Chapter 10 - Cost Recovery on Property -- Depreciation, Depletion, and Amortization

Chapter 10 - Cost Recovery on Property -- Depreciation, Depletion, and Amortization

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Chapter 10 – Cost Recovery on Property: Depreciation, Depletion, and Amortization I. Introduction a. A taxpayer can choose among three alternative depreciation methods i. Method chosen determines the timing and the amount of the annual depreciation deduction 1. Timing and amount affect the present value of the tax savings from the deduction a. Earlier the taxpayer can claim a depreciation deduction, the greater its present value is II. Capital Recovery from Depreciation or Cost Recovery a. Modified Accelerated Cost Recovery System (MACRS): i. MACRS specifies longer recovery periods for depreciable assets, which result in slow depreciation than allowed by ACRS b. Alternative Depreciation System (ADS): i. Primary use is for calculating the alternative minimum tax 1. Taxpayers may elect ADS for determining regular taxable income when there is no need for the greater MACRS deductions III. Section 179 Election to Expense Assets a. Section 179: i. Allows an annual current expense deduction for the cost of qualifying depreciable property purchased for use in a trade or business 1. Deduction is treated as a depreciation deduction b. Qualified Taxpayers: i. Individuals, corporations, S corporations, and partnerships may elect to deducts as an expense up to $134,000 in investment in qualified property to be used in an active trade or business 1. Husband and wife are considered one entity c. Qualified Property:
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i. Allowed only on depreciable, tangible, personal property used in a trade or business 1. Trucks, machinery, furniture, computers, etc. ii. Real property, such as buildings and their structures, do not qualify 1. Improvements are also disallowed d. Limitations and Deductions: i. Three Limitations: 1. A taxpayer’s annual Section 179 deduction cannot exceed the maximum annual limitation ($134,000) 2. If the taxpayer’s investment in Section 179 property exceeds $530,000 for the tax year, the annual deduction limit is reduced by one dollar for each dollar of investment over $530,000 3. The Section 179 deduction allowed for a tax year cannot exceed the taxable income from the active conduct of all the taxpayer’s trade or business activities ii. Annual Deduction Limit: 1. Does not have to prorated according to the length of time an asset is used during the year 2. The Section 179 deduction for S corporations and Partnerships flows through to the owner’s who subtract the deduction as an expense on their tax returns a. Total allocated to the owners can’t exceed annual limit 3. May choose to use all, part, or none of the annual deduction 4. After an asset’s basis is reduced by the amount expensed under Section 179, the remaining basis is subject to regular depreciation under any valid method 5. Two general rules when choosing which assets to expense: a. Do not use the Section 179 election to expense automobiles b. Based on time value of money concepts, taxpayers should take the depreciation deduction as early as possible
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i. Done by expensing the assets with the longest life and using
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Chapter 10 - Cost Recovery on Property -- Depreciation, Depletion, and Amortization

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