How do you treat Section 179 deductions for depreciation which are found on the shareholder's K-1 statement and how do they affect discretionary earnings?

Because the reported depreciation expense as used to calculate discretionary earnings within the transaction databases includes only that which is deducted at the firm level, including shareholder level adjustments as you describe would lead to an "apples versus oranges" comparison.

In addition, if this extra deduction via K-1 were accounted for at the firm level, then the pretax income would be lower by the exact amount of the additional depreciation expense, i.e. they would represent a "wash" in terms of discretionary earnings - which are the purest, most commonly-utilized metric of owner-operated business cash flows as they represent the pretax, cash equivalent financial resources available to a hypothetical (single owner) buyer working on a full-time basis.

In short, the change you reference would impact after-tax cash flows and certain KPI's - but not pretax cash flows as in the form of discretionary earnings.