Chapter 11 and 12 - Income Taxation: Chapters 11 &...

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Unformatted text preview: Income Taxation: Chapters 11 & 12 Income 1 History of Depreciation Methods s Pre - 1981 s 1971 Class Life System with ADR or facts & circumstances s Straight-Line Method s Declining-Balance Method (Rate times Adjusted Basis) s s Sum of the Years Digits Method Sum Units of Production Method s 1981-Present: ACRS/MACRS s eliminates estimates & salvage value s shortens recovery period shortens s 1986 TRA ‘86: MACRS effective 1/1/87 2 Double Declining Balance Depreciation Asset with 5 year life, $20,000 purchase cost, Asset $2,000 salvage value $2,000 Step 1: Calculate Rate 1/years useful life = 1/5 = 20% 2 * 1/5 = 2/5 = 40% 3 Double Declining Balance Depreciation Step 2: Calculate depreciation: Undep. Year 1 2 3 4 *5 *5 Depr. Balance $20,000 12,000 7,200 4,320 2,592 X X X X X Rate 40% 40% 40% 40% 40% = = = = = Exp. $8,000 4,800 2,880 1,728 592 $18,000 DDB* Asset cannot be depreciated below the salvage value of $2,000. If S/L depreciation used, the annual deduction would be $3,600. 4 MACRS s General Concept: s Statutory life - mandatory “cost recovery” s Prescribed depreciation rates s No salvage value s Property Covered: MACRS applies to all T.P. Property (tangible property) that is (tangible s Used in T/B or for production of income s Subject to depreciation, i.e., determinable life and is Subject subject to exhaustion, wear and tear, and obsolescence subject 5 MACRS s Property not covered by MACRS s Pre-1981 property Pre-1981 s Property depreciated with nontime-based methods, e.g., Property units of production, standard mileage rates units s Special public utility property and specified amortization Special property (leasehold improvements & rehab expenditures on low income housing) low s Videotapes & motion picture films s Intangible assets 6 ACRS/MACRS Depreciation of Real Property Class Life Depr. Effective Dates (Yrs) Method 15 1.75 1. Depr. real prop. placed in service before 3/16/84 DB/SL 2. Qualified low income housing 18 1.75 DB/SL Placed in service after 3/15/84 & before 5/9/85 19 1.75 DB/SL Placed in service after 5/9/85 & before 1/1/87 27.5 SL After Residential real prop. & most low income housing 1986 Conventions Based on actual # months in service beginning and ending year Mid-month convention: ½ month depr. for month placed in service & for final month of service mid- month 31.5 SL Nonresidential real & real prop. w/midpoint of 27.5 years or more mid- month 39 SL Nonresidential real estate after May 12, 1993 mid- month 7 ACRS/MACRS Application to Real Property s Apply recovery % from 15, 18 or 19, 27.5, 31.5 and 39 year tables to unadjusted basis s First month’s depreciation is adjusted in tables to reflect beginning conventions, therefore, no adjustment is necessary s In year of disposal, multiply table percentage by fraction of year the property was in service, using the 1/2 month convention 8 ACRS/MACRS Depreciation of Personalty Class Life (Yrs) ADR* Midpoint Depr. Method Specific Requirements (examples in parens) 3 ≤4 2 DB/SL 5 >4, <10 2 Most race horses, tractors, breeding hogs, manufacturing tools, and certain computer software Autos & most trucks, semi-conductor manuf. equip. , computers, copiers, typewriters, some renewable & biomass power plants, R&E property DB/SL 7 10, <16 2 DB/SL 10 16, <20 2 DB/SL Single purpose agricultural & horticultural structures; RR track; prop. with no ADR midpoint (office furniture, agric. Machinery & equip.) Fruit-bearing trees and vines, barges, tugboats, other water trans. vessels 9 ACRS/MACRS Depreciation of Personalty Class Life (Yrs) ADR* Midpoint Depr. Method Specific Requirements (examples in parens) 15 ≥ 25 1.5 DB/SL Sewage treatment facilities, telephone distribution plant & comparable equip. for 2-way voice & data communication 20 ≥ 25 1.5 DB/SL Municipal sewers certain farm buildings; excludes real property with ADR midpoint of 27.5 years or more * ADRs specified in Rev. Proc. 87­56; 1987 CB 745; and Rev. Proc. 88­22, 1988 CB 785 • Modified 1/2 year convention is used • Special 40% rule • Recovery period is extended to recover the last 1/2 year depreciation 10 Depreciation of Personalty Example Depreciation s In 2008, a TP acquired the following property for use in a In business: equipment, 14,000; copier, 2,000; office furniture, 4,000; and a machine, 9,000. 4,000; s Ignore Section 179 s Depreciation for 2008: s s s 5-year property: s 14,000 equipment + 2,000 copier = 16,000 s 16,000 * 20% = $3,200 7-year property: s 4,000 office furniture + 9,000 machine = 13,000 s 13,000 * 14.29% = $1,857.70 Total depreciation for 2008: s 3,200 + 1,857.70 = $5,057.70 11 Depreciation of Personalty Example Depreciation s Depreciation for 2009: s 5-year property: s 16,000 * 32% = $5,120 s 7-year property: s 13,000 * 24.49% = $3,183.70 s Total depreciation for 2009: s 5,120 + 3,183.70 = $8,303.70 12 Special 40% Rule s Special 40% Rule: If > 40% of aggregate bases of all TPP placed in service during the year is placed in service in the last three months of the year, a midservice quarter convention will apply: s 1st qtr. gets 3.5 qtrs. depr. (87.5%) s 2nd qtr. gets 2.5 qtrs. depr. (62.5%) s 3rd qtr. gets 1.5 qtrs. depr. (37.5%) s 4th qtr. gets 0.5 qtrs. depr. (12.5%) 13 40% Rule Example Four machines placed in service during the year. All are 7 year property. Machine A B C D Cost 10,000 5,000 20,000 5,000 40,000 Date put in service Jan. 10 July 1 Oct. 15 Dec. 1 20,000 + 5,000 = more than 40%, therefore, the $40,000 is depreciated under the mid-quarter convention Machine A B C D Total depreciation Date 1/10 7/1 10/15 12/1 Qtr 1 3 4 4 Factor X 25% 10.71 3.57 3.57 Basis 10,000 5,000 20,000 5,000 Depr. 2,500 536 714 179 $3,929 14 Alternative Depreciation System (ADS) s When to Use: s Mandatory for 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 depreciation under the Alternative Minimum Tax s Elective for all other depreciable property 15 Recapture s When some assets are sold or disposed of at a gain, part of the When gain may be “recaptured” by adding it to ordinary income gain s Rationale/Rules (Sections 1245 and 1250) s s s s Sale of most TPP and real estate for a gain -- recapture Sale lesser of the realized gain or the depreciation already taken lesser Personal (Sec 1245) Property: Full Recapture Realty (Sec 1250): Only Excess Depreciation Recaptured Realty on property depreciated under ACRS (1981- 1986) Post – 1986 Realty (Sec 1250): “Special” 25% rate applies Post to Capital Gain attributed to Depreciation upon sale 16 A Key Deduction: Section 179 Key s General Rule for Section 179 (“Old” Rule) s s s s Businesses may expense, rather than capitalize and depreciate, Businesses some TPP asset acquisitions (N/A to R/E) some “Bonus Depreciation” under both Job Creation Act and Bonus JGTRRA of 2003 expired as of December 31, 2004 Small Business and Work Opportunity Tax Act of 2007 Small increased Section 179 expensing limit to $125,000 (from $112,000). Note: $25,000 limit / $200,000 phase-out scheduled to reappear in 2011 Year Amount that may be Amount expensed expensed 2007 125,000 2007 2008 128,000 17 A Key Deduction: Section 179 Key s Expanded Rules for Section 179 Expanded s s Small Business and Work Opportunity Tax Act of 2007 Small increased Section 179 expensing limit by $35,000 to $160,000 for Enterprise Zones, Renewal Communities, D.C., and NYC Liberty Zones Businesses ($163,000 in 2008). Liberty Small Business and Work Opportunity Tax Act of 2007 also Small increased Section 179 expensing limit by $100,000 to $225,000 for qualified Section 179 Gulf Opportunity Zone property through 2008. (Phase-out begins at $1.1 million) through Year Amount that may be Amount expensed expensed 2007 225,000 2007 18 A Key Deduction: Section 179 Key s General Rule for Section 179 (“New” Rule) s Businesses may expense, rather than capitalize and depreciate, some TPP Businesses asset acquisitions (N/A to R/E) asset s “Bonus Depreciation” of 50% reinstated under Economic Stimulus Act of Bonus 2008 for NEW property acquired in 2008. 2008 s Economic Stimulus Act of 2008 increased Sec. 179 expensing limit to Economic $250,000 (from $128,000) for tax years beginning between January 1, 2008 and December 31, 2008. s Both provisions extended thru December 31, 2009 under the Both American Recovery and Reinvestment Act of 2009. American s Note: $25,000 limit / $200,000 phase-out scheduled to re-appear in 2011 Year Amount that may be expensed expensed 2008/09 250,000 2008/09 19 A Key Deduction: Section 179 Key s Expanded Rules for Section 179 under Economic Stimulus Act s s Small Business and Work Opportunity Tax Act of 2007 Small increased Sec. 179 expensing limit by $35,000 to $160,000 for Enterprise Zones, Renewal Communities, D.C., and NYC Liberty Zones Businesses (Now $285,000 in 2008 and 2009). Liberty Small Business and Work Opportunity Tax Act of 2007 Small originally increased Sec. 179 expensing limit by $100,000 to $225,000 for qualified Sec. 179 Gulf Opportunity Zone property. (Now $350,000 for 2008 and 2009 with phase-out now beginning at $1.4 million) now Year Amount that may be Amount expensed expensed 2007 225,000 2007 2008/09 350,000 20 A Key Deduction: Section 179 Key s General Rules for 2008’s “Bonus Depreciation” s s “Bonus Depreciation” reinstated under Economic Stimulus Act Bonus of 2008 for NEW property acquired in 2008 (and 2009). of Bonus Depreciation also includes NEW Property placed in Bonus service after 2008 (thru December 31, 2010 under the American Recovery and Reinvestment Act of 2009), for property with a recovery period of 10 years or longer, transportation property (tangible personal property used to transport people or property), and for certain aircraft. property), s CAVEAT: Estimated production period must exceed one year and cost must CAVEAT: exceed $1 million for extended period. exceed s Sec. 280F limitations to include “Bonus” of $8,000 for “luxury” Sec. autos, creating a first year cap of $10,960 for 2008 (and 2009). 21 autos, A Key Deduction: Section 179 s Limitations: s Sec. 179 expensing is phased out $-for-$ for any asset Sec. additions over $800,000 under 2008’s Economic Stimulus Act (was originally scheduled at $510,000 for 2008) s Ex: $675,000 in asset additions in 2007: Sec. 179 Ex: expensing is completely phased out at $625,000. (2008/09: complete phase-out occurs at $1,050,000) (2008/09: s The amount expensed may not exceed taxable income. The -Indefinite carryover is permitted s s s Ex: If $18,500 in asset additions qualifies for Sec. 179 expensing, Ex: but there is only $5,000 of taxable income, $13,500 carries over and is subject to the limitation next year. is The amount expensed under Sec. 179 is considered to be The depreciation and reduces the asset’s basis ($ for $). depreciation No further depreciation is taken on the amount expensed 22 Rev. Proc. 2008-54: Section 179 s Rev. Proc. 2008-54 explains Sec. 179 Rev. implications for Pass-thru Entities implications The Sec. 179 expensing limit is $250,000 for The a tax year beginning in 2008 and 2009, and $125,000 (plus inflation) for a tax year beginning in 2010 under the new 2009 Act. beginning s However, Partnerships and S-Corporations However, on a fiscal year may be subject to a different Sec. 179 limitation than its partner or shareholder on a calendar year. shareholder s 23 Rev. Proc. 2008-54: Section 179 s Example: Implications for Pass-thru Entities s An S Corp with one shareholder has a fiscal year An ending March 31, 2010. The S Corp acquires property for $250,000 and places it in service on April 18, 2009. The S Corp can claim Sec. 179 of $250,000, since the property was purchased and placed in service in a tax year beginning in 2009. Although the shareholder’s allocable share of the Sec. 179 expense is $250,000, the shareholder’s limit is based on the calendar year 2010 (the year in which the S Corp’s year ends). Thus, the shareholder’s limit is $125,000 (plus inflation) for a tax year beginning in 2010. in 24 Limitations for Some Property Used for Limitations Both Personal & Business Use Both aka “Listed Property” Section 280F s Listed Property: s Passenger automobiles (unloaded gross vehicle weight under 6,000 pounds) s Other property used for transportation (motorcycles, boats, planes) s Computer or peripheral equipment unless used exclusively in a regular business establishment (includes home offices under Sec. 280A) s Property used for entertainment, recreation or amusement, unless used in a regular business establishment 25 Limitations for Some Property Used for Limitations Both Personal & Business Use Both aka “Listed Property” Section 280F s Limitations: s If “qualified business use” ≤ 50% in year the listed property is placed in service s s s No Sec. 179 expensing nor Bonus Depreciation ADS depreciation required (i.e., straight-line deprec.) “Qualified Business Use” s s Includes only T/B use (business for which Sec. 162 authorizes deductions) But, use of assets for production of income is included in calculating depreciation 26 Limitations for Some Property Used for Limitations Both Personal & Business Use Both aka “Listed Property” Section 280F Example 1 of “Qualified Business Use” TP, salesperson, purchases computer system for $3,000. She uses TP, computer 60% of time to maintain client data and sales orders, and 20% of time to maintain books on rental properties. of Tax Result: Since more than 50% of computer use is for business, MACRS is used based on combined business and investment 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. 27 Limitations for Some Property Used for Limitations Both Personal & Business Use Both aka “Listed Property” Section 280F s “Luxury” Automobiles: Section 280F limits Luxury” both MACRS depreciation and Section 179 expensing. s Cost Recovery Limitations significantly limit Cost depreciation. The maximum limits for 2008/09 are $2,960, $4,800, $2,850, and $1,775 ($3,060, $4,900, $2,850, and $1,775 for 2007) and represent 100% bus/prod use. 28 Limitations for Some Property Used for Limitations Both Personal & Business Use aka “Listed Property” Section 280F aka s A “Luxury” auto is a passenger car costing “Luxury” around $14,800 s However, “listed” property does NOT include: However, Trucks, Vans and “Heavy Land Yachts” (i.e., Bentleys!) weighing over 6,000 pounds, ambulances, hearses, and vehicles used in transporting services (limo services). 29 A Key Deduction: Combining Sec. 179 and Reg. Depreciation s January 15, 2007 purchase of $75,000 SUV weighing over 6,000 January pounds (less than 14,000 pounds) Not “Listed Property” Not s Used in business 100% s Year 1 Deductions (under American Jobs Creation Act): s Section 179: $25,000 limit for SUVs after October 22, 2004 s Reg. Depreciation : $10,000 ($50,000 times 20%) s TOTAL DEDUCTION: $35,000 (Sec. 179 & Reg. Dep.) Year expensed expensed 2007 2008 Amount that may be Amount 35,000 16,000 30 A Key Deduction: Combining Sec. 179, Bonus and Reg. Depreciation s s s March 15, 2008 (or 2009) purchase of $75,000 SUV weighing over 6,000 March pounds (less than 14,000 pounds) Not “Listed Property” Not Used in business 100% Year 1 Deductions (under Economic Stimulus Act): s Section 179: $25,000 limit for SUVs after October 22, 2004 s Bonus Depreciation: $25,000 ($50,000 times 50%) s Reg. Depreciation : $5,000 ($25,000 times 20%) s TOTAL DEDUCTION: $55,000 (Sec. 179/Bonus & Dep.) s Same result under American Recovery and Reinvestment Act of 2009 Year Amount that may be Amount expensed expensed 2008 (or 2009) 55,000 2009 (or 2010) 8,000 31 A Key Deduction: Combining Sec. 179, Bonus and Reg. Depreciation s February 15, 2008 (or 2009) purchase of $18,266 “Luxury February Automobile weighing less 6,000 pounds “Listed Property” “Listed s Used in business 100% s Year 1 Deductions (under Economic Stimulus Act): s Section 179/Bonus Dep: $9,133 ($18,266 times 50%) s Reg. Depreciation : $1,827 ($9,133 times 20%) s TOTAL DEDUCTION: $10,960 (Sec. 179/Bonus & Dep.) s Same result under American Recovery and Reinvestment Act of 2009 Year Amount that may be Amount expensed expensed 2008 (or 2009) 10,960 2009 (or 2010) 2,923 32 A Key Deduction: Combining Sec. 179, Bonus and Reg. Depreciation s s s April 15, 2008 (or 2009) purchase of new business machine for $800,000 April Used in business 100% Year 1 Deductions (under Economic Stimulus Act): s Section 179: $250,000 s Bonus Depreciation: $275,000 ($550,000 times 50%) s Reg. Depreciation : $55,000 ($275,000 times 20%) s TOTAL DEDUCTION: $580,000 (Sec. 179/Bonus & Dep.) s Same result under American Recovery and Reinvestment Act of 2009 Year Amount that may be Amount expensed expensed 2008 (or 2009) 580,000 2009 (or 2010) 88,000 33 Amortization of Intangibles s Amortize using SL method, over useful life (Sec 197) s Must be used in a trade or business or held for the Must production of income production s Examples: Goodwill and Covenants Not to Compete s Amortize over 15 years, SL s Effective as of August 11, 1993 34 Chapter 12: Overview: “Passive” Activities s Definition of “Passive Activity” Turns on the Term Definition “Material Participation” meaning “regular, “Material continuous, and substantial” involvement. continuous, s Rental Activities Are “Passive” Regardless of Rental Participation Unless Taxpayer is a Dealer or FullParticipation Time Property Manager s Deductible Passive Activity Losses Generally Limited Deductible to Taxpayer’s Passive Activity Income to s “Active Participation” Exception May Be Available 35 General Features of Section 469 Passive Activities Section 469 applies to individuals, estates, trusts, personal Section service corps., and closely held corporations service Classify All Business Activity Into Three Types A “Portfolio” Investment Income/Loss B “Active” Business Income/Loss C “Passive” Lacks “Material Part.” 36 General Features of Section 469 Basic Tax Aspects Basic s Losses from passive activities cannot be deducted Losses from active or portfolio income. from s Unlimited carryovers of disallowed losses. s Accumulated (carryover) passive losses are Accumulated deductible from active and/or portfolio income without limitation if the activity is completely disposed of in a taxable transaction to a nonrelated party. Deducted in order against: nonrelated s Passive gains on the sale s Current year passive income s Active/portfolio income 37 General Features of Section 469 Basic Tax Aspects (Continued) Basic s For closely held corporations, passive losses can For offset active income, but not portfolio income. (Corporations not closely held are not subject to passive limitations). passive s Tax credits produced from passive activities can Tax offset only taxes attributable to passive income, with unlimited carryovers of unused credit. with s Separate accounting is required for each active, Separate passive, or portfolio activity. passive, 38 Applying Section 469 s If the sum of all passive activity = If net loss, then apply passive activity rules activity s If the sum of all passive activity = If net gain, then the passive activity rules don’t apply that year rules s Unlimited c/o of disallowed losses s Allocate c/o among passive Allocate activities activities 39 Exception to Passive Activity Rules Rental property can be either s A “non-rental” activity, or s An “active” rental activity, or s A “passive” rental activity 40 Nonrental Activities: Incidental Rentals of a Nonrental Personal Residence Personal s Two cases: s s Nominal rentals of a personal residence: s Residence is rented less than 15 days s Tax result: No rental income and no deductions Nonexclusive use (a.k.a. Substantial owner use): the TP uses the residence more than the greater of s 14 days, or s 10% of the number of days actually rented s Tax result: Deductions for rental expenses limited Tax to gross income from the rentals less otherwise allowable deductions (mortgage interest and taxes) allowable s Carryovers of unused losses allowed 41 Rental Activities s When is a rental activity not deemed “passive”? s Unlimited losses from the rental can be deducted Unlimited if the TP meets two tests: if s More than 50% of all personal services during More the year must be for real property trade or business, and business, s The TP performs more than 750 hours in real The property trades or businesses property --- Must meet definition of Material Participation --for exception: Regular, Continuous, and Substantial Involvement Substantial 42 Rental Activities: Another Exception to the Rental Passive Activity Rules Passive s Individual TPs who “actively participate” in Individual passive rental real estate businesses may deduct up to $25,000 in losses per year from nonpassive income. -This $25,000 allowance is reduced by 50% of the individual’s -This AGI in excess of $100,000 of nonpassive income. AGI EXAMPLE AGI = $110,000 A maximum of $20,000 may be deducted against active and portfolio income. (50%)(110,000 - 100,000) = $5,000 $25,000 - 5,000 = $20,000 43 “Active Participation” in Passive Rental Activities s TP must have > 10% ownership interest (in the value TP of the property) of s TP must have “significant and bona fide” involvement Example of “Active Participation” Approval of tenants, setting rental terms, approving repairs and improvements, etc. Use of rental agents does not defeat “active participation” “Active participation” is less restrictive than “material Active participation.” If “material participation” is present, then the rental business is “active.” then 44 ...
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This note was uploaded on 06/06/2011 for the course ACE 346 taught by Professor Peter during the Spring '11 term at University of Illinois, Urbana Champaign.

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