Chapter 8 - Chapter 8: Depreciation, Cost Recovery,...

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Chapter 8: Depreciation, Cost Recovery, Amortization, and Depletion Tax law provides deduction for consumption of the cost of an asset through depreciation, cost recovery, amortization, or depletion Concept of depreciation is based on premise that asset acquired benefits more than one accounting period Congress overhauled depreciation rules in 1981 by creating accelerated cost recovery system (ACRs); in 1986 changed to MACRs Changes in tax rules have widened the gap between accounting and tax versions of depreciation Taxpayers write off the cost of certain assets that are used in a trade or business or held for the production of income—this write-off can take the form of depreciation, depletion, or amortization o Tangible assets— depreciated o Natural resources— oil, gas, coal, timber, etc—depleted o Intangible assets —amortized No write-off allowed for asset that does not have a determinable useful life Concepts Relating to Depreciation Nature of Property— property includes both realty (real property) and personalty (personal property) o Realty = lands and buildings permanently affixed to land o Personalty = furniture, machinery, equipment, etc (NOT the same as personal use property!) o Both realty and personalty can be either business use/income-producing property or personal use property—write-offs are NOT allowed for personal use property o Assets used in trade or business or for production of income are eligible for cost recovery if they are subject to wear and tear, decay or decline from natural causes, or obsolescence. Assets that do not decline in value or do not have determinable useful life are not eligible for cost recovery. Placed in Service Requirement —date depreciation begins is the date asset is placed in service (NOT purchase date) o Important for assets purchased at end of year but not placed in service until following year Cost Recovery Allowed or Allowable o Allowed cost recovery = cost recovery actually taken o Allowable cost recovery = amount that could have been taken under the applicable cost recovery method o Basis of cost recovery property must be reduced by cost recovery allowed or allowable Personal use assets converted to business use—basis for cost recovery = lower of adjusted basis or FV upon conversion MODIFIED ACCELERATED COST RECOVERY SYSTEM (MACRs) Cost of asset is recovered over a predetermined period that is generally shorter than the useful life of the asset MACRs rules developed to encourage investment and simplify tax law/administration Separate cost recovery tables for realty and personalty Write-offs not available for land because it does not have a determinable life Assets used in trade or business or for income production are eligible under MACRs Personalty: Recovery Periods and Methods— the cost of eligible personalty property is recovered based on class lives: 3 YEAR: ADR midpoints of 4 years and less. Excludes automobiles and light trucks. Includes certain
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Chapter 8 - Chapter 8: Depreciation, Cost Recovery,...

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