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Unformatted text preview: * C HAPTER NINE * CAPITAL RECOVERY: DEPRECIATION, AMORTIZATION, AND DEPLETION SOLUTIONS TO PROBLEM MATERIALS DISCUSSION QUESTIONS 9-1 Section 167 sets forth the basic requirements, stating that a depreciation deduction is allowed for the exhaustion, wear and tear, and obsolescence of property that is either used in a trade or business or held for the production of income. The regulations further state that only property that has a determinable life can be depreciated. Property must be used for business or income-producing purposes, at least in part, to be eligible for depreciation. [See p. 9-3, 167(a), and Reg. 1.167(a)-2.] 9-2 a. Land is not depreciable because it does not have a determinable life. [See p. 9-3, 167, and Reg. 1.167(a)-2.] b. If a single asset is used for both personal and profit-seeking activities, the taxpayer may deduct depreciation on the portion of the asset used for business or production of income. Here, the taxpayer cannot deduct depreciation for the half of the duplex he lives in because this is personal use of the asset. He can deduct depreciation for the half he rents out, as this property is used for the production of income. (See Example 1 and p. 9-3.) c. As in part (b), the taxpayer can deduct depreciation on the portion of the asset used in business or for the production of income. Here, the taxpayer can deduct depreciation on the portion of the residence she uses as a home office. (See Example 1 and p. 9-3.) d. Taxpayer can deduct depreciation on property that was formerly used for personal purposes (e.g., a residence) and has been converted to business or production of income use. A depreciation deduction can be taken on a former residence held out for rental use (i.e., production of income), even if the property has not yet been rented. [See p. 9-4 and Reg. 1.167(a)-10.] e. As in part (d), where property used for personal use is converted to business or production of income use, depreciation can be deducted on that property. (See Example 2 and p. 9-4.) f. For many years, covenants not to compete could be amortized over their useful life. In contrast, goodwill could not be amortized since it did not have a determinable life. However, since 1993 197 has permitted amortization of both intangibles over 15 years regardless of their actual life. [See p. 9-40 and 197.] g. If the standard mileage rate is used to compute the deduction for business or income-producing usage of an automobile, no depreciation deduction can be taken. The decline in value (i.e., depreciation) is already included in the standard mileage rate. (See Chapter 8) 9-3 Depreciation denotes the process by which expenditures for tangible property with a determinable life are systematically and rationally allocated to the periods that the property benefits. Amortization is the same process applied to intangible assets with determinable lives, such as patents or copyrights. Depletion is the method of recovering the cost of investments in natural resources, such as oil, gas,...
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