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Unformatted text preview: Chapter 07 - Property Acquisitions and Cost Recovery Deductions Chapter 7 Property Acquisitions and Cost Recovery Deductions Questions and Problems for Discussion 1. The tax law presumes that no expenditure is deductible unless a specific statutory rule allows the deduction. Furthermore, if the tax treatment of a business expenditure is uncertain, the expense must be capitalized to an asset account rather than deducted in the computation of taxable income. 2. If a deduction for advertising expense was replaced with 20-year amortization, the after-tax cost of advertising (in present value terms) would increase substantially. Presumably, firms would purchase less advertising or advertising companies would reduce their prices (before-tax cost) in response to such a tax law change. 3. Cost recovery deductions are not based on current cash outflows. In other words, these deductions reduce capitalized costs rather than the firm’s cash account. However, the tax savings from a cost recovery deduction represents a positive cash flow. 4. Cost recovery deductions have no relationship to any decline in value of the property to which the deduction relates. Taxpayers may claim cost recovery deductions even if the value of the property increases over time. 5. Tax basis represents the unrecovered investment in a business asset. If the owner of the asset has recovered her entire investment in the form of cost recovery deductions, the basis of the asset is zero. An asset may not have a negative tax basis. 6. Because land is a nonwasting (nondepreciable) asset, capitalized soil and water conservation expenditures are recovered in the year the land is sold. 7. Because Corporation J’s insurance premiums related to assets used in the production of inventory, the unicap rules require that the premiums be capitalized to inventory rather than deducted. Corporation K is a service business with no inventory. Therefore, its insurance premiums are period rather than product costs and can be deducted. 8. In a period of inflation in which the most recently purchased goods are the most expensive, the LIFO costing convention maximizes cost of goods sold and minimizes the capitalized cost of inventory. Consequently, the LIFO method minimizes current income, which is good from a tax perspective but bad from a financial reporting perspective. Firms cannot use LIFO for tax and another method for financial reporting and, thus, must take the good with the bad. Finally, International Financial Reporting Standards do not permit the use of LIFO, which could preclude its use for tax purposes when U.S. standards converge to IFRS in the future. 9. The capitalized cost of a depreciable asset could be different for tax purposes than for financial statement purposes. The time period over which the cost is recovered could be different. The method for computing annual depreciation could be different. Finally, the convention for determining depreciation in the year of acquisition or disposition could be different. determining depreciation in the year of acquisition or disposition could be different....
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This note was uploaded on 12/08/2010 for the course TAX 4011 taught by Professor Staff during the Spring '08 term at FAU.
- Spring '08