I received the following email from a CPA in Michigan in response to my most recent post on recapturing Section 179 expense deductions.

Subject: Your Blog Article On Section 179 Recapture

The sale of an asset that taxpayer had originally taken Sec. 179 deduction is more complex than this.

How it is handled depends on the entity (I am ignoring trades)

 

Section 179 recapture is ordinary income subject to self-employment taxes for self-employed/partners. The recapture adds to basis creating smaller gains or larger losses. The losses are 1231 losses subject to 5 year lookback on 1040s etc.

 

Milt Baker CPA  Michigan  

 

P.S. I enjoy your Blog site on which you post great information and fabulous cartoons.

THANK YOU

Milton:

Thanks for the additional info.  I always have the dilemma of how technical to make my answers for non tax pros.  In this case, I was just trying to let him know that there were potentially expensive tax consequences to his scheme of buying and selling new vehicles each year.  As I’m sure you encounter in your practice, there is no shortage of people who think they’ve discovered a way to game the system, only to make things worse for themselves.

I hope that everyone who reads my postings gets my point that they need to consult with a tax pro before embarking on their tax savings plans.

Thanks again for writing and feel free to contribute anything else that you feel is appropriate.

Kerry Kerstetter

 

Q:

Hi,

Was perusing your site and saw the wealth of information you provide.  Clarifying question I did not find referenced:

If you purchase a qualifying vehicle (6,000 LB+ SUV) and take the $25K deduction in 2005 (regardless of if the vehicle is financed), can you sell that vehicle in ’06, purchase another qualifying vehicle, can you take another $25K deduction in ’06 (assuming the guidelines and limits remain unchanged)?  My question is, if the guidelines for weight and maximum allowable deduction remained the same for the next five years, could you sell your vehicle annually, replace it with another qualifying vehicle annually, and take an annual 179 deduction each year?

Thanks for any insight you can offer.

Regards,

A:

You can buy new vehicles each year and claim the Section 179 for them, as long as each one meets the weight and over 50% business usage tests. 

If you sell the previously deducted vehicles, you need to report the sales on Form 4797 and show anything that you get for it above its depreciated book value as depreciation recapture ordinary income.   A sale only makes sense tax wise if the price you can get for it is less than the adjusted depreciated book value, so that you can claim the loss on Form 4797.

If you trade the old vehicles in on new ones, you will avoid having to report the gain because that will be rolled over into the new replacement vehicle on Form 8824.  In regard to them claiming Section 179 deductions on the new replacement vehicles, you will only be able to do so on the additional amounts paid for the new vehicles after the trade-in allowance.  To count the full cost before adjusting for the trade-in would be effectively double-dipping.

This is why it’s so important to keep tabs on the depreciation schedule for your business vehicles and why I am so upset when I hear that tax pros are not providing their clients with detailed depreciation schedules with their tax returns for both the year being prepared, as well as the following year.  Most tax prep programs will print out both years’ schedules automatically.  To not provide clients with those detailed schedules is wrong.

Good luck.  I hope this helps.  Your personal tax pro should be able to give you more specific advice for your circumstances.

Kerry Kerstetter

Q:

I have a small electrical business. I have been told by my CPA that my taxes could be lowered overall if I were to purchase the trucks I use for my business, in my name, and then lease them to the company. The company is a C-Corporation. How could I deduct my the depreciation on these personal vehicles that are leased to the Corp?

A:

That is a very common strategy that can save a lot of tax money by avoiding the payroll taxes that a salary would entail. It is also a popular technique for people who are receiving Social Security income and have a limit on how much earned income they can make without having their benefits reduced.  Lease income is not classified as earned income.

The lease income is reported on your Schedule E (or Sch. C as some people use) and the expenses of the leased item that you pay personally, including depreciation and Section 179, are deducted on that same schedule.

What I am most curious about is why your personal CPA didn’t explain these basic facts to you and you had to ask a stranger on the internet.  Tax pros should always be prepared to explain the pros and cons of any strategy that they advise for their clients.

I hope this helps.  Good luck.

Kerry Kerstetter

Q:

I am a self employed, Realtor.  I purchased a SUV last July, 2004.  It weighs more than 6000 pounds.  When I first discovered Section 179 I also read that you receive 35% the purchase price back as depreciation.  Can you instruct me as what exactly to inform my CPA when doing my taxes this year? 

 

I would appreciate any advice you have for me.

 

Thank you,

 

PS  Did I also read somewhere that you can deduct more that 50% of meals this year?  I thought I read was increase to 60%???

A:

I’m not sure if I’m understanding what you are asking me.  Do you actually want me to tell you how to calculate the depreciation and Section 179 deductions on your new SUV so that you can pass that along to your CPA?  If that’s the case, you really should be looking for a new tax preparer because these are very basic calculations that have been around for decades.

The 35% figure you are mentioning sounds like a rough guesstimate of how much tax you would save from the deduction of the SUV purchase.  Many people do make the erroneous assumption that every dollar deducted on a tax return results in a dollar for dollar tax saving.  That might be the case if the effective marginal tax rates were 100%.  However, the actual tax savings from a deduction is lower than 100% and is based on your personal effective tax rates.  What I have frequently seen, when counting Federal and State income tax rates, plus the 15.3% self employment tax, an effective combined tax rate of over 50%.  This would mean that deducting $40,000 for the purchase of an SUV would reduce your taxes by around $20,000 for that year.

When setting up the new SUV on your depreciation schedule, there are a number of possible ways to claim the expense, which your tax preparer can work out to the best advantage for you.  There is the Section 179 expensing election.  There is also a possible 50% bonus depreciation as long as you were the first purchaser of the SUV, and there is normal depreciation, which can be computed using either the straight line or accelerated methods. 

So in regard to what you need to provide your tax preparer for your 2004 returns, I would start with a copy of the purchase invoice. That will provide him with the date purchased, its cost, any trade-in info, whether the vehicle was new or used, and how it was financed (cash and/or loan).  You also need to provide him with the total number of miles you drove the SUV during 2004, as well as how many of them were for your real estate business.  If you are going to be claiming the Sec. 179 or bonus depreciation, you will be using the actual cost method of calculating that vehicle’s expense instead of the standard mileage rate.  This means that you will also need to provide him with all of the vehicle’s operating costs for 2004, including fuel, repairs, insurance, registration, washing, and interest on the loan, if you didn’t pay cash for it. 

Be sure to provide the totals for these costs.  Your preparer will apply the business usage percentage against them.  A common mistake I find some of my clients making is self reducing the vehicle expenses they report to me.  For example, if their business usage was 80%, they only report 80% of their costs to me.  Unless I catch that, our tax program will multiply the total costs we enter by 80%.  This ends up giving them a deduction of only 64% (80% X 80%).

In regard to the deduction for business meals, it is still 50% for most businesses, including Realtors.  The allowance is 70% only for some kinds of transportation workers, such as pilots, truck drivers and railroad worker.  There is always talk about increasing it for the rest of us, especially when the restaurant business is slow; but nothing new has made it into law. 

Again, just as with the vehicle costs issue I mentioned above, tell your tax preparer the total you spent and his tax program will reduce that by the 50%.  I occasionally discover clients thinking they are helping me out by only entering 50% of their business meals and entertainment costs in their organizers.  If I don’t catch what they’ve done, their actual deduction will be only 25% (50% X 50%) of their actual costs because my tax prep program reduces whatever I enter by 50%.

Good luck.  I hope this helps.

Kerry Kerstetter

Follow-Up Q:

Thank you for your response.  I was under the assumption that you deduct the entire amount of purchase price from your gross income.  (ie: gross income 100,000 SUV 50,000 then I only owe taxes on the remaining 50,000 of which all expenses (meals, dues, cell phone, advertising etc) and depreciation would apply.  What kind of mileage log is needed.  Mine is very generic, as my past tax preparer only asked for total miles per month.

What is your charge for tax preparation?

Thank you,

A:

It’s not quite that straight forward.  Your business vehicle expenses will go on your Schedule C. along with your Realtor income and other related business expenses.

There are several ways to keep records of business driving that will satisfy IRS requirements.  At a bare minimum, you need to record the odometer at the end of each year so that you can document how many miles the vehicle was used for that year.  Then, you can either back out the purely personal miles to arrive at the business total or you can total up the business miles for the year.  This can be done either trip by trip or by the average method; such as average number of business miles per day (or week or month) multiplied by the number of days (or weeks or months) worked in the year.  Use whichever method fits you best.

We are not currently accepting any new tax clients and are in fact still trimming back on the ones we have to arrive at a level that I can better handle.  You can see my tips on selecting a preparer here on my web site.

Good luck.

Kerry Kerstetter

Q:

I don’t know whether you respond to specific questions/individuals but in trying to do some research came across your site.  I have gotten two different responses to a tax question so thought I would give you a try.
I did a 1031 exchange this year–sold a condo I had rented for years and bought a home in a resort area in Delaware that will be rented on a weekly basis.  In order to rent this home it had to be fully furnished–can this furniture and everything purchased to set up the kitchen for use be deducted in one year as a Section 179 expense??  I am a real estate agent so I know all my losses this year are not limited and since I didn’t settle on this till June I did not have a lot of rental income on it.
Thanks for any insight you can give.

A:

It depends on how you are going to show the new rental property on your tax return.

If you are going to show it on Schedule E as a regular rental property, you can’t claim Section 179 for the furnishings.

However, if you show it on Schedule C as a short-term rental property (average stay of seven days or less), you will be able to use Section 179 for the furnishings. 

This special rule, which I usually call the “motel exception,” and many tax pros overlook, makes the activity not considered to be a passive one and thus not subject to those deductible loss limitations.  You do need to be actively involved in the operation of the property to be able to claim the losses. 

Another big benefit of this approach is to generate self employment losses on the rental Sch. C to offset self employment income from other business activities, such as real estate sales.

Good luck.  I hope this helps.

Kerry Kerstetter 

Q:

Subject: Section 179 Deductions

I’ve been studying this section all day, and according to EVERYONE on the internet, a self-employed taxpayer may take a one-time deduction of up to $25,000 on a 6000+ lb. vehicle in the year the vehicle was put into service.  BUT, according to the IRS, and 3 CPA’s, who I have been on the phone with ALL DAY LONG, no such deduction exists!  Where can I find this in an IRS publication? TaxGuru, help me please!
Respectfully,
Debbie

A:

Debbie:

If you go to my blog (www.TaxGuru.net) and use the search tool at the top to look for 179, you will see dozens of postings on this very topic.  You can also see it described on my main website at:
http://www.taxguru.org/incometax/Rates/Sec179.htm

Since you don’t seem to be doing very well at finding a tax pro who is very current on important tax topics, you should also check out my guide to finding a good tax advisor at:
http://www.taxguru.org/incometax/prepare.htm

Good luck.

Kerry Kerstetter

Q:

Kerry- You have a great Website with lots of good information.  Thank you for sharing your knowledge.  I elected to purchase a SUV in 2004 and will take the 179 deduction.  I have a LLC, but purchased it in my name and use it 95% for business.  I do not really like driving it.  It is OK for me to just give the Vehicle to my wife next year and let her inherit my cost basis which will be zero?  Seems like that would be too good to be true.  Thanks if you answer the question.

A:

Your “too good to be true” analysis is right on the money.

The law is very explicit that any Section 179 deduction has to be recaptured if the business use of the asset falls below 50% during its normal depreciable life, which would be five years in your example.

Your plan would still have some merit if you are just looking to shift some taxes into a future, possibly lower rate, tax year.  You could claim the Sec. 179 on your 2004 1040 and then pick almost that same amount up as income on your 2005 1040 when you convert the SUV to zero percent usage.  Actually, the recapture amount will be less than the full Sec. 179 because you only need to pick up as income the excess of what you claimed on your 2004 1040 over what the normal depreciation deduction would have been without the Sec. 179.

Good luck.  I hope this clears this matter up for you.  Your personal tax advisor should be able to help you decide if claiming the Sec. 179 under these circumstances is a good idea for you and your wife or not.

Kerry Kerstetter

As simple as it seems to calculate depreciation for tax purposes, there are far too many options and variables to consider; such as in this recent exchange I had with a tax pro in Virginia:

One thing you should talk about is the fact that if more than 40% of depreciable purchases are made in the 4th quarter of a tax year, all depreciation of that asset class is subject to the mid-quarter convention, not the half-year.  So long as a taxpayer is 179-expensing everything, this doesn’t matter (with the exception of listed property converted from personal assets).  However, someone hoping to depreciate other pieces of 5-year property using normal GDS tables would face a larger bill.  Not a deal-breaker, just something to throw into the calculation.
 
Ryan Ellis
www.ryanellisassociates.com

I wrote back:

Ryan:

Excellent point, although a little more technical than I usually like to get in this forum, which isn’t intended to replace consultations with tax pros. 

That reminds me of the following email I received a while back from someone with a Federal government (not IRS) email address with the subject of “section179”

if i buy equipment for 400,000 (laser machine) in 04 how much can i depriciate?

My Reply:

Such an answer is impossible to give.  There are too many variables to consider before being able to calculate the Section 179 and depreciation deductions on such a purchase; such as what your taxable income is, how much you have spent on new equipment for the year, as well as when in the year the item was purchased. 

Your personal tax advisor can work out more precise figures for you.  If you aren’t working with a tax pro, and you’re ready to plunk down that much money for one machine, all I can say is I wish you lots of luck.

Thanks for writing Ryan, and I hope your tax season goes smoothly.

Kerry Kerstetter

Q:

My accountant told me that as a C-Corp in the state of California, I do not qualify for the IRS code 179 immediate deduction of up to $100,000 and that I need to depreciate assets I buy this year (i.e. office furniture, computers, etc.).  He also said that in California S-Corps do qualify for the 179 deduction but C-Corps don’t which makes no sense to me.  Is he correct?  I hope not…….personally, I would rather deduct the whole amount and reduce my tax burden.

A:

What your accountant is referring to is the fact that California tax law – for California income tax returns – does not match Federal tax law in regard to the Section 179 deduction. Similar differences exist in many other states as well.

A C corp does qualify for the up to $102,000 of Section 179 deduction on the Federal 1120.  However, there is no Section 179 expensing allowed for C corporations on the California 100.  Those assets would have to be depreciated normally.

On individual income tax returns, the Federal law allows up to $102,000 of Section 179 deduction on the 1040.  On the California 540, the annual maximum is only $25,000.  Anything above that would need to be depreciated normally.

Since S corps don’t pay income tax, and their income and expenses are passed through to their shareholders via the K-1s, it is true that some of the of cost business equipment purchased by an S corp may be able to be deducted as Section 179 expense on the shareholders’ 1040s and 540s with the same maximums as I mentioned above.

The real downside to this disparity between the Federal and State rules is that you need to keep two sets of depreciation schedules.  When assets are sold, the gain or loss will be different on the Federal and State tax returns.

Over time, you will still be able to claim the same over all cost for business assets on the Federal and State returns.  The difference is in the timing.  It would be nice if there were more consistency; but that isn’t always possible.

I hope this clarifies the situation for you.

Good luck.

Kerry Kerstetter

Q:

Hi Tax Guru,

I was researching buying an suv for our business and ran into your column.
My husband and his brother (partnership) opened up a business in the mall (food court) on November 2, 2004 and it is doing fairly well. I was wondering if we should go ahead and buy an suv this year by Dec 31, 2004 to get the 179 deduction or should we wait until January 2005 to purchase our vehicle since we’ve only been in business for 2 months. I know that the deduction for a vehicle changed from up to 100k to 25k but I am not sure what that means since we’ve only been in business a short period of time. I also have a full time job not related to the business. Thanks for your advice.

Sincerely,

A:

As I always advise, it’s never a good idea to spend money just for the tax break, especially on something as expensive as an SUV.  However, since you seem to have already decided on getting one, the other standard advice kicks in.  A deduction on your 2004 tax return (by buying the SUV and placing it into service by 12/31/04) is worth more in the time value of money than the same deduction on your 2005 tax return. 

If your SUV is going to be purchased as a brand new vehicle costing more than $25,000, this decision is even more lopsided this year.  As I’ve already discussed in a number of postings on my blog, the 50% bonus depreciation deduction will expire as of 12/31/04.

The Section 179 deduction is not based on how long the business was in existence.  A business that has been operating two months of the year is entitled to the same $102,000 maximum Section 179 deduction as a business that was active for the full twelve months.

There is a limit on the amount of Section 179 that can be claimed on a tax return based on your taxable income for the year.  However, this calculation isn’t limited to the income generated by the specific business that will be using the new Sec. 179 equipment.  If you have other income, such as from W-2s, the Sec. 179 can be used to offset that.

There could be a difference in the allowable Sec. 179 deduction depending on how the new SUV is purchased.  If the partnership buys it, the taxable income limit will be calculated at the 1065 level, which could mean that nothing is allowed if the partnership already has an operating loss.

If you buy it in your personal name and show it on your 1040, you will be able to use other income, such as W-2s to qualify for a higher Sec. 179 deduction. 

You really should be working directly with a tax pro who can work with your actual figures and circumstances to help you come up with the best game plan.

I hope this helps.  Good luck.

Kerry Kerstetter