Expense Method Depreciation - Great Tax Planning Opportunities On Amended Returns

Historically, the I.R.C. §179 election was required to be made as part of a timely filed return.  No revocations of the election, once it was made, were allowed without IRS consent.  However, in 2003, the Congress enacted I.R.C. §179(c)(2) to permit taxpayers to revoke the I.R.C. §179 election on an amended return.  Subsequent extender legislation continually renewed the revocation ability so that it applied to tax years beginning before 2015.  Then, the PATH Act enacted in December of 2015 retroactively extended the provision for tax years beginning before 2016 and then permanently extended the provision for later years. 

Here’s an example of revoking the I.R.C. §179 deduction on an amended return:

Joe, a farm proprietor, is a 50% shareholder in an S corporation that conducts a 

hog breeding activity. The other 50% shareholder is Joe’s brother. When Joe

receives the Form 1120S Schedule K-1 for 2015, he recognizes that the S corporation

has made a 179 election with respect to $500,000 of farm equipment (Joe is

allocated a $250,000 Sec. 179 deduction as a 50% shareholder). However, during

2015, Joe made well and drainage facility improvements of approximately $400,000.

Recognizing that these improvements in his proprietorship are 15-year recovery

assets, Joe suggests to his brother that the S corporation amend its return to reduce

the I.R.C.  §179 election on the farm equipment to $200,000, so that his 50% is no

more than $100,000.

Treasury Regulation §1.179-5(c) allows a late I.R.C. §179 election on an amended return at any time within the statute of limitations for years beginning after 2002 and before 2008. The IRS later announced in Rev. Proc. 2008-54, Sec. 7 that I.R.C. §179 elections may be made by amended return for any taxable year in which Sec. 179(c)(2) allows a revocation of the election.  Thus, given the PATH Act provision that permanently extended I.R.C. §179 and, hence, I.R.C. §179(c)(2), this amended return opportunity is available for property placed in service in tax years beginning after 2002.  In addition, Treas. Reg. §1.179-5(a) specifies that any amended election must specify the items of I.R.C. §179 property and the portion of the cost of each item to be taken into account, and must also make other appropriate adjustments to the depreciation computations for the current and any succeeding tax years.

Consider the following example of making the I.R.C. §179 election on an amended return:

Tom, a farm proprietor, purchased and placed in service one item of Sec. 179

property during 2014, a tractor costing $135,000. On Tom’s 2014 tax return,

he elected to expense under Sec. 179 only $20,000 of the cost of this

asset, as that deduction reduced his joint taxable income to the top of the 15%

federal tax bracket. Subsequently, in the course of preparation of Tom’s 2015

return it becomes apparent that a Schedule J farm income averaging election

would be beneficial, and Tom would be better served if the 2014 base year had lower

taxable income. Accordingly, an amended return is prepared for 2014, increasing the

Sec. 179 deduction on the tractor by $30,000, to better position the Schedule J

income averaging calculation as part of Tom’s 2015 tax return. As an added benefit,

Tom’s SE tax was also reduced for 2014.

So, when would an amended I.R.C. §179 election be useful?  Here are some possibilities:

• Whenever there is late-appearing income. An example would be a corrected Schedule K-1 requiring an amended return which could be offset by an amended I.R.C. §179 election (if, of course, the taxpayer did not originally maximize the I.R.C. §179 limit). 

• If, upon IRS examination, an expenditure originally deducted as a repair is capitalized, the taxpayer could make a late I.R.C. §179 election if the maximum amount had not earlier been utilized.

• As noted in the second example above, an amended election could be used to better position the based period income for a current Schedule J farm income averaging election.

• In situations where the taxpayer did not originally properly designate or specify assets that were the subject of an I.R.C. §179 election, the IRS cannot disallow the election because of lack of disclosure. That’s because the taxpayer can make a late or corrected election on an amended return.

• If an asset that has been recently acquired is sold, the I.R.C. §179 election in the earlier year could be switched to other qualifying assets that were purchased in that year. Doing so will restore basis on the asset that is currently sold (and minimize gain on sale).  The following example illustrates this.

            Example

Tim, an ag producer, purchased and placed in service two items of Sec. 179

property in 2014 a tractor costing $120,000 and a combine costing $230,000.

In his 2014 Form 1040, Tim elected to expense all of the $120,000 tractor. 

In November 2015, Tim decided he no longer needed the tractor and sells

that asset for $110,000. Under the regulations, Tim is allowed to file an amended

return for 2014, revoking the Sec. 179 election for the tractor, claiming

normal depreciation for 2014 on that asset, and making an election under I.R.C.

179 to claim the $120,000 amount on the combine. The amended return must

also include an adjustment to the depreciation previously claimed on the

combine. As a result of the amended I.R.C. §179 election, Tim has eliminated

over $100,000 of gain that would have occurred from the sale of the tractor.

Conclusion

Rev. Proc. 2008-54, Sec. 7, was released in response to a commentator claiming that an I.R.C. §179 election could not be made on an amended return.  In the revenue procedure, IRS stated that the Treasury intended to amend Treas. Reg. §1.179-5(c) to incorporate the guidance set forth in Sec. 7.  The IRS also stated that until that time, taxpayers could rely on the guidance of Sec. 7 of Rev. Proc. 2008-54.  Even assuming that the IRS has no authority to issue a revenue procedure that changes the effect of a Treasury Regulation before the Regulation is amended, that point is irrelevant. The IRS view is that a taxpayer can make and/or revoke an I.R.C. §179 election on an amended return for an open tax year. Substantial IRS resources are required to change a regulation. Issuing a revenue procedure provided a fix while the law was in flux. Taxpayers may continue to rely on the official release from the National Office of the IRS to originally elect and/or amend a previous election, regardless of the regulation’s higher authority.

 

Ignore any commentary that would indicate otherwise, unless it comes from the IRS.