Recapture of deprecation for business property
converted to personal use.
Do you have to recapture the 179 depreciation and special depreciation allowance (bonus depreciation) on a simply conversion from business use to personal use? Let’s discuss the issue of recapture.
Here is an example. Bob, an airplane pilot, has an office in his home and buys a computer. He is self employed and is using the computer 100% for business in the first year and take 179 or special allowance depreciation in the first year. In year three he decides to change his focus, and gets a job with an airline as an employee and only flies for his own clients part time. Now he uses the computer 10% of the time for business. The other 90% he uses the computer to do emails with family and friends.
So we have a self employed individual who starts a company and takes full advantage of code section 179 and special depreciation allowance provisions of the tax code. The businessman is allowed to do this because the property is being used more than 50% for the business purpose vs. personal use.
What happens to all the bonus deprecation and 179 deduction when the property is converted back to personal use. Not sold, not disposed of, but simply now used for personal use.
The issue comes down to whether the property is “listed property”. If the property is listed property, then on the conversion there is a recapture of depreciation taken in prior years.
If the property is not listed property, then the mere conversion from business to personal use creates no recapture. But if after the conversion, the property now being used personally is sold, then there could be recapture of the 179 or bonus depreciation. There is a difference between how the computer is being used vs. the sale of the computer.
What is listed property?
26 US Code §280F(d)(4) defines it as:
(4) Listed property
(A) In general Except as provided in subparagraph (B), the term “listed property” means—
(i) any passenger automobile,
(ii) any other property used as a means of transportation,
(iii) any property of a type generally used for purposes of entertainment, recreation, or amusement, and
(iv) any other property of a type specified by the Secretary by regulations.
Here is an exception for companies transporting people or property:
(B) Exception for property used in business of transporting persons or property
Except to the extent provided in regulations, clause (ii) of subparagraph (A) shall not apply to any property substantially all of the use of which is in a trade or business of providing to unrelated persons services consisting of the transportation of persons or property for compensation or hire.
Not looking so good for Bob at this point is it? But hold on, see that provision under (iv) about regulations.
If you look at Regulation §1.280F-6(b), “listed property” is further defined as
(b)Listed property –
(1)In general. Except as otherwise provided in paragraph (b)(5) of this section, the term listed property means:
(i) Any passenger automobile (as defined in paragraph (c) of this section),
(ii) Any other property used as a means of transportation (as defined in paragraph (b)(2) of this section),
(iii) Any property of a type generally used for purposes of entertainment, recreation, or amusement, and
(iv) Any computer or peripheral equipment (as defined in section 168(i)(2)(B)), and
(v) Any other property specified in paragraph (b)(4) of this section.
(b)(5) there is another exception!!! Let’s take a look at (b)(5),
(5)Exception for computers. The term listed property shall not include any computer (including peripheral equipment) used exclusively at a regular business establishment. For purposes of the preceding sentence, a portion of a dwelling unit shall be treated as a regular business establishment if (and only if) the requirements of section 280A(c)(1) are met with respect to that portion.
Bob is using his computer at his regular business establishment. And he is also okay having used his home office as his regular business establishment.
So good news for Bob. His computer is not listed property and no recapture on the simple conversion. If however he sold the computer in year 3 at a gain, then yes he would have to get out his MACRS depreciation schedule and calculated the recapture. He would report the excess depreciation on his year 3 tax return as ordinary income on form 4797.
How much is the recapture when listed property is converted from business use to personal use?
IRC §280F(b)(2)(A) says it is the difference between the “excess depreciation”.
(A) Where business use percentage does not exceed 50 percent If-
(i) property is predominantly used in a qualified business use in a taxable year in which it is placed in service, and
(ii) such property is not predominantly used in a qualified business use for any subsequent taxable year,
then any excess depreciation shall be included in gross income for the taxable year referred to in clause (ii), and the depreciation deduction for the taxable year referred to in clause (ii) and any subsequent taxable years shall be determined under section 168(g) (relating to alternative depreciation system).
(B) Excess depreciation For purposes of subparagraph (A), the term “excess depreciation” means the excess (if any) of-
(i) the amount of the depreciation deductions allowable with respect to the property for taxable years before the 1st taxable year in which the property was not predominantly used in a qualified business use, over
(ii) the amount which would have been so allowable if the property had not been predominantly used in a qualified business use for the taxable year in which it was placed in service.
See you own tax preparer for your specific issue, as this is a generic discussion.
A final thought. Now that we have a better understanding of depreciation recapture, how did we capture it in the first place?