How does leased property affect Section 179 expense eligibility for a business?
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Leased property presents unique considerations for Section 179 expensing. The eligibility of leased property for Section 179 expense depends on the nature of the lease, the tax ownership of the property, and the specific requirements and limitations set forth in the Internal Revenue Code and Treasury Regulations.
1. General Rule: Section 179 and Leased Property
Section 179 allows a taxpayer to elect to expense the cost of qualifying property rather than recover it through depreciation. However, to claim a Section 179 deduction, the taxpayer must acquire the property by purchase for use in the active conduct of a trade or business. The property must be "section 179 property," which generally means tangible personal property or certain qualified real property, acquired by purchase and used in the business.
Leased property is generally not eligible for Section 179 expensing by the lessee, because the lessee does not acquire the property by purchase. The lessor, as the owner, may be eligible, but only under certain conditions.
2. Noncorporate Lessors: Special Limitation
Section 179(d)(5) imposes a significant limitation on noncorporate lessors (e.g., individuals, partnerships, S corporations):
- General Rule: A noncorporate lessor cannot claim a Section 179 deduction for property purchased for leasing purposes.
- Exceptions: The noncorporate lessor may claim Section 179 if one of the following is true:
- The property was manufactured or produced by the lessor in the ordinary course of business; or
- The lease term (including renewal options) is less than 50% of the class life of the property, and for the first 12 months after transfer to the lessee, the lessor’s Section 162 deductions (other than rents and reimbursed amounts) with respect to the property exceed 15% of the rental income from the property.
This two-prong test is difficult to satisfy in practice. Most lessors do not manufacture the property, and typical rental expenses (excluding depreciation, interest, and taxes) often do not exceed 15% of rental income.
Case Law Example: In Thomann v. Commissioner, the Tax Court denied Section 179 deductions to noncorporate lessors who failed to meet these requirements, particularly where the lease terms were not clearly documented and the lease term could not be shown to be less than 50% of the class life.
3. Tax Ownership and Lease Structure
- Finance Leases (Capital Leases): If a lease is structured so that the lessee is treated as the tax owner (e.g., the lessee bears the risks and rewards of ownership, has a bargain purchase option, or the lease term covers most of the asset’s useful life), the lessee may be treated as the purchaser for tax purposes. In such cases, the lessee may be eligible to claim Section 179, provided all other requirements are met.
- Operating Leases: If the lease is a true rental (operating lease), the lessee cannot claim Section 179, as they are not the tax owner. The lessor may be eligible, but only if the above noncorporate lessor exceptions are satisfied.
4. Section 179 Deduction Limits and Carryover
- The maximum Section 179 deduction for 2025 is $2,500,000, with a phase-out beginning at $4,000,000 of qualifying property placed in service.
- The deduction is also limited to the taxpayer’s aggregate business income for the year; any excess can be carried forward.
5. Other Considerations
- Estates and Trusts: Estates and trusts cannot claim Section 179.
- Controlled Groups: All members of a controlled group are treated as one taxpayer for Section 179 purposes, and the deduction must be allocated among them.
- Recapture: If property for which a Section 179 deduction was claimed is no longer used predominantly in the business, the deduction may be subject to recapture as ordinary income.
6. Summary Table
7. Practical Planning
- For most businesses, Section 179 expensing is not available for property merely leased from a third party under an operating lease.
- If a business enters into a finance lease and is treated as the tax owner, Section 179 may be available.
- For noncorporate lessors, the Section 179 deduction is generally unavailable unless the lease is short-term relative to the asset’s class life and the lessor incurs significant non-rent expenses in the first year.
8. Bonus Depreciation Alternative
If Section 179 is unavailable, bonus depreciation under Section 168(k) may be available to the tax owner of the property, subject to its own requirements and phase-out schedule.
In summary: Leased property is generally not eligible for Section 179 expensing by the lessee unless the lessee is treated as the tax owner under a finance lease. For noncorporate lessors, Section 179 is only available if strict requirements are met regarding the lease term and expenses. Most operating leases do not qualify for Section 179 expensing by either party, and lease payments are instead deductible as business expenses.
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