Chapter9 - Chapter 9 1 What is depreciation? Deduct cost of...

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Unformatted text preview: Chapter 9 1 What is depreciation? Deduct cost of asset over the useful life of the asset 1 2 3 4 5 2 What can you depreciate? Can you depreciate? Land, landscaping, trees, flowers, sculpture Ford, Chevy, BMW, Cadillac, SUV, F150, 747, HDTV, DVD player, VCR, stereo, iPod, computer, printer, scanner, cell phone, Blackberry, Blueberry, desk, chair, file, calculator, AUL building, duplex, apartment, Glendale, Castleton, Riley Towers, parking lot, garage, phone pole, residence, farmhouse, cattle, pigs, chickens, goats, etc., etc., etc. 3 What can you depreciate? What can you deduct? Sec. 162 Business Expenses Sec. 212 Production of Income Sec. Expenses Expenses 4 Sec. 167 Depreciation (a) General rule There shall be allowed as a depreciation DEDUCTION a reasonable allowance for the exhaustion wear and tear (including a reasonable allowance for obsolescence) OF (1) Property used in a TRADE OR BUSINESS; (2) Property held for the PRODUCTION OF INCOME 5 Sec. 167 Depreciation What is Eligible for Depreciation? (1) Property used in a TRADE OR BUSINESS; (2) Property held for the PRODUCTION OF INCOME ADDITIONAL CONSIDERATIONS •Dual use property: business and personal •Converted property •Gifted 6 Sec. 167 Depreciation What is Eligible for Depreciation? (1) Property used in a TRADE OR BUSINESS; (2) Property held for the PRODUCTION OF INCOME •Requirements •Determinable life required 7 What is the useful life? 8 What is my useful life? 9 What is the useful life? 10 What is the useful life? 11 What is the useful life? 12 Problem 9-2 IIndicate whether a taxpayer could claim deductions for ndicate depreciation or amortization of the following property: depreciation a. Land used in the taxpayer’s farming business. b. A duplex—taxpayer lives in one half while he rents the other half duplex—taxpayer out. out. c. Portion of the taxpayer’s residence that she uses as a home Portion office. office. d. Taxpayer’s former residence, which he listed for rental Taxpayer’s temporarily until he is able to sell it. The residence was listed in late November and was not rented as of the end of the taxable year. November e. A mobile home that the taxpayer initially purchased and used mobile while he was in college and this year began renting to several students. students. f. The costs attributable to goodwill and a covenant not to compete. The 13 Problem 9-27 F purchased a mobile home to live in while at college. The home cost purchased $12,000. When he graduated, he left the home in the trailer park and rented it. At the time he converted the home to rental property, it had a fair market value of $10,000. What is F’s basis for depreciation? fair $10,000. F must use lesser of FMV or basis at time of conversion $10,000. Same as above except the value of the home at the time it was converted was $18,000. What is F’s basis for depreciation was 12,000. F must use lesser of FMV or basis at time of conversion F now lives 75 miles away from his alma mater. Can he deduct the cost of now traveling back to check on his rental property (including those trips on which he also attended a football game)? Yes. Because the property is held for the production of rents, the traveling expenses incurred to check on his property are deductible for A.G.I. It is irrelevant that the property is near his alma mater. irrelevant 14 Asset Breakdown Overview Amortize Deplete Depreciate Intangible Tangible Natural Resources Everything Else Realty 1. Statutory Period 1. % Depletion 2. Est Useful Life 3. If no EUL = 0 2. Cost Depletion Personalty 3, 5, 7 10, 15, 20 MACRS 15 27.5 39 Intangibles s Patents, copyrights, etc. s Specified life s Sec. 197 Intangibles s s s s s Goodwill Covenant not to compete Customer lists Etc. Amortize over 15 years regardless of actual life Amortize 16 Depreciation Methods s Taxpayer objectives 17 Depreciation Methods Government objectives s Eliminate controversy Eliminate s s s Useful lives Methods Methods Salvage value 18 Depreciation Methods 1981- Present: ’81 ACRS and ’86 MACRS s s s s Eliminates estimates Specifies recovery period (useful life) No salvage value Simplicity at its best 19 Calculation of Depreciation Depreciable unadjusted basis x Percentage for year Annual depreciation Depends on type of property: Recovery period, method, conventions 20 Recovery Period and Method s Rev. Proc. 87-56 Rev. s Specifies recovery period Specifies s Periodically updated by rulings, etc. s Excerpt of Rev. Proc. 87-56 21 Exhibit 9-2: Excerpt from Rev Proc. 87-56 Recovery Period Asset GDS ADS Class Description of Assets Included Class Life System System SPECIFIC DEPRECIABLE ASSETS USED IN ALL BUSINESS ACTIVITIES, EXCEPT AS NOTED: 00.11 Office Furniture, Fixtures, and Equipment: Includes furniture and fixtures that are not structural components of a building. Includes such assets as desks, files, safes, and communications equipment…. 10 00.13 Data Handling Equipment, except Computers: Includes only typewriters, calculators, adding and accounting machines, copiers, and … 6 7 5 5 10 6 6 00.21 Airplanes … 00.22 Automobiles, Taxis 00.23 Buses 00.241 Light General Purpose Trucks: 6 3 9 4 5 5 5 5 9 5 22 Exhibit 9-3 Examples of MACRS Property Class Examples 3 yrs Special tools, race horses, tractors, class life of 4 yrs or less 5 yrs Automobiles, trucks, computers and peripheral equipment (such as printers, external disk drives, and modems), typewriters, copiers, R&E equipment, class life of > 4 years and < 10 yrs 7 yrs Office furniture, fixtures, office equipment, most machinery, class life of > 10 yrs but < 16 yrs, property no assigned class life 10 yrs Single-purpose agricultural and horticultural structures, … 15 yrs Land improvements (e.g., sidewalks, roads, parking lots, irrigation systems, sewers, fences, landscaping), service stations, billboards, …and class life of > 20 yrs and < 25 yrs 27.5 yrs Residential rental real estate, apartment buildings, duplexes, etc. 39 yrs Nonresidential real estate, including office buildings, warehouses, factories and farm buildings 23 Recovery Period and Method s Rev. Proc. 87-56 s Personal (non-realty) and some realty s s s 3, 5, 7 yr 3, 200% DB (may elect straight-line) Convention: Convention: s Half-year: Half-year: s ½ yr of depreciation in yr of acquisition and disposition ½ qtr of depreciation for qtr of acquisition and disposition s Mid-quarter s s Realty s s s Residential 27.5 yrs, nonresidential 39 years Residential Straight-line Convention: Convention: s Mid-month s ½ month of depreciation in yr of acquisition and disposition 24 Exhibit 9-4: Exhibit MACRS Depreciation Percentages Using DDB and Half-Year Convention for 3, 5, 7 Year Property Year 1 2 3 4 5 6 7 8 3-Year 33.33% 44.45 14.81 7.41 5-Year 20.00% 32.00 19.20 11.52 11.52 5.76 7-Year 14.29% 24.49 17.49 12.49 8.93 8.92 8.93 4.46 25 Exhibit 9-4: Exhibit MACRS Depreciation Percentages Using DDB and Half-Year Convention for 3, 5, 7 Year Property Year 3-Year 5-Year 7-Year 1 20.00% Recovery period 5 yrs Straight line ANNUAL rate 1/5 = Double declining balance Annual DDB rate Half year convention First year rate 20% x2 40% x½ 20% 26 Exhibit 9-4: Exhibit MACRS Depreciation Percentages Using DDB and Half-Year Convention for 3, 5, 7 Year Property Year 1 2 3-Year 5-Year 20.00% 32.00 7-Year Year 2 Straight line ANNUAL rate 1/5 = 20% Double declining balance x2 Annual DDB rate 40% Declining balance (100% - 20% yr 1) x 80% Year 2 rate 32% Note this rate is applied to unadjusted basis and NOT the declining balance! 27 Double Declining Balance Depreciation Double with a Change to SL Example with Asset with 5 year life, $20,000 purchase cost, Asset Step 1: Calculate Rate 1/years useful life = 1/5 = 20% 2 x 1/5 = 2/5 = 40% is DDB 28 Double Declining Balance Depreciation Double with a Change to SL Example with Step 2: Calculate depreciation: Year 1 2 3 *4 5 Undep. Balance $20,000 12,000 7,200 4,320 2,160 Depr. Depr. Rate 40% 40% 40% 1/2 remainder Exp. $8,000 4,800 2,880 2,160 2,160 $20,000 X X X X X = = = = = * DDB would be $4,320 X 40% = $1,728 Change to SL with 2 yrs. life remaining gives greater depreciation: $4,320/2 = $2,160. Tables automatically switch 29 Example s8/1 purchase copier sType of property sPersonalty: 5 year property sComputation of Rate: Year of acquisition Straight-line rate (1/5) x Declining balance (200%) Annual rate Convention for personalty Convention Half-yr or Mid-quarter Half-yr Rate for year of acquisition per table s Year 2 Remaining basis (D.B. 100% - 20%) Annual declining balance rate Depreciation rate per table 20% x 200% 40% x 1/2 1/2 20% 80% x 40% 40 32% 30 ACRS/MACRS Depreciation of Real Property Post 1980 Class Life Depr. (Yrs) Method 15 1.75 DB/SL 1.75 DB/SL 1.75 DB/SL SL SL SL Effective Dates Conventions 1. Depr. real prop. placed in Based on actual # service before 3/16/84 months in service 2. Qualified low income housing beginning and ending year Placed in service after 3/15/84 & before 5/9/85 Placed in service after 5/9/85 – 12/31/86 Mid-month convention: ½ month depr. For month placed in service & for final month of service 18 19 27.5 31.5 39 Residential real prop. & most low mid-month income housing After 1986 Nonresidential real & real prop.’ 1986 -1993 Nonresidential real estate after After 1993 mid-month mid-month 31 Exhibit 9-5: Exhibit MACRS Residential Realty (Post 1986 SL 27.5 Yr) Residential Using Mid-Month Convention Month Placed in Service 1 2 3-26 27 28 29 1 2 3 4 5 6 7 8 9 10 11 12 3.485% 3.182 2.879 2.576 2.273 1.970 1.667 1.364 1.061 0.758 0.455 0.152 3.636% 3.363 3.636 3.636 3.636 3.636 3.636 3.636 3.636 3.636 3.636 3.636 3.636% 3.636 3.636 3.636 3.636 3.636 3.636 3.636 3.636 3.636 3.636 3.636 3.636% 3.636 3.636 3.636 3.636 3.636 3.637 3.637 3.637 3.637 3.637 3.637 1.970% 2.273 2.576 2.879 3.182 3.485 3.636 3.636 3.636 3.636 3.636 3.636 0.000% 0.000 0.000 0.000 0.000 0.000 0.152 0.455 0.758 1.061 1.364 1.667 32 Exhibit 9-5: Exhibit MACRS Residential Realty (Post 1986 SL 27.5 Yr) Residential Using Mid-Month Convention Month Placed in Service 1 2 3-26 27 28 29 1 3.485% 3.636% 3.636% 3.636 3.636% 3.636 1.970% 0.000% 2.273 0.000 2 3.182 3.363 Recovery period 27.5 yrs Straight line ANNUAL rate 1/27.5 = 3.636% . Mid-month convention (1/2 for month of acquisition + 10) First year rate 3.182% x 10.5/12 33 Exhibit 9-6: Exhibit MACRS Nonresidential Realty (Post 1986 SL 39 Yr) Using Mid-Month Convention Month Placed in Service 1 2 3 4 5 6 7 8 9 10 11 12 Yr 1 2.461% 2.247 2.033 1.819 1.605 1.391 1.177 0.963 0.749 0.535 0.321 0.107 Yr 2-39 2.564% 2.564 2.564 2.564 2.564 2.564 2.564 2.564 2.564 2.564 2.564 2.564 Yr 40 0.107% 0.321 0.535 0.749 0.963 1.177 1.391 1.605 1.819 2.033 2.247 2.461 34 Special 40% Rule: Mid-Quarter Convention s If > 40% of aggregate bases of all tangible If personal property is placed in service during the year is placed in service in the last three months of the year, a mid-quarter convention will apply: will s s s s 1st qtr. gets 3.5 qtrs. depr. (87.5%) 2nd qtr. gets 2.5 qtrs. depr. (62.5%) 3rd qtr. gets 1.5 qtrs. depr. (37.5%) 4th qtr. gets 0.5 qtrs. depr. (12.5%) 35 Mid-Quarter Conventions Quarter Placed in Service First Second Third Jan-Mar Apr-Jun Jul-Sep quarters quarters Fourth Oct-Dec 2.5 3.5 quarters 2.5 quarters 1.5 quarters 3.5 1.5 4 Percent of annual Percent Depreciation Allowed 4 62.5% 4 37.5% 4 12.5% 87.5% 36 40% Rule Example Four machines placed in service during the year. All are 7 year property. Four machines placed in service during the year. All are 7 year property. Machine Machine A A B B C C D D Cost Cost 10,000 10,000 5,000 5,000 20,000 20,000 5,000 5,000 40,000 40,000 Date put in service Date put in service Jan. 10 Jan. 10 July 1 July 1 Oct. 15 Oct. 15 Dec. 1 Dec. 1 20,000 + 5,000 = 25/40 = 62.5% > 40%, thus mid-quarter convention applies 20,000 + 5,000 = 25/40 = 62.5% > 40%, thus mid-quarter convention applies Machine Date Machine Date A 1/10 A 1/10 B 7/1 B 7/1 C 10/15 C 10/15 D 12/1 D 12/1 Total depreciation. Total depreciation. Qtr Qtr 1 1 3 3 4 4 4 4 Factor X Factor X 25% 25% 10.71 10.71 3.57 3.57 3.57 3.57 Basis Basis 10,000 10,000 5,000 5,000 20,000 20,000 5,000 5,000 Depr. Depr. 2,500 2,500 536 536 714 714 179 179 $3,939 $3,939 37 Exhibit 9 - 7: Exhibit MACRS Depreciation Percentages Using DDB and Mid Quarter Convention for 3 and 5 Year Property 3-year property: Recovery Year 1 2 3 4 58.33% 27.78 12.35 1.54 41.67% 38.89 14.14 5.30 25.00% 50.00 16.67 8.33 8.33% 61.11 20.37 10.19 Quarter Placed in Service 1 2 3 4 5-Year Property: 1 2 3 4 5 6 35.00 26.00 15.60 11.01 11.01 1.38 25.00 30.00 18.00 11.37 11.37 4.26 15.00 34.00 20.40 12.24 11.30 7.06 5.00 38.00 22.80 13.68 10.94 9.58 38 Exhibit 9 - 7: Exhibit MACRS Depreciation Percentages Using DDB and Mid Quarter Convention for 3 and 5 Year Property 3-year property: Quarter Placed in Service Recovery Year 1 58.33% 41.67% 25.00% 8.33% 1 2 3 4 Recovery period 3 yrs Straight line ANNUAL rate 1/3 = Double declining balance Annual DDB rate . Mid quarter convention First year rate 33% x2 66% x 3.5/4 39 Example: Mid Quarter Convention Example: 8/1 purchase copier sType of property: Personalty: 5 year property sComputation of Rate: Year of acquisition Straight-line rate (1/5) 20% x Declining balance (200%) x 200% Annual rate 40% Convention for personalty Convention Mid-quarter for ALL if > 40% personalty ALL personalty placed in service last 3 mths of year placed (1.5/4 = 37.5%) x 37.5% 37.5 Rate for year of acquisition per table 15% s Year 2 Remaining basis (D.B. 100% - 15%) 85% Annual declining balance rate x 40% 40 Depreciation rate per table 34% 40 Problem 9-28 T decided to move her insurance business into another office building. decided She purchased a used building for $70,000 on March 15. T also used purchased new office furniture for the building. The furniture was acquired new for $20,000 on May 1. The first‑year expensing option is not elected, yet for T wants to depreciate her assets as rapidly as possible. wants Depreciation for first year: Depreciation Used office building placed in service in March office Property type: Office building is nonresidential New or used: Irrelevant (except for bonus & N/A to buildings) Irrelevant Life: 39 yrs Method: Post 1986: Straight-line Convention:mid-month (1/2 mth for mth placed in service & yr of sale) Salvage value: irrelevant Depreciation Rate: 1/39 annual SL rate x (.5 month for March + 9 months = 9.5)/12 =2.033% 1/39 Building: $70,000 x 2.033% = $1,423 41 Problem 9-28 (cont.) Exhibit 9-6: Exhibit MACRS Nonresidential Realty (Post 1986 SL 39 Yr) Using Mid-Month Convention Month Placed in Service 1 2 Yr 1 2.461% 2.247 Yr 2-39 2.564% 2.564 2.564 2.564 2.564 2.564 2.564 2.564 2.564 2.564 2.564 2.564 Yr 40 0.107% 0.321 0.535 0.749 0.963 1.177 1.391 1.605 1.819 2.033 2.247 2.461 3 4 5 6 7 8 9 10 11 12 2.033 1.819 1.605 1.391 1.177 0.963 0.749 0.535 0.321 0.107 42 Problem 9-28 (cont.) Depreciation for first year: New furniture placed in service in May; cost $20,000 furniture Property type: 7-year New or used: Relevant for bonus depreciation Life: 7 yrs Method: DDB Convention: Which convention applies: half year or mid-quarter? Was > 40% of PERSONALTY placed in service in last 3 months of year? PERSONALTY Half-year: ½ year for year placed in service and year of sale Half-year: Salvage value: Irrelevant Salvage Irrelevant Depreciation Rate: 1/7 annual SL rate x 2 DDB x ½ half-year convention = 14.29% 1/7 Furniture: $20,000 x 14.29% = $2,858 43 Problem 9-28 (cont.) Exhibit 9-4: Exhibit MACRS Depreciation Percentages Using DDB and Half-Year Convention for 3, 5, 7 Year Property Year 7-Year 1 2 3 4 5 6 7 8 14.29% 24.49 17.49 12.49 8.93 8.92 8.93 4.46 44 Problem 9-28 cont. Depreciation for 2d year: Depreciation 2d Used office office building placed in service in March placed Property type: Office building is nonresidential New or used: Irrelevant (except for bonus & N/A to buildings) Life: 39 yrs Method: Post 1986: Straight-line Convention:mid-month (1/2 month for month placed in service & yr of sale) :mid-month Salvage value is irrelevant Depreciation Rate: 1/39 annual SL rate x 12/12 = 2.564 % 1/39 Building: $70,000 x 2.564% = $1,795 Building: 2.564% 45 Problem 9-28 cont. Exhibit 9-6: Exhibit MACRS Nonresidential Realty (Post 1986 SL 39 Yr) Using Mid-Month Convention Month Placed in Service 1 2 Yr 1 2.461% 2.247 2.033 1.819 1.605 1.391 1.177 0.963 0.749 0.535 0.321 0.107 Yr 2-39 2.564% 2.564 Yr 40 0.107% 0.321 0.535 0.749 0.963 1.177 1.391 1.605 1.819 2.033 2.247 2.461 3 4 5 6 7 8 9 10 11 12 2.564 2.564 2.564 2.564 2.564 2.564 2.564 2.564 2.564 2.564 46 Problem 9-28 cont. Depreciation for 2d yr: Depreciation 2d New furniture placed in service in May furniture Property type: 7-year New or used: Relevant for bonus depreciation Life: 7 yrs Method: DDB Convention: Half-year Salvage value: Irrelevant Salvage Irrelevant Depreciation Rate: 1/7 annual SL rate x 2 DDB x (100% - 14.29% = 85.71) = 24.49% 1/7 Furniture: $20,000 x Furniture: 24.49% 24.49% = $4,898 47 Problem 9-28 cont. Exhibit 9-4: Exhibit MACRS Depreciation Percentages Using DDB and Half-Year Convention for 3, 5, 7 Year Property Year 1 7-Year 14.29% 2 3 4 5 6 7 8 24.49 17.49 12.49 8.93 8.92 8.93 4.46 48 Problem 9-28 cont. Depreciation for 3rd yr: Depreciation Used office building placed in service in March and SOLD on 7/20 office SOLD Property type: Office building is nonresidential New or used: Irrelevant (except for bonus depreciation) Life: 39 yrs Method: Post 1986: Straight-line Convention: mid-month (1/2 month for month placed in service and sold) and Salvage value is irrelevant Depreciation Rate: 1/39 annual SL rate = 2.564% x half-month for July disposition 6.5/12 half-month Building: $70,000 x 2.564% x 6.5/12 6.5/12 = $ 972 972 49 Problem 9-28 cont. Exhibit 9-6: Exhibit MACRS Nonresidential Realty (Post 1986 SL 39 Yr) Using Mid-Month Convention Month Placed in Service 1 2 Yr 1 2.461% 2.247 2.033 1.819 1.605 1.391 1.177 0.963 0.749 0.535 0.321 0.107 Yr 2-39 2.564% 2.564 Yr 40 0.107% 0.321 0.535 0.749 0.963 1.177 1.391 1.605 1.819 2.033 2.247 2.461 3 4 5 6 7 8 9 10 11 12 2.564 2.564 2.564 2.564 2.564 2.564 2.564 2.564 2.564 2.564 50 Problem 9-28 cont. Depreciation for 3rd yr: Depreciation New furniture placed in service in May and SOLD July 20 SOLD furniture Property type: 7-year New or used: Relevant for bonus depreciation Life: 7 yrs Method: DDB Convention: Half-year in year placed in service and year of sale Half-year year Salvage value: Irrelevant Salvage Irrelevant Depreciation Rate: 1/7 SL rate x 2 DDB x (100% - 14.29% -24.49% = 61.22%) = 17.49% 1/7 Furniture: Furniture: $20,000 x 17.49% x Annual Rate ½ yr convention in yr of sale = $1,749 51 Problem 9-28 cont. Exhibit 9-4: Exhibit MACRS Depreciation Percentages Using DDB and Half-Year Convention for 3, 5, 7 Year Property Year 1 2 7-Year 14.29% 24.49 3 4 5 6 7 8 17.49 12.49 8.93 8.92 8.93 4.46 52 Problem 9-28 (d) Depreciation for first year: New furniture placed in service in October; cost $20,000 cost furniture Property type: 7-year New or used: Relevant for bonus depreciation Life: 7 yrs Method: DDB Convention: Which convention applies: ½ yr or mid-quarter? Which Was > 40% of PERSONALTY placed in service in last 3 months of year? Yes PERSONALTY Yes Mid-quarter: ½ quarter for quarter of year placed in service and year of sale Mid-quarter Salvage value: Irrelevant Salvage Irrelevant Depreciation Rate: 1/7 annual SL rate x 2 DDB x ½ x 1/4 mid qtr convention = 3.57% 1/7 Furniture: $20,000 x 3.57% = $2,858 53 Problem 9-28(d) Appendix C-9: MACRS Depreciation Percentages Using DDB and Mid Quarter Convention for 7 Year Property 7-year property: Quarter Placed in Service Recovery Year 1 25.00 21.43 15.31 10.93 8.75 8.74 8.75 1.09 2 17.85 23.47 16.76 11.37 8.87 8.87 8.87 3.33 3 10.71 25.51 18.22 13.02 9.30 8.85 8.86 5.53 4 1 2 3 4 5 6 7 8 3.57 27.55 19.68 14.06 10.04 8.73 8.73 7.64 54 Problem 9-28(d) Depreciation for 2d year: Depreciation 2d New furniture placed in service in October; cost $20,000 cost furniture Property type: 7-year New or used: Relevant for bonus depreciation Life: 7 yrs Method: DDB Convention: Which convention applies: ½ yr or mid-quarter? Which Was > 40% of PERSONALTY placed in service in last 3 months of year? Yes PERSONALTY Yes Mid-quarter: ½ quarter for quarter of year placed in service and year of sale Mid-quarter Salvage value: Irrelevant Salvage Irrelevant Depreciation Rate: 1/7 annual SL rate x 2 DDB = 2/7 x (100% - 3.57% = 96.43%) = 27.55% 1/7 Furniture: $20,000 x 27.55% = $5,510 55 Problem 9-28(d) cont. Appendix C-9: MACRS Depreciation Percentages Using DDB and Mid Quarter Convention for 7 Year Property 7-year property: Quarter Placed in Service Recovery Year 1 1 25.00 21.43 15.31 10.93 8.75 8.74 8.75 1.09 2 17.85 23.47 16.76 11.37 8.87 8.87 8.87 3.33 3 10.71 25.51 18.22 13.02 9.30 8.85 8.86 5.53 4 3.57 2 3 4 5 6 7 8 27.55 19.68 14.06 10.04 8.73 8.73 7.64 56 Problem 9-28 cont. Depreciation for 3rd year: Depreciation 3rd New furniture placed in service in October; sold July October; furniture Property type: 7-year New or used: Relevant for bonus depreciation Life: 7 yrs Method: DDB Convention: Which convention applies: ½ yr or mid-quarter? Which Was > 40% of PERSONALTY placed in service in last 3 months of year? Yes PERSONALTY Yes Mid-quarter: ½ quarter for quarter in year of sale year Mid-quarter quarter Salvage value: Irrelevant Salvage Irrelevant Depreciation Rate: 1/7 SL rate x 2 DDB = 2/7 x (100% - 3.57 - 27.55 = 68.88) = 19.68% annual rate 1/7 Annual rate 19.68% x mid qtr convention 2.5/4 Annual Furniture: $20,000 x 19.68% x 62.5% = $2,460 Furniture: 57 Appendix C-9: MACRS Depreciation Percentages Using DDB and Mid Quarter Convention for 7 Year Property 7-year property: Quarter Placed in Service Recovery Year 1 2 1 25.00 21.43 15.31 10.93 8.75 8.74 8.75 1.09 2 17.85 23.47 16.76 11.37 8.87 8.87 8.87 3.33 3 10.71 25.51 18.22 13.02 9.30 8.85 8.86 5.53 4 3.57 27.55 3 4 5 6 7 8 19.68 14.06 10.04 8.73 8.73 7.64 58 Bonus Depreciation s Additional first year depreciation for qualified property Additional qualified s Amount allowed: Amount s s s s 50% x Adjusted Basis (after § 179). 50% Allowed in addition to § 179 and normal MACRS No overall limitation Only for property placed in service in 2008 & 2009 s Qualified property 59 Bonus Depreciation s Qualified property s s s s s s Only new property qualifies (other than realty). Only Used property does not qualify. Used The property’s first or original use must commence with the The taxpayer after 12/31/07 taxpayer Property eligible for MACRS with recovery period of 20 yrs Property or less (business and investment property) Capital expenditures to recondition or rebuild property meet Capital the “new” requirement but purchase of such property is not qualified qualified Property that must be depreciated using ADS not qualified s ADS is required for tangible property (e.g., a machine) ADS used predominantly outside of the U.S. 60 Bonus Depreciation Truck #1 Truck #2 Adjusted basis $200,000 $200,000 § 179 expensed portion (100,000) $100,000 –– –– Remaining depreciable basis $100,000 $200,000 Remaining Additional allowance x 50% x 50% Bonus depreciation $50,000 50,000 $100,000 Remaining depreciable basis $50,000 $100,000 Regular depreciation x 20% x 20% Regular depreciation $10,000 10,000 $20,000 Total deduction Total $160,000 $160,000 $100,000 20,000 $120,000 $120,000 61 Alternative Depreciation System (ADS) s Defined s Straight-line alternative to MACRS s Required in some cases May elect Method: straight line rather than DDB s s s s Recovery periods: longer than MACRS Conventions: same as MACRS 62 Alternative Depreciation System (ADS) ADS recovery period is property’s ADS (1) No class life or (2) A special class life has been designated (2) Type of Property class life unless class Recovery Recovery Period (yrs) Period Personal property with no class life 12 Nonresidential real property with no class life 40 Residential rental property with no class life 40 Cars, light general‑purpose trucks, certain technological equipment, ….. 5 Computer‑based telephone switching equipment 9.5 Railroad track 10 Single‑purpose agricultural or horticultural structures 15 Municipal wastewater treatment plants, etc. 24 Low‑income housing financed by tax‑exempt bonds 27.5 Municipal sewers 50 63 Alternative Depreciation System (ADS) s When to Use: s Mandatory for for Listed property used < 50% for business s Recovery of cost of property used outside the U.S. (more than half of the tax year) s Tax-exempt use of property (property leased by a taxexempt entity) s Property financed with tax-exempt bonds s Designated imported property (from countries which restrict U.S. imports) s computing E&P and AMT depreciation Elective for all other depreciable property s 64 s Section 179 Expensing s General Rule: s Expense, rather than capitalize and depreciate, acquisitions Expense, of certain PERSONAL property of s Portion not expensed can be depreciated Year Amount that may be expensed 2008 2009 128,000 $250,000 Oh my! I can write off soooo much 65 9‑35 N purchased duplicating equipment to use in his business. He purchased purchased the equipment on June 3 of the current year for $300,000. N elects to expense the maximum amount allowable with respect to the equipment. a.What portion of the cost of the equipment may N expense for year? a. Up to $250,000 b.Compute N’s depreciation deduction for the current year. Ignoring bonus depreciation Original cost $300,000 Portion elected to expense (250,000) $250,000 Unadjusted basis for recovery $50,000 $50,000 Recovery percentage for 5‑year property X 20% Recovery Depreciation deduction $ 10,000 10,000 Depreciation 10,000 N’s total depreciation deduction is $260,000 N’s $260,000 66 Section 179 Expensing s Eligible property s Depreciable s Used in a trade or business NOT investment s Acquired by purchase from an unrelated party s Ineligible property s Most buildings s Certain property related to furnishing lodging s Recapture s Must continue to use the property for 2 taxable yrs s Failure to continue use: include in income amount Failure deducted less depreciation deducted 67 Section 179 Expensing s Limitations: s Expense allowance reduced $-for-$ for acquisitions of Expense ELIGIBLE property over $800,000 for 2009) $800,000 s s s Example: Example: $900,000 in asset additions. What is the §179 amount? $150,000 [$250,000 – ($900,000 - $800,000 = $100,000)] Indefinite carryover is permitted Example: Example: $105,000 in asset additions qualifies for § 179 expensing, $105,000 $25,000 of taxable income. What is the deduction? $25,000 $25,000; $80,000 carries over subject to limitation next year. s The amount expensed may not exceed taxable income. The s s s s s s Amount expensed under §179 is considered depreciation No further depreciation is taken on the amount expensed 68 § 179 Limited Expensing Deduction Year 2007 2008 Revised Maximum Deduction $125,000 $128,000 $250,000 Phase-out Begins $500,000 $510,000 $800,000 Phase-out Ends $625,000 $638,000 $1,050,000 69 69 9‑33 Indicate whether T may elect to use the Indicate limited‑expensing provisions of § 179. Assume limited acquisition qualifies unless otherwise indicated. a. T is a corporate taxpayer. YES; § 179 available to all taxpayers except estates/trusts YES; b. This year, T purchased a $300,000 building and $50,000 of equipment. equipment. YES; only the equipment; buildings are not eligible c. T suffered an of $40,000 this year before consideration of § 179 deduction. 179 No; insufficient taxable income d. T purchased the asset on the last day of the taxable year. YES YES 70 9‑34 For each of the following assets, indicate whether the taxpayer may elect to expense a portion or all of the asset’s cost. a. A $10,000 car used 75% for business and 25% for personal. Depreciable basis is $7,500 (75% of cost). If a computer instead of a car, the entire $7,500 basis could be expensed. But for cars, §280F limits the total write‑off in the first year (depreciation plus limited expensing) to $2,220 (75% x $2,960 increased for 2007). b. A home computer used by the taxpayer to maintain records and b. home perform financial analyses with respect to her investments. perform No; not used in a trade or business c. An apartment building owned by a large property company. No; buildings are not eligible d. A roll‑top desk purchased by the taxpayer’s father, who gave it to the taxpayer to use in her business. No; must be acquired by purchase from unrelated 3rd party 71 Sec. 280F: Luxury Automobiles s Limitations on deductions related to luxury Limitations automobiles automobiles s Which of the cars below is a luxury auto? Volkswagen Saturn Corvette Yugo Junk Rolls Royce 72 Sec. 280F: Luxury Automobiles s Automobiles Effected s s Passenger automobiles Includes any 4-wheeled vehicle for use on public streets, roads, and highways weighing no greater than 6,000 lbs. s Not ambulance, hearse, vehicles used by the taxpayer directly in the trade or business of transporting persons for compensation (taxis, jitney) or commuter highway vehicles For 2009, any of the above if the cost exceeds $14,800 ($2,960/20%) 73 s Sec. 280F: Luxury Automobiles s Limitation on Depreciation and § 179 Expense Trucks Vans Special Taxable Year 1 2 3 Thereafter 2009 Limit $2,960* 4,800 2,850 1,775 * Increase by $8,000 if bonus applies s Note: standard mileage rate includes depreciation & §179 expense s Limitations must be adjusted for personal use s Example: s s Car used 80% for business in year 1 Limit is 80% of normal amount in 2009 (80% * $2,960 = $2,368). 74 Sec. 280F: TRUCKS AND VANS Sec. TRUCKS s Limitation on Depreciation and § 179 Expense s Built on truck chassis Taxable Year 1 2 3 Thereafter 2007 Limit $3,060 4,900 2,950 1,775 Increase by $8,000 if bonus 75 9‑37 In the current year, H purchased a new automobile for $30,000. The In first‑year expensing election is not made. first a. Assuming the car is used solely for business, prepare a depreciation schedule illustrating the amount of annual depreciation to which H is entitled assuming he holds the car until the entire cost is recovered. entitled Yr 1 Yr 2 Yr 3 Yr 4 Yr 5 Yr 6 Basis 30,000 30,000 30,000 30,000 30,000 30,000 Depreciation percentage 20% 32% 19.2% 11.52% 11.52% ´5.76% MACRS 6,000 9,600 5,760 3,456 3,456 1,728 Limit 2,960 4,800 2,850 1,775 1,775 1,775 Deduction 2,960 4,800 2,850 1,775 1,775 1,037 Remaining Basis 27,040 22,240 19,390 17,615 15,840 14,112 FULLY DEPRECIATED IN YEAR 14 Yr 7 Yr 8 30,000 30,000 1,775 1,775 1,775 1,328 12,237 10,562 76 9‑37 continued b. Same facts as (a) except car is used 80% for business and 20% for Same personal. Compute the current year’s depreciation deduction. current > 50% use thus can use § 179 and MACRS. Adjust basis and limitation to reflect personal use. $24,000 ($30,000 x 80%) 80 x 20% $ 4,800 2,368 2,368 $ 2,368 Adjusted basis Adjusted MACRS recovery % MACRS depreciation Limit ($2,960 x 80%) ($2,960 80%) Deduction c. Same as (b) except the car is used 70% for business, 10% for Same production of income activities, and 20% for personal purposes. production “Business” use 70% > 50% thus can use § 179 and MACRS Include production of income use of 10% to compute depreciation. Thus can depreciation 80%, same as above. 77 9‑37 continued d. Same as (a) except used 40% business & 60% for personal purposes. Same personal s s s s s Not used > 50% for business; thus §179 and MACRS not allowed. Must use ADS (straight-line and perhaps a longer life) Adjust basis and limitation to reflect personal use. Basis: $30,000 x 40% business use = $12,000 Limit: First year $2,960 x 40% = $1,184 Yr 5 Yr 6 12,000 12,000 20% 10% 2,400 1,200 710 710 710 710 Yr 7 Yr 8 Yr 9 Yr 1 Yr 2 Yr 3 Yr 4 Basis 12,000 12,000 12,000 12,000 ADS Dep % 10% 20% 20% 20% ADS Dep 1,200 2,400 2,400 2,400 Limit 1,184 1,920 1,140 710 Deduction 1,184 1,920 1,140 710 Remaining basis 10,816 8,896 7,756 7,046 FULLY DEPRECIATED IN YEAR 14 710 710 710 710 710710 6,336 5,662 4,916 4,206 3,496 78 Listed Property s Limitations: If listed s If “qualified business use” ≤ 50% in year the listed property is placed in service s s No § 179 expensing; No MACRS ADS depreciation required Includes only business use s s “Qualified Business Use” s Production of income use is not counted for 50% test but is included in calculating depreciation Defined: see below 79 s Listed Property Example 1 of “Qualified Business Use” Salesman purchases computer system for $3,000. He uses computer Salesman 60% of time to maintain client data and sales orders, and 20% of time to maintain books on rental properties. to Tax Result: Since more than 50% of computer use is for business, Tax Result: Since more than 50% of computer use is for business, MACRS is used based on combined business and investment use MACRS is used based on combined business and investment use ((60% + 20% = 80%; 20% personal use). 60% + 20% = 80%; 20% personal use). Example 2 of “Qualified Business Use” If business use had been 45% and investment use was 20%, ADS would be required for 45% + 20% = 65% of asset; 35% would be personal use. 80 Listed Property s Qualified Business Use for Employees s If taxpayer is an employee, use is not business If use unless use For the convenience of the employer s Required for employment s s s Enables taxpayer to perform duties Mere statement requiring employee to have a Mere car is insufficient car 81 Sec. 280F: Listed Property Limitations for Certain Property Used for Both Limitations Personal & Business Use Personal s Listed Property: s s Passenger automobiles Other property used for transportation (motorcycles, boats, planes) Computer or peripheral equipment unless used exclusively in a regular business establishment (includes home offices under Sec. 280A) Property used for entertainment, recreation or amusement, unless used in a regular business establishment Cellular phones 82 s s s 9‑12 Luxury Cars. Indicate whether the following statements are true or false. If false, explain why. are a. W purchased a car used solely for business for $12,000. The limitations purchased imposed by § 280F on deductions related to automobiles do not alter what W could claim in the year of acquisition. could False. Absent § 280F, in the year of acquisition, the taxpayer could elect False. to expense the entire cost of the car. Section 280F limits depreciation to $3,060 in 2007 in the first year. $3,060 b.. b Pa Corporation is a distributor of hospital supplies. During the year, it Pa purchased a $20,000 car for its best salesperson. Section 280F does not alter the total amount of depreciation deducted while P owns the car. True. Section 280F alters only the timing of the depreciation deductions. True. 83 Listed Property: Recapture s If qualified business use > 50% first year but later If falls to ≤ 50%, recapture rules require TP to include in income the excess of MACRS deductions taken over what ADS deductions would have been over Computation MACRS & SEC. 179 Deductions - ADS Income 84 Deducting High Priced SUVs Effect of increasing § 179 to its current level of $250,000 s Absent special rule, could expense vehicles weighing over 6,000 since the automobile limitations do not apply to such vehicles s Now § 179 for SUV is limited to $25,000 (no adjustment for personal use) s Can also claim depreciation on remaining basis 85 Listed Property Example 1 of “Qualified Business Use” Salesman purchases computer system for $3,000. He uses computer Salesman 60% of time to maintain client data and sales orders, and 20% of time to maintain books on rental properties. to Tax Result: Since more than 50% of computer use is for business, Tax Result: Since more than 50% of computer use is for business, MACRS is used based on combined business and investment use MACRS is used based on combined business and investment use ((60% + 20% = 80%; 20% personal use). 60% + 20% = 80%; 20% personal use). Example 2 of “Qualified Business Use” If business use had been 45% and investment use = 20%, ADS would be required for 45% + 20% = 65% of asset; 35% would be personal use. 86 9‑14 Indicate whether the following statements are true or false. If false, explain why. a. J is a part‑time photographer. This year she purchased a camera that cost $1,000 for her videocassette recorder. Thirty percent of her usage was for business while the remainder was personal. J may use the accelerated depreciation recovery percentages of MACRS. s s No; Under § 280F, camera is listed property because it is entertainment‑related equipment. Not > 50% business use; may still depreciate using ADS straight line b. P, a proprietor, purchased computer equipment for $10,000 that he uses 50% for business. Under § 280F, the maximum deduction for depreciation and §179 in first year is $500, while without § 280F deduction would be $5,000. s Not > 50% business use; must use ADS: 10% x 50% x $10,000 = $500 s If no §280F, § 179 would be $5,000 s True 87 9‑14 continued c. C purchased computer equipment that he uses 60% for managing his investments and 35% in connection with a mail‑order business he operates out of his home. C may claim straight‑line depreciation deductions based on 95 % of the cost of the asset. True. In applying the 50% test, only qualified business use is counted—Managing investments is not considered business use thus only 35% use in the mail-order business is counted which does not exceed 50%. Consequently, § 280F applies ADS must be used. In determining the asset’s depreciable basis, the time used for investment purposes is combined with qualified business use. Thus, 95 percent (60% + 35%) of the cost is subject to depreciation 88 c. Listed Property Example 1 of “Qualified Business Use” Salesman purchases computer system for $3,000. He uses computer Salesman 60% of time to maintain client data and sales orders, and 20% of time to maintain books on rental properties. to Tax Result: Since more than 50% of computer use is for business, Tax Result: Since more than 50% of computer use is for business, MACRS is used based on combined business and investment use MACRS is used based on combined business and investment use ((60% + 20% = 80%; 20% personal use). 60% + 20% = 80%; 20% personal use). Example 2 of “Qualified Business Use” If business use had been 45% and investment use = 20%, ADS would be required for 45% + 20% = 65% of asset; 35% would be personal use. 89 9‑14 continued d. G is employed as a research consultant for RND Corporation, a research institute. G uses the company’s computer at the office but often takes home work, which she does on her home computer. G’s use of her home computer for work done for her employer is qualified business use. False. An employee’s use is considered “qualified business use” only if it is for the convenience of the employer and it is required as a condition of employment. Although it is not completely clear what these standards demand, the proposed regulations suggest that use such as C’s is not for her employer’s convenience nor is it required. T is a college professor who uses a computer, for which he properly claims deductions, to write textbooks in his home office. It is unnecessary for T to maintain records on business usage of the computer. True. Because the computer is used exclusively at a regular business establishment—in this case a home office that satisfies the requirements of § 280A—it is not considered listed property 90 e. Sec. 280F: Luxury Automobiles s Leasing s To prevent taxpayers from avoiding these limitations by leasing, special rules apply s The taxpayer may deduct the lease expense in the normal fashion s The taxpayer is required to include an amount in income based on the value of the car. 91 EXHIBIT 9-12 LEASED LUXURY AUTOMOBILES: EXCERPT FROM INCOME INCLUSION TABLE FOR AUTO LEASES 2001 FMV of Automobile Over Not Over 15,500 18,000 27,000 30,000 35,000 40,000 45,000 240,000 $15,800 18,500 28,000 31,000 36,000 41,000 46,000 250,000 1st $3 25 102 127 169 210 252 1,917 2nd $6 54 223 278 369 461 552 4,202 Year of Lease 3rd 4th 5th and Later $9 79 330 412 548 683 819 6,233 $10 95 396 493 656 819 982 7,474 $ 12 109 457 570 757 946 1,133 8,629 92 MACRS s Property not covered by MACRS s s Pre-1981 property Pre-1981 Property depr. with nontime-based methods, e.g. units of Property production, standard mileage rates production, Special public utility property and specified amortization Special property (leasehold improvements & rehab expenditures on low income housing) low Videotapes & motion picture films Intangible assets s s s 93 MACRS Straight-line option For assets place in service after 1986, the SL life of the asset, For e.g., a 7-yr. class life asset must be depreciated over 7 years. e.g., s The straight-line depreciation election must be made for all s The straight-line depreciation election must be made for all TPP property within a recovery class placed in service TPP property within a recovery class placed in service during the year. during the year. s One recovery class may be depreciated using the SL s One recovery class may be depreciated using the SL option, while another may be depreciated using regular or option, while another may be depreciated using regular or MACRS MACRS The election is binding on the assets placed in service in the year The election is binding on the assets placed in service in the year off the election; it is not binding on the same class of assets placed o the election; it is not binding on the same class of assets placed iin service in future years n service in future years 94 Amortization of Intangibles s Amortize using SL method, over useful life s Goodwill and covenants not to compete s Amortize over 15 years, SL 95 Depletion s Defined: Depreciation of natural resources s Taxpayer may elect to compute depletion deduction in either Taxpayer of two ways: of s Cost depletion: Cost s Recover cost as mineral is produced s Deduction limited to basis Percentage depletion: Percentage s Computed without reference to cost s Simply a percentage of the income derived from property s Functions much like an exclusion s Deduction is NOT limited to basis s 96 Cost Depletion Cost depletion to recover only adjusted basis Annual Cost Depletion Unrecovered Basis estimated recoverable units Number of units sold during the year 97 Percentage Depletion s Formula: Gross income from mineral X Percentage rate specified by statute Percentage depletion deduction unless limited s Generally limited to 50% of taxable income from mineral properties s TP must reduce basis (not below 0) by depletion claimed s Depletion in excess of basis may be claimed 98 Percentage Depletion Statutory Rates Natural Resource Rate 1. Gravel, sand, and other items 2. Shale and clay used for sewer pipes; or brick and clay, shale, and slate used for lightweight aggregates 3. Asbestos, coal, sodium chloride, etc. 4. Gold, silver, oil and gas, oil shale, copper, and iron ore from deposits in the U.S. 5. Sulfur and uranium and a series of minerals from deposits in the U.S. 6. Metals, other than those subject to 22% or 15% rate 5 7.5 10 15 22 14 99 Percentage Depletion Example 15,000 barrels of oil is pumped and sold for $15/barrel Gross revenues Less: operating expenses Taxable inc. before depletion Potential percentage depletion 50% of taxable income limitation *Percentage depletion limited to $225,000 (200,000) $25,000 15% x $225,000 = $33,750 50% x 25,000 = $12,500 $12,500 = $12,500 100 Taxable income after percentage depletion = (25,000 - 12,500) Taxable (25,000 Research and Experimental Costs Three alternatives: Expense all nondepreciable costs immediately Amortize over 60 months Capitalize and do not amortize Taxpayer must follow one method consistently R&E Credit also available 101 Expenses of Farmers and Ranchers s Expenses related to livestock s Costs of acquiring animals for breeding, dairy, work or sport are capital expenditures subject to depreciation s If raise animals for sale, inventory s Soil and water conservation, fertilizer, land clearing s s s s s Capitalize unless plan approved by Dept. of Agriculture Must be in business of farming Deductions limited to 25% of gross income from farming No limitation on fertilizer, etc. Land clearing costs are capitalized s Development costs s Capitalize or expense but certain limitations 102 The End 103 History of Depreciation Methods s Revenue Act of 1913: s “Reasonable allowance for depreciation” s Taxpayer could choose rates s Controversies over rates and salvage s 1971 Class Life System with ADR or F&C s 1981-Present: ’81 ACRS and ’86 MACRS s s s Eliminates estimates Specifies recovery period (useful life) No salvage value e value No 104 History of Depreciation Methods s Revenue Act of 1913: s “Reasonable allowance for depreciation” s Taxpayer could choose rates s Bulletin F, 1920 s 1933: New Deal Financing s Taxpayer to prove reasonableness of rates s Bulletin F revised -- specified unusually long Bulletin “reasonable lives” “reasonable s Controversies over rates and salvage value Controversies 105 History of Depreciation Methods s 1953 - 1980 s s s s s Accelerated methods allowed, 1954 AFY - 1954 IRS given burden of proof on rates 1962: Rev. Proc. 62-21: more reasonable useful lives 1962: specified specified 1971 Class Life System with ADR or F&C Eliminates estimates Specifies recovery period (useful life) No salvage value 106 s 1981-Present: ’81 ACRS and ’86 MACRS s s s ...
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