 Hello and welcome to the session in which we will discuss section 179 deduction. Now, what is the big idea of section 179 deduction? Because if you understand the big idea of sections 179, you will start to understand the concept. The idea is to give businesses a deduction. A deduction to do what? More expenses to reduce their taxable income. But how? Well, you will encourage them to do what? To purchase property, plant, and equipment. And this deduction is specifically targeting, you're gonna see small and mid-sized businesses. It's encouraged them to invest in themselves by purchasing equipment and technology. And by doing so, you can have a tax deduction. And that tax deduction is called section 179. So go ahead, buy more equipment. Why? Because if you buy more equipment, the manufacturer will have to hire people to manufacture those equipment. And they'll have to pay them. And once they pay them, those individuals, they'll spend money in the economy. Once they spend money in the economy, other businesses will have to hire more people and we will stimulate the economy. Now, the idea is the company can elect. Notice it's an election. You can take it, you don't have to take it. To immediately expense up to $1,080,000 of business-tingible personal property. Now, first of all, the amount is for 2022. So if you're looking at this recording in 2026 or 2023, 2025, the amount will be different. It's gonna change from year to year. But the point is, there's an amount that you can immediately expense. And it has to be tangible, means physical, and it's a personal property in contrast to real property, which is building. Now, you cannot use section 179 for real property or production of income property, which is rental property. Now, certain rental property items are okay. So although the building itself, you might not be able to take a deduction for it, but roofs, heating, ventilation, air conditioning, fire protection, and alarm system, those are considered separate from the real property. Those are considered kind of personal property for the purpose of 179, they're okay. But the property itself is not. Now, obviously, any amount you expense under section 179 will reduce your basis. And of course, it's going to, just like what we learned in makers. And by the way, if you don't know what makers is, mid quarter and mid year convention, please go back to the prior session because this session would imply you understand what makers is. But it's basically the depreciation, modify accelerated cost recovery system, makers. And same thing with makers. Once you expense an asset, you have to reduce your basis. Now, any elected section 179 is taken before what we call additional first year depreciation, which we'll see this in the next session. We'll talk about first year depreciation and before makers. And to be more specific here's what's going to happen. First, you can take section 179, then you can take the additional first year depreciation, first year depreciation, then you go into makers. We already covered makers. Now we're covering section 179, and in the next session, we'll cover first year depreciation. Now, obviously just like with everything that we learned in taxation, the election is phased out and a subject to limitation, subject specifically to taxpayer business income. So not every penny you spend, you'll be able to deduct. We're gonna see its subject to two limitation. One is how much asset you purchase for that year, personal property, and what's your taxable income. Before we proceed any further, I have a public announcement about my company, farhatlectures.com. Farhat accounting lectures is a supplemental educational tool that's gonna help you with your CPA exam preparation as well as your accounting courses. My CPA material is aligned with your CPA review course such as Becker, Roger, Wiley, Gleam, Miles. My accounting courses are aligned with your accounting courses, broken down by chapter and topics. My resources consist of lectures, multiple choice questions, true-false questions, as well as exercises. Go ahead, start your free trial today. Let's take a look at a simple example with no limitation whatsoever to just kind of put you in this idea. What's the benefit of section 179? Well, let's assume John purchases and start using business equipment, a five-year class asset on February 1st, 2022. Well, John paid 100,000 and this is the only asset that John purchased in 2022. Well, what can John do? Assuming no limitation, John can opt, can choose, can elect to take this 100,000 as a section 179 and have a 100% deduction for the 100,000. Excellent. Or John don't have to do that. He can depreciate this asset using makers. He can recover his cost over the next six years. Like this, the first year, 20%. The second year, 32%. The third year, 19.2%, 11.52%, 11.52% and 5.76%. Now, if you don't know where these percentages are coming from, this is the table for five-year class, half a year convention. So that's why I told you at the beginning you want to be familiar with makers for this session. So you should not be able to understand section 179 if you don't understand makers. So I assume you know what otherwise, go to Farhat Lectures and look at the makers mid-quarter and half-year convention, or mid-year, half-year or mid-year convention. Now, obviously, as I mentioned, every time you take a deduction, whether that's a makers or section 179, it's gonna reduce your basis. So let's kind of give you an idea how the section 179 reduces your basis. Assuming John sells the asset in 2024. Well, if John elects section 179, what's a John basis for this asset? The basis for this asset is zero. Why? Because the cost, the basis started at 100,000 and immediately John deducted the 100,000, therefore the basis is zero. Therefore, if John sells this asset for five dollars, the full five dollars is gained. Any amount he sells it for, it's gonna be again taxable to John. If John elected to use the makers depreciation over three years, year 120,000, year 22,000, year three, remember when we talked about in makers, you will take the full amount times a half a year because we assume we dispose of the asset mid-year. Therefore, the basis for John will be 100,000 minus the depreciation taking. The basis will be 48,250. Now, if we sold this asset for 50,000, we're gonna take 50,000 proceeds minus 48,250 and the difference will be what? Will be the gain, will be the gain that John will have to record a taxable income which is 1,750. If he elected section 179, the whole thing, the 50,000, if he elected section 179, the 50,000 will be gains that's taxable. Why? Because you would recapture that depreciation. Let's look at a quick lesson or history lesson for section 179. It started at 10,000, in 2001 went to 24, then it was increased to 100,000, then it was increased to 250. In 2010 it was half a million, and in 2015 they made it a permanent, so this way it's a permanent deduction because it was always a temporary one. Now it's a permanent. In 2018, part of the tax cuts and jobs act for President Trump, they went up to a million. Always there's a phase out or threshold, we'll talk about that later. But the point is, it started small and it was a temporary deduction, then now they make it permanent. And now again, as we saw now in 2022, it's 1,080,000, again it could be a different amount in future years. Now Congress is generous, but they're generous to a point. What does that mean? It means they always gonna give you some sort of a limitation. As we said, the expense is 1,880,000, but that amount is reduced by the amount of asset you placed into service. And once you exceed 2.7 million in asset, for every dollar more, for every dollar more, you reduce $1 of deduction. Well, what does that mean? It means you can go from 2.7 million up to 3,780,000. But once you exceed 3,780,000, it means that's 1,080,000. Minus 1,080,000 you would lose all your deduction. You would lose your deduction. You can no longer use it, why? Because now the key is now, you have so much money, you don't need a tax deduction. That's the point. Once you exceed 2.7, you will start to lose it. Every dollar you purchase more, let's assume you purchase 2.8 million worth of asset. It means $100,000 more than the starting in the range. The range goes from 2.7 to 2.78. If you're 2.8, 100,000, then you would lose 100,000 of section 179. For example, if a taxpayer placed in service, 2,775,000 worth of property, that's 75,000 more than the limit for 2022. Well, guess what? That's $75,000 more, and that's gonna be reduced. That's gonna be reducing the 1,080,000. It means for that year, you can only get 1,00,000 and 5,000. Now, there's another limitation, which is called the business income limitation. Section 179 allowed for taxable year cannot exceed the taxpayer business income, to simply put, well, this is the first limitation. So the maximum you take is 1,00,000 and 5,000, as long as you have income of 1,00,000 and 5,000. If you have less income than that, then you are limited. Don't worry, we'll look at an example. As I mentioned on the first slide, there's a priority for section 179 deduction. It means it's taking first. It's taking first section 179 first, then first year depreciation first, then maker third. So let's assume Adam put half a million worth of seven year makers asset into service in 2022. He has the option to take the full half a million if he chose to, but he did not. He chose to only take 300,000 instead. So what he did, he took the 300,000 and combined the other depreciation with makers. Now we're ignoring the first year depreciation. And this way, Adam was able to reduce his taxable income to zero. Why? Because Adam wanted to defer, although he invested half a million for section 179, I said, I'm going to need 300,000. I'm going to keep the 200,000 for the future. Why? Because in future years, maybe his marginal tax rate is higher. So as a result of this, here's what's going to happen. Section 179 is 300,000. Then we're going to take half a million minus 300,000, which is section 179. The remaining is 200,000. Multiply at times the makers rate, 0.1429. If you don't know what this is, again, go to makers half a year convention. We'll give us 28,580. So the total cost recovery or the total depreciation we'll take is 328,580. Now let's talk about the limitation of investment. Let's assume Adam puts in service 1,445,000 worth of section 179 property for his own accounting consultancy in his business. Can he take the full 1,080,000? And the answer is yes, he can take the full amount because you don't lose any of the 1,080,000 until you placed in service 2.7 up to, you would lose everything at 3,780,000. So remember, Adam is qualified to take 1.8 million, assuming no other limitation. So since the property placed in service, maximum of 2 million was not reached because only 1,445,000, Adam can still invest more actually without losing a penny of the 1,080,000. He could invest up to 2.7 million before starting to lose any deduction. Remember, up to 3,780,000 for 2022 and this amount could be different in future years. Let's take a look at another example. During 2022, Noah places 3.4 million of section 179 property. Well, guess what? 3.7 million is higher than 2.7 million in his manufacturing business. All assets are seven year makers because Noah placed more than 2.7 million. He must reduce his section 179. How? Well, we're gonna take 3.4 minus 2.7, so he is 700,000 above the limit. Therefore, he's gonna take his full amount minus 700,000. The only thing he can take for section 179 is 380,000. Therefore, section 179 is 380,000. Now he's gonna take sections 179 and which is, it's gonna be 3.4 million minus 380 because he took section 379, multiply by the makers and that's gonna give them 431,558 if my math is right, four makers. Let's assume Noah placed in service a building worth 1.5 million. What's the effect on section 179? None. Remember, section 179, a reminder, applies to tangible, personal property. A building is not that. There's another limitation, business income limitation. The deduction cannot exceed the taxable income of the business. Now what is the business income? There's a term called business income and any amount that exceeds the deduction must be depreciated over several years. In other words, if you have excess depreciation, you can take it later. Simply put, section 179 cannot create a net operating loss. It cannot take you into a negative or if you are into negative, and oh well, it cannot increase your net operating loss. Now the term business income, it include not just the income generated by the sole proprietorship, it also include income from wages and any other business income assigned to the taxpayer from a partnership or an S corporation. It has to be a partnership or an S corporation. So your wages from those are included in this business income definition. Again, an example would illustrate this point. In 2022, Adam operates a sole proprietorship that provide consulting services resulting in an income of 70,000. Would that be taken into account as business income? Of course. That's A, that's a business income, clearly a business income. Also, Adam owns 30% of a management consultancy that operate as an S corporation. So he has his own business and owns 30% and another S corporation. Now the S corporation pays Adam 50,000. Is that included? Sure, because that's his salary from basically his own business. And the S corporation reported 80,000. Now of that 80,000, he owns 30%. His share is 24,000. So Adam business income for this purpose is 144,000. How? Well, the $70,000 from his own business, the $50,000 wages from the S corp and the 40%, the 24,000, the profit from the S corp. Now, access 179 amount above business income also carried forward. You don't lose it and you combine it with other eligible expenses in future years. However, also the future years is also subject to limitation. There's always a ceiling on this amount. There's always a ceiling. So although it's a future, you carry it, it's subject to the same rules. So let's take a look at a business income limitation example. Noah, a sole proprietary of a computer service company and in 2022, his taxable income was 165 prior to taking section 179. Assuming he spends, Noah spends 2.9 million on new equipment. So notice here, Noah spent 2.9. He would start to lose section 179 at 2.7. So how do we compute how much they can take? Well, let's start with the limitation of section 179. He was 200,000 above the limit. So if we start with 1 million and 80,000, we reduce it by 200,000, 880,000 remaining for section 179. So that's the first limitation. Can Noah take 880,000? And he would like to, but he can't. Why? His business income is 165. Therefore, of the 880,000, he can only deduct 165 and the remaining 715 is carried forward as section 179, carried forward to future years. Now there's also one additional, I call it bonus. It's not really a bonus, but I call it bonus because kind of what section 179 is generous, but we're gonna look at another truly bonus in the next session, the first year bonus depreciation, that's different, but section 179 is generous. If you guys remember, we have two type of convention for personal property, the half a year or mid-year, half a year or mid-year, mid-year or mid-quarter. And hopefully you know that mid-year will give you more depreciation than the mid-quarter. So mid-quarter convention computation is carried after applying section 179. So when you are trying to find out, do I qualify for the half a year convention or mid-quarter convention? Well, the first thing you do is you take section 179, but here's the good thing. When you're taking section 179, you can select, you can say what? I wanna take section 179 and apply it to the asset that I placed in the fourth quarter. Why the fourth quarter? Remember when we have fourth quarters, one, two, three, four, when they use the mid-quarter convention, we use the mid-quarter convention when 40% of our assets are placed in the fourth quarter. So section, if you're using section 179, it comes first, you would say I'm applying section 179 to those assets, therefore you would remove them from the computation to reduce that 40% chance. In other words, when you reduce your asset from the fourth quarter, there's a more chance that you're gonna be using the half-year convention. And this way you would avoid the mid-quarter convention using the mid-year or half-year convention. The best way to illustrate this is to look at an example. No manufacturing places the following asset in 2022. All assets are five-year class assets. Asset one purchased March 3rd, which is the first quarter. Asset two purchased June 28th, second quarter. Asset three was purchased October 10th, which is the fourth quarter. Now, total of 2,112. Right now, assuming there's no section 179, we would say 1,100,000 was placed in the fourth quarter. Divide this by the total asset placed, 52% was placed in the fourth quarter. You will default to the mid-quarter convention. And as a result, if you compute your depreciation using the mid-quarter convention, if you don't know where these percentages are coming from, it means you don't know how mid-quarter convention works. Go to my mid-quarter convention lesson, but simply put, you will total 292 in depreciation. That's fine. Now, if you elect to choose section 179, what you will do, you will apply section 179 to this asset. You would say, you know what? I have 1,100,000 of assets placed in the fourth quarter. I'm gonna be using my section 179 to reduce it down to what? To reduce it down to 20,000, right? If I reduce it down to 20,000, now 20,000 placed in the fourth quarter compared to the other assets, it's not 40%. So what I will do, I will expense immediately 1,080,000, assuming no taxable income limitation. And as a result, what I'm left with is 1,032,000. Well, if I have 20,000 left, and if I compare this to the remaining asset, it's not 40%. So I'm in good shape. Now I skipped the mid-quarter convention. I default back to the half-year convention. Therefore, I will take 1,032,000, the remaining asset times 20%, the half-year convention equal to 206,400. Well, what's my total depreciation? Total the cost recovery expense or depreciation? It's section 179 that I took plus makers, which will give me 1,286,000. And that's a huge difference from 292,000. Simply put, I added a million dollar, almost more than a million dollar. Let's say a million dollar for the sake of illustration real quick. I added almost a million dollar of deduction, which if I'm in the 30% tax bracket, I saved myself 300,000 in taxes by just electing section 179, assuming section 179 will have no other limitation. What should you do now? Go to Farhat Lectures. Look at additional resources, lectures, MCQs, true, false. We need to learn also about, the next topic we'll talk about about first-year bonus depreciation. You need to learn about makers, which is prior to this session. Look, whether you are a student, whether you are a CPA candidate, whether you are an enrolled agent. This topic is important. Good luck, study hard, and of course, stay safe.