Publication 225 (2007), Farmer's Tax Guide

IRS Resources

7. Depreciation, Depletion, and Amortization

Table of Contents

What's New for 2007

Increased section 179 deduction dollar limits. The maximum amount you can elect to deduct for most section 179 property you placed in service in 2007 is $125,000. This limit is reduced by the amount by which the cost of the property placed in service during the tax year exceeds $500,000. See Dollar Limits under Section 179 Deduction, later.

What's New for 2008

Extension of increased section 179 deduction. If you own qualified section 179 GO Zone property acquired after August 27, 2005, and placed it in service before January 1, 2009, you may be eligible for an increased section 179 deduction.

Introduction

If you buy farm property such as machinery, equipment, livestock, or a structure with a useful life of more than a year, you generally cannot deduct its entire cost in one year. Instead, you must spread the cost over the time you use the property and deduct part of it each year. For most types of property, this is called depreciation.

This chapter gives information on depreciation methods that generally apply to property placed in service after 1986. For information on depreciating pre-1987 property, see Publication 534, Depreciating Property Placed in Service Before 1987.

To help you understand depreciation and how to complete Form 4562, Depreciation and Amortization, see the filled-in Form 4562 and related discussion in chapter 16.

Topics - This chapter discusses:

Overview of depreciation.
Section 179 deduction.
Special depreciation allowance.
Modified Accelerated Cost Recovery
System (MACRS).
Listed property.
Basic information on cost depletion (including timber depletion) and percentage depletion.
Amortization of the costs of going into business, reforestation costs, the costs of pollution control facilities, and the costs of section 197 intangibles.

Useful Items - You may want to see:

Publication

463 Travel, Entertainment, Gift, and Car Expenses
534 Depreciating Property Placed in Service Before 1987
535 Business Expenses
544 Sales and Other Dispositions of Assets
551 Basis of Assets
946 How To Depreciate Property

Form (and Instructions)

T
Forest Activities Schedule
3115
Application for Change in Accounting Method
4562
Depreciation and Amortization
4797
Sales of Business Property

See chapter 17 for information about getting publications and forms.

It is important to keep good records for property you depreciate. Do not file these records with your return. Instead, you should keep them as part of the permanent records of the depreciated property. They will help you verify the accuracy of the depreciation of assets placed in service in the current and previous tax years. For general information on recordkeeping, see Publication 583, Starting a Business and Keeping Records. For specific information on keeping records for section 179 property and listed property, see
Publication 946.

Overview of Depreciation

This overview discusses basic information on the following.

What property can be depreciated.
What property cannot be depreciated.
When depreciation begins and ends.
Whether MACRS can be used to figure depreciation.
What is the basis of your depreciable property.
How to treat repairs and improvements.
When you must file Form 4562.
How you can correct depreciation claimed incorrectly.

What Property Can Be Depreciated?

You can depreciate most types of tangible property (except land), such as buildings, machinery, equipment, vehicles, certain livestock, and furniture. You can also depreciate certain intangible property, such as copyrights, patents, and computer software. To be depreciable, the property must meet all the following requirements.

It must be property you own.
It must be used in your business or income-producing activity.
It must have a determinable useful life.
It must have a useful life that extends substantially beyond the year you place it in service.

Property You Own

To claim depreciation, you usually must be the owner of the property. You are considered as owning property even if it is subject to a debt.

Leased property. You can depreciate leased property only if you retain the incidents of ownership in the property. This means you bear the burden of exhaustion of the capital investment in the property. Therefore, if you lease property from someone to use in your trade or business or for the production of income, you generally cannot depreciate its cost because you do not retain the incidents of ownership. You can, however, depreciate any capital improvements you make to the leased property. See Additions and Improvements under Which Recovery Period Applies in chapter 4 of Publication 946.

If you lease property to someone, you generally can depreciate its cost even if the lessee (the person leasing from you) has agreed to preserve, replace, renew, and maintain the property. However, you cannot depreciate the cost of the property if the lease provides that the lessee is to maintain the property and return to you the same property or its equivalent in value at the expiration of the lease in as good condition and value as when leased.

Life tenant. Generally, if you hold business or investment property as a life tenant, you can depreciate it as if you were the absolute owner of the property. See Certain term interests in property, later for an exception.

Property Used in Your Business or Income-Producing Activity

To claim depreciation on property, you must use it in your business or income-producing activity. If you use property to produce income (investment use), the income must be taxable. You cannot depreciate property that you use solely for personal activities. However, if you use property for business or investment purposes and for personal purposes, you can deduct depreciation based only on the percentage of business or investment use.

Example 1. If you use your car for farm business, you can deduct depreciation based on its percentage of use in farming. If you also use it for investment purposes, you can depreciate it based on its percentage of investment use.

Example 2. If you use part of your home for business, you may be able to deduct depreciation on that part based on its business use. For more information, see Business Use of Your Home in chapter 4.

Inventory. You can never depreciate inventory because it is not held for use in your business. Inventory is any property you hold primarily for sale to customers in the ordinary course of your business.

Livestock. Livestock purchased for draft, breeding, or dairy purposes can be depreciated only if they are not kept in an inventory account. Livestock you raise usually has no depreciable basis because the costs of raising them are deducted and not added to their basis. However, see Immature livestock under When Does Depreciation Begin and End, later for a special rule.

Property Having a Determinable Useful Life

To be depreciable, your property must have a determinable useful life. This means it must be something that wears out, decays, gets used up, becomes obsolete, or loses its value from natural causes.

Irrigation systems and water wells. Irrigation systems and wells used in a trade or business can be depreciated if their useful life can be determined. You can depreciate irrigation systems and wells composed of masonry, concrete, tile, metal, or wood. In addition, you can depreciate costs for moving dirt to construct irrigation systems and water wells composed of these materials. However, land preparation costs for center pivot irrigation systems are not depreciable.

Dams, ponds, and terraces. In general, you cannot depreciate earthen dams, ponds, and terraces unless the structures have a determinable useful life.

What Property Cannot Be Depreciated?

Certain property cannot be depreciated, even if the requirements explained earlier are met. This includes the following.

Land. You can never depreciate the cost of land because land does not wear out, become obsolete, or get used up. The cost of land generally includes the cost of clearing, grading, planting, and landscaping. Although you cannot depreciate land, you can depreciate certain costs incurred in preparing land for business use. See chapter 1 of Publication 946.
Property placed in service and disposed of in the same year. Determining when property is placed in service is explained later.
Equipment used to build capital improvements. You must add otherwise allowable depreciation on the equipment during the period of construction to the basis of your improvements.
Intangible property such as section 197 intangibles. This property does not have a determinable useful life and generally cannot be depreciated. However, see Amortization, later. Special rules apply to computer software (discussed below).
Certain term interests (discussed below).

Computer software. Computer software is not a section 197 intangible even if acquired in connection with the acquisition of a business, if it meets all of the following tests.

It is readily available for purchase by the general public.
It is subject to a nonexclusive license.
It has not been substantially modified.

If the software meets the tests above, it can be depreciated and may qualify for the section 179 deduction and the special depreciation allowance (if applicable), discussed later.

Certain term interests in property. You cannot depreciate a term interest in property created or acquired after July 27, 1989, for any period during which the remainder interest is held, directly or indirectly, by a person related to you. This rule does not apply to the holder of a term interest in property acquired by gift, bequest, or inheritance. For more information, see chapter 1 of Publication 946.

When Does Depreciation Begin and End?

You begin to depreciate your property when you place it in service for use in your trade or business or for the production of income. You stop depreciating property either when you have fully recovered your cost or other basis or when you retire it from service, whichever happens first.

Placed in Service

Property is placed in service when it is ready and available for a specific use, whether in a business activity, an income-producing activity, a tax-exempt activity, or a personal activity. Even if you are not using the property, it is in service when it is ready and available for its specific use.

Example.

You bought a planter for use in your farm business. The planter was delivered in December 2007 after harvest was over. You begin to depreciate the planter for 2007 because it was ready and available for its specific use in 2007, even though it will not be used until the spring of 2008.

If your planter comes unassembled in December 2007 and is put together in February 2008, it is not placed in service until 2008. You begin to depreciate it in 2008.

If your planter was delivered and assembled in February 2008 but not used until April 2008, it is placed in service in February 2008, because this is when the planter was ready for its specified use. You begin to depreciate it in 2008.

Fruit or nut trees and vines. If you acquire an orchard, grove, or vineyard before the trees or vines have reached the income-producing stage, and they have a preproductive period of more than 2 years, you must capitalize the preproductive-period costs under the uniform capitalization rules (unless you elect not to use these rules). See chapter 6 for information about the uniform capitalization rules. Your depreciation begins when the trees and vines reach the income-producing stage (that is, when they bear fruit, nuts, or grapes in quantities sufficient to commercially warrant harvesting).

Immature livestock. Depreciation for livestock begins when the livestock reaches the age of maturity. If you acquire immature livestock for draft, dairy, or breeding purposes, your depreciation begins when the livestock reach the age when they can be worked, milked, or bred. When this occurs, your basis for depreciation is your initial cost for the immature livestock.

Idle Property

Continue to claim a deduction for depreciation on property used in your business or for the production of income even if it is temporarily idle. For example, if you stop using a machine because there is a temporary lack of a market for a product made with that machine, continue to deduct depreciation on the machine.

Cost or Other Basis Fully Recovered

You stop depreciating property when you have fully recovered your cost or other basis. This happens when your section 179 and allowed or allowable depreciation deductions equal your cost or investment in the property.

Retired From Service

You stop depreciating property when you retire it from service, even if you have not fully recovered its cost or other basis. You retire property from service when you permanently withdraw it from use in a trade or business or from use in the production of income because of any of the following events.

You sell or exchange the property.
You convert the property to personal use.
You abandon the property.
You transfer the property to a supplies or scrap account.
The property is destroyed.

For information on abandonment of property, see chapter 8. For information on destroyed property, see chapter 11 and Publication 547, Casualties, Disasters, and Thefts.

Can You Use MACRS To Depreciate Your Property?

You must use the Modified Accelerated Cost Recovery System (MACRS) to depreciate most business and investment property placed in service after 1986. MACRS is explained later under Figuring Depreciation Under MACRS.

You cannot use MACRS to depreciate the following property.

Property you placed in service before 1987. Use the methods discussed in Publication 534
Certain property owned or used in 1986. See Chapter 1 of Publication 946.
Intangible property.
Films, video tapes, and recordings.
Certain corporate or partnership property acquired in a nontaxable transfer.
Property you elected to exclude from MACRS.

For more information, see Chapter 1 of Publication 946.

What Is the Basis of Your Depreciable Property?

To figure your depreciation deduction, you must determine the basis of your property. To determine basis, you need to know the cost or other basis of your property.

Cost or other basis. The basis of property you buy is usually its cost plus amounts you paid for items such as sales tax, freight charges, and installation and testing fees. The cost includes the amount you pay in cash, debt obligations, other property, or services.

There are times when you cannot use cost as basis. In these situations, the fair market value (FMV) or the adjusted basis of the property may be used.

Adjusted basis. To find your property's basis for depreciation, you may have to make certain adjustments (increases and decreases) to the basis of the property for events occurring between the time you acquired the property and the time you placed it in service.

Basis adjustment for depreciation allowed or allowable. After you place your property in service, you must reduce the basis of the property by the depreciation allowed or allowable, whichever is greater. Depreciation allowed is depreciation you actually deducted (from which you received a tax benefit). Depreciation allowable is depreciation you are entitled to deduct.

If you do not claim depreciation you are entitled to deduct, you must still reduce the basis of the property by the full amount of depreciation allowable.

If you deduct more depreciation than you should, you must reduce your basis by any amount deducted from which you received a tax benefit (the depreciation allowed).

For more information, see chapter 6.

How Do You Treat Repairs and Improvements?

You generally deduct the cost of repairing business property in the same way as any other business expense. However, if a repair or replacement increases the value of your property, makes it more useful, or lengthens its life, you must treat it as an improvement and depreciate it. Treat improvements as separate depreciable property. See chapter 1 of Publication 946 for more information.

Improvements to rented property. You can depreciate permanent improvements you make to business property you rent from someone else.

Example.

You repair a small section on a corner of the roof of a barn that you rent to others. You deduct the cost of the repair as a business expense. However, if you replace the entire roof, the new roof is considered to be an improvement because it increases the value and lengthens the life for the property. You depreciate the cost of the new roof.

Do You Have To File Form 4562?

Use Form 4562 to claim your deduction for depreciation and amortization. You must complete and attach Form 4562 to your tax return if you are claiming any of the following.

A section 179 deduction for the current year or a section 179 carryover from a prior year.
Depreciation for property placed in service during the current year.
Depreciation on any vehicle or other listed property, regardless of when it was placed in service.
Amortization of costs that began in the current year.

For more information, see the Instructions for Form 4562.

How Do You Correct Depreciation Deductions?

If you deducted an incorrect amount of depreciation in any year, you may be able to make a correction by filing an amended return for that year. You can file an amended return to correct the amount of depreciation claimed for any property in any of the following situations.

You claimed the incorrect amount because of a mathematical error made in any year.
You claimed the incorrect amount because of a posting error made in any year, for example, omitting an asset from the depreciation schedule.
You have not adopted a method of accounting for the property.

If you are not allowed to make the correction on an amended return, you may be able to change your accounting method to claim the correct amount of depreciation. See the Instructions for Form 3115.

Section 179 Deduction

You can elect to recover all or part of the cost of certain qualifying property, up to a limit, by deducting it in the year you place the property in service. This is the section 179 deduction. You can elect the section 179 deduction instead of recovering the cost by taking depreciation deductions.

This part of the chapter explains the rules for the section 179 deduction. It explains what property qualifies for the deduction, what property does not qualify for the deduction, the limits that may apply, how to elect the deduction, and when you may have to recapture the deduction.

For more information, see chapter 2 of Publication 946.

What Property Qualifies?

To qualify for the section 179 deduction, your property must meet all the following requirements.

It must be eligible property.
It must be acquired for business use.
It must have been acquired by purchase.

Eligible Property

To qualify for the section 179 deduction, your property must be one of the following types of depreciable property.

Tangible personal property.
Other tangible property (except buildings and their structural components) used as:
1. An integral part of manufacturing, production, or extraction or of furnishing transportation, communications, electricity, gas, water, or sewage disposal services,
2. A research facility used in connection with any of the activities in (a) above, or
3. A facility used in connection with any of the activities in (a) for the bulk storage of fungible commodities.
Single purpose agricultural (livestock) or horticultural structures.
Storage facilities (except buildings and their structural components) used in connection with distributing petroleum or any primary product of petroleum.
Off-the-shelf computer software that is readily available for purchase by the general public, is subject to a nonexclusive lease, and has not been substantially modified.

Tangible personal property. Tangible personal property is any tangible property that is not real property. It includes the following property.

Machinery and equipment.
Property contained in or attached to a building (other than structural components), such as milk tanks, automatic feeders, barn cleaners, and office equipment.
Gasoline storage tanks and pumps at retail service stations.
Livestock, including horses, cattle, hogs, sheep, goats, and mink and other fur-bearing animals.

Facility used for the bulk storage of fungible commodities. A facility used for the bulk storage of fungible commodities is qualifying property for purposes of the section 179 deduction if it is used in connection with any of the activities listed earlier in item (2)(a). Bulk storage means the storage of a commodity in a large mass before it is used.

Grain bins. A grain bin is an example of a storage facility that is qualifying section 179 property. It is a facility used in connection with the production of grain or livestock for the bulk storage of fungible commodities.

Single purpose agricultural or horticultural structures. A single purpose agricultural (livestock) or horticultural structure is qualifying property for purposes of the section 179 deduction.

Agricultural structure. A single purpose agricultural (livestock) structure is any building or enclosure specifically designed, constructed, and used for both the following reasons.

To house, raise, and feed a particular type of livestock and its produce.
To house the equipment, including any replacements, needed to house, raise, or feed the livestock.

For this purpose, livestock includes poultry.

Single purpose structures are qualifying property if used, for example, to breed chickens or hogs, produce milk from dairy cattle, or produce feeder cattle or pigs, broiler chickens, or eggs. The facility must include, as an integral part of the structure or enclosure, equipment necessary to house, raise, and feed the livestock.

Horticultural structure. A single purpose horticultural structure is either of the following.

A greenhouse specifically designed, constructed, and used for the commercial production of plants.
A structure specifically designed, constructed, and used for the commercial production of mushrooms.

Use of structure. A structure must be used only for the purpose that qualified it. For example, a hog barn will not be qualifying property if you use it to house poultry. Similarly, using part of your greenhouse to sell plants will make the greenhouse nonqualifying property.

If a structure includes work space, the work space can be used only for the following activities.

Stocking, caring for, or collecting livestock or plants or their produce.
Maintaining the enclosure or structure.
Maintaining or replacing the equipment or stock enclosed or housed in the structure.

Property Acquired by Purchase

To qualify for the section 179 deduction, your property must have been acquired by purchase. For example, property acquired by gift or inheritance does not qualify. Property acquired from a related person (that is, your spouse, ancestors, or lineal descendants) is not considered acquired by purchase.

Example.

Ken is a farmer. He purchased two tractors from his father. He placed both tractors in service in the same year he bought them. The tractors do not qualify as section 179 property because Ken and his father are related persons. He cannot claim a section 179 deduction for the cost of these machines.

What Property Does Not Qualify?

Land and improvements. Land and land improvements, such as buildings and other permanent structures and their components, are real property, not personal property and do not qualify as section 179 property. Land improvements include nonagricultural fences, swimming pools, paved parking areas, wharves, docks, bridges, and fences. However, agricultural fences do qualify as section 179 property. Similarly, field drainage tile also qualifies as section 179 property.

Excepted property. Even if the requirements explained in the preceding discussions are met, farmers cannot elect the section 179 deduction for the following property.

Certain property you lease to others (if you are a noncorporate lessor).
Certain property used predominantly to furnish lodging or in connection with the furnishing of lodging.
Air conditioning or heating units.
Property used by a tax-exempt organization (other than a tax-exempt farmers' cooperative) unless the property is used mainly in a taxable unrelated trade or business.
Property used by governmental units or foreign persons or entities (except property used under a lease with a term of less than 6 months).

How Much Can You Deduct?

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 Limits, later. See also the special rules for applying the limits for partnerships and S corporations, later, under Partnerships and S Corporations.

If you deduct only part of the cost of qualifying property as a section 179 deduction, you can generally depreciate the cost you do not deduct.

Use Part I of Form 4562 to figure your section 179 deduction.

Partial business use. When you use property for business and nonbusiness purposes, you can elect the section 179 deduction only if you use it more than 50% for business in the year you place it in service. If you used the property more than 50% for business, multiply the cost of the property by the percentage of business use. Use the resulting business cost 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. For example, if you buy (for cash and a trade-in) a new tractor for use in your business, your cost for the section 179 deduction is the cash you paid. It does not include the adjusted basis of the old tractor you trade for the new tractor.

Example.

J-Bar Farms traded two cultivators having a total adjusted basis of $6,800 for a new cultivator costing $13,200. They received an $8,000 trade-in allowance for the old cultivators and paid $5,200 cash for the new cultivator. J-Bar also traded a used pickup truck with an adjusted basis of $8,000 for a new pickup truck costing $15,000. They received a $5,000 trade-in allowance and paid $10,000 cash for the new pickup truck.

Only the cash paid by J-Bar qualifies for the section 179 deduction. J-Bar's business costs that qualify for a section 179 deduction are $15,200 ($5,200 + $10,000).

Dollar Limits

The total amount you can elect to deduct under section 179 for most property placed in service in 2007 is $125,000. 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 $125,000. You do not have to claim the full $125,000.

Example.

This year, you bought and placed in service a tractor for $120,000 and a mower for $6,200 for use in your farming business. You elect to deduct the entire $6,200 for the mower and $118,800 for the tractor, a total of $125,000. This is the most you can deduct. Your $6,200 deduction for the mower completely recovered its cost. Your basis for depreciation is zero. The basis of your tractor for depreciation is $1,200. You figure this by subtracting the amount of your section 179 deduction, $118,800, from the cost of the tractor, $120,000.

Reduced dollar limit for cost exceeding $500,000. If the cost of your qualifying section 179 property placed in service in 2007 is over $500,000, you must reduce the dollar limit (but not below zero) by the amount of cost over $500,000. If the cost of your section 179 property placed in service during 2007 is $625,000 or more, you cannot take a section 179 deduction and you cannot carry over the cost that is more than $625,000.

Example.

This year, James Smith placed in service machinery costing $550,000. Because this cost is $50,000 more than $500,000, he must reduce his dollar limit to $75,000 ($125,000 - $50,000).

Limits for qualified section 179 GO Zone property. If you placed in service qualified section 179 GO Zone property (described below) in 2007, the amount of property for which you can make the election under section 179 is increased by the smaller of:

$100,000 or
The cost of the qualified section 179
GO Zone property placed in service during the year.

The amount for which you can make the election is reduced if the cost of all section 179 property placed in service during the year exceeds $500,000 increased by the smaller of:

$600,000 or
The cost of qualified section 179 GO Zone property placed in service during the year.

Qualified section 179 GO Zone property is section 179 property that is also qualified GO Zone property (described later under Claiming the Special Depreciation Allowance).

Limits for sport utility vehicles. The total amount you can elect to deduct for certain sport utility vehicles and certain other vehicles placed in service in 2007 is $25,000. This rule applies to any 4-wheeled vehicle primarily designed or used to carry passengers over public streets, roads, and highways that is rated at more than 6,000 pounds gross vehicle weight and not more than 14,000 pounds gross vehicle weight.

For more information, see chapter 2 of Publication 946.

Limits for passenger automobiles. For a passenger automobile that is placed in service in 2007, the total section 179 and depreciation deduction is limited. See Do the Passenger Automobile Limits Apply later.

Married individuals. If you are married, how you figure your section 179 deduction depends on whether you file jointly or separately. 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. If you and your spouse file separate returns, you are treated as one taxpayer for the dollar limit, including the reduction for costs over $500,000. You must allocate the dollar limit (after any reduction) equally between you, 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.

Joint return after 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 $500,000).
The total cost of section 179 property you and your spouse elected to expense on your 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. In general, figure taxable income for this purpose by totaling the net income and losses from all trades and businesses you actively conducted during the year. In addition to net income or loss from a sole proprietorship, partnership, or S corporation, net income or loss derived from a trade or business also includes the following items.

Section 1231 gains (or losses) as discussed in chapter 9.
Interest from working capital of your trade or business.
Wages, salaries, tips, or other pay earned 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 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 (for example, charitable contributions). 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.

On February 1, 2007, the XYZ farm corporation purchased and placed in service qualifying section 179 property that cost $125,000. It elects to expense the entire $125,000 cost under section 179. In June, the corporation gave a charitable contribution of $10,000. A corporation's limit on charitable contributions is 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 $145,000. XYZ figures its section 179 deduction and its deduction for charitable contributions as follows.

Step 1. Taxable income figured without either deduction is $145,000.

Step 2. Using $145,000 as taxable income, XYZ's hypothetical section 179 deduction is $125,000.

Step 3. $20,000 ($145,000 - $125,000).

Step 4. Using $20,000 (from Step 3) as taxable income, XYZ's hypothetical charitable contribution (limited to 10% of taxable income) is $2,000.

Step 5. $143,000 ($145,000 - $2,000).

Step 6. Using $143,000 (from Step 5) as taxable income, XYZ figures the actual section 179 deduction. Because the taxable income is at least $125,000, XYZ can take a $125,000 section 179 deduction.

Step 7. $20,000 ($145,000 - $125,000).

Step 8. Using $20,000 (from Step 7) as taxable income, XYZ's actual charitable contribution (limited to 10% of taxable income) is $2,000.

Carryover of disallowed deduction. You can carry over for an unlimited number of years the cost of any section 179 property you elected to expense but were unable to because of the business income limit.

The amount you carry over is used in determining your section 179 deduction in the next year. However, it is subject to the limits in that 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 cost will be carried forward. Your selections must be shown in your books and records.

Example.

Last year, Joyce Jones placed in service a machine that cost $8,000 and elected to deduct all $8,000 under section 179. The taxable income from her business (determined without regard to both a section 179 deduction for the cost of the machine and the self-employment tax deduction) was $6,000. Her section 179 deduction was limited to $6,000. The $2,000 cost that was not allowed as a section 179 deduction (because of the business income limit) is carried to this year.

This year, Joyce placed another machine in service that cost $9,000. Her taxable income from business (determined without regard to both a section 179 deduction for the cost of the machine and the self-employment tax deduction) is $10,000. Joyce can deduct the full cost of the machine ($9,000) but only $1,000 of the carryover from last year because of the business income limit. She can carry over the balance of $1,000 to next year.

Partnerships and S Corporations

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

If you are a partner in a partnership or shareholder of an S corporation, you add the amount allocated from the partnership or S corporation to any section 179 costs not related to the partnership or S corporation and then apply the dollar limit to this total. To determine any reduction in the dollar limit for costs over $500,000, you do not include any of the cost of section 179 property placed in service by the partnership or S corporation. After you apply the dollar limit, you apply the business income limit to any remaining section 179 costs. For more information, see chapter 2 of Publication 946.

Example.

In 2007, Partnership P placed in service section 179 property with a total cost of $580,000. P must reduce its dollar limit by $80,000 ($580,000 - $500,000). Its maximum section 179 deduction is $45,000 ($125,000 - $80,000), and it elects to expense that amount. Because P's taxable income from the active conduct of all its trades or businesses for the year was $50,000, it can deduct the full $45,000. P allocates $20,000 of its section 179 deduction and $25,000 of its taxable income to John, one of its partners.

John also conducts a business as a sole proprietor and in 2007, placed in service in that business, section 179 property costing $14,000. John's taxable income from that business was $5,000. He elects to expense the $20,000 allocated from P, plus the $14,000 of his sole proprietorship's section 179 costs. However, John's deduction is limited to his business taxable income of $30,000 ($25,000 from P plus $5,000 from his sole proprietorship). He carries over $4,000 ($34,000 - $30,000) of the elected section 179 costs to 2008.

How Do You Elect the Deduction?

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

If you elect the deduction for listed property, complete Part V of
Form 4562 before completing Part I.

File Form 4562 with either of the following:

Your original tax return (whether or not you filed it timely), or
An amended return filed within the time prescribed by law. An election made on an amended return must specify the item of section 179 property to which the election applies and the part of the cost of each such item to be taken into account. The amended return must also include any resulting adjustments to taxable income.

Revoking an election. An election (or any specification made in the election) to take a section 179 deduction for 2007 can be revoked without IRS approval by filing an amended return. The amended return must be filed within the time prescribed by law. The amended return must also include any resulting adjustments to taxable income (for example, allowable depreciation in that tax year for the item of section 179 property for which the election pertains.) Once made, the revocation is irrevocable.

When Must You Recapture the Deduction?

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. You also increase the basis of the property by the recapture amount. Recovery periods for property are discussed later.

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 9 under Section 1245 Property .

If the property is listed property, 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 of Publication 946 under Recapture of Excess Depreciation .

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

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

Example.

In January 2005, 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 and also elected not to claim a special depreciation allowance. He used the property only for business in 2005 and 2006. During 2007, he used the property 40% for business and 60% for personal use. He figures his recapture amount as follows.

Section 179 deduction claimed (2005)		$5,000
Minus: Allowable depreciation (instead of section 179 deduction):
2005	$1,250