depreciating the excess cost. If you deduct only part of the cost of your qualifying property as a section 179 deduction, you can generally depreciate the cost you do not deduct. To figure your basis for depreciation using MACRS (discussed in chapter 3), you must subtract the amount of the section 179 deduction from the cost of the qualifying property. The result is the amount you use to figure any depreciation deduction. For information on how to figure depreciation, see chapter 3. Dollar Limit The total amount you can elect to deduct under section 179 for 2001 cannot be more than $24,000. If you acquire and place in service more than one item of qualifying property during the year, you can allocate the section 179 deduction among the items in any way, as long as the total deduction is not more than $24,000. You do not have to claim the full $24,000. Beginning in 2003, the total amount you can elect to deduct under section 179 will increase to $25,000. After you apply the dollar limit to determine a tentative deduction, you must apply the business income limit (described later) to determine your actual section 179 deduction. Example. In 2001, you bought and placed in service a $25,000 forklift and a $1,500 circular saw for your business. You elect to deduct $22,500 for the forklift and the entire $1,500 for the saw, a total of $24,000. This is the maximum amount you can deduct. Your $1,500 deduction for the saw completely recovered its cost. Your basis for depreciation is zero. The basis for depreciation of your forklift is $2,500. You figure this by subtracting your $22,500 section 179 deduction for the forklift from the $25,000 cost of the forklift. Reduced dollar limit for cost exceeding $200,000. If the cost of your qualifying section 179 property placed in service in a year is over $200,000, you must reduce the dollar limit (but not below zero) by the amount of cost over $200,000. If the cost of your section 179 property placed in service during 2001 is $224,000 or more, you cannot take a section 179 deduction and you cannot carry over the cost that is more than $224,000. 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 dollar limit to $17,000 ($24,000 - $7,000). Increased dollar limit for enterprise zone businesses. The dollar limit on the section 179 deduction is increased if your business qualifies as an enterprise zone business. The increase is the smaller of the following amounts. $20,000 ($35,000 for tax years beginning after 2001). The cost of section 179 property that is also qualified zone property. For more information, see Publication 954, Tax Incentives for Empowerment Zones and Other Distressed Communities. Additional limit for passenger automobiles. For passenger automobiles placed in service in 2001, the total of the section 179 and depreciation deductions generally cannot be more than $3,060. For more information, see Do the Passenger Automobile Limits Apply? in chapter 4. Married Individuals 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 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 dollar limit, including the reduction for costs over $200,000. You must allocate the dollar limit (after any reduction) between you. You must allocate 50% to each, unless you both elect a different allocation. If the percentages elected by each of you do not total 100%, 50% will be allocated to each of you. Example. Jack Elm is married. He and his wife file separate returns. Jack bought and placed in service $200,000 of qualified farm machinery in 2001. His wife has her own business, and she bought and placed in service $5,000 of qualified business equipment. Their combined dollar limit is $19,000. This is because they must figure the limit as if they were one taxpayer. They reduce the $24,000 dollar limit by the $5,000 excess of their costs over $200,000. They elect to allocate the $19,000 dollar limit as follows. $14,250 (75%) to Mr. Elm's machinery. $4,750 (25%) to Mrs. Elm's equipment. If they did not make an election to allocate their costs in this way, they would each be limited to $9,500 ($19,000 × 50%). Joint return after filing separate returns. If you and your spouse elect to amend your separate returns by filing a joint return after the due date for filing your return, the dollar limit on the joint return is the lesser of the following amounts. The dollar limit (after reduction for any cost of section 179 property over $200,000). The total cost of section 179 property you and your spouse elected to expense on your separate returns. Example. The facts are the same as in the previous example except that Jack elected to deduct $4,000 on his separate return and his wife elected to deduct $2,000. After the due date of their returns, they file a joint return. Their dollar limit for the section 179 deduction is $6,000. This is the lesser of the following amounts. $19,000--The dollar limit less the cost of section 179 property over $200,000. $6,000--The total they elected to expense on their separate 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. Step Action 1 Figure taxable income without the section 179 deduction or the other deduction. 2 Figure a hypothetical section 179 deduction using the taxable income figured in Step 1. 3 Subtract the hypothetical section 179 deduction figured in Step 2 from the taxable income figured in Step 1. 4 Figure a hypothetical amount for the other deduction using the amount figured in Step 3 as taxable income. 5 Subtract the hypothetical other deduction figured in Step 4 from the taxable income figured in Step 1. 6 Figure your actual section 179 deduction using the taxable income figured in Step 5. 7 Subtract your actual section 179 deduction figured in Step 6 from the taxable income figured in Step 1. 8 Figure your actual other deduction using the taxable income figured in Step 7. 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 a subsequent year in which only part of the total carryover can be deducted, you must deduct the costs being carried 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 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. Example. In 2001, 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. Because the partnership's taxable income from the active conduct of all its trades or businesses for the year was $30,000, 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. In addition to being a partner in Beech Partnership, Dean is also a partner in the Cedar Partnership, which allocated to him a $7,000 section 179 deduction and $12,000 taxable income from the active conduct of its business. He also conducts a business as a sole proprietor and, in 2001, placed in service in that business qualifying section 179 property costing $15,500. He had a net loss of $5,000 from that business for the year. Because Dean does not have to include partnership costs to figure any reduction in his dollar limit, 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 2002. 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. 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. 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, 2001, Oak Company's taxable income from the active conduct of its business is $80,000, of which $70,000 was earned during 2000. John and James each include $40,000 (each partner's entire share) of partnership taxable income in computing their business income limit for the 2001 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. 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.