When you purchase equipment for use in your business, normally you would recover the cost through depreciation deductions according to the useful life of the equipment. But you can write off the cost in the year of purchase by electing the section 179 deduction. According to the IRS, for 2011 the maximum section 179 deduction is $500,000. The deduction is reduced by the amount by which the cost of section 179 property you placed in service during the year exceeds $2 million.
If you later sell or exchange that equipment, the section 179 deduction would have to be recaptured for tax purposes. In effect, the section 179 deduction, just like the depreciation you claim on the assets in your business, reduces the basis of the assets. Then when you sell or exchange the equipment the gain or loss is calculated as the amount you realize on the sale less the cost of the equipment, reduced by the section 179 deduction and any depreciation you claimed. If you wrote off the entire cost using the section 179 deduction, your basis would be zero and the entire amount realized on the sale or exchange would be a taxable gain.
Sales of business property are generally reported on Form 4797. The section 179 deduction that you claimed for the property would be reported on the line for depreciation allowed or allowable. If you held the property for one year or less, the sale or exchange would be reported in Part II of Form 4797. If you held the property for more than one year and realized a gain, the sale or exchange would be reported in Part III. If you realized a loss, you would report it in Part I.
If you live in a state that has a state income tax, you may need to make an adjustment depending on how the state handles the federal section 179 deduction. For example, if the state does not allow the full federal section 179 deduction, you will have a different tax basis in your business assets for federal and state purposes. This will affect the gain or loss you report on your state income tax return if you sell the equipment.
It is therefore important to keep track of the tax basis of the assets in your business, including the original cost, the section 179 deduction, and depreciation claimed on each item, for both federal and state tax purposes. Then if you decide to sell or dispose of the equipment you will have the information you need to calculate the gain or loss on the sale or disposal for tax filing purposes.
Sources:
Instructions for Form 4562, IRS
Form 4797, Sales of Business Property, IRS
Instructions for Form 4797, IRS
Publication 544, Sales and Other Dispositions of Assets, IRS
