Lack of Records Equals Recapture

BY CHARLES J. REICHERT

The Tax Court held that a taxpayer had to recapture the majority of his prior-year section 179 deduction since he failed to show that the business use of his GMC Suburban remained above 50% in the following tax year. His testimony of the business use of the vehicle, although considered credible by the court, did not satisfy the substantiation requirements of section 274(d) related to listed property.

Code § 179 permits taxpayers to immediately expense all or part of the cost of listed property (autos, computers, cell phones, video equipment, etc.) if the property is used more than 50% in a trade or business during the year it is placed in service. If, in a subsequent tax year, the business use of the property drops to 50% or less, some of the deduction must be recaptured. The recapture amount is the difference between the section 179 amount deducted and the amount of deprecation that would have been allowed under the Alternative Depreciation System (ADS) for the years when the business use exceeded 50%. The recapture potential ceases after the normal recovery period has elapsed—six years in the case of automobiles. Section 274(d) requires taxpayers to maintain sufficient records and documentary evidence to determine each element of an expenditure. The records must have the same reliability as a contemporaneous record.

In 2002, Michael Birdsill, a California resident, started a broadcast engineering consulting business in which he drove his 1998 GMC Suburban to radio towers to gather information. He deducted depreciation of $26,396 related to the use of the vehicle. In 2003, Birdsill also deducted $11,968 under section 179 on a 1993 Ford F-250 pickup truck that he placed into service in that year, reporting 8,110 miles of business and total use. He claimed no expenses on the Suburban in 2003 and reported a net loss of approximately $21,000 from his business. In 2006, the IRS sent Birdsill a deficiency notice for tax year 2003, claiming he was required to report $23,756 of depreciation recapture related to the Suburban—the difference between his 2002 section 179 deduction and the $2,640 (10% of $26,396) depreciation that would have been allowed under the ADS. Birdsill petitioned the Tax Court for relief.

Birdsill testified that in 2003 he used the Ford for 75% of his total business miles and the Suburban for the other 25%, and that both vehicles were used more than 50% for business. These amounts were estimates by Birdsill, as he had not kept any records to support his business use of the Suburban in 2003. Since he had not satisfied the substantiation requirements of section 274(d), the court held that Birdsill had not established that his business use of the Suburban continued to exceed 50% in 2003; thus he had to include the recapture amount in his 2003 taxable income. The court also rejected Birdsill’s argument that the deficiency notice should be voided because the recapture issue was brought up in retaliation for his filing an appeal. The court could find no evidence of IRS wrongdoing and stated that even in cases where the taxpayer’s constitutional rights had been violated, the deficiency notice had not been voided by the court.

This case illustrates the importance of continuing to use listed property predominantly for business purposes and substantiating that use throughout the normal recovery period after a section 179 amount has been claimed.

Michael R. and Melanie J. Birdsill v. Commissioner, TC Summary Opinion 2008-55

By Charles J. Reichert, CPA, professor of accounting, University of Wisconsin–Superior.

©2008 AICPA

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