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Chapter 9 Capital Recovery: Depreciation, Amortization, & Depletion Amortize Deplete Depreciate Asset Breakdown Overview Intangible Tangible Natural Resources Everything Else Realty Personalty 3, 5, 7 10, 15, 20 MACRS Statutory Period

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Chapter 9 l.jpg

Chapter 9

Capital Recovery: Depreciation, Amortization, & Depletion


Asset breakdown overview l.jpg

Amortize Deplete Depreciate

Asset Breakdown Overview

Intangible Tangible

Natural Resources

Everything Else

Realty Personalty

3, 5, 7

10, 15, 20

MACRS

  • Statutory Period

  • Est Useful Life

  • If no EUL = 0

  • % Depletion

  • Cost Depletion

27.5

39


History of depreciation methods l.jpg
History of Depreciation Methods Depreciate

  • Revenue Act of 1913:

    • “Reasonable allowance for depreciation”

    • Taxpayer could choose rates

    • Controversies over rates and salvage

    • 1971 Class Life System with ADR or F&C

  • 1981-Present: ’81 ACRS and ’86 MACRS

    • Eliminates estimates

    • Specifies recovery period (useful life)

    • No salvage value


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History of Depreciation Methods Depreciate

  • Revenue Act of 1913:

    • “Reasonable allowance for depreciation”

    • Taxpayer could choose rates

    • Bulletin F, 1920

  • 1933: New Deal Financing

    • Taxpayer to prove reasonableness of rates

    • Bulletin F revised -- specified unusually long “reasonable lives”

    • Controversies over rates and salvage value


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History of Depreciation Methods Depreciate

  • 1953 - 1980

    • Accelerated methods allowed, 1954

    • AFY - 1954

    • IRS given burden of proof on rates

    • 1962: Rev. Proc. 62-21: more reasonable useful lives specified

    • 1971 Class Life System with ADR or F&C

  • 1981-Present: ’81 ACRS and ’86 MACRS

    • Eliminates estimates

    • Specifies recovery period (useful life)

    • No salvage value


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MACRS Depreciation Depreciate


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Sec. 167 Depreciation Depreciate

  • General rule

  • There shall be allowed as a depreciation DEDUCTION a reasonable allowance for the exhaustion wear and tear (including a reasonable allowance for obsolescence) OF

  • Property used in a TRADE OR BUSINESS;

  • Property held for the PRODUCTION OF INCOME


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Sec. 167 Depreciation DepreciateWhat is Eligible for Depreciation?

  • Property used in a TRADE OR BUSINESS;

  • Property held for the PRODUCTION OF INCOME

  • ADDITIONAL CONSIDERATIONS

    • Dual use property: business and personal

    • Converted property

    • Gifted

    • Determinable life required


Macrs l.jpg
MACRS Depreciate

  • Property not covered by MACRS

    • Pre-1981 property

    • Property depr. with nontime-based methods, e.g. units of production, standard mileage rates

    • Special public utility property and specified amortization property (leasehold improvements & rehab expenditures on low income housing)

    • Videotapes & motion picture films

    • Intangible assets


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Problem 9-2 Depreciate

Indicate whether a taxpayer could claim deductions for depreciation or amortization of the following property:

a. Land used in the taxpayer’s farming business.

b. A duplex—taxpayer lives in one half while he rents the other half out.

c. Portion of the taxpayer’s residence that she uses as a home office.

d. Taxpayer’s former residence, which he listed for rental temporarily until he is able to sell it. The residence was listed in late November and was not rented as of the end of the taxable year.

e. A mobile home that the taxpayer initially purchased and used while he was in college and this year began renting to several students.

f. The costs attributable to goodwill and a covenant not to compete.

g. An automobile used for business. The taxpayer accounts for his deductible car expenses using the standard mileage rate.


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Problem 9-27 Depreciate

F purchased a mobile home to live in while at college. The home cost $12,000. When he graduated, he left the home in the trailer park and rented it. At the time he converted the home to rental property, it had a fair market value of $10,000. What is F’s basis for depreciation?

$10,000. F must use lesser of FMV or basis at time of conversion

Same as above except the value of the home at the time it was converted was $18,000. What is F’s basis for depreciation

12,000. F must use lesser of FMV or basis at time of conversion

F now lives 75 miles away from his alma mater. Can he deduct the cost of traveling back to check on his rental property (including those trips on which he also attended a football game)?

Yes. Because the property is held for the production of rents, the traveling expenses incurred to check on his property are deductible for A.G.I. It is irrelevant that the property is near his alma mater.


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Depreciation Methods Depreciate

1981- Present: ’81 ACRS and ’86 MACRS

  • Eliminates estimates

  • Specifies recovery period (useful life)

  • No salvage value

  • Simplicity at its best


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Calculation of Depreciation Depreciate

Depreciable unadjusted basis

x Percentage for year

Annual depreciation

Depends on type of property:

Recovery period, method, conventions


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Recovery Period and Method Depreciate

  • Rev. Proc. 87-56

    • Specifies recovery period

    • Periodically updated by rulings, etc.

  • Excerpt of Rev. Proc. 87-56


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Exhibit 9-2: Excerpt from Rev Proc. 87-56 DepreciateRecovery PeriodAsset GDS ADSClassDescription of Assets Included Class Life System System SPECIFIC DEPRECIABLE ASSETS USED IN ALLBUSINESS ACTIVITIES, EXCEPT AS NOTED:

00.11 Office Furniture, Fixtures, and Equipment:

Includes furniture and fixtures that are not structural com-

ponents of a building. Includes such assets as desks,

files, safes, and communications equipment…. 10710

00.13Data Handling Equipment, except Computers: Includes only typewriters, calculators, adding and ac-

counting machines, copiers, and … 6 5 600.21 Airplanes … 6 5 6

00.22 Automobiles, Taxis3 5 5

00.23 Buses 9 5 9

00.241 Light General Purpose Trucks: 4 5 5


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Exhibit 9-3 Examples of MACRS Property Depreciate

Class Examples

  3 yrs Special tools, race horses, tractors, class life of 4 yrs or less

5 yrs Automobiles, trucks, computers and peripheral equipment (such as printers, external disk drives, and modems), typewriters, copiers, R&E equipment, class life of > 4 years and < 10 yrs

7 yrs Office furniture, fixtures, office equipment, most machinery, class life of > 10 yrs but < 16 yrs, property no assigned class life

10 yrs Single-purpose agricultural and horticultural structures, …

15 yrs Land improvements (e.g., sidewalks, roads, parking lots, irrigation systems, sewers, fences, landscaping), service stations, billboards, …and class life of > 20 yrs and < 25 yrs

27.5 yrs Residential rental real estate, apartment buildings, duplexes, etc.

39 yrs Nonresidential real estate, including office buildings, warehouses, factories and farm buildings


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Recovery Period and Method Depreciate

  • Rev. Proc. 87-56

  • Personal (non-realty) and some realty

    • 3, 5, 7 yr

    • 200% DB (may elect straight-line)

    • Convention:

      • Half-year:

        • ½ yr of depreciation in yr of acquisition and disposition

      • Mid-quarter

        • ½ qtr of depreciation for qtr of acquisition and disposition

  • Realty

    • Residential 27.5 yrs, nonresidential 39 years

    • Straight-line

    • Convention:

      • Mid-month

        • ½ month of depreciation in month of acquisition and disposition


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Exhibit 9-4: Depreciate

MACRS Depreciation Percentages Using DDB and Half-Year Convention for 3, 5, 7 Year Property

Year 3-Year 5-Year 7-Year

1 33.33% 20.00% 14.29%

2 44.45 32.00 24.49

3 14.81 19.20 17.49

4 7.41 11.52 12.49

5 11.52 8.93

6 5.76 8.92

7 8.93

8 4.46

.


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Exhibit 9-4: Depreciate

MACRS Depreciation Percentages Using DDB and Half-Year Convention for 3, 5, 7 Year Property

Year 3-Year 5-Year 7-Year

 1 20.00%

Recovery period 5 yrs

Straight line ANNUAL rate 1/5 = 20%

Double declining balance x 2

Annual DDB rate 40%

Half year convention x ½

First year rate 20%


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Exhibit 9-4: Depreciate

MACRS Depreciation Percentages Using DDB and Half-Year Convention for 3, 5, 7 Year Property

Year 3-Year 5-Year 7-Year

1 20.00%

2 32.00

Year 2

Straight line ANNUAL rate 1/5 = 20%

Double declining balance x 2

Annual DDB rate 40%

Declining balance (100% - 20% yr 1) x 80%

Year 2 rate 32%

Note this rate is applied to unadjusted basis and NOT the declining balance!


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Double Declining Balance Depreciation with a Change to SL Example

Asset with 5 year life, $20,000 purchase cost.

Step 1: Calculate Rate

1/years useful life = 1/5 = 20%

2 x 1/5 = 2/5 = 40% is DDB


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Double Declining Balance Depreciation with a Change to SL Example

Step 2: Calculate depreciation:

Undep. Depr.

Year Balance Rate Exp.

1 $20,000 X 40% = $8,000

2 12,000 X 40% = 4,800

3 7,200 X 40% = 2,880

* 4 4,320 X 1/2 = 2,160

5 2,160 X remainder = 2,160

$20,000

* DDB would be $4,320 X 40% = $1,728

Change to SL with 2 yrs. life remaining gives greater depreciation: $4,320/2 = $2,160. Tables automatically switch.


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ACRS/MACRS ExampleDepreciation of Real Property Post 1980


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Exhibit 9-5: Example

MACRS Residential Realty (Post 1986 SL 27.5 Yr) Using Mid-Month Convention

Month Placed

in Service 1 2 3-26 27 28 29

1 3.485% 3.636% 3.636% 3.636% 1.970% 0.000%

2 3.182 3.363 3.636 3.636 2.273 0.000

3 2.879 3.636 3.636 3.636 2.576 0.000

4 2.576 3.636 3.636 3.636 2.879 0.000

5 2.273 3.636 3.636 3.636 3.182 0.000

6 1.970 3.636 3.636 3.636 3.485 0.000

7 1.667 3.636 3.636 3.637 3.636 0.152

8 1.364 3.636 3.636 3.637 3.636 0.455

9 1.061 3.636 3.636 3.637 3.636 0.758

10 0.758 3.636 3.636 3.637 3.636 1.061

11 0.455 3.636 3.636 3.637 3.636 1.364

12 0.152 3.636 3.636 3.637 3.636 1.667

.


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Exhibit 9-5: Example

MACRS Residential Realty (Post 1986 SL 27.5 Yr) Using Mid-Month Convention

Month Placed

in Service 1 2 3-26 27 28 29

1 3.485% 3.636% 3.636% 3.636% 1.970% 0.000%

2 3.182 3.363 3.636 3.636 2.273 0.000  

.

Recovery period 27.5 yrs

Straight line ANNUAL rate 1/27.5 = 3.636%

Mid-month convention (1/2 for month of acquisition + 10) x 10.5/12

First year rate 3.182%


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Exhibit 9-6: Example

MACRS Nonresidential Realty (Post 1986 SL 39 Yr) Using Mid-Month Convention

Month Placed Yr YrYr

in Service 1 2-3940

1 2.461% 2.564% 0.107%

2 2.247 2.564 0.321

3 2.033 2.564 0.535

4 1.819 2.564 0.749

5 1.605 2.564 0.963

6 1.391 2.564 1.177

7 1.177 2.564 1.391

8 0.963 2.564 1.605

9 0.749 2.564 1.819

10 0.535 2.564 2.033

11 0.321 2.564 2.247

12 0.107 2.564 2.461

.


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Mid-Quarter Convention Example

  • If > 40% of aggregate bases of all tangible personal property is placed in service during the year is placed in service in the last three months of the year, a mid-quarter convention will apply:

    • 1st qtr. gets 3.5 qtrs. depr. (87.5%)

    • 2nd qtr. gets 2.5 qtrs. depr. (62.5%)

    • 3rd qtr. gets 1.5 qtrs. depr. (37.5%)

    • 4th qtr. gets 0.5 qtrs. depr. (12.5%)


Mid quarter convention28 l.jpg

Mid-Quarter Convention Example

Quarter Placed in Service First Second Third FourthJan-MarApr-JunJul-SepOct-Dec

3.5 quarters2.5 quarters1.5 quarters0.5 quarters

4 4 4 4

Percent of annual

Depreciation Allowed 87.5% 62.5% 37.5% 12.5%


Mid quarter convention example l.jpg
Mid Quarter Convention Example Example

Four machines placed in service during the year. All are 7 year property.

Machine Cost Date put in service

A 10,000 Jan. 10

B 5,000 July 1

C 20,000 Oct. 15

D 5,000 Dec. 1

40,000

20,000 + 5,000 = 25/40 = 62.5% > 40%, thus mid-quarter convention applies

Machine Date Qtr Factor X Basis Depr.

A 1/10 1 25% 10,000 2,500

B 7/1 3 10.71 5,000 536

C 10/15 4 3.57 20,000 714

D 12/1 4 3.57 5,000 179

Total depreciation. $3,939


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Exhibit 9 - 7: Example

MACRS Depreciation Percentages Using DDB and Mid Quarter Convention for 3 and 5 Year Property

3-year property:

Quarter Placed in Service

Recovery

Year 123 4

1 58.33% 41.67% 25.00% 8.33%

2 27.78 38.89 50.00 61.11

3 12.35 14.14 16.67 20.37

4 1.54 5.30 8.33 10.19

5-Year Property:

1 35.00 25.00 15.00 5.00

2 26.00 30.00 34.00 38.00

3 15.60 18.00 20.40 22.80

4 11.01 11.37 12.24 13.68

5 11.01 11.37 11.30 10.94

6 1.38 4.26 7.06 9.58

.


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Exhibit 9 - 7: Example

MACRS Depreciation Percentages Using DDB and Mid Quarter Convention for 3 and 5 Year Property

3-year property:  

Quarter Placed in Service

Recovery

Year 123 4

1 58.33% 41.67% 25.00% 8.33%

.

Recovery period 3 yrs

Straight line ANNUAL rate 1/3 = 33%

Double declining balance x 2

Annual DDB rate 66%

Mid quarter convention x 3.5/4

First year rate 58.33%


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Problem 9-28 Example


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Problem 9-28 Example

T decided to move her insurance business into another office building. She purchased a used building for $70,000 on March 15. T also purchased new office furniture for the building. The furniture was acquired for $20,000 on May 1. The first‑year expensing option is not elected, yet T wants to depreciate her assets as rapidly as possible.

Depreciation for first year:

Used office building placed in service in March

Property type: Office building is nonresidential

New or used: Irrelevant (except for bonus & N/A to buildings)

Life: 39 yrs

Method: Post 1986: Straight-line

Convention:mid-month (1/2 mth for mth placed in service & yr of sale)

Salvage value: irrelevant

Depreciation Rate: 1/39 annual SL rate x (.5 month for March + 9 months = 9.5)/12 =2.033%

Building: $70,000 x 2.033% = $1,423


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Problem 9-28 (cont.) Example

Exhibit 9-6:

MACRS Nonresidential Realty (Post 1986 SL 39 Yr) Using Mid-Month Convention

Month Placed Yr YrYr

in Service 1 2-3940

1 2.461% 2.564% 0.107%

2 2.247 2.564 0.321

3 2.033 2.564 0.535

4 1.819 2.564 0.749

5 1.605 2.564 0.963

6 1.391 2.564 1.177

7 1.177 2.564 1.391

8 0.963 2.564 1.605

9 0.749 2.564 1.819

10 0.535 2.564 2.033

11 0.321 2.564 2.247

12 0.107 2.564 2.461

.


Problem 9 28 cont l.jpg

Problem 9-28 (cont.) Example

Depreciation for first year:New furniture placed in service in May; cost $20,000

Property type: 7-year

New or used: Relevant for bonus depreciation

Life: 7 yrs

Method: DDB

Convention: Which convention applies: half year or mid-quarter?

Was > 40% of PERSONALTY placed in service in last 3 months of year?

Half-year: ½ year for year placed in service and year of sale

Salvage value: Irrelevant

Depreciation Rate: 1/7 annual SL rate x 2 DDB x ½ half-year convention = 14.29%

Furniture: $20,000 x 14.29% = $2,858


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Problem 9-28 (cont.) Example

Exhibit 9-4:

MACRS Depreciation Percentages Using DDB and Half-Year Convention for 3, 5, 7 Year Property

Year 7-Year

1 14.29%

2 24.49

3 17.49

4 12.49

5 8.93

6 8.92

7 8.93

8 4.46

.


Problem 9 28 cont37 l.jpg

Problem 9-28 (cont.) Example

Depreciation for 2nd year:

Used office buildingplaced in service in March

Property type: Office building is nonresidential

New or used: Irrelevant (except for bonus & N/A to buildings)

Life: 39 yrs

Method: Post 1986: Straight-line

Convention:mid-month (1/2 month for month placed in service & yr of sale)

Salvage value is irrelevant

Depreciation Rate: 1/39 annual SL rate x 12/12 = 2.564 %

Building: $70,000 x 2.564% = $1,795


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Problem 9-28 (cont.) Example

Exhibit 9-6:

MACRS Nonresidential Realty (Post 1986 SL 39 Yr) Using Mid-Month Convention

Month Placed Yr YrYr

in Service 1 2-3940

1 2.461% 2.564% 0.107%

2 2.247 2.564 0.321

3 2.033 2.564 0.535

4 1.819 2.564 0.749

5 1.605 2.564 0.963

6 1.391 2.564 1.177

7 1.177 2.564 1.391

8 0.963 2.564 1.605

9 0.749 2.564 1.819

10 0.535 2.564 2.033

11 0.321 2.564 2.247

12 0.107 2.564 2.461

.


Problem 9 28 cont39 l.jpg

Problem 9-28 (cont.) Example

Depreciation for 2nd yr:

New furniture placed in service in May

Property type: 7-year

New or used: Relevant for bonus depreciationLife: 7 yrsMethod: DDBConvention: Half-yearSalvage value: IrrelevantDepreciation Rate: 1/7 annual SL rate x 2 DDB x (100% - 14.29% = 85.71) = 24.49%

Furniture: $20,000 x 24.49% = $4,898


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Problem 9-28 (cont.) Example

Exhibit 9-4:

MACRS Depreciation Percentages Using DDB and Half-Year Convention for 3, 5, 7 Year Property

Year 7-Year

1 14.29%

2 24.49

3 17.49

4 12.49

5 8.93

6 8.92

7 8.93

8 4.46

.


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Problem 9-28 (cont.) Example

Depreciation for 3rd yr:

Used office building placed in service in March and SOLD on 7/20

Property type: Office building is nonresidentialNew or used: Irrelevant (except for bonus depreciation)Life: 39 yrsMethod: Post 1986: Straight-lineConvention: mid-month (1/2 month for month placed in service and sold)Salvage value is irrelevantDepreciation Rate: 1/39 annual SL rate = 2.564% x half-month for July disposition 6.5/12

Building: $70,000 x 2.564% x 6.5/12 = $ 972


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Problem 9-28 (cont.) Example

Exhibit 9-6:

MACRS Nonresidential Realty (Post 1986 SL 39 Yr) Using Mid-Month Convention

Month Placed Yr YrYr

in Service 1 2-3940

1 2.461% 2.564% 0.107%

2 2.247 2.564 0.321

3 2.033 2.564 0.535

4 1.819 2.564 0.749

5 1.605 2.564 0.963

6 1.391 2.564 1.177

7 1.177 2.564 1.391

8 0.963 2.564 1.605

9 0.749 2.564 1.819

10 0.535 2.564 2.033

11 0.321 2.564 2.247

12 0.107 2.564 2.461

.


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Problem 9-28 (cont.) Example

Depreciation for 3rd yr:

New furniture placed in service in May and SOLD July 20

Property type: 7-yearNew or used: Relevant for bonus depreciationLife: 7 yrsMethod: DDBConvention: Half-year in year placed in service and year of saleSalvage value: IrrelevantDepreciation Rate: 1/7 SL rate x 2 DDB x (100% - 14.29% -24.49% = 61.22%) = 17.49%

Furniture:

$20,000 x 17.49% x ½ yr convention in yr of sale = $1,749

Annual Rate


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Problem 9-28 (cont.) Example

Exhibit 9-4:

MACRS Depreciation Percentages Using DDB and Half-Year Convention for 3, 5, 7 Year Property

Year 7-Year

1 14.29%

2 24.49

3 17.49

4 12.49

5 8.93

6 8.92

7 8.93

8 4.46

.


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Problem 9-28 (d) Example

Depreciation for first year:New furniture placed in service in October; cost $20,000

Property type: 7-year

New or used: Relevant for bonus depreciationLife: 7 yrsMethod: DDBConvention: Which convention applies: ½ yr or mid-quarter?

Was > 40% of PERSONALTY placed in service in last 3 months of year? Yes

Mid-quarter: ½ quarter for quarter of year placed in service and year of saleSalvage value: IrrelevantDepreciation Rate: 1/7 annual SL rate x 2 DDB x ½ x 1/4 mid qtr convention = 3.57%

Furniture: $20,000 x 3.57% = $2,858


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Problem 9-28(d) Example

Appendix C-9:

MACRS Depreciation Percentages Using DDB and Mid Quarter Convention for 7 Year Property

7-year property:  

Quarter Placed in Service

Recovery

Year 123 4

125.0017.85 10.713.57

2 21.43 23.47 25.51 27.55

3 15.31 16.76 18.22 19.68

4 10.93 11.37 13.02 14.06

5 8.75 8.87 9.30 10.04

6 8.74 8.87 8.85 8.73 7 8.75 8.87 8.86 8.73 8 1.09 3.33 5.53 7.64

.


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Problem 9-28(d) Example

Depreciation for 2nd year:New furniture placed in service in October; cost $20,000

Property type: 7-year

New or used: Relevant for bonus depreciationLife: 7 yrsMethod: DDBConvention: Which convention applies: ½ yr or mid-quarter?

Was > 40% of PERSONALTY placed in service in last 3 months of year? Yes

Mid-quarter: ½ quarter for quarter of year placed in service and year of saleSalvage value: IrrelevantDepreciation Rate: 1/7 annual SL rate x 2 DDB = 2/7 x (100% - 3.57% = 96.43%) = 27.55%

Furniture: $20,000 x 27.55% = $5,510


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Problem 9-28(d) (cont.) Example

Appendix C-9:

MACRS Depreciation Percentages Using DDB and Mid Quarter Convention for 7 Year Property

7-year property:  

Quarter Placed in Service

Recovery

Year 123 4

 1 25.00 17.85 10.71 3.57

2 21.43 23.47 25.51 27.55

3 15.31 16.76 18.22 19.68

4 10.93 11.37 13.02 14.06

5 8.75 8.87 9.30 10.04

6 8.74 8.87 8.85 8.73 7 8.75 8.87 8.86 8.73 8 1.09 3.33 5.53 7.64

.


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Problem 9-28 (cont.) Example

Depreciation for 3rd year:New furniture placed in service in October; sold July

Property type: 7-year

New or used: Relevant for bonus depreciationLife: 7 yrsMethod: DDBConvention: Which convention applies: ½ yr or mid-quarter?

Was > 40% of PERSONALTY placed in service in last 3 months of year? Yes

Mid-quarter: ½ quarter for quarter in year of saleSalvage value: IrrelevantDepreciation Rate: 1/7 SL rate x 2 DDB = 2/7 x (100% - 3.57 - 27.55 = 68.88) = 19.68% annual rate

Annual rate 19.68% x mid qtr convention 2.5/4

Furniture: $20,000 x 19.68% x 62.5% = $2,460


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Appendix Example C-9:

MACRS Depreciation Percentages Using DDB and Mid Quarter Convention for 7 Year Property

7-year property:  

Quarter Placed in Service

Recovery

Year 123 4

 1 25.00 17.85 10.71 3.57

2 21.43 23.47 25.51 27.55

3 15.31 16.76 18.22 19.68

4 10.93 11.37 13.02 14.06

5 8.75 8.87 9.30 10.04

6 8.74 8.87 8.85 8.73 7 8.75 8.87 8.86 8.73 8 1.09 3.33 5.53 7.64

.



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MACRS Straight-line option Example

  • The straight-line depreciation election must be made for all TPP property within a recovery class placed in service during the year.

  • One recovery class may be depreciated using the SL option, while another may be depreciated using regular or MACRS

For assets place in service after 1986, the SL life of the asset, e.g., a 7-yr. class life asset must be depreciated over 7 years.

The election is binding on the assets placed in service in the year of the election; it is not binding on the same class of assets placed in service in future years


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Alternative Depreciation System (ADS) Example

  • Defined

    • Straight-line alternative to MACRS

      • Required in some cases

      • May elect

    • Method: straight line rather than DDB

    • Recovery periods: longer than MACRS

    • Conventions: same as MACRS


Alternative depreciation system ads54 l.jpg
Alternative Depreciation System (ADS) Example

ADS recovery period is property’s class life unless

  • No class life or

    (2) A special class life has been designated

    Recovery Type of Property Period (yrs)

    Personal property with no class life 12

    Nonresidential real property with no class life 40

    Residential rental property with no class life 40

    Cars, light general‑purpose trucks, certaintechnological equipment, ….. 5

    Computer‑based telephone switching equipment 9.5

    Railroad track 10

    Single‑purpose agricultural or horticultural structures 15

    Municipal wastewater treatment plants, etc. 24

    Low‑income housing financed by tax‑exempt bonds 27.5

    Municipal sewers 50


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Alternative Depreciation System (ADS) Example

  • Listed property used < 50% for business

  • Recovery of cost of property used outside the U.S. (more than half of the tax year)

  • Tax-exempt use of property (property leased by a tax-exempt entity)

  • Property financed with tax-exempt bonds

  • Designated imported property (from countries which restrict U.S. imports)

  • Computing E&P and AMT depreciation

  • Mandatoryfor

  • Elective for all other depreciable property


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Section 179 Example


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Section 179 Expensing Example

  • General Rule:

    • Expense, rather than capitalize and depreciate, acquisitions of certain PERSONAL property

    • Portion not expensed can be depreciated

YearAmount that may be expensed

2008 $128,000

2009 $250,000


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Problem 9‑35 Example

N purchased duplicating equipment to use in his business. He purchased the equipment on June 3 of the current year for $300,000. N elects to expense the maximum amount allowable with respect to the equipment.

a.What portion of the cost of the equipment may N expense for year?

Up to $250,000

b.Compute N’s depreciation deduction for the current year.Ignoring bonus depreciation

Original cost $300,000

Portion elected to expense (250,000) $250,000

Unadjusted basis for recovery $50,000 Recovery percentage for 5‑year property X 20%

Depreciation deduction $ 10,00010,000

N’s total depreciation deduction is $260,000


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Section 179 Expensing Example

  • Eligible property

    • Depreciable

    • Used in a trade or business NOT investment

    • Acquired by purchase from an unrelated party

  • Ineligible property

    • Most buildings

    • Certain property related to furnishing lodging

  • Recapture

    • Must continue to use the property for 2 taxable yrs

    • Failure to continue use: include in income amount deducted less depreciation


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Section 179 Expensing Example

  • Limitations:

    • Expense allowance reduced $-for-$ for acquisitions of ELIGIBLE property over $800,000 for 2009

      • Example:

      • $900,000 in asset additions. What is the §179 amount?

      • $150,000 [$250,000 – ($900,000 - $800,000 = $100,000)]

    • The amount expensed may not exceed taxable income.

      • Indefinite carryover is permitted

      • Example:

      • $105,000 in asset additions qualifies for § 179 expensing, $25,000 of taxable income. What is the deduction?

      • $25,000; $80,000 carries over subject to limitation next year.

    • Amount expensed under §179 is considered depreciation

    • No further depreciation is taken on the amount expensed



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Problem 9‑33 Example

Indicate whether T may elect to use the limited‑expensing provisions of § 179. Assume acquisition qualifies unless otherwise indicated.

a.T is a corporate taxpayer.

YES; §179 available to all taxpayers except estates/trusts.

b. This year, T purchased a $300,000 building and $50,000 of equipment.

YES; only the equipment; buildings are not eligible

c. T suffered a net loss of $40,000 this year before consideration of §179 deduction.

No; insufficient taxable income.

d. T purchased the asset on the last day of the taxable year.

YES


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Problem 9‑34 Example

For each of the following assets, indicate whether the taxpayer mayelect to expense a portion or all of the asset’s cost.

A $10,000 car used 75% for business and 25% for personal.

Depreciable basis is $7,500 (75% of cost). If a computer instead of a car, the entire $7,500 basis could be expensed. But for cars, §280F limits the total write‑off in the first year (depreciation plus limited expensing) to $2,220 (75% x $2,960 increased for 2007).

A home computer used by the taxpayer to maintain records and perform financial analyses with respect to her investments.

No; not used in a trade or business

An apartment building owned by a large property company.

No; buildings are not eligible

A roll‑top desk purchased by the taxpayer’s father, who gave it to the taxpayer to use in her business.

No; must be acquired by purchase from unrelated 3rd party


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Bonus ExampleDepreciation


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Bonus Depreciation Example

Additional first year depreciation for qualified property

Amount allowed:

50% x Adjusted Basis (after § 179).

Allowed in addition to § 179 and normal MACRS

No overall limitation

Only for property placed in service in 2008 & 2009

Qualified property


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Bonus Depreciation Example

Qualified property

Only new property qualifies (other than realty).

Used property does not qualify.

The property’s first or original use must commence with the taxpayer after 12/31/07

Property eligible for MACRS with recovery period of 20 yrs or less (business and investment property)

Capital expenditures to recondition or rebuild property meet the “new” requirement but purchase of such property is not qualified

Property that must be depreciated using ADS not qualified

ADS is required for tangible property (e.g., a machine) used predominantly outside of the U.S.


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Bonus Depreciation Example

Truck #1Truck #2Adjusted basis $200,000 $200,000

§ 179 expense (100,000) $100,000       ––

Remaining basis $100,000 $200,000

Additional allowance x 50% x 50%

Bonus depreciation $50,000 50,000 $100,000 $100,000

Remaining basis $50,000 $100,000

Regular depreciation x 20% x 20%

Regular depreciation $10,000 10,000 $20,000 20,000

Total deduction $160,000$120,000



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Sec. 280F: Luxury Automobiles Example

  • Automobiles Effected

  • Passenger automobiles

  • Includes any 4-wheeled vehicle for use on public streets, roads, and highways weighing no greater than 6,000 lbs.

  • Not ambulance, hearse, vehicles used by the taxpayer directly in the trade or business of transporting persons for compensation (taxis, jitney) or commuter highway vehicles

  • For 2009, any of the above if the cost exceeds $14,800 ($2,960/20%)


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Sec. 280F: Luxury Automobiles Example

  • Limitation on Depreciation and § 179 Expense

Trucks Taxable Year2009 LimitVans

1 $2,960* Special 2 4,800 3 2,850 Thereafter 1,775

* Increase by $8,000 if bonus applies

  • Note: standard mileage rate includes depreciation & §179 expense

  • Limitations must be adjusted for personal use

  • Example:

    • Car used 80% for business in year 1

    • Limit is 80% of normal amount in 2009 (80% * $2,960 = $2,368).


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Sec. 280F: TRUCKS AND VANS Example

  • Limitation on Depreciation and § 179 Expense

  • Built on truck chassis

Taxable Year2007 Limit

1 $3,060 Increase by $8,000 if bonus 2 4,900 3 2,950 Thereafter 1,775


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Problem 9‑12 Example

Luxury Cars. Indicate whether the following statements are true or false. If false, explain why.

a. W purchased a car used solely for business for $12,000. The limitations imposed by § 280F on deductions related to automobiles do not alter what W could claim in the year of acquisition.

False. Absent § 280F, in the year of acquisition, the taxpayer could elect to expense the entire cost of the car. Section 280F limits depreciation to $2,960 in the first year.

b. Pa Corporation is a distributor of hospital supplies. During the year, it purchased a $20,000 car for its best salesperson. Section 280F does not alter the total amount of depreciation deducted while P owns the car.

True. Section 280F alters only the timing of the depreciation deductions.


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Problem 9‑37 Example

In the current year, H purchased a new automobile for $30,000. The first‑year expensing election is not made.

a. Assuming the car is used solely for business, prepare a depreciation schedule illustrating the amount of annual depreciation to which H is entitled assuming he holds the car until the entire cost is recovered.

Yr 1 Yr 2 Yr 3 Yr 4 Yr 5 Yr 6 Yr 7 Yr 8 Basis 30,000 30,000 30,000 30,000 30,000 30,000 30,000 30,000

Depreciationpercentage 20%32%19.2%11.52%11.52%´5.76%MACRS 6,000 9,600 5,760 3,456 3,456 1,728 Limit 2,960 4,800 2,850 1,775 1,775 1,775 1,775 1,775Deduction 2,960 4,800 2,850 1,775 1,775 1,037 1,775 1,328RemainingBasis 27,040 22,240 19,390 17,615 15,840 14,112 12,237 10,562

FULLY DEPRECIATED IN YEAR 14


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Problem 9‑37 (cont.) Example

b. Same facts as (a) except car is used 80% for business and 20% for personal. Compute the current year’s depreciation deduction.

> 50% use thus can use § 179 and MACRS.

Adjust basis and limitation to reflect personal use. Adjusted basis $24,000 ($30,000 x 80%)

MACRS recovery % x 20%

MACRS depreciation $ 4,800

Limit ($2,960 x 80%) 2,368

Deduction $ 2,368

Same as (b) except the car is used 70% for business, 10% for production of income activities, and 20% for personal purposes.

“Business” use 70% > 50% thus can use § 179 and MACRS

Include production of income use of 10% to compute depreciation. Thus can depreciation 80%, same as above.


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Problem 9‑37 (cont.) Example

d. Same as (a) except used 40% business & 60% for personal purposes.

Not used > 50% for business; thus §179 and MACRS not allowed.

Must use ADS (straight-line + perhaps a longer life)

Adjust basis and limitation to reflect personal use.

Basis: $30,000 x 40% business use = $12,000

Limit: First year $2,960 x 40% = $1,184

Yr 1Yr 2Yr 3Yr 4Yr 5Yr 6Yr 7Yr 8Yr 9Basis 12,000 12,000 12,000 12,000 12,000 12,000ADS Dep % 10%20%20%20%20%10%

ADS Dep 1,200 2,400 2,400 2,400 2,400 1,200

Limit 1,184 1,920 1,140 710 710 710 710 710 710 Deduction 1,184 1,920 1,140 710 710 710 710 710 710 Remainingbasis 10,816 8,896 7,756 7,046 6,336 5,662 4,916 4,206 3,496

FULLY DEPRECIATED IN YEAR 14


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Sec. 280F: Luxury Automobiles Example

  • Leasing

  • To prevent taxpayers from avoiding these limitations by leasing, special rules apply

  • The taxpayer may deduct the lease expense in the normal fashion

  • The taxpayer is required to include an amount in income based on the value of the car.


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EXHIBIT 9-12 Example

LEASED LUXURY AUTOMOBILES: EXCERPT FROM INCOME INCLUSION TABLE FOR AUTO LEASES 2001

FMV of AutomobileYear of LeaseOverNot Over1st2nd3rd4th5th and Later15,500 $15,800 $3 $6 $9 $10 $ 12

18,000 18,500 25 54 79 95 109

27,000 28,000 102 223 330 396 457

30,000 31,000 127 278 412 493 570

35,000 36,000 169 369 548 656 75740,000 41,000 210 461 683 819 94645,000 46,000 252 552 819 982 1,133

240,000 250,000 1,917 4,202 6,233 7,474 8,629


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Deducting High Priced SUVs Example

Effect of increasing § 179 to its current level of $250,000

Absent special rule, could expense vehicles weighing over 6,000 since the automobile limitations do not apply to such vehicles

Now § 179 for SUV is limited to $25,000 (no adjustment for personal use)

Can also claim depreciation on remaining basis



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Listed Property Example

  • Listed Property includes:

  • Passenger automobiles

  • Other property used for transportation (motorcycles, boats, planes)

  • Computer or peripheral equipment unless used exclusively in a regular business establishment (includes home offices under Sec. 280A)

  • Property used for entertainment, recreation or amusement, unless used in a regular business establishment

  • Cellular phones


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Listed Property Example

  • Limitations: If listed

  • If “qualified business use”  50% in year the listed property is placed in service

    • No § 179 expensing; No MACRS

    • ADS depreciation required

  • “Qualified Business Use”

    • Includes only business use

      • Production of income use is not counted for 50% test but is included in calculating depreciation


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Listed Property Example

Example 1 of “Qualified Business Use”

Salesman purchases computer system for $3,000. He uses computer 60% of time to maintain client data and sales orders, and 20% of time to maintain books on rental properties.

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 was 20%, ADS would be required for 45% + 20% = 65% of asset; 35% would be personal use.


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Listed Property Example

  • Qualified Business Use for Employees

    • If taxpayer is an employee, use is not business use unless

      • For the convenience of the employer

      • Required for employment

        • Enables taxpayer to perform duties

        • Mere statement requiring employee to have a car is insufficient


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Listed Property: Recapture Example

  • If qualified business use > 50% first year but later falls to  50%, recapture rules require taxpayer to include in income the excess of MACRS deductions taken over what ADS deductions would have been

    Computation

    MACRS & SEC. 179 Deductions- ADS Income


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Problem 9‑14 Example

Indicate whether the following statements are true or false. If false, explain why.

a. J is a part‑time photographer. This year she purchased a camera that cost $1,000 for her videocassette recorder. Thirty percent of her usage was for business while the remainder was personal. J may use the accelerated depreciation recovery percentages of MACRS.

No; Under § 280F, camera is listed property because it is entertainment‑related equipment.

Not > 50% business use; may still depreciate using ADS straight line


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Problem 9‑14 Example

P, a proprietor, purchased computer equipment for $10,000 that he uses 50% for business. Under § 280F, the maximum deduction for depreciation and §179 in first year is $500, while without § 280F deduction would be $5,000.

Not > 50% business use; must use ADS: 10% x 50% x $10,000 = $500

If no §280F, § 179 would be $5,000

True


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Problem Example9‑14 (cont.)

C purchased computer equipment that he uses 60% for managing his investments and 35% in connection with a mail‑order business he operates out of his home. C may claim straight‑line depreciation deductions based on 95 % of the cost of the asset.

True. In applying the 50% test, only qualified business use is counted—Managing investments is not considered business use thus only 35% use in the mail-order business is counted which does not exceed 50%. Consequently, § 280F applies ADS must be used. In determining the asset’s depreciable basis, the time used for investment purposes is combined with qualified business use. Thus, 95 percent (60% + 35%) of the cost is subject to depreciation.


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Problem Example9‑14 (cont.)

G is employed as a research consultant for RND Corporation, a research institute. G uses the company’s computer at the office but often takes home work, which she does on her home computer. G’s use of her home computer for work done for her employer is qualified business use.

False. An employee’s use is considered “qualified business use” only if it is for the convenience of the employer and it is required as a condition of employment. Although it is not completely clear what these standards demand, the proposed regulations suggest that use such as C’s is not for her employer’s convenience nor is it required.


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Problem Example9‑14 (cont.)

T is a college professor who uses a computer, for which he properly claims deductions, to write textbooks in his home office. It is unnecessary for T to maintain records on business usage of the computer.

True. Because the computer is used exclusively at a regular business establishment—in this case a home office that satisfies the requirements of § 280A—it is not considered listed property.



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Amortization of Intangibles Example

  • MACRS does not apply to intangibles.

  • General rule: amortize straight-line over useful life. Example: patents and copyrights with specified life.

  • Special rules: §197 intangibles, leasehold improvements


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Amortization of Intangibles Example

  • Sec. 197 Intangibles

    • Goodwill, covenant not to compete, customer lists, know-how, etc.

    • Amortize over 15 years regardless of actual life

    • Effective for all acquisitions after 8/10/93.

    • Gain on disposition is §1231 or ordinary, depending on holding period.

    • Anti-churning rules for goodwill.


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Depletion Example

  • Defined: Depreciation of natural resources

  • Taxpayer may elect to compute depletion deduction in either of two ways:

    • Cost depletion:

      • Recover cost as mineral is produced

      • Deduction limited to basis

    • Percentage depletion:

      • Computed without reference to cost

      • Simply a percentage of the income derived from property

      • Functions much like an exclusion

      • Deduction is NOT limited to basis


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Cost Depletion Example

Cost depletion to recover only adjusted basis

Annual Cost Depletion

Unrecovered Basis estimated recoverable units

Number of units sold during the year

=

x


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Percentage Depletion Example

  • Formula:

    Gross income from mineralX Percentage rate specified by statute Percentage depletion deduction unless limited

  • Generally limited to 50% of taxable income from mineral properties

  • TP must reduce basis (not below 0) by depletion claimed

  • Depletion in excess of basis may be claimed


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Percentage Depletion Statutory Rates Example

Natural Resource Rate

  1. Gravel, sand, and other items 5

2. Shale and clay used for sewer pipes; or brick and clay, shale, and slate used for lightweight aggregates 7.5

3. Asbestos, coal, sodium chloride, etc. 10

4. Gold, silver, oil and gas, oil shale, copper, and iron ore from deposits in the U.S. 155. Sulfur and uranium and a series of minerals from deposits in the U.S. 226. Metals, other than those subject to 22% or 15% rate 14


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Percentage Depletion Example Example

15,000 barrels of oil is pumped and sold for $15/barrel

Gross revenues $225,000

Less: operating expenses (200,000)

Taxable inc. before depletion $25,000

Potential percentage depletion 15% x $225,000 = $33,750

50% of taxable income limitation 50% x 25,000 = $12,500

*Percentage depletion limited to $12,500

Taxable income after percentage depletion = (25,000 - 12,500)

= $12,500


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Research and Experimental Costs Example

Three alternatives:

  • Expense all nondepreciable costs immediately

  • Amortize over 60 months

  • Capitalize and do not amortize

    Taxpayer must follow one method consistently

    R&E Credit also available


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Expenses of Farmers and Ranchers Example

Expenses related to livestock

Costs of acquiring animals for breeding, dairy, work or sport are capital expenditures subject to depreciation

If raise animals for sale, inventory

Soil and water conservation, fertilizer, land clearing

Capitalize unless plan approved by Dept. of Agriculture

Must be in business of farming

Deductions limited to 25% of gross income from farming

No limitation on fertilizer, etc.

Land clearing costs are capitalized

Development costs

Capitalize or expense but certain limitations


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