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Income Tax Solutions Chapter 8

# Income Tax Solutions Chapter 8 - 131 Chapter 8 Depreciation...

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131 Chapter 8 Depreciation and Amortization Teaching Suggestions 1. Computing first-year depreciation for personal property placed in service during 2007 may involve two separate calculations. Students need to be aware of the rules for each calculation and, more importantly, the order in which these calculations need to be made. First, if Section 179 property is placed in service during the year, the taxpayer must first determine the maximum Section 179 that is available. The statutory dollar limit (\$125,000 in 2007), placed in service limit (\$500,000), and taxable income limit all come into consideration in making the decision. Once the taxpayer determines the maximum Section 179 that is available, the decision must be made on how much to elect to expense in the first year. The maximum amount of Section 179 expense that can be elected is based on the dollar and placed- in-service limits. The maximum amount that can be deducted is based on the taxable income limitation. Second, the remainder of the taxpayer’s basis in the property (after subtracting out the amount elected ) is depreciated over the appropriate recovery period under MACRS/ADS (whichever the taxpayer elects to use). The sum of the deductible Section 179 expense and the amount of MACRS/ADS comprise the taxpayer’s total first-year depreciation for property placed in service in 2007. 2. Students who have used the double declining balance (DDB) method in a financial accounting course may have difficulty with multiplying the cost of the property by the percentages provided in the tax depreciation tables. Students will want to use the “adjusted basis of the property (cost minus accumulated depreciation). Showing students how the percentages in the table were derived may help them understand (1) that the half-year/mid- quarter convention has been incorporated into the percentages for the first year (but not for the year of sale) and (2) that the property’s adjusted basis actually is used in computing the annual cost recovery percentages. For example, students could be presented with 5-year property costing \$1,000. Assuming the half-year convention applies, the first year of cost recovery would be \$200 (\$1,000 × 1/5 × 200% × 1 / 2 year). Therefore, the first year recovery percentage would be 20% (\$200/\$1,000), the percentage from the table for Year 1. Using the DDB method, cost recovery for the second year would begin with the adjusted basis of the property, or \$800 (\$1,000 − \$200). Cost recovery for the second year would be \$320 (\$800 × 1/5 × 200%). This amount equals 32% of the property’s cost (\$320/\$1,000), which is the percentage shown in the table for Year 2. The cost recovery for the third year would begin with the adjusted basis of \$480 (\$1,000 − \$200 − \$320). The cost recovery amount for Year 3 would be \$192 (\$480 × 1/5 × 200%), which is 19.2% of the cost of the property (and the percentage shown in the table for Year 3).

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