What is single member LLC depreciation and how does it impact federal taxes?
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A single-member LLC (SMLLC) is a limited liability company with only one owner. For federal tax purposes, the IRS treats most SMLLCs as “disregarded entities” by default, meaning the LLC is not recognized as separate from its owner for income tax purposes. However, the SMLLC is treated as a separate entity for certain employment and excise taxes.
Depreciation for a Single-Member LLC
1. Tax Classification and Reporting
- Default Treatment: If the SMLLC is owned by an individual, it is treated as a sole proprietorship. The LLC’s income, deductions, gains, losses, and credits are reported directly on the owner’s individual tax return (typically on Schedule C, E, or F of Form 1040).
- Alternative Election: The SMLLC can elect to be taxed as a corporation (C or S) by filing Form 8832 or Form 2553. If this election is made, the LLC files a corporate tax return and depreciation is reported at the entity level.
2. Depreciation Rules
- Eligibility: The SMLLC (or its owner, if disregarded) can depreciate tangible property (except land) and certain intangible property used in the business, provided the property:
- Is owned by the SMLLC/owner,
- Is used in a trade or business or for the production of income,
- Has a determinable useful life,
- Is expected to last more than one year.
- Method: Most business property is depreciated under the Modified Accelerated Cost Recovery System (MACRS), which includes the General Depreciation System (GDS) and the Alternative Depreciation System (ADS).
- Section 179 Deduction: The SMLLC/owner may elect to expense the cost of qualifying property (up to the annual limit) in the year placed in service, subject to business income and investment limitations.
- Bonus Depreciation: The SMLLC/owner may also claim bonus depreciation for qualified property, subject to current law phase-out schedules and recent legislative changes.
3. How Depreciation Impacts Federal Taxes
- Deduction: Depreciation is a non-cash expense that reduces taxable income. For a disregarded SMLLC, the depreciation deduction is claimed on the owner’s tax return, reducing the owner’s taxable income and, therefore, the federal income tax liability.
- Recapture: If the property is sold or otherwise disposed of, any gain up to the amount of depreciation previously claimed may be recaptured as ordinary income.
- Basis Adjustment: The basis of the property is reduced by the amount of depreciation allowed or allowable, affecting the calculation of gain or loss on disposition.
4. Special Considerations for SMLLCs
- Employment and Excise Taxes: For employment and certain excise taxes, the SMLLC is treated as a separate entity and must use its own EIN.
- Tax-Exempt SMLLCs: If a tax-exempt organization owns an SMLLC, the SMLLC is generally disregarded for income tax purposes, and its activities are reported on the parent’s Form 990. However, the SMLLC must use its own EIN for employment tax filings.
5. Reporting on Tax Returns
- Disregarded Entity: The owner reports depreciation on the appropriate schedule of their individual return (e.g., Schedule C for business, Schedule E for rental, Schedule F for farming).
- Corporation Election: If the SMLLC elects to be taxed as a corporation, depreciation is reported on the corporate return (Form 1120 or 1120S).
Summary Table: SMLLC Depreciation and Federal Taxes
Key Points
- SMLLCs can depreciate business property under MACRS, claim Section 179, and bonus depreciation, subject to the same rules as other businesses.
- For disregarded entities, depreciation is claimed by the owner on their individual return.
- Depreciation reduces taxable income, lowering federal tax liability.
- If the SMLLC elects corporate tax status, depreciation is claimed at the entity level.
- For employment and excise taxes, the SMLLC is treated as a separate entity and must use its own EIN.
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