One of the tax benefits available to businesses is the section 179 deduction that allows you to write off the cost of certain property in the year you purchase it instead of recovering the cost through depreciation deductions. But if you later decide to close your business you may have to recapture a portion of the deduction and report it as ordinary income on your tax return.
According to the IRS, you have to recapture a section 179 deduction if your business use of the property drops to 50% or less in any year during the property’s recovery period. The amount of the deduction you have to recover is calculated as the amount of the section 179 deduction you claimed minus the depreciation that would have been allowable on the property during the period you used the property for business purposes.
The recaptured section 179 deduction would be reported as ordinary income in Part IV of Form 4797. The income from the recapture would then be included on the schedule on which you report the income from your business, for example Schedule C, or Schedule F if it is a farming business. The IRS points out that if the recapture is applicable to a trade or business, the income resulting from the section 179 recapture would be subject to income tax and self-employment tax.
If you claimed the section 179 deduction on listed property, which includes passenger vehicles, other property used for transportation, and certain computers, the recapture calculation is different. In this case you would take the allowable depreciation on the property during the period you used it predominately for business purposes, including the section 179 deduction and any special depreciation deduction you claimed, and subtract the depreciation using the straight line method and the ADS recovery period.
If you close a business and sell or dispose of property that you used in the business, part of any gain you realize on the sale or disposition may have to be recaptured if you claimed a section 179 deduction. If the property was Section 1245 property (generally personal property and other tangible property except for buildings and their structural components), the amount you would have to recapture as ordinary income is the lesser of the depreciation allowable on the property, including the section 179 deduction, or the gain realized on the sale.
When you are in business, whether to claim the section 179 deduction or to depreciate the property is a decision that should be made as part of your overall tax planning. The overall tax effect if you claimed the section 179 deduction and then have to recapture part of it if you close the business, would depend on your effective tax rate each year. If you have claimed the section 179 deduction and are closing the business, the tax effect of the recapture as ordinary income should be taken into consideration in your cash flow planning, and you may need to adjust your estimated tax payments.
Sources:
Form 4797, Sales of Business Property, IRS
Publication 544, Sales and Other Dispositions of Assets, IRS
Publication 946, How To Depreciate Property, IRS
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