 Income tax 2022-2023. Section 179, deduction part number three. Let's do some wealth preservation with some tax preparation. Most of this information comes from publication 946, How to Depreciate Property Tax Year 2022. You can find on the IRS website, irs.gov, irs.gov. Looking at the income tax formula, we're focused online. Remembering the first half of the income tax formula is in essence an income statement, although just an outline of scaffolding other forms and schedules flowing into these line items. One of those, the schedule C, having business income minus business income minus business expenses, gets us to the net business income that rolls into line one income of our income tax formula. First page of the form 1040, remembering the schedule C rolls into the schedule one, which rolls into page one of form 1040, line number eight. We're looking at the schedule C, profit or loss from business, noting the income statement format with the income and expense categories. We're focused now on the expense categories, more specifically the depreciation, more specifically, still the 179 type of deduction. So quick recap, remember, support accounting instruction by clicking the link below, giving you a free 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. For that, when you have property, then you might have to put it on the books, deviating from a cash based system to an accrual based system in essence, as an asset allocating the cost over the useful life, a common accrual type of concept. And in general, what we would like to do as taxpayers is get the deductions as soon as possible, although there could be exceptions to that rule for the tax code and depreciation. They might have an accelerated depreciation method instead of straight line, which is usually getting us a deduction sooner, which is usually good. And then if we can get a 179 deduction in essence deducting as much as we can in the first year, that's usually a benefit as well. We might have a special deduction as well. Special depreciation we'll talk about in future presentations. All right, that said, we're focusing in once again on the 179 deduction. Just as a recap, electing the 179 deduction introduction, 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 a section 179 deduction. You can elect the 179 deduction instead of recovering the cost by taking depreciation deduction, which would be a benefit if we can get the benefit in the current year. We're continuing on now. This is the third part of our 179 deduction discussion. We're now taking a look at the limitations on the amount that you might be able to deduct for the 179 deduction. We looked at dollar limitations in prior presentations. Now we're looking at the 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. So the prime example of that would be reporting, say, on a schedule C generally. Remember when we're thinking about different kinds of incomes, it's kind of a good idea to have a general categorization of different kinds of income, the most common often being, say, what I would call W-2 income that you are receiving as an employee from an employer. One of the distinguishing factors that might help you to kind of categorize the different types of income in your mind is to think about how the FICA taxes are being paid. That's the Social Security and Medicare, for example. As an employee, they're going to be the payroll taxes, so they're going to be withholdings in that type of situation. As an employee, you typically don't have as many of the business expenses that you're able to be taking because the employer then is the one that is going to be responsible for most of those types of expenses. Although as an employee, you are, of course, doing active work in that situation. And then you have a schedule C situation where you're actively participating in, say, your own type of business. And in that situation, the Social Security and Medicare is being paid in the form of self-employment tax, which would be an indication oftentimes that it's a business kind of activity. And then you have activities that might be more passive in nature, such as investing in stocks and bonds, where you might have interest in dividends, and those are not subject to any form of Social Security FICA taxes, not in terms of withholdings usually, and not in terms of self-employment taxes. And then the other kind of passive-ish kind of situation is where you have real estate property on the schedule E. And there's a question there whether or not some of those businesses are active or not or passive in nature. So those are the general categories. Okay, and that could lend to some of these limitations as well. So any cost not deductible in one year under section 179 because of this limit can be carried to the next year. So clearly if you're limited to the 179 deduction, then you would expect possibly that in the following years you might be able to take the normal depreciation, so you don't like lose the capacity for the deduction. You were just limited due to the income limitation, and now it wouldn't really be called a carry forward, but you do have kind of a carry forward situation with the basis that still has the capacity for deduction that you would deduct under normal rules such as, for example, makers deduction in the future. So special rules apply to the deduction of qualified section 179 real property that is placed in service by you in tax years beginning before 2016 and disallowed because of the business income limit. See special rules for qualified section 179 real property under carryover of disallowed deduction later. 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, net income or loss from a trade or business includes the following. You got section 1231 gains or losses, interest from working capital or your trade or business, and wages, salaries, tips or other pay earned as an employee. Now remember just as a general rule, the IRS is of course skeptical on losses. The IRS wants to be your silent partner. They want to have the benefit of taking a piece of the income, but they don't want to have to take on the risk of the losses. So losses could be a benefit with regards to taxes. So just as a general rule, you would think that you want to always be thinking, well, there might be limitations if this cuts into a loss situation for many areas in the tax code. So in addition, figuring taxable income without regard to any of the following. So the section 179 deduction, so the self-employment tax deduction, any net operating loss carry back or carry over any unreimbursed employee business expenses. Two different taxable income limits. In addition to the business income limit for section 179 deduction, you may have a taxable income limit for some other deduction. You may have to figure the limit for this other deduction taking into account the section 179 deduction if so complete the following steps. So in other words, now you've got this income limitation with regards to this one deduction. They apply the same principle sometimes to other deductions, which also might be subject to an income limitation. So now the question is, well, how are you going to figure out which deduction is going to be limited and which order with these two deductions or multiple deductions that have these income limitations? Okay, so one, figure taxable income without the section 179 deduction or the other deduction. Two, figure a hypothetical section 179 deduction using the taxable income figure in step one. Three, subtract the hypothetical section 179 deduction figured in step two from the taxable income figured in step one. Four, figure a hypothetical amount for the other deduction using the amount figured in step three as taxable income. Notice that this is a complex series of steps here. You can see conceptually why this problem happens, but running through these calculations can be quite tedious. Software hopefully can help us run through those calculations and then we might be able to unpack or deconstruct using the software and applying these concepts. Five, subtract the hypothetical other deduction figure in step four from the taxable income figured in step one. Six, figure your actual 179 deduction using the taxable income figured in step five. Seven, subtract your actual section 179 deduction figured in step six from the taxable income figured in step one. And finally, eight, figure your actual other deduction using the taxable income figured in step seven. Okay, carryover of disallowed deduction. You can carryover for an unlimited number of years the cost of any qualified section 179 real property that you placed in service in tax years beginning after 2015 and that you elected to expense, but we're unable to deduct because of the business income limitation. So this disallowed deduction amount is shown online 13 a form 4562 you use the amount you carry over to determine your section 179 deduction in the next year. Enter that amount online 10 of your form 4562 for the next year. If you place more than one property in service in a year, you can select the properties for which all or part of the cost will be carried forward. Your selections must be shown in your books and records for this purpose treats section 179 costs allocated from a partnership or an escort operation as one item of section 179 property. So clearly when we think about the different kind of business entities, you know the partnership is a flow through entity as is a an escort kind of situation. So if you do not make a make a selection the total when I say flow through entity meaning they flow through from the the other tax return instead of being taxed at the S corporation level or partnership level they flow through with a K one form to the form 1040s and then are taxed on the form 1040 so the total so the total carryover will be allocated equally among properties you elected to expense for the year. If costs from more than one year are carried forward to a subsequent year in which only part of the total carryover can be deducted you must deduct the costs being carried forward from the earliest year first. All right special rules for qualified section 179 real property like real estate typically property. So you can carry over to 2023 a 2022 deduction attributable to the qualified section 179 real property that you placed in service during the tax year and that you elected to expense but we're unable to take because of the business income limitation. See carry forward of disallowed deduction earlier thus the amount of any 2022 disallowed section 179 expense deduction attributable to qualified section 179 real property will be reported online 13 of form 4562. And then how do you elect the deduction you elect to take the section 179 deduction by completing part one of form 4562 software obvious is helpful and useful to try to guide you through the process here and then you can kind of deconstruct it will possibly look at some software examples in future presentations to get an idea. So the property placed in service in 2022 file form 4562 with either of the following your original 2022 tax return whether or not you file it timely and amended return for 2022 filed within the time prescribed by law. So 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 of the cost of each such item to be taken into account. The amended return must also include any resulting adjustments to taxable income. So in other words you would like to do it when you file the actual tax return. But if you have to if you didn't take it and you need to go back and amend it then you might be able to amend the tax return in order to properly make the election. So election for qualified section 179 real property you can elect to expense certain qualified real property that you placed in service as section 179 property for tax years beginning in 2022. For more information see election above also see revenue procedure 2019-8 on page 347 of internal revenue bulletin 2019-3 2019-3 available at the IRS website. Revoking an election is possible to revoke the election and election or any specification made in the election to take a section 179 deduction for 2022 can be revoked without IRS approval by filing an amended return as you would kind of expect. Why would you do that maybe you elected the 179 deduction and and you figured that it was an actual a beneficial thing or possibly you didn't qualify for it and you want to correct the situation amend the return. So the amended return must be filed within the time prescribed by law. The amended return must also include any resulting adjustment to taxable income. That's the standard process for an amended return once made the revocation is irrevocable. That's sounds quite definite. So when must you recapture the deduction. You you may have to recapture the section 179 deduction if an any year during the properties recovery period the percent of the business use drops to 50% or less. So this is another kind of strange situation when they do these when they do these kind of weird deviations of a normal accounting process of this big depreciation upfront. You can imagine a situation where someone has a business and they basically take this massive 179 deduction but then they change the property from business use property to personal property. So now it's personal property not business property anymore and you used it to take this massive business deduction related to it in the prior year which you only got the massive business deduction because they allowed you this massive. Front year loading of the deduction which normally should have been allocated from normal accounting principles over the useful life of the equipment. So so now so so then you might have to recapture it in that case. So in the year the business use drops to 50% or less. You include the recapture amount as ordinary income in part four of form four seven nine seven. So it's probably fairly unusual of a situation but you can imagine why they need it there because if they didn't put it there people might try to manipulate the tax code and cheat. You know a little bit you would think and that might be one way to people try to manipulate the system. So you also increase the basis of the property by the recapture amount. So then you have a basis adjustment of course because you don't get the in essence the deduction recovery periods for property are discussed under which recovery period applies in chapter four. Figuring the recapture amount to figure the amount to recapture take the following steps one figure the depreciation that would have been allowed on the section 179 deduction you claimed. Begin with the year you place the property in service and include the year of recapture to subtract the depreciation figured in one from the section 179 deduction you claimed because you don't get that you're going to have to reverse that. The result is the amount you must recapture. Example let's check it out in January 2020 Paul Lamb a calendar your taxpayer bought and placed in service section 179 property costing $10,000 the property is not listed property the property is three year property. So Paul elected a $5,000 section 179 deduction for the property and also elected not to claim a special depreciation allowance. We'll talk about special depreciation later. Paul used the property only for business in 2020 and 2021. In 2022 Paul used the property 40% for business and 60% for personal use. So Paul figures. So now it they fell he fell below the 50% business use. Uh oh recapture point. So Paul figures the recapture amount as follows. You got the 179 deduction claimed in 2019 was 5,000. So mine is allowable depreciation using a table one a which I'm not going to jump to here but you got the 2020 1,066 50 2021 2022 and that's going to give us the total of the the 4,185 20. So the recapture amount then at the 8 at the 814 80. So Paul must include then the $814 and 80 cents in income for 2022. So not not a totally common scenario but you can imagine that scenario coming up from time to time.