Depreciation, or Cost Recovery

Depreciation, or Cost Recovery - Depreciation, or Cost...

Info iconThis preview shows pages 1–2. Sign up to view the full content.

View Full Document Right Arrow Icon
Depreciation, or Cost Recovery An asset used in the taxpayer's trade or business which has a life of one year or less is simply deducted when computing business income or loss for the year. However, if the asset's life is longer (e.g., equipment, buildings), the cost must be "recovered" through a "stream" of deductions over the asset's life, or "recovery period." These deductions are commonly called depreciation deductions because they reflect the fact that the asset is declining in value (depreciating, wearing out) over time. Technically, the deductions are "cost recovery" deductions because the taxpayer is recovering his cost of the asset (through the deductions). Thus, the current depreciation system is called "MACRS" which stands for the Modified Accelerated Cost Recovery System. Note that assets not used in a trade or business (or for the production of income, i.e., investment assets) are neither deductible nor depreciable. These are simply "personal" assets such as your home, your personal car, etc., which have no impact on your tax situation. Assets which are depreciable include "personalty" and real estate (realty) other than land (land is not depreciable). Personalty is a legal term meaning assets which are not real estate. Typical depreciable personalty is equipment, furniture, machinery, a truck or car used in the business, etc. How to arrive at the deduction. Two pieces of information are needed to determine the depreciation deduction. The first is the "class" or recovery period for the property. For example, basic automobiles used in the business are in the 5-year class (regardless of the type of car: even a Volvo or Mercedes which should last well over 5 years is a 5-year asset). Office furniture and equipment generally falls into the 7-year class. The second piece of information is the "method" of depreciation. Most commonly, the method used is the "double declining balance" method, which is already worked into the depreciation tables. See the tables in your text. These tables make the depreciation area fairly simple. For example, a 7-year item of property is depreciable over an 8-year period according to the following percentages in the table: 14.29%, 24.49%, 17.49%, 12.49%, 8.93%, 8.92%, 8.93%, and 4.46%. Note that except for the first year, the deductions for the first few years are higher. This favors the taxpayer who wants the tax benefits as soon as possible. That's why the system is called "accelerated." So a machine placed in service in Year 1 with a basis (cost) of $100,000, would generate a depreciation deduction of $14,290 in Year 1 (14.29% X $100,000); $24,490 in Year 2, and so on. If you don't use the "Table" method, you will generally be using "straight line." This means the basis is spread evenly over the depreciation period. A five year asset will get 20% a year for five years. However, because the mid-year convention applies (as discussed immediately below), the asset is treated as placed in service in the middle of the first year,
Background image of page 1

Info iconThis preview has intentionally blurred sections. Sign up to view the full version.

View Full DocumentRight Arrow Icon
Image of page 2
This is the end of the preview. Sign up to access the rest of the document.

Page1 / 3

Depreciation, or Cost Recovery - Depreciation, or Cost...

This preview shows document pages 1 - 2. Sign up to view the full document.

View Full Document Right Arrow Icon
Ask a homework question - tutors are online