Code Section 179 Expense Election

Generally, the cost of property placed in service in a trade or business can't be deducted in the year it's placed in service if the property will be useful beyond the year. The cost is “capitalized” and depreciation deductions are allowed for the property, but are spread out over a period of years (a “cost recovery period”). Capitalization delays the tax benefits of business expenditures. For example, you may spend $50,000 on a new computer system today, but must spread your depreciation deductions over a five-year period. That's why the election to take immediate deductions is important.

The expense election is made available, on a tax year by tax year basis, under Section 179 of the Internal Revenue Code (the “Code”), and is often referred to as the “Section 179 election” or the “Code Section 179 election.”

Subject to a dollar limit, the election allows you to deduct, in the tax year for which the election is made, the cost of qualifying property (described below) placed in service during the tax year. The deductions allowed are in lieu of depreciation deductions. For tax years beginning in 2007, the dollar limit is $125,000 (up from $108,000 in 2006). Based on the rate of inflation, the limit may be raised higher in 2008, 2009, and 2010. However, for tax years beginning after 2010 (i.e., 2011 and later) the dollar limit is scheduled to drop to $25,000. (As discussed below, the dollar limit is reduced, i.e., made more stringent, if more than $500,000 of qualifying property is placed in service during the 2007 tax year ($430,000 for tax year 2006), or if taxable income from your trade or business is low for the tax year. On the other hand, higher limits apply to certain property used in a qualified business in designated geographic areas, such as the DC Zone, the New York Liberty Zone, and the Gulf Opportunity Zone.)

Qualifying property. To qualify for the election, the property must be “tangible personal” property. This means that real estate (land, buildings, and their structural components) does not qualify, nor do intangibles such as patent rights. However, for tax years beginning before Jan. 1, 2011, off-the-shelf computer software qualifies. Also, to qualify, property must be “purchased.” Thus, if you acquired the property in a tax-free exchange or from an individual or entity to which you bear a close relationship specified in the Code, the property does not qualify.

Dollar limit. The dollar limit doesn't mean the election can't be made for property costing more than that amount. For example, if you buy a machine for $133,000 and place it in service in a business in a tax year beginning in 2007, you can elect to deduct $125,000 of its cost for that year. The remainder ($8,000) is capitalized and depreciated. Also, you can make the election for two or more separate assets as long as the total cost covered by the election doesn't exceed the dollar limit for that year.

You should be aware, regarding the dollar limit, that if the total cost of qualifying property that you place in service during a tax year beginning in 2007 is over $500,000 (the “phaseout” amount), the dollar limit is reduced by that extra amount. For example, if you place in service $520,000 of qualifying property in a tax year beginning in 2007, you can make the election for no more than $105,000 of property ($125,000 minus the $20,000 excess over $500,000). For tax years beginning in 2006, the phaseout began at $430,000. Based on the rate of inflation, the phaseout amount may be raised higher in 2008, 2009, or 2010. For tax years beginning after 2010, the phaseout amount is scheduled to drop to $200,000.

You might consider postponing, to later tax years, or accelerating, into earlier tax years, placing property into service, to take best advantage of the dollar limits (as further limited by the phaseout rule). For example, if you have ordered two items of qualifying property costing $125,000 each, you might want to consider placing only one of them in service in 2007. Doing so will permit you to elect to expense $125,000 in 2007 and $125,000 in 2008 (when the inflation-adjusted amount will be at least $125,000). If both are placed in service in 2007, your expense election for the two items is limited to one $125,000 deduction.

Taxable income limit. If your taxable income from all of your trades or businesses is less than the dollar limit for that year, the amount for which you can make the election is limited to that taxable income. However, any amount you can't currently deduct because of the taxable income limitation is carried forward and may be deducted in later years (to the extent that the applicable dollar limit, the phaseout rule and the taxable income limit permit).

Recapture. If you dispose of the property, or stop using it in a trade or business, before the end of the cost recovery period that would have applied to the property had you not made the election for the property, all or part of the amount of the deduction you claimed under the election must be taken back into income (“recaptured”). Exactly how much will depend on the type of property and how long you used the property in a trade or business.

The above information covers the essential elements of the Code Section 179 election. Clearly, many considerations go into each decision to acquire business assets, and most involve non-tax factors. However, the election should play a role; accelerated tax benefits may enable you to obtain the property you need earlier and at reduced after-tax costs.