Chapter 3 Income Sources ©2007 South-Western Kevin Murphy Mark Higgins Kevin Murphy Mark Higgins.
Chapter 10 Cost Recovery on Property: Depreciation, Depletion, and Amortization ©2008 South-Western...
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Transcript of Chapter 10 Cost Recovery on Property: Depreciation, Depletion, and Amortization ©2008 South-Western...
Chapter 10Chapter 10
Cost Recovery on Property: Depreciation, Depletion, and
Amortization
Cost Recovery on Property: Depreciation, Depletion, and
Amortization
©2008 South-Western©2008 South-Western©2008 South-Western©2008 South-Western
Kevin MurphyKevin MurphyMark HigginsMark Higgins
Kevin MurphyKevin MurphyMark HigginsMark Higgins
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Concept ReviewConcept Review
The capital recovery concept allows a taxpayer to recover all invested capital before income is taxedAn asset’s basis is the maximum
investment that qualifies as capital for recovery
Legislative grace allows the capital to be recovered systematically over the life of the asset
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Methods of RecoveryMethods of Recovery
Depreciation: used for tangible assets that Are used for a business or production of
income purposeHave a determinable life
Depletion: used for wasting assets Amortization: used for intangible assets
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History of DepreciationHistory of Depreciation
Based on facts and circumstances related to asset life and taxpayer’s
situation
ACRSBased on method and life
prescribed by law
MACRSBased on method and life
prescribed by law; less accelerated than ACRS
1981 1987
Section 179 Electionto Expense Assets
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Section 179 ElectionSection 179 Election
Promotes administrative convenience Treated as a depreciation deduction
A taxpayer may elect to expense rather than capitalize qualifying property placed in service during the year.
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Section 179 ElectionQualifying PropertySection 179 ElectionQualifying Property
Tangible, personal propertyReal estate does not qualify
Used in a trade or businessInvestment property does not qualify
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Section 179 ElectionDeduction LimitationsSection 179 Election
Deduction Limitations
Limitations apply to each entity Cannot exceed $112,000 Cannot exceed taxable income from the
businessExcess may be carried forward
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Section 179 ElectionDeduction Phase-OutSection 179 ElectionDeduction Phase-Out
Deduction decreased if total cost of qualifying property placed in service exceeds $450,000by $1 for every $1 of value over $450,000thus, when total cost = $562,000,
deduction = $0
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MACRSQualifying Property
MACRSQualifying Property
MACRS applies to New and used tangible, depreciable
propertyUsed in a trade or business or for the
production of income
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MACRSBasis
MACRSBasis
Depreciable basis is The asset’s original basis for depreciation
(discussed in Chapter 9)Reduced by any § 179 deduction
Adjusted basis is The remaining unrecovered capital of an
asset = asset basis minus accumulated depreciation
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MACRSRecovery Period
MACRSRecovery Period
Each asset must be placed in a MACRS class according to its class lifeMost personal property is in a 3, 5, or 7
year classMost land improvements and specialized
property are in a 10, 15, or 20 year class Real estate is in a 27.5, 31.5, or 39 year
class
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MACRSConventions
MACRSConventions
For administrative convenience, three assumptions are made about the time property was placed in service during the yearMid-year convention applies to all property
except real estateMid-month convention applies to real estate
onlyMid-quarter convention applies to some
personal property
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Mid-Year ConventionMid-Year Convention
Assumes property is placed in service and will be disposed of at the mid-point of the yearOne-half year depreciation allowed in the
first year of serviceOne-half year depreciation allowed in the
last year of service
IRS tables reflect the mid-year adjustment only for the first year
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Mid-Month ConventionMid-Month Convention
Assumes property is placed in service and will be disposed of at the mid-point of a monthOne-half month allowed at the beginningOne-half month allowed at disposition
IRS tables reflect the adjustment only for acquisition
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Mid-Quarter ConventionMid-Quarter Convention
If > 40% of the total depreciable basis of all personal property is placed in service during the 4th quarter of the year, mid-quarter:Assumes property is placed in service and
will be disposed of at the mid-point of a quarter rather than at mid-year
Determine the 40% after taking §179 expense
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Depreciation Method Alternatives
Depreciation Method Alternatives
Regular MACRS with Section 179
Straight-line MACRS
Straight-line Alternative Depreciation
System (ADS)
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Regular MACRSRegular MACRS
Method is double declining balanceIRS tables provide the depreciation rate
Designed to permit full recovery of depreciable basis
Incorporate the conventions
Maximizes acquisition year deduction using the Section 179 election
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Straight-Line MACRSStraight-Line MACRS
Taxpayers may elect to use the slower straight-line methodElection is made each yearMACRS recovery periods are usedMid-year convention applies
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Alternative Depreciation System
Alternative Depreciation System
Taxpayers may elect to use ADS Use is mandatory for Alternative
Minimum Taxable Income Uses a longer recovery period than
MACRS Election is made on a class-by-class,
year-by-year basis
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Limitations on Listed Property
Limitations on Listed Property
Most mixed-use property is considered listed property and subject to special limitationsExamples: automobiles, computers,
cellular phones, etc.
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Limitations on Listed Property
Limitations on Listed Property
Treatment depends on the percentage of business usageif >50% business use, treated like other
depreciable assetsif < 50% business use, deductions are
limited to ADS without Section 179 In either case, only the business portion of
the asset’s basis is depreciable
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Limitation on Passenger Autos
Limitation on Passenger Autos
The total amount of depreciation and Section 179 expense that can be deducted is limitedAnnual maximum limit set and linked to the year
the car was placed in serviceAnnual limit is further reduced by the business
use %
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Adequate Record KeepingAdequate Record Keeping
Listed property is subject to strict record keeping requirements
No deduction is allowed without proof ofWhy? The business purpose of the
useWhat? The amountWhen? The dates of useWhere? The reality of the use
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DepletionDepletion
The basis of natural resource assets subject to wasting away is recovered using depletion
Basis used is generally fees paid to acquire a lease and the costs of the lease, exploration, and drilling
Computed using two methods Figure both each year and use the largest
as deduction
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Cost Depletion MethodCost Depletion Method
Allocates unrecovered basis over the number of estimated units of resource
= Depletion per Unit Unrecovered Basis Estimated Recoverable Units
Cost Depletion = Depletion per Unit X # of Units Sold
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Percentage Depletion Method
Percentage Depletion Method
Depletion is the lesser of50% of taxable income before depletion, orGross income from the sale of the natural
resource times a statutory depletion rate Different statutory % for each type of resource
is given in IRS tables
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AmortizationAmortization
The basis of intangible assets is recovered using the straight-line method over the life of the asset
Intangible assets acquired through purchase generally use a 15 year life
Created assets and assets specifically excluded from use of the 15 year period are amortized over their legal life