 Income tax 2022-2023, section 179, deduction part number one. Let's do some wealth preservation with some tax preparation. Most of this information comes from publication 946, How to Depreciate Property Taxure 2022. You can find it on the IRS website, irs.gov, irs.gov. Looking at the income tax formula, we're focused on line one income. Remember, in the first half of the income tax formula is an essence and income statement, but just to outline a scaffolding, other forms and schedules flowing into it. One of those, the Schedule C, business income minus business expenses, gives us the net business income. The Schedule C then flowing into line one of income on the income tax formula. First page of the form 1040. Remembering the Schedule C flows into the Schedule 1, which flows into the first page of 1040, line number eight, as we see here. Schedule C, profit or loss from business income statement format, income minus the expenses, we're focused on the expenses side of things. And more particularly, focused on the depreciation, noting that even if you're on a cash base, support accounting instruction by clicking the link below, giving you a free month membership to all of the content on our website, broken out by category, further broken out by course. Each course then organized in a logical, reasonable fashion, making it much more easy to find what you need than can be done on a YouTube page. We also include added resources such as Excel practice problems, PDF files and more like QuickBooks backup files when applicable. So once again, click the link below for a free month membership to our website and all the content on it. Method you're going to have to do in a cruel thing. Oftentimes of the depreciation, putting the property, planting equipment on the books as an asset, allocating the cost over the useful life. However, the depreciation standards for the tax code might be different and they might have different objectives than on the business side of things. So we have to be following the tax code. Sometimes they might try to accelerate the depreciation in the current, in the first half of the year, first part of the depreciation period. Why would they do that? Normally for political type of reasons to try to stimulate the economy or whatever they're trying to do. So that's basically what we have here. We're talking now about the electing the section 179 deduction. So note, we're talking depreciation. The first thing you want to think about is we're putting it on the books as an asset, allocating the cost over the useful life. That's the normal accounting structure as to why you would be doing that for for depreciation. The first one to think about is straight line depreciation. That would be the easiest thing to conceptually visualize. You're just going to have an even amount allocated over the useful life of the thing that is being depreciated, allocating the cost evenly over the timeframes that you're using it. Then you might have accelerated depreciation methods like double declining balance, front loading the first side of the depreciation, which could be useful and correct in terms of like equipment, which you might be getting more use out of in the first years than the latter years, which is the accounting defense for like a double declining balance. But for taxes, the double declining balance is usually good because we want the depreciation up front because deductions are good for taxes, right? So we'd whether have the deduction sooner. And then we can go deviate completely from bookkeeping, the thought process. And that would be like having a front loaded 179 deduction, for example, which basically means we're going to be able to get this big deduction upfront. Similarly, like a special deduction. These are things that are basically usually politically related, trying to stimulate the economy or something like that. That's where we are now. So electing the 179 deduction introduction. So you can elect to recover all or part of the cost of certain qualified property up to a limit by deducting it in the year you place the property in service. So it's going to be important that you have to think about this election when you place the property in service because that's the point in time when you could take the election or not. Normally, if you could take the election, usually we would want to because that would allow us to deduct sooner and the typical tax planning strategies would be I'd rather have the deduction sooner than later because of the time value and money and the possibility that the tax code could change. But that's not always the case because it might be the case that in future years, I think my revenue is going to be higher than in the current year, in which case my progressive tax rates might be higher in future years as well. So in that case, you could imagine a scenario where you wouldn't want the 179 deduction in a low-income tax year and would rather take it in future years where you think the income level might be higher. So this is the section 179 deduction. You can elect the 179 deduction instead of recovering the cost by taking depreciation deductions. So it's kind of like an accelerated depreciation or you're basically depreciating it all up front. Okay, Purpose of Form 4562. This table describes the purpose of the various parts of Form 4562. For more information, see Form 4562. So part one, what's the purpose of electing the section 179 deduction figuring the maximum section 179 deduction for the current year figuring any section 179 deduction carryover to the next year. Part number two, Form 4562. Reporting the special depreciation allowance for property other than listed property placed in service during the tax year. Reporting depreciation deductions on property being depreciated under any method other than makers. Part three, reporting makers depreciation deduction for property placed in service before this year. Makers is like the normal thing that usually comes to mind for depreciation methods for tax code which is kind of a double declining balance usually with a half-year convention. For example, reporting makers depreciation deduction for property other than listed property placed in service during the tax year. Part four, summarizing other parts. Part five, reporting the special depreciation allowance for automobiles and other listed property. Automobiles having its own special rules because of the problems related to automobiles and what not. Reporting makers depreciation on automobiles and other listed property. Reporting section 179 cost elected for automobiles and other listed property. Reporting information on the use of automobiles and other transportation vehicles. And then we've got part number six, reporting amortization deductions. Okay, useful items. You may want to see publications. So you can dive into these publications if you want to get into more detail. 537 installment sales. So if you have that particular situation, 544 sales and other disposition of assets when you're disposing of the assets form and publication form and instructions for form 4562 depreciation amortization. You can find these on the IRS website of course iris.gov and form 4797 sales of business property. Okay, so what property qualifies we're talking 179 deduction here to qualify for the section 179 deduction. Your property must meet all of the following requirements. It must be eligible property. It must be acquired for business use. This is a business type of thing here, not a personal deduction. It must have been acquired by purchase. So you purchased it as opposed to just finding it or gifting it or something like that. You bought the thing. It must not be property described later under what property does not qualify. So we'll talk about that shortly. Eligible property. What does that mean to qualify for the section 179 deduction? Your property must be one of the following types of depreciable property. Number one, tangible personal property. Number two, other tangible property except buildings and their structural components used as A and intangible part of manufacturing production or extraction or of furnishing transportation, communications, electricity, gas, water or sewage disposal services. B, a research facility used in connection with any of the activities in A above or C, a facility used in connection with any of the activities in A for bulk storage of fungible commodities. Three, single purpose agricultural, livestock or horticultural structures. C, chapter seven of publication 225 for definitions and information regarding the use requirements that apply to these structures. Number four, storage facilities except buildings and their structural components used in connection with distributing petroleum or any primary product of petroleum. Five, off the shelf computer software. Six, qualified section 179 real property described below. Alright, so tangible personal property. Tangible personal property is any tangible property that is not real property. It includes the following property machinery and equipment. So that would be, you know, one of the more common types of examples here, right? Machine or equipment, property contained in or attached to a building other than structural components. So these areas get a little bit kind of confusing because remember, if you have something that's going to be part of the building itself, then you have a much longer depreciation period that you have to depreciate a building and generally improvements than other types of things such as equipment, for example. So then the question is, is it possible because remember the general rule is that we would like to take the deduction sooner rather than later. Therefore, if at all possible, we would have, we would like to have lower lives assigned to the property that's being depreciated so we can get the depreciation sooner. And of course, if we can accelerate the depreciation with a double declining balance type of situation as opposed to straight line or and or if we could get some kind of lump sum depreciation in period one, 179 or special depreciation, we would like to do that. So you get into these, these issues of well now I have a building, but I have this thing. Is it part of the building or can I call it something other than part of the building? If I can say it's not actually part of the building, but a piece of equipment, then maybe I can apply 179 deduction to it. Maybe I can get a shorter period that I can depreciate it over and so on and so forth. So this categorization becomes important when we're trying to maximize the depreciation. So again, property containing in or attached to a building other than structural components such as refrigerators, grocery store containers, office equipment, printing processes, testing equipment and signs, Gasoline storage tanks and pumps at retail service stations, livestock, including horses, cattle, hogs, sheep, goats and mink and other forbearing animals, forbearing animals, Portable air conditioners or heaters placed in service by you in tax years beginning after 2015. That's when you know they gets a little bit more messy with the heaters and in the air conditioning of a part of the building or they portable and not part of whatever. So certain property use a predominantly to furnish lodging or in connection with the furnishing of lodging, except as provided in section 50B2. So the treatment of property as tangible personal property for the section 179 deduction is not controlled by its treatment under local law. For example, property may not be tangible personal property for the deduction, even if treated so under local law. So sometimes when you when you look at these terminologies, basically it goes to the state in terms of what the law is related to them. So for example, if you if you think about community property states versus non community property states with regards to marriage and the impact it could have on married filing joint or separate, then you've got to go to the state law. But when you're talking about other definitions, then the federal government may not obviously allow the state and locality to just change the definition of something, which could change how something would be treated in one state or locality to another that would be kind of cheating or disingenuous. We need the same definitions to apply evenly. So for example, property may not be tangible personal property for the deduction, even if treated so under local law and some properties such as fixtures may be tangible personal property for the deduction, even if treated as real property under local law off the shelf computer software off the shelf computer software is qualifying property for purposes of the section 179 deduction. So this is computer software that is readily available for purchase by the general public is subject to non exclusive license and has not been substantially modified. So software becomes an issue because the question is, you know, did you just buy like the software that could be quite expensive kind of software, or is it like research and development, kind of internally and whatnot. And then, you know, is that going to change the treatment of, you know, how you're going to be accounting for the software. So it includes any program designed to cause a computer to perform a desired function. However, a database or similar items is not considered computer software unless it is in the public domain and is incidental to the operation of otherwise qualifying software. So qualified section 179 real property. So you can elect to create certain qualified real property you place in service during the tax year as section 179 property. If this election is made the term quote section 179 property and quote will include any qualified real property we're talking like real estate here generally, that is qualified improvement property as described in section 168 E six of the internal revenue code and any of the following improvements to non residential real property placed in service after the date the non residential real property was first place in service. So number one roofs number two heating ventilation and air conditioning property number three fire protection and alarm systems number four security systems property acquired for business use. So to qualify for the section 179 deduction your property must have been acquired for use in your trade or business. That's kind of a general rule for deductions business related deductions is generally what we're thinking of. And remember that's the natural kind of thought process we would think of in an income tax system what kinds of things should we be able to deduct those things we had to consume in order to generate revenue. So property you acquired only for the production of income such as investment property rental property if routine property is not your trade or business and property that produces royalties does not qualify. In other words you kind of have this idea of of when you're trying to generate income is it property that you're just sitting on that's going to basically appreciate in value or you kind of actively involved in the property. This is one of the issues that sometimes come up with some of the rules that are going to be applied. So if you're talking like something that's reported on a schedule C for example that you have a sole proprietorship and the general idea would be you're actively involved in the sole proprietorship. You're subject to self self employment tax. I'll relate it to it and so on. But if you buy property that you're just holding on to and hoping it appreciates in value and you're not actively kind of involved in it that would be kind of thought of more as a passive type of investment situation. And sometimes there's a distinction in the tax code for those types different types of holding. So once again property you acquire property you acquire only for the production of income such as investment property. So you're investing in it and you're just kind of holding on to it waiting for it to go up in value rental property. So rental property has another issue that's why it's not reported on the schedule C. Oftentimes unless it's like a principal business and you're actively involved but rather on a schedule E. Because you may not be subject to self employment tax because you're not actively involved in what not. However you could have passive income rules and what not related to it. So if renting property is not your trader or business that's why that exception is there and property that produces royalties does not qualify. So partial business use when you use property for both business and non business purposes you can elect the 179 deduction only if you use the property more than 50% for business in the year you place it in service. So you have to clear that threshold before you can take the 179 deduction. If you use 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. So now you're going to have to think about you know what what the use is a percentage usage that is business versus professional. So you can properly calculate the 179 as well as the normal depreciation typically you would think. So example may oak bought and placed in service an item of 179 property costing $11,000 may use the property 80% for business and 20% for personal use. The business part of the cost of the property is 80% of the cost 11,000 which is 8,800. So property acquired by purchase. So this was another requirement we had we're going through all these requirements. So to qualify for section 179 deduction your property must have been acquired by purchase for example property acquired by gift or inheritance does not qualify. So obviously the idea here is you're getting the property and you're getting this massive upfront deduction for it. So if you just got a gift of the property then you still have this question of basis like what's going to be the cost of the property. But it does seem kind of inappropriate possibly to get this massive deduction in the first year if you were gifted it or if you have basically inherited it at that point in time. Although again we still have this basis kind of issue for normal depreciation or capital gain or loss if you were to sell the property in the future. So meaning obviously if you pay for the property you know what the cost was because you pay for it in a market transaction. If it was gifted for you then what are you going to put it on the books as you would like to put it on the books at the highest basis possible. Because that allows you possibly depreciation if not 179 deduction in the future and when you sell the property it will lower the amount of gain or increase the amount of loss at that point in time. But usually you would think in a gift you might have to take on the basis of the person that gifted it to you and that person might have bought the property way far back in history which means they might have a fairly low basis which usually isn't as good. In an inheritance if someone dies and give you the property because their inheritance may be subject to like a state tax then it might be taxed when the person dies if they're wealthy and individual. And at that point if they inherited it to you you might get a step up in basis is what they call it. So now you might be able to put it on the books at a higher base so you can get into that as a whole nother kind of issue but not subject you can't do the 179 so you have to buy it for 179. Property is not considered acquired by purchase in the following situations. One it is acquired by one component member of a controlled group from another component member of the same group. Two its basis is determined either A in whole or in part by its adjusted basis in the hands of the person from whom it was acquired. You would think that might be the case in the case of a gift. This first one seems kind of like it's a related party transaction kind of thing which means it might not be an arms length transaction type of thing. That's why that's an issue because it may not be a market transaction as my interpretation at least be under the stepped up basis rules for property acquired from a descendant. So that sounds like an inheritance situation where you got a stepped up basis but you didn't you didn't buy it. Generally three is acquired from a related person. So now you've got this related person thing which means that it might not be a market transaction. So one in three looks similar. Number one says it is acquired by one component member of a controlled of a controlled group from another component member of the same group. Okay. What is related person then if I can't do the related person thing related person are described under related persons earlier. However to determine whether property qualifies for the section 179 deduction treat as an individual's family only their spouse ancestors and lineal descendants and substitute quote 50% end quote for quote 10% end quote each place it appears. So this related person thing becomes an issue because oftentimes when we're doing business we do business with people we trust which is often could be you know family and related. And you also could think about related like entities that have been put together corporations sub corporations and whatnot. But so but but obviously if there's a related person situation you might not have a market transaction a transaction between a father and a son is likely possibly not exactly an arms length. Transaction partially gift be involved in it as opposed to if you have two people that are separate. Then you would expect them to be looking out for their own self interest and therefore have a have a solid market based transaction. So so when you have whenever you have these related person transactions you got to dive into it and say what what do I need to do to deal with that situation. So example you are a tailor you bought to industrial sewing machines from your father you place both machines in service in the same year you bought them. So they do not qualify for section 179 property because you and your father father or related your related person so you cannot claim a section 179 deduction for the cost of these machines. What property does not qualify. So now we've got the specific items that do not qualify. So land and improvements. So land and land improvements do not qualify a section 179 property land improvements include swimming pools paved parking areas. Warves docks bridges and fences. So clearly you would think that when we talked before about just depreciation in general the amount that's allocated to just land is something that's not depreciable because the land doesn't deteriorate in value. So you would think it wouldn't be subject to 179 as well. But then you've got these things that are improvements to land which you would think that those would kind of those would deteriorate over time. And that's where it gets a little bit messy. So that's why you've got the land and improvements. So again land and land improvements do not qualify for section 179 land improvements include the swimming pool paved parking areas. Warves docks bridges and fences. OK accepted property even if the requirements explained earlier under what property qualifies are met. You cannot elect the section 179 deduction for the following property. So certain property you lease to others. If you are a non corporate less or property used predominantly outside the United States except property described in section 168 G4 of the internal revenue code property used by certain tax exempt organizations except property used in connection with the production of income subject attacks on unrelated trade or business income property used by governmental units or foreign persons or entities except property used under a lease with a term of lease of less than six months or at least property. Generally you cannot claim a section 179 deduction based on the cost of property you lease to someone else. So these rules do not apply to corporations. However you can claim a 179 deduction for the cost of the following property one property you manufacture or produce and lease to others to property you purchase and lease to others if both the following tests are met. The term of the lease including options to renew is less than 50% of the properties class life B for the first 12 months after the property is transferred to the lease. See the total business deductions you are allowed on the property other than rents and reimbursement amounts are more than 15% of the rental income from the property.