Module 10 Cost Recovery Deductions. Cost Recovery Topics n Depreciation u Accelerated Cost Recovery...
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Transcript of Module 10 Cost Recovery Deductions. Cost Recovery Topics n Depreciation u Accelerated Cost Recovery...
Module 10
Cost Recovery DeductionsCost Recovery Deductions
Cost Recovery Topics
DepreciationDepreciation Accelerated Cost Recovery SystemAccelerated Cost Recovery System Modified Accelerated Cost Recovery SystemModified Accelerated Cost Recovery System
AmortizationAmortization DepletionDepletion
Economics of Cost Recovery
Expenditure benefits more than 1 tax yearExpenditure benefits more than 1 tax year §263 denies a current deduction §263 denies a current deduction Cost recovery allows deduction over timeCost recovery allows deduction over time Tax policy issues Tax policy issues
Marginal efficiency of capital affected by tax Marginal efficiency of capital affected by tax savings savings Recovery periodsRecovery periods Recovery methodsRecovery methods
Cost Recovery Tax Savings AssumptionsAssumptions
$10,000 asset $10,000 asset 35% marginal tax rate 35% marginal tax rate 10% interest rate10% interest rate
Cost Recovery Tax Savings AssumptionsAssumptions
$10,000 asset $10,000 asset 35% marginal tax rate 35% marginal tax rate 10% interest rate10% interest rate
Method ofCost Recovery
After-tax NPV ofDeduction
Expense $3,500
Accelerated(over 5 years)
$2,977
Straight line(over 5 Years)
$2,786
The Depreciation Allowance: Basic Requirements
Key Learning ObjectiveKey Learning Objective
Basic requirement Basic requirement Qualifying propertyQualifying property Placed in servicePlaced in service Depreciable basisDepreciable basis
Qualifying Property
Limited (Exhaustible) Useful LifeLimited (Exhaustible) Useful Life Qualifying Use of PropertyQualifying Use of Property
Trade or BusinessTrade or Business Income-Producing ActivityIncome-Producing Activity
Placed in Service (PLIS)
PLIS when taxpayer can demonstrate PLIS when taxpayer can demonstrate ReadinessReadiness AvailabilityAvailability Capacity to performCapacity to perform
Date PLIS can effect amount of cost Date PLIS can effect amount of cost recoveryrecovery Change in tax lawChange in tax law Affect modifying conventionAffect modifying convention
Cost Recovery Basis
Initial basis Initial basis Purchased propertyPurchased property Constructed propertyConstructed property Personal property converted to business usePersonal property converted to business use
Subsequent changes in basisSubsequent changes in basis Capital improvementsCapital improvements Depreciation “allowed or allowable”Depreciation “allowed or allowable” Return of capitalReturn of capital
Compliance Query: Conversion from Personal to Business Use Purchased home for $125,000Purchased home for $125,000 IF FMV = $112,000 at conversionIF FMV = $112,000 at conversion
What is basis for depreciation?What is basis for depreciation?
IF FMV = $150,000 at conversionIF FMV = $150,000 at conversion What is basis for depreciation?What is basis for depreciation?
Solution to Compliance Query: Conversion from Personal Use Get lower of basis or FMV Get lower of basis or FMV Basis if converted when FMV = $112,000Basis if converted when FMV = $112,000
$112,000--lose decline in value during personal $112,000--lose decline in value during personal useuse
Basis if converted when FMV = $150,000Basis if converted when FMV = $150,000 $125,000--no step up for unrealized $125,000--no step up for unrealized
appreciationappreciation
MACRS--The Basic Rules
Key Learning ObjectivesKey Learning Objectives
Class life Class life Depreciable basisDepreciable basis Recovery method Recovery method Modifying conventionModifying convention
Class Life = Recovery Period
EquipmentEquipment 5 & 7 year classes5 & 7 year classes
Most commonMost common Tangible equipmentTangible equipment
3 year class 3 year class Some animals & Some animals &
specialized equipmentspecialized equipment
10,15,20 10,15,20 Specialized usesSpecialized uses
Real EstateReal Estate Residential--27.5 yearResidential--27.5 year
Generally apartments Generally apartments & rental houses& rental houses
Non-residentialNon-residential 39 year 39 year
In service after 8-9-93In service after 8-9-93
31.5 year31.5 year In service before 8-8-93In service before 8-8-93
Class Life Rev. Procs. 87-56 & 88-22
IRS provides information as to class lifeIRS provides information as to class life Assets used in all businesses Assets used in all businesses
Classes 00.11 - 00.4Classes 00.11 - 00.4 Assets used in particular activitiesAssets used in particular activities
Classes 01.1 - 80.0Classes 01.1 - 80.0 Equipment with no class life given Equipment with no class life given
Use 7 yearsUse 7 years
Research Query: MACRS Recovery Periods
This year Sea DrillingThis year Sea Drilling Installed sidewalks around its office buildingInstalled sidewalks around its office building Purchased five floating drilling platforms for Purchased five floating drilling platforms for
at-sea exploration. at-sea exploration. See Rev. Proc. 87-56 in the OnPoint See Rev. Proc. 87-56 in the OnPoint
Service to determine recovery periods.Service to determine recovery periods.
Solution--Research Query
Sidewalks -- Sidewalks -- MACRS life of 15 yearsMACRS life of 15 years used in all business activitiesused in all business activities listed in Class 00.3 listed in Class 00.3
Drilling platforms -- Drilling platforms -- MACRS life of 5 yearsMACRS life of 5 years used in specific activities used in specific activities listed in Class 13.0 listed in Class 13.0
TaxPoint: Class 57.0-- 7 Gets You 5
Class 57.0 reads as follows:Class 57.0 reads as follows: Distributive Trades and Services: Includes Distributive Trades and Services: Includes
assets used in wholesale and retail trade, and assets used in wholesale and retail trade, and personal and professional services. Includes personal and professional services. Includes section 1245 assets used in marketing section 1245 assets used in marketing petroleum and petroleum productspetroleum and petroleum products
If used in a “distributive trade or service,” an If used in a “distributive trade or service,” an asset normally classified as 7-year property asset normally classified as 7-year property would get 5-year class life.would get 5-year class life.
Depreciable (Recovery) Basis
Salvage value always ignoredSalvage value always ignored Equipment (equipment)Equipment (equipment)
Reduction for §179 ElectionReduction for §179 Election Reduction for 50% of certain business creditsReduction for 50% of certain business credits
RealtyRealty Exclusion of any land costsExclusion of any land costs Reduction for rehabilitation creditsReduction for rehabilitation credits
MACRS Recovery Methods
200% declining balance 200% declining balance 3,5,7,10 year classes of equipment 3,5,7,10 year classes of equipment
150% declining balance150% declining balance 15 and 20 year classes of equipment 15 and 20 year classes of equipment
Conversion to straight-line allowed Conversion to straight-line allowed Straight-lineStraight-line
All realtyAll realty
Modifying ConventionYear of Acquisition
EquipmentEquipment General rule--half-year conventionGeneral rule--half-year convention Exception--mid-quarter convention Exception--mid-quarter convention IFIF
More than 40%More than 40% In service in last quarterIn service in last quarter
RealtyRealty Mid-month conventionMid-month convention
The Four Quarters of Mid-Quarter
Applies to all assets according to quarter placed in service
Table 10-3-A. MACRS 5-Year propertyYear Midyear First
quarterSecondquarter
Thirdquarter
Fourthquarter
1 20.00% 35.00% 25.00% 15.00% 5.00%2 32.00 26.00 30.00 34.00 38.003 19.20 15.60 18.00 20.40 22.804 11.52 11.01 11.37 12.24 13.685 11.52 11.01 11.37 11.30 10.946 5.76 1.38 4.26 7.06 9.58
Compliance Query: Modifying Convention
A calendar year taxpayer places in service:
Date Asset Type Cost
March Machine (No class life)
$ 250,000
October Warehouse $100,000
December Computer (Class life = 5) $ 10,000
Solution to Compliance Query: Modifying Convention
First test for mid-quarterFirst test for mid-quarter The warehouse is ignored for the 40% testThe warehouse is ignored for the 40% test 4th quarter divided by all Equipment acquisitions4th quarter divided by all Equipment acquisitions
10,000 ÷ 260,000 = 3.8%10,000 ÷ 260,000 = 3.8% This is less than 40%This is less than 40%
The half-year convention appliesThe half-year convention applies
Solution--Compliance Query Appropriate MACRS Deduction
Machine ($250,000 x .1429) . . . . . $35,725Machine ($250,000 x .1429) . . . . . $35,725
Computer ($10,000 x .20) . . . . . . 2,000Computer ($10,000 x .20) . . . . . . 2,000
Warehouse ($100,000 x .00535) . . 535Warehouse ($100,000 x .00535) . . 535 The mid-month convention applies to buildings.The mid-month convention applies to buildings.
Note that the tables other than five -year are on the Note that the tables other than five -year are on the TaxPoint disk.TaxPoint disk.
Compliance Query: Modifying Convention
If we reverse the month of acquisition for the equipment that our calendar year taxpayer places in service, we get a different answer for the computer and equipment but not the building.
Date Asset Type Cost
December Machine (No class life)
$ 250,000
October Warehouse $100,000
March Computer (Class life = 5) $ 10,000
Solution to Compliance Query: Modifying Convention
First test for mid-quarterFirst test for mid-quarter The warehouse is ignored for the 40% testThe warehouse is ignored for the 40% test 4th quarter divided by all equipment acquisitions4th quarter divided by all equipment acquisitions
250,000 ÷ 260,000 = 96.2%250,000 ÷ 260,000 = 96.2% This is more than 40%This is more than 40%
The mid-quarter convention appliesThe mid-quarter convention applies
The Four Quarters of Mid-Quarter
The computer was placed in service in March, so it is first The computer was placed in service in March, so it is first quarter mid quarter 5-year property--35%.quarter mid quarter 5-year property--35%.
The equipment is fourth quarter, mid quarter 7 year, so this The equipment is fourth quarter, mid quarter 7 year, so this
table doesn’t apply.table doesn’t apply. You will find 3.57% in the 7 year 4th You will find 3.57% in the 7 year 4th quarter mid-quarter table on the disk.quarter mid-quarter table on the disk.
Table 10-3-A. MACRS 5-Year propertyYear Midyear First
quarterSecondquarter
Thirdquarter
Fourthquarter
1 20.00% 35.00% 25.00% 15.00% 5.00%2 32.00 26.00 30.00 34.00 38.003 19.20 15.60 18.00 20.40 22.804 11.52 11.01 11.37 12.24 13.685 11.52 11.01 11.37 11.30 10.946 5.76 1.38 4.26 7.06 9.58
Solution--Compliance Query Appropriate MACRS Deduction
Machine ($250,000 x .0357) . . . . . $8,925Machine ($250,000 x .0357) . . . . . $8,925
Computer ($10,000 x .35) . . . . . . . . 3,500Computer ($10,000 x .35) . . . . . . . . 3,500
Warehouse ($100,000 x .00535) . . . . 535Warehouse ($100,000 x .00535) . . . . 535 The mid-month convention applies to buildings.The mid-month convention applies to buildings.
Note that the tables other than five -year are on the Note that the tables other than five -year are on the TaxPoint disk.TaxPoint disk.
Compliance Query: MACRS Deduction in Year 2, (no disposition)
Do not leave the column you started in!Do not leave the column you started in!
Machine ($250,000 x .2755) . . . . . $ 68,875Machine ($250,000 x .2755) . . . . . $ 68,875
Computer ($10,000 x .26) . . . . . . . .$ 2,600Computer ($10,000 x .26) . . . . . . . .$ 2,600
Warehouse ($100,000 x .02564) . . $ 2,564Warehouse ($100,000 x .02564) . . $ 2,564
Note that the tables other than five -year are on the Note that the tables other than five -year are on the TaxPoint disk.TaxPoint disk.
Modifying ConventionYear of Disposition
Applies to both equipment & realtyApplies to both equipment & realty Use same convention as in year acquiredUse same convention as in year acquired
If mid-month, count the months, subtract 1/2 month, If mid-month, count the months, subtract 1/2 month, divide by 12divide by 12
If mid-year, use 1/2 If mid-year, use 1/2 If mid-quarter, count the quarters, subtract 1/2 If mid-quarter, count the quarters, subtract 1/2
quarter, divide by 4quarter, divide by 4
Compliance Query MACRS Deduction in Year 3, (sell in July)
Do not leave the column you started in!Do not leave the column you started in!
MachineMachine
($250,000 x .1968 x ($250,000 x .1968 x 2.5 ÷ 42.5 ÷ 4) . . . . $30,750) . . . . $30,750
Computer Computer
($10,000 x .1560 x ($10,000 x .1560 x 2.5 ÷ 42.5 ÷ 4) . . . . . .$975) . . . . . .$975
Warehouse Warehouse
($100,000 x .02564 x ($100,000 x .02564 x 6.5÷126.5÷12) . . . . $1,389) . . . . $1,389
Compliance Query: Once More, on Your Own
Mac Co. a calendar-year corporationMac Co. a calendar-year corporation Placed in service in OctoberPlaced in service in October $250,000 of computers$250,000 of computers
only assets acquired that yearonly assets acquired that year What is the recovery deduction for Year 1?What is the recovery deduction for Year 1? If Mac sells the computer in June, of Year 3 If Mac sells the computer in June, of Year 3
what is the year 3 recovery deduction?what is the year 3 recovery deduction?
Solution--Compliance Query: Once More, on Your Own.
Solution Year 1: 5 year/ mid-quarter propertySolution Year 1: 5 year/ mid-quarter property
$250,000 x .05 = $12,500$250,000 x .05 = $12,500
Solution Year 3: still 5 year/mid-quarterSolution Year 3: still 5 year/mid-quarter
$250,000 x .2280 x (1.5/4) = $21,375$250,000 x .2280 x (1.5/4) = $21,375 Mid-quarter, count the quarters, subtract 1/2 quarter, divide by 4Mid-quarter, count the quarters, subtract 1/2 quarter, divide by 4
MACRS - Special Elections
Key Learning ObjectivesKey Learning Objectives
The requirements for the §179 election The requirements for the §179 election The two straight-line recovery methods The two straight-line recovery methods
available under MACRSavailable under MACRS
§179 Immediate Expensing Election
Qualifying personal propertyQualifying personal property
equipment used in an active trade or businessequipment used in an active trade or business
Year of acquisition onlyYear of acquisition only $20,000 maximum annual election -- 2000$20,000 maximum annual election -- 2000 $ for $ phaseout of $ 20,000 for acquisitions $ for $ phaseout of $ 20,000 for acquisitions
over $200,000over $200,000 Can’t create a loss with §179 deductionCan’t create a loss with §179 deduction
Tax Planning QueryMake a §179 Election?
Minor Co. a calendar-year corporationMinor Co. a calendar-year corporation PLIS a $15,000 computer in AprilPLIS a $15,000 computer in April
(the only asset acquired that year). (the only asset acquired that year). Taxable income for the current year is $500 before Taxable income for the current year is $500 before
considering MACRS recovery considering MACRS recovery Minor had profits of $120,000 in each of the Minor had profits of $120,000 in each of the
preceding five years. preceding five years. What factors should Minor consider in evaluating a What factors should Minor consider in evaluating a
§179 election?§179 election?
Solution--Tax Planning Query Make a §179 Election?
Key Factor--Expected profitability in future
Electing §179Electing §179
Expense $15,000Expense $15,000
Deduction limited to Deduction limited to $500 (limited to $500 (limited to taxable income)taxable income)
$14,500 may be carried $14,500 may be carried to the next yearto the next year
Not Electing §179Not Electing §179
MACRS deduction = MACRS deduction = $3,000 ($15,000 x .05) $3,000 ($15,000 x .05)
creating an NOLcreating an NOL
NOL may be carried back NOL may be carried back to the third prior tax yearto the third prior tax year
Refund = $975Refund = $975
($2,500 x .39) ($2,500 x .39)
Tax Planning Query:Place In Service This Year or Next?
Meta Co. a calendar-year corporationMeta Co. a calendar-year corporation Put in service in FebruaryPut in service in February
$120,000 equipment (only acquisition to date) $120,000 equipment (only acquisition to date) Meta wants to acquire $83,000 of furnitureMeta wants to acquire $83,000 of furniture Should Meta placed the furniture in service Should Meta placed the furniture in service
in December or January of the next tax year?in December or January of the next tax year? What factors should Meta consider in What factors should Meta consider in
deciding when to buy the furniture? deciding when to buy the furniture?
Solution--Tax Planning Query Place In Service This Year or Next?
If placed in service in DecemberIf placed in service in December Total acquisitions = $203,000Total acquisitions = $203,000
Maximum §179 = 17,000. (20,000Maximum §179 = 17,000. (20,000 - 3000)- 3000) Expensed property not used in test for mid-quarterExpensed property not used in test for mid-quarter
Could expense either equipment or furnitureCould expense either equipment or furniture If equipment, then mid-quarterIf equipment, then mid-quarter
83,000 ÷ (203,000-17,000) = 44.6%83,000 ÷ (203,000-17,000) = 44.6% If furniture, then half yearIf furniture, then half year
(83,000-17,000) ÷ (203,000-17,000) = 35.5%(83,000-17,000) ÷ (203,000-17,000) = 35.5%
Solution--Tax Planning Query Place In Service This Year or Next?
If placed in service in January of next yearIf placed in service in January of next year Then for the current year Then for the current year
Maximum §179 is $ 20,000 (assumes 2000)Maximum §179 is $ 20,000 (assumes 2000) The half-year convention will applyThe half-year convention will apply
no acquisitions in fourth quarterno acquisitions in fourth quarter
MACRS Straight-Line Options
Acquisition year conventions applyAcquisition year conventions apply Must make election by class by yearMust make election by class by year Straight-line over the MACRS life Straight-line over the MACRS life Straight-line over the class lifeStraight-line over the class life
Alternative depreciation system (ADS)Alternative depreciation system (ADS) Major exceptions to the class life rule:Major exceptions to the class life rule:
Autos and computers (5 years)Autos and computers (5 years) equipment with no class life (12 years)equipment with no class life (12 years) Realty (40 years)Realty (40 years)
Compliance Query:Which MACRS Elections?
Melon Corp. a calendar-year corporationMelon Corp. a calendar-year corporation PLIS a $29,000 machine in March 2000PLIS a $29,000 machine in March 2000
(the only asset acquired this year) (the only asset acquired this year) The machine does not have a class liveThe machine does not have a class live Melon elects §179Melon elects §179 What is the TOTAL cost recovery underWhat is the TOTAL cost recovery under
Regular MACRS recoveryRegular MACRS recovery Straight-line MACRS recoveryStraight-line MACRS recovery Alternative Depreciation System (ADS) Alternative Depreciation System (ADS)
Solution--Compliance Query Which MACRS Elections?
§179 deduction = $20,000§179 deduction = $20,000
Remaining basis = $ 9,000 Remaining basis = $ 9,000
No class live so MACRS = 7 and ADS = 12No class live so MACRS = 7 and ADS = 12
MACRS = $1,286 ($9,000 x .1429) MACRS = $1,286 ($9,000 x .1429)
MACRS SL = $ 643 ($9,000 x 1/7 x .5)MACRS SL = $ 643 ($9,000 x 1/7 x .5)
ADS SL = $ 375 ($9,000 x 1/12 x .5)ADS SL = $ 375 ($9,000 x 1/12 x .5)
TOTAL deduction increased by $ 20,000 in each TOTAL deduction increased by $ 20,000 in each casecase
MACRS--Special Restrictions
Key Learning ObjectivesKey Learning Objectives The anti-churning rulesThe anti-churning rules Restrictions applicable to listed properties Restrictions applicable to listed properties
Including special limits on automobilesIncluding special limits on automobiles MACRS computations for alternative MACRS computations for alternative
minimum tax (AMT) purposesminimum tax (AMT) purposes
Anti-churning RulesPrevent Perceived Abuse
Prevents using sales between related parties Prevents using sales between related parties to change depreciation methods when tax to change depreciation methods when tax law changeslaw changes
If related party sale occurs, the transaction If related party sale occurs, the transaction is ignored, old recovery method continuesis ignored, old recovery method continues
Listed Property Rules: Personal Use Can Limit Recovery
Applies only to equipment Applies only to equipment Subject to restriction if Subject to restriction if Qualified Business Qualified Business
UseUse (QBU) < 50% (QBU) < 50% QBU generally limited to non-employee QBU generally limited to non-employee
trade/business usetrade/business use
Listed Property Rules: Personal Use Can Limit Recovery
Straight line over Straight line over CLASS LIFECLASS LIFE used in used in any year QBU < 50%any year QBU < 50%
Test must be applied each yearTest must be applied each year Recapture applies if MACRS used prior to Recapture applies if MACRS used prior to
failing the business usage testfailing the business usage test
Compliance Query:Change in QBU
Sue Adams , a calendar-year taxpayerSue Adams , a calendar-year taxpayer Placed in service in MarchPlaced in service in March $10,000 computer$10,000 computer
the only asset acquired this yearthe only asset acquired this year §179 NOT elected§179 NOT elected For Year 1 QBU = 90%.For Year 1 QBU = 90%. For Year 2 QBU = 40%.For Year 2 QBU = 40%.
What are Sue’s recovery deductions?What are Sue’s recovery deductions?
Solution--Compliance Query Change in QBU
Year 1Year 1
MACRS recovery = MACRS recovery = $1,800 $1,800
($10,000 x .2 x .9)($10,000 x .2 x .9)
($10000 ($10000 ÷ 5 x 2 x .9)x .9)
Note ADS would have Note ADS would have been $900been $900
($10,000 ($10,000 ÷ 5 x .9)x .9)
Year 2Year 2
ADS straight-line ADS straight-line recovery = $800 recovery = $800 ($10,000 x 1/5 x .40).($10,000 x 1/5 x .40).
$900 recaptured as $900 recaptured as additional incomeadditional income
This is the difference This is the difference between MACRS Yr 1 between MACRS Yr 1 (1800)(1800) & ADS Yr 1 & ADS Yr 1 (900)(900)
Luxury Auto Rules--Everyone Bought a $15,300 Car in 1999
Limits for autos placed into service in 2000Limits for autos placed into service in 2000 First year $3,060First year $3,060 (15,300 x .20) (15,300 x .20) Second year $5,000 Second year $5,000 (15,300 x .32) (15,300 x .32) Third year $2,950Third year $2,950 Remaining years $1,775Remaining years $1,775
Luxury Auto Rules IBM follows them too!
Indexed annually for inflation Indexed annually for inflation Limit is reduced by personal useLimit is reduced by personal use Limit applies to recovery and §179 electionLimit applies to recovery and §179 election Special rules for leased autosSpecial rules for leased autos
Compliance Query: Recovering the Cost of Autos
Deck’s Realty, a calendar-year taxpayerDeck’s Realty, a calendar-year taxpayer Placed in service in May, 1999Placed in service in May, 1999 $40,000 auto $40,000 auto (the only asset acquired that (the only asset acquired that
year) year) QBU = 80% QBU = 80% What is the 1999 cost recovery deduction?What is the 1999 cost recovery deduction?
Solution to Compliance Query: Recovering the Cost of Autos
Car is half year, five year propertyCar is half year, five year property MACRS and §179 are availableMACRS and §179 are available If this was not a car, without §179, the If this was not a car, without §179, the
deduction would bededuction would be 40,000 x .2 x .8 = 6,40040,000 x .2 x .8 = 6,400
But auto rules limit deduction toBut auto rules limit deduction to $2,448 (3,060 x .80)$2,448 (3,060 x .80)
Alternative Minimum Tax Cost Recovery
Alternative Depreciation System (ADS)Alternative Depreciation System (ADS) Equipment--150% DB over class lifeEquipment--150% DB over class life Realty--Straight-line over 40 yearsRealty--Straight-line over 40 years ADS--150% & SL OK for regular tax ADS--150% & SL OK for regular tax
To slow down deductionTo slow down deduction To reduce record keepingTo reduce record keeping
Election on class by class, Election on class by class,
year-by-year basisyear-by-year basis
TaxPoint: Possible Taxpayer Depreciation Records
Regular federal income taxRegular federal income tax Alternative minimum taxAlternative minimum tax Earnings and profits determinationEarnings and profits determination Adjusted current earnings determinationAdjusted current earnings determination State income taxState income tax Financial accounting recordsFinancial accounting records Regulatory agency mandated methodsRegulatory agency mandated methods
Compliance QueryName That Method!
Technoid Corporation, 12/31 year end.Technoid Corporation, 12/31 year end. Put in service in May $20,000 of new Put in service in May $20,000 of new
equipment equipment (the only asset acquired that year).(the only asset acquired that year).
Technoid may choose one of 8 different Technoid may choose one of 8 different methods of cost recovery for this methods of cost recovery for this equipment. equipment.
Can you name them?Can you name them?
Solution - Compliance Query Name That Method!
§179 election & normal MACRS §179 election & normal MACRS §179 election & straight-line MACRS §179 election & straight-line MACRS §179 election & ADS straight-line§179 election & ADS straight-line §179 election & 150% ADS (AMT)§179 election & 150% ADS (AMT) Normal MACRS recovery onlyNormal MACRS recovery only Straight-line MACRS recovery onlyStraight-line MACRS recovery only Straight-line ADS recovery onlyStraight-line ADS recovery only 150% ADS (AMT) recovery150% ADS (AMT) recovery
Ace Co., a calendar-year taxpayer, Placed in service in 2000 the following assets. What is Ace’s maximum cost recovery deduction?
Date Asset Cost June Auto $ 10,000June Warehouse 100,000June Apartment 200,000July Equipment
(10 year CL) 20,000
October Punch Machine (8 year CL)
38,000
November Drill Machine (No Class Life)
30,000
December Cutting Machine (12 year CL)
104,000
Solution to Concepts Review:
Step 1: Separate equipment and realtyStep 1: Separate equipment and realty Equipment--$202,000Equipment--$202,000 Realty--$300,000Realty--$300,000
Step 2: Separate reality into Step 2: Separate reality into Residential (27.5 year recovery) -- 200,000Residential (27.5 year recovery) -- 200,000 Non-residential (39 year recovery) -- 100,000Non-residential (39 year recovery) -- 100,000
Solution to Concepts Review:
Step 3: Calculate §179 deduction Step 3: Calculate §179 deduction 20,000-2,000 = 18,00020,000-2,000 = 18,000 Before selecting consider impact on mid-quarter Before selecting consider impact on mid-quarter
test (none in this problem)test (none in this problem) Generally best to take from property with Generally best to take from property with
longest recovery period-- but no set rulelongest recovery period-- but no set rule In next slide you will see that mid-quarter applies. In next slide you will see that mid-quarter applies.
Therefore largest deduction will come from Therefore largest deduction will come from expensing some of the 4th quarter, mid-quarter stuff. expensing some of the 4th quarter, mid-quarter stuff.
Solution to Concepts Review:
Step 4: Determine modifying convention Step 4: Determine modifying convention for equipmentfor equipment Allocate equipment by quarterAllocate equipment by quarter
2th Qtr -- $ 10,000 2th Qtr -- $ 10,000 3th Qtr.-- $ 20,000 3th Qtr.-- $ 20,000 4th Qtr.--$172,000 4th Qtr.--$172,000
MQ convention applies to equipmentMQ convention applies to equipment 172,000÷ 202,000 = 85.1% 172,000÷ 202,000 = 85.1%
Solution to Concepts Review:
Step 5: Stop to consider impact of listed Step 5: Stop to consider impact of listed property and luxury auto rules.property and luxury auto rules. None in this problem.None in this problem. Since cost of car is only $10,000, the first year Since cost of car is only $10,000, the first year
will not exceed 3,060.will not exceed 3,060.
Solution to Concepts Review: Total Deduction $34,013
WarehouseWarehouse $100,000 x .0139 = 1,390$100,000 x .0139 = 1,390
Rental ApartmentRental Apartment $200,000 x .0197) = 3,940 $200,000 x .0197) = 3,940
Auto Auto 2nd qtr, MQ 5 year2nd qtr, MQ 5 year $10,000 x .25$10,000 x .25 = 2,500 = 2,500
Equip Equip 3rd qtr, MQ 7 year3rd qtr, MQ 7 year ($20,000 x .1071) = 2,142($20,000 x .1071) = 2,142
Punch MachinePunch Machine 4th qtr, MQ 5 year4th qtr, MQ 5 year 38,000 x .05) = 1,900 38,000 x .05) = 1,900
Drill MachineDrill Machine 4th qtr, MQ 7 year 4th qtr, MQ 7 year 30,000 x .0357 = 1,071 30,000 x .0357 = 1,071
Cutting MachineCutting Machine 4th qtr, MQ 7 year 4th qtr, MQ 7 year expense 18,000expense 18,000 depreciate 86,000 3,070depreciate 86,000 3,070
Cost Recovery of Intangibles
Key Learning ObjectivesKey Learning Objectives
General tax rules for amortization of General tax rules for amortization of intangiblesintangibles
Special rules for §197 intangiblesSpecial rules for §197 intangibles Special provisions for research and Special provisions for research and
experimentation expenses experimentation expenses
Amortization--Cost Recovery for Intangible Assets
Need estimated useful or legal lifeNeed estimated useful or legal life Straight-line recoveryStraight-line recovery Whole month convention usedWhole month convention used Special 5-year recovery periodSpecial 5-year recovery period
Organization & start-up costsOrganization & start-up costs §197 purchased intangibles§197 purchased intangibles Research & experimentation expendituresResearch & experimentation expenditures
§197 Amortizing Goodwill Post 8/10/93 Acquisitions
Acquisitions of a business if purchase price Acquisitions of a business if purchase price includes intangiblesincludes intangibles GoodwillGoodwill Going concern valueGoing concern value Other purchased intangibles (covenants not to Other purchased intangibles (covenants not to
compete, customer lists, workforce, etc...)compete, customer lists, workforce, etc...) Amortize over 15 yearsAmortize over 15 years Amortization begins in month of acquisitionAmortization begins in month of acquisition
Compliance Query§197 Intangibles
As part of the acquisition of Bee Company, As part of the acquisition of Bee Company, Ace Company paid $20,000 for Bee’s Ace Company paid $20,000 for Bee’s contractual agreement not to enter into a contractual agreement not to enter into a competing business for the next 10 years. competing business for the next 10 years. What is Ace’s recovery period for the $20,000?What is Ace’s recovery period for the $20,000?
Solution--The agreement not to compete is a Solution--The agreement not to compete is a §197 intangible and must be amortized over 15 §197 intangible and must be amortized over 15 years. The contract is irrelevant.years. The contract is irrelevant.
Research and Experimentation Expenditures (R&E)
Definition--incident to product or processDefinition--incident to product or process Three tax options:Three tax options:
Expense immediatelyExpense immediately Amortize over a period of not less than 5 yearsAmortize over a period of not less than 5 years CapitalizeCapitalize
Any tangible property must be capitalized and Any tangible property must be capitalized and depreciateddepreciated
Any R&E credit allowed reduces the deductionAny R&E credit allowed reduces the deduction
Compliance Query
Which of the following expenditures do not Which of the following expenditures do not qualify as R&E?qualify as R&E? Depreciation on research buildingDepreciation on research building Wages of R&E employeesWages of R&E employees Consumer survey costsConsumer survey costs Blueprints and drawings of productBlueprints and drawings of product
Solution:Solution: The consumer surveys are development costs and do The consumer surveys are development costs and do
not qualify.not qualify.
Depletion Deductions
Key Learning ConceptKey Learning Concept
Requirements for the depletion deductionRequirements for the depletion deduction Computations under the Computations under the
Cost andCost and Percentage methodsPercentage methods
Depletion--General Concepts
Cost recovery for natural resourcesCost recovery for natural resources Allowed to anyone with an economic interest Allowed to anyone with an economic interest
in the minerals or natural resource in placein the minerals or natural resource in place Two methods of computing depletion:Two methods of computing depletion:
Cost methodCost method Percentage (statutory) methodPercentage (statutory) method
Taxpayer may deduct the larger of the two Taxpayer may deduct the larger of the two methodsmethods
TaxPoint: Blood as a Mineral?
In the case of Margaret Green, 74 TC 1229, the In the case of Margaret Green, 74 TC 1229, the taxpayer attempted to deplete the mineral content taxpayer attempted to deplete the mineral content of her blood using statutory recovery. of her blood using statutory recovery.
She received commissions for donating her blood She received commissions for donating her blood (a rare AB-type), and argued that she should be (a rare AB-type), and argued that she should be able to deplete her blood supply. able to deplete her blood supply.
The Tax Court disagreed, stating that such minerals The Tax Court disagreed, stating that such minerals were not “natural deposits,” and eventual loss of were not “natural deposits,” and eventual loss of
ability to regenerate minerals was not relevantability to regenerate minerals was not relevant. .
Cost Method of Depletion
Determine a depletion rate per unitDetermine a depletion rate per unit Undepleted cost/estimated remaining Undepleted cost/estimated remaining
recoverable unitsrecoverable units Multiply the rate times the number of units Multiply the rate times the number of units
sold during the tax yearsold during the tax year Total recovery may not exceed investment Total recovery may not exceed investment
costcost
Percentage Method of Depletion
Determine statutory (code) rate for particular Determine statutory (code) rate for particular resourceresource
Multiply rate times the gross income from the Multiply rate times the gross income from the propertyproperty
Statutory depletion is further limited to:Statutory depletion is further limited to: 50% of the taxable income from the property (100% 50% of the taxable income from the property (100%
of taxable income for oil properties)of taxable income for oil properties) 65% of the taxpayer’s taxable income65% of the taxpayer’s taxable income
Percentage depletion may exceed costPercentage depletion may exceed cost
Compliance Query
Sierra Co. paid $600,000 to lease land for mining Sierra Co. paid $600,000 to lease land for mining uranium (22% rate). uranium (22% rate).
Mine is estimated to contain 200,000 tons of ore. Mine is estimated to contain 200,000 tons of ore. This year, Sierra extracted 60,000 tons of ore and This year, Sierra extracted 60,000 tons of ore and
sold 40,000 tons for $20 per ton. sold 40,000 tons for $20 per ton. Sierra’s gross income for the year was $700,000Sierra’s gross income for the year was $700,000
($800,000 sales less a $100,000 royalty) ($800,000 sales less a $100,000 royalty) Expenses totaled $480,000. Expenses totaled $480,000. What is Sierra’s depletion deduction ?What is Sierra’s depletion deduction ?
Solution--Compliance Query
Cost depletion:Cost depletion: $600,000/200,000 x 40,000 = $120,000$600,000/200,000 x 40,000 = $120,000
Percentage (statutory) depletion:Percentage (statutory) depletion: $700,000 x .22 = $154,000, limited to:$700,000 x .22 = $154,000, limited to: ($700,000 - $480,000) x .50 = $110,000($700,000 - $480,000) x .50 = $110,000
Deduction is $120,000 (larger of the two)Deduction is $120,000 (larger of the two)
Research Query
M Company discovered that Sleasy had drilled a slant M Company discovered that Sleasy had drilled a slant hole under their property and had stolen 50,000 barrels hole under their property and had stolen 50,000 barrels of oil.of oil.
M initiated a lawsuit to recover the value of the stolen M initiated a lawsuit to recover the value of the stolen oil. oil.
Early Win, an attorney, agreed to represent M Company Early Win, an attorney, agreed to represent M Company on a 1/3 contingency basis (receives 1/3 of the value if on a 1/3 contingency basis (receives 1/3 of the value if M wins, and nothing if M loses). M wins, and nothing if M loses).
If Win wins the case, can he take a depletion deduction If Win wins the case, can he take a depletion deduction
on his 1/3 of the proceeds?on his 1/3 of the proceeds?
Solution--Research Query
No, Win will not qualify for depletion. In a No, Win will not qualify for depletion. In a similar case, Parr v. Schofield (89 F Supp similar case, Parr v. Schofield (89 F Supp 98), the Court of Appeals for the 5th Circuit 98), the Court of Appeals for the 5th Circuit stated that such recoveries were not stated that such recoveries were not depletable gross income because the legal depletable gross income because the legal contract did not cause a transfer of an interest contract did not cause a transfer of an interest in the mineral property to the attorney. in the mineral property to the attorney.
(Federal Tax Coordinator, Para.N-2113)(Federal Tax Coordinator, Para.N-2113)
Appendix--Pre-1981 Depreciation
Useful lifeUseful life Salvage valueSalvage value Maximum depreciation recovery methods:Maximum depreciation recovery methods:
Equipment Equipment RealtyRealty
Appendix--Pre-1987 ACRS
Equipment classes (3, 5, 10, and 15)Equipment classes (3, 5, 10, and 15) Realty classes (15, 18, and 19)Realty classes (15, 18, and 19) Acquisition year assumptionAcquisition year assumption Maximum recovery rates:Maximum recovery rates:
EquipmentEquipment RealtyRealty
§179 expensing option§179 expensing option Straight-line optionsStraight-line options