DEPR., COST RECOVERY, AMORTIZATION, & DEPLETION

DEPR., COST RECOVERY, AMORTIZATION, & DEPLETION • Depreciation and cost recovery • Amortization • Depletion, intangible drilling an development costs • Tax planning considerations • Compliance and procedural considerations ©2010 Pearson Education, Inc. Publishing as Prentice Hall

General Considerations(1 of 4) • Taxpayers must use specific depreciation methods depending on when an asset is placed into service • Prior to 1981 (pre-ACRS) • 1981 through 1986 (ACRS) • 1987 through present (MACRS) ©2010 Pearson Education, Inc. Publishing as Prentice Hall

General Considerations(2 of 4) • Common rules to all systems • No depreciation may claimed on land or other assets with an indefinite life • Depreciation permitted in year asset placed into service • Apply method consistently • Basis of property being depreciated reduced by amount of allowable depreciation each taxable year ©2010 Pearson Education, Inc. Publishing as Prentice Hall

General Considerations(3 of 4) • Types of Property • Tangible Property (physical) • Intangible Property (non-physical) • Real Property • Personal Property vs. Personal-use Property ©2010 Pearson Education, Inc. Publishing as Prentice Hall

General Considerations(4 of 4) • Capitalization vs. expense • Materiality plays a role • Frequent disputes between taxpayers and IRS • Conversion of personal-use property • Basis is lesser of adjusted basis or FMV • Prevents taxpayers from depreciating non-deductible decline in value of personal asset ©2010 Pearson Education, Inc. Publishing as Prentice Hall

Depreciation Methods(1 of 3) • MACRS • Personal property • Use 3, 5, 7, 10, 15, 20 year useful life • DDB with conversion to straight-line • Half-year convention • ½ year depr in 1st year and year of disposition • Mid-Quarter convention when aggregate basis of all personal property placed into service during last three months of year exceed 40% • No salvage value ©2010 Pearson Education, Inc. Publishing as Prentice Hall

Depreciation Methods(2 of 3) • MACRS • Real property • Residential rental property 27.5 years • Nonresidential rental property 39 years • Straight-line depreciation method • Mid-month convention in year of acquisition and year of disposition • Straight-line or Alternate Depreciation System (ADS) ©2010 Pearson Education, Inc. Publishing as Prentice Hall

Depreciation Methods(3 of 3) • MACRS (continued) • Qualified leasehold improvements • Interior nonresidential improvements • 15-year straight-line recovery ©2010 Pearson Education, Inc. Publishing as Prentice Hall

Calculation of Depreciation§179 Expense • May elect to expense up to $133K ( in 2009) for certain tangible personal property placed into service during year • $ for $ phaseout if qualified property placed into service during year >$530K • Limited to taxable ToB income • Unused portion carried over indefinitely and added future §179 amounts ©2010 Pearson Education, Inc. Publishing as Prentice Hall

Calculation of DepreciationMid-quarter Convention • Applies to personal property placed in service during the year • Must use mid-quarter convention for ALL property if > 40% of cost of property placed in service during last three months of year • Does NOT include property expense under §179 ©2010 Pearson Education, Inc. Publishing as Prentice Hall

Calculation of DepreciationYear of Disposition • MACRS allows ½ of last period of depreciation to be taken in year of disposition based on convention • E.g., mid-year, mid-quarter, mid-month ©2010 Pearson Education, Inc. Publishing as Prentice Hall

MACRS Restrictions(1 of 3) • Portion of asset used for personal use is not depreciable • Listed property rules • Must use straight-line of business use < 50% • Recapture of excess cost-recovery if MACRS claimed and business use falls below 50% ©2010 Pearson Education, Inc. Publishing as Prentice Hall

MACRS Restrictions(2 of 3) • Luxury automobile limitation • Passenger vehicles ≤ 6,000 lb • Depreciation can’t exceed ceiling limits • E.g., $2,960 in 1st year • “Luxury” auto defined by 2009 ceiling limits is any passenger vehicle costing > $14,800 ©2010 Pearson Education, Inc. Publishing as Prentice Hall

MACRS Restrictions(3 of 3) • Trucks, vans and SUVs (>6,000 lb) • Max §179 expense is $25,000 • No ceiling limits like luxury autos • Trucks, vans and SUVs (<6,000 lb) • Subject to ceiling limits • Higher than for luxury autos • Leased vehicles • Income inclusion based on IRS tables to eliminate avoiding luxury auto rules ©2010 Pearson Education, Inc. Publishing as Prentice Hall

§197 Intangibles • Goodwill, going concern value, trademarks, trade names, etc. • Classification and disposition of intangibles • 15-year straight-line • §197 asset treated as depreciable prop so that §1231 treatment accorded disposition if held > 1 year ©2010 Pearson Education, Inc. Publishing as Prentice Hall

Research and Experimental Expenditures • Include experimental and laboratory costs incidental to the development of a product (see Table 4) • Tax treatment options • Expense in year paid • Capitalize & amortize costs over 60 mo • Capitalize and write-off when project abandoned or is worthless ©2010 Pearson Education, Inc. Publishing as Prentice Hall

Computer Software • Developed computer software • Cost of developing software is qualified R&E under §174 • Expense immediately or • Amortize over 60 months • Separately purchased and non-§174 developed software • Straight-line depreciation over 36 months ©2010 Pearson Education, Inc. Publishing as Prentice Hall

Depletion, Intangible Drilling and Development Costs (1 of 2) • Depletion methods • Cost depletion • Similar to units of activity depreciation • Percentage depletion • Depletion rates based on statutory percentages • Can claim depletion deductions in excess of cost over the life of the asset ©2010 Pearson Education, Inc. Publishing as Prentice Hall

Depletion, Intangible Drilling and Development Costs (2 of 2) • Treatment of intangible drilling and development costs • Capitalized or deducted currently • Decision to expense or capitalize depends on taxpayer’s current position • Expected marginal tax rates ©2010 Pearson Education, Inc. Publishing as Prentice Hall

Tax Planning Considerations • Alternative depreciation under MACRS • Units of production depreciation • May use instead of MACRS • Structuring a business combination • Must consider amortization of goodwill ©2010 Pearson Education, Inc. Publishing as Prentice Hall

DEPR., COST RECOVERY, AMORTIZATION, & DEPLETION