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Chapter 10 . Cost Recovery on Property: Depreciation, Depletion, and Amortization. Murphy & Higgins, Concepts in Federal Taxation, 2012 edition. Concept Review. Capital recovery concept allows a taxpayer to recover all invested capital before income is taxed

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chapter 10

Chapter 10

Cost Recovery on Property: Depreciation, Depletion, and Amortization

Murphy & Higgins, Concepts in Federal Taxation, 2012 edition

© 20121 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

concept review
Concept Review
  • Capital recovery concept allows a taxpayer to recover all invested capital before income is taxed
    • An asset’s basis is the maximum investment that qualifies as capital for recovery
  • Legislative grace allows the capital to be recovered systematically over the life of the asset

© 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

methods of recovery
Methods of Recovery
  • Depreciation: used for tangible assets that
    • Are used for a business or production of income purpose
    • Have a determinable life
  • Depletion: used for wasting assets
  • Amortization: used for intangible assets

© 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

history of depreciation
History of Depreciation

Section 179 Election

to Expense Assets

1981

1987

MACRSBased on method and life prescribed by law;

less accelerated than ACRS

ACRSBased on method and life

prescribed by law

Based on facts and circumstances related to asset life and taxpayer’s situation

© 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

section 179 election
Section 179 Election
  • Taxpayer may elect to expense rather than capitalize qualifying property placed in service during the year
  • Promotes administrative convenience
  • Treated as a depreciation deduction

© 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

section 179 election qualified taxpayers
Section 179 ElectionQualified Taxpayers
  • In 2011, organizations may elect to deduct as an expense up to $500,000 in investment
  • Elements required for an activity to qualify under Section 179 election:
    • profit motivation
    • regularity
    • continuity of the taxpayer’s involvement

© 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

section 179 election qualified taxpayers7
Section 179 ElectionQualified Taxpayers
  • Activities that will not qualify for Section 179 election
    • hobby
    • amusement
    • similar motivations

© 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

section 179 election qualifying property
Section 179 ElectionQualifying Property
  • Tangible, personal property
    • Real estate does not qualify
  • Used in a trade or business
    • Investment property does not qualify

© 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

section 179 election deduction limitations
Section 179 ElectionDeduction Limitations
  • Limitations apply to each entity
  • Maximum deduction = $500,000
  • Deduction cannot exceed taxable income from the business
    • Excess may be carried forward

© 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

section 179 election deduction phase out
Section 179 ElectionDeduction Phase-Out
  • Deduction decreased if total cost of qualifying property placed in service exceeds $2,000,000
    • by $1 for every $1 of value over $2,000,000
    • thus, when total cost = $2,500,000,
    • deduction = $500,000 – ($2,500,000 - $2,000,000)

= $0

© 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

bonus depreciation
Bonus Depreciation
  • 100% for property acquired after 9/8/10 and before 1/1/12
  • 50% for property acquired after 12/31/11 and before 1/1/13
  • No purchase limit
  • No annual income restriction

© 2010 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

bonus depreciation qualified property
Bonus Depreciation Qualified Property
  • New MACRS property with life ≤ 20 years
  • MACRS water utility property
  • Computer software not acquired in the acquisition of all assets of a business
  • Qualified leasehold improvement property

© 2010 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

bonus depreciation non qualifying property
Bonus DepreciationNon-Qualifying Property
  • Property that must be depreciated using ADS
  • Property whose original use did not begin with the taxpayer

© 2010 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

bonus depreciation other rules
Bonus DepreciationOther Rules
  • Mandatory unless election not to claim is made
    • Election not to claim must be made for each class of property acquired during the year
  • Section 179 must be claimed before calculation of bonus depreciation
  • Bonus depreciation reduces depreciable basis

© 2010 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

macrs qualifying property
MACRSQualifying Property
  • MACRS applies to
    • New and used tangible, depreciable property
    • Used in a trade or business or for the production of income

© 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

macrs basis
MACRS Basis
  • Depreciable basis is
    • Asset’s original basis for depreciation (discussed in Chapter 9)
    • Reduced by any § 179 deduction
    • Reduced by any Bonus Depreciation
  • Adjusted basis is
    • Remaining unrecovered capital of an asset = asset basis minus accumulated depreciation

© 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

macrs recovery period
MACRSRecovery Period
  • Each asset must be placed in a MACRS class according to its class life
    • Most personal property is in a 3, 5, or 7 year class
    • Most land improvements and specialized property are in a 10, 15, or 20 year class
    • Real estate is in a 27.5, 31.5, or 39 year class

© 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

macrs conventions
MACRSConventions
  • Administrative convenience, three assumptions are made about the time property was placed in service during the year
    • Mid-year convention applies to all property except real estate
    • Mid-month convention applies to real estate only
    • Mid-quarter convention applies to some personal property

© 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

macrs mid year convention
MACRSMid-Year Convention
  • Assumes property is placed in service and will be disposed of at the mid-point of the year
    • One-half year depreciation allowed in the first year of service
    • One-half year depreciation allowed in the last year of service
  • IRS tables reflect the mid-year adjustment only for the first year

© 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

macrs mid month convention
MACRSMid-Month Convention
  • Assumes property is placed in service and will be disposed of at the mid-point of a month
    • One-half month allowed at the beginning
    • One-half month allowed at disposition
  • IRS tables reflect the adjustment only for acquisition

© 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

macrs mid quarter convention
MACRSMid-Quarter Convention
  • If > 40% of the total depreciable basis of all personal property is placed in service during the 4th quarter of the year, mid-quarter:
    • Assumes property is placed in service and will be disposed of at the mid-point of a quarter rather than at mid-year
    • Determine the 40% after taking §179 expense

© 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

depreciation method alternatives
Depreciation Method Alternatives
  • Regular MACRS
    • with Section 179
  • Straight-line MACRS
  • Straight-line Alternative Depreciation System (ADS)

© 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

regular macrs
Regular MACRS
  • Method is double declining balance
    • IRS tables provide the depreciation rate
      • Designed to permit full recovery of depreciable basis
      • Incorporate the conventions
  • Maximizes acquisition year deduction using the Section 179 election

© 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

straight line macrs
Straight-Line MACRS
  • Taxpayers may elect to use the slower straight-line method
    • Election is made each year
    • MACRS recovery periods are used
    • Mid-year convention applies

© 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

alternative depreciation system ads
Alternative Depreciation System (ADS)
  • Taxpayers may elect to use ADS
  • Use is mandatory for Alternative Minimum Taxable Income
  • Uses a longer recovery period than MACRS
  • Election is made on a class-by-class, year-by-year basis

© 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

limitations on listed property
Limitations on Listed Property
  • Most mixed-use property is considered listed property and subject to special limitations
    • Examples: automobiles, computers, etc.

© 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

limitations on listed property27
Limitations on Listed Property
  • Treatment depends on the percentage of business usage
    • if >50% business use, treated like other depreciable assets
    • if < 50% business use, deductions are limited to ADS without Section 179
    • In either case, only the business portion of the asset’s basis is depreciable

© 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

limitations on passenger autos
Limitations on Passenger Autos
  • Total amount of depreciation and § 179 expense that can be deducted is limited
    • Annual maximum limit set and linked to the year the car was placed in service
    • Annual limit is further reduced by the business use %

© 2012Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

adequate record keeping
Adequate Record Keeping
  • Listed property is subject to strict record keeping requirements
  • No deduction is allowed without proof of
    • Why? The business purpose of the use
    • What? The amount
    • When? The dates of use
    • Where? The reality of the use

© 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

depletion
Depletion
  • Basis of natural resource assets subject to wasting away is recovered using depletion
  • Basis used is generally fees paid to acquire a lease and the costs of the lease, exploration, and drilling
  • Computed using two methods
    • Figure both each year and use the largest as deduction

© 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

cost depletion method
Cost Depletion Method
  • Allocates unrecovered basis over the number of estimated units of resource

Unrecovered Basis

Estimated Recoverable Units

= Depletion per Unit

Cost Depletion= Depletion per Unit x # of Units Sold

© 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

percentage depletion method
Percentage Depletion Method
  • Also called Statutory depletion
  • Depletion is the lesser of
    • 50% of taxable income before depletion, or
    • Gross income from the sale of the natural resource times a statutory depletion rate
      • Different statutory % for each type of resource is given in IRS tables

© 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

amortization
Amortization
  • Basis of intangible assets is recovered using the straight-line method over the life of the asset
  • Intangible assets acquired through purchase generally use a 15 year life
  • Created assets and assets specifically excluded from use of the 15 year period are amortized over their legal life

© 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

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