Can Section 179 limitations be carried forward, and if so, how does the carryover work?
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Yes, Section 179 limitations can be carried forward, and the carryover mechanism is a key feature of the Section 179 expensing regime. Here’s a detailed explanation of how the carryover works, including the legal framework, mechanics, and practical considerations:
1. Legal Basis for Section 179 Carryover
Section 179(b)(3)(A) of the Internal Revenue Code limits the amount of Section 179 expense deduction to the aggregate amount of taxable income derived from the active conduct of any trade or business during the taxable year. If the amount elected to be expensed exceeds this taxable income limitation, the excess is not lost; instead, it is carried forward to future years.
Treasury Regulation § 1.179-2(c)(1) confirms this, stating that any cost that is elected to be expensed but is not currently deductible because of the taxable income limitation may be carried forward to the next taxable year. The carryover is often referred to as a “carryover of disallowed deduction”.
Treasury Regulation § 1.179-3 provides further detail, explaining that the carryover can be deducted in a future year, subject to the same limitations (dollar limitation and taxable income limitation) that apply in the year the deduction is claimed.
2. How the Carryover Works
a. When Does a Carryover Arise?
A Section 179 carryover arises when:- The amount elected to be expensed under Section 179 exceeds the taxpayer’s taxable income from the active conduct of a trade or business for the year, or- The total cost of qualifying property placed in service exceeds the annual Section 179 dollar limitation (after phase-out).
b. Mechanics of the Carryover
- Calculation: In the year the Section 179 election is made, the taxpayer determines the maximum allowable deduction based on the dollar limitation and the taxable income limitation. Any amount elected to be expensed that exceeds the allowable deduction is carried forward.
- Unlimited Duration: The carryover can be used in any subsequent year, subject to the same limitations, and there is no expiration period for the carryover (it can be carried forward indefinitely until fully used).
- Order of Application: In each subsequent year, the taxpayer first applies the current year’s Section 179 limit to new property placed in service, and then applies any carryover from prior years, up to the available taxable income limitation for that year.
c. Example
Suppose a taxpayer elects to expense $100,000 under Section 179 in Year 1, but only has $60,000 of taxable income from active business activities. The taxpayer can deduct $60,000 in Year 1 and must carry forward the remaining $40,000. In Year 2, if the taxpayer has $80,000 of taxable income and no new Section 179 property, the taxpayer can deduct the remaining $40,000 carryover in Year 2, subject to the Year 2 limitations.
d. Recordkeeping
Taxpayers must maintain records of the carryover amount, the year(s) in which it arose, and the amount used in each subsequent year. This is essential for compliance and audit purposes.
3. Special Considerations
a. Pass-Through Entities
For partnerships and S corporations, the Section 179 deduction is allocated to partners or shareholders, who then apply the deduction (and any carryover) on their individual returns, subject to their own taxable income limitations. If a partner or shareholder cannot use their full allocated deduction due to insufficient taxable income, the unused portion is carried forward at the individual level, not at the entity level.
b. Qualified Real Property
For certain years, Section 179(f) provided that unused Section 179 deductions attributable to qualified real property could only be carried forward for a limited period, not indefinitely. However, for most Section 179 property, the carryover is unlimited.
c. Coordination with Other Deductions
The carryover is always subject to the annual Section 179 dollar limitation and the taxable income limitation in the year it is used. It does not take precedence over current-year Section 179 elections; rather, it is used after applying the current year’s allowable Section 179 deduction.
4. Practical Application
- Tax Planning: Businesses with fluctuating income can use the carryover to maximize deductions in profitable years.
- No Expiration: There is no time limit for using the carryover, so it remains available until fully utilized.
- No Net Operating Loss Creation: Section 179 cannot create or increase a net operating loss; the carryover ensures the deduction is not lost but deferred.
5. Summary
Section 179 limitations can be carried forward. If a taxpayer cannot use the full Section 179 deduction in a given year due to the taxable income limitation (or, in rare cases, the dollar limitation), the unused amount is carried forward to future years. The carryover is applied in subsequent years, subject to the same limitations, and can be carried forward indefinitely until fully used. This mechanism ensures that taxpayers are not permanently denied the benefit of the Section 179 deduction due to temporary income constraints.
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