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The American College: HS 321 Income Taxation

Objectives. State the history of cost recovery, and explain how accelerated cost recovery systems (ACRS and MACRS) allow the recovery of investment capital for income tax purposes.Explain depreciation recapture, and describe the election to expense certain depreciable business assets.. Objectives.

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The American College: HS 321 Income Taxation

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    1. The American College: HS 321 Income Taxation Class 7: Chapters 11 and 12 Cost Recovery Deductions

    2. Objectives State the history of cost recovery, and explain how accelerated cost recovery systems (ACRS and MACRS) allow the recovery of investment capital for income tax purposes. Explain depreciation recapture, and describe the election to expense certain depreciable business assets.

    3. Objectives Describe cost recovery limitations on certain depreciable assets collectively known as listed property, and explain the concept of amortizing certain intangible assets. Explain the limitations on passive-activity losses and credits.

    4. History of Depreciation Methods

    5. History of Depreciation Methods Pre-1981 1971 class life system with ADR or facts and circumstances 1981–present: ACRS/MACRS Eliminates estimates and salvage value Shortens recovery period 1986 TRA ’86: MACRS effective 1/1/87

    6. Calculating Depreciation

    7. Calculating Depreciation Cost — $10,000 Useful life — 5 years Recovery per year — $2,000

    8. ACRS and MACRS

    9. MACRS General concept Statutory life-mandatory “cost recovery” Prescribed depreciation rates No salvage value

    10. MACRS Property covered: MACRS applies to all T.P. (tangible property) that is Used in T/B or for production of income Subject to depreciation, i.e., determinable life and is subject to exhaustion, wear and tear, and obsolescence

    11. ACRS/MACRS Application to real property Apply recovery % from 15, 18, or 19, 27.5, 31.5, and 39 year tables to unadjusted basis.

    12. ACRS/MACRS .01819 X $150,000 = $2,728.50

    13. ACRS and MACRS (Continued)

    14. Special 40% Rule If > 40% of aggregate bases of all TPP placed in service during the year is placed in service in the last 3 months of the year, a midquarter convention will apply.

    15. Quiz Questions

    16. Short Quiz #1 A depreciation deduction for property placed in service before January 1981 may be claimed under one of several acceptable depreciation methods. True False

    17. Short Quiz #1 Under the double-declining-balance method of depreciation, the annual amount of depreciation for an asset with a life of 5 years would be 40% of an asset’s unrecovered cost. True False

    18. Depreciation and Recapture

    19. Recapture When some assets are sold or disposed of at a gain, part of the gain may be “recaptured” by adding it to ordinary income. Depreciation recapture is limited to the lesser of the gain realized or the depreciation already taken. Rationale (Sections 1245 and 1250)

    20. Recapture Rules Sale of most TPP and real estate for a gain — recapture lesser of the realized gain or the depreciation already taken Personal (Sec. 1245) Property: Full recapture

    21. Section 1250

    22. Section 1250 Rules Realty (Sec. 1250): Only excess depreciation recaptured on ACRS property. Post 1986 realty (Sec. 1250): “Special” 25% rate applies to capital gain attributed to depreciation upon sale.

    23. Expensing: Section 179

    24. A Key Deduction: Expensing Section 179 General rule for Section 179 Businesses may expense, rather than capitalize and depreciate, some TPP asset acquisitions (N/A to R/E). This is now the only graphic from this section.This is now the only graphic from this section.

    25. Quiz Questions

    26. Short Quiz #2 The expensing election is available for property held for investment. True False

    27. Listed Property: Section 280F

    28. Limitations for Some Property Used for Both Personal & Business Use (a.k.a. “Listed Property” Section 280F) Listed property Passenger automobiles (under 6,000 pounds) 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)

    29. Limitations for Some Property Used for Both Personal & Business Use (a.k.a. “Listed Property” Section 280F) Listed property Property used for entertainment, recreation or amusement, unless used in a regular business establishment

    30. Limitations for Some Property Used for Both Personal & Business Use (a.k.a. “Listed Property” Section 280F) Limitations: If “qualified business use” = 50% in year the listed property is placed in service No Sec. 179 expensing ADS depreciation required (i.e., straight-line depreciation)

    31. Limitations for Some Property Used for Both Personal & Business Use (a.k.a. “Listed Property” Section 280F) Limitations: “Qualified Business Use” 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

    32. Limitations for Some Property Used for Both Personal & Business Use (a.k.a. “Listed Property” Section 280F) “Luxury” automobiles: Section 280F limits both MACRS depreciation and Section 179 expensing. Added approxAdded approx

    33. Limitations for Some Property Used for Both Personal & Business Use (a.k.a. “Listed Property” Section 280F) Cost recovery limitations significantly limit depreciation. The maximum limitations represent 100% business/production use. Numbers RemovedNumbers Removed

    34. Limitations for Some Property Used for Both Personal & Business Use (a.k.a. “Listed Property” Section 280F) “Luxury” automobiles: Section 280F limits both MACRS depreciation and Section 179 expensing. A “luxury” auto is a passenger car costing approximately $16,000. Added approxAdded approx

    35. Limitations for Some Property Used for Both Personal & Business Use (a.k.a. “Listed Property” Section 280F) “Listed property does NOT include: Trucks, vans, and “heavy land yachts” (i.e., Hummers) weighing over 6,000 pounds, ambulances, hearses, and vehicles used in transporting services (limo services).

    36. Amortization of Intangibles

    37. Amortization of Intangibles Amortize using SL method, over useful life (Sec. 197). Examples: Goodwill and Covenants not to compete Amortize over 15 years, SL Effective as of August 11, 1993

    38. Quiz Questions

    39. Short Quiz #3 The dollar limits applicable to luxury automobiles prevent them from ever being fully depreciated for tax purposes. True False

    40. Short Quiz #3 Certain intangible assets acquired after August 10, 1993, are eligible for amortization over a fixed period. True False

    41. Chapter 12: “Passive” Activities

    42. Chapter 12: “Passive” Activities Definition of “passive activity” turns on the term “material participation.” Rental activities are “passive” regardless of participation unless taxpayer is a dealer or full-time property manager.

    43. Chapter 12: “Passive” Activities Deductible passive-activity losses generally limited to taxpayer’s passive activity income.

    44. General Features of Section 469 Passive Activities Section 469 applies to individuals, estates, trusts, personal service corps., and closely held corporations.

    45. General Features of Section 469 Basic Tax Aspects Losses from passive activities cannot be deducted from active or portfolio income. Unlimited carryovers of disallowed losses.

    46. General Features of Section 469 Basic Tax Aspects Accumulated (carryover) passive losses are 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: Passive gains on the sale Current year passive income Active/portfolio income

    47. General Features of Section 469 Basic Tax Aspects For closely held corporations, passive losses can offset active income but not portfolio income. (Corporations not closely held are not subject to passive limitations.)

    48. General Features of Section 469 Basic Tax Aspects Tax credits produced from passive activities can offset only taxes attributable to passive income, with unlimited carryovers of unused credit.

    49. Applying Section 469 If the sum of all passive activity = net loss, then apply passive-activity rules. If the sum of all passive activity = net gain, then the passive-activity rules don’t apply that year. Unlimited c/o of disallowed losses.

    50. Exceptions to the Passive Activity Rules

    51. Exception to Passive Activity Rules (Rental Activities) When is a rental activity not deemed “passive”? Unlimited losses from the rental can be deducted if the TP meets 2 tests: More than 50% of all personal services during the year must be for real property trade or business, and The TP performs more than 750 hours in real property trades or businesses.

    52. Exception to Passive Activity Rules (Rental Activities) When is a rental activity not deemed “passive”? Unlimited losses from the rental can be deducted if the TP meets 2 tests: More than 50% of all personal services during the year must be for real property trade or business, and The TP performs more than 750 hours in real property trades or businesses.

    53. Exception to Passive Activity Rules Individual TPs who “actively participate” in 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 AGI in excess of $100,000 of nonpassive income.

    54. “Active Participation” in Passive-Rental Activities TP must have > 10% ownership interest (in the value of the property). TP must have “significant and bona fide” involvement.

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