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DEPR., COST RECOVERY, AMORTIZATION, & DEPLETION. Depreciation and cost recovery Amortization Depletion, intangible drilling an development costs Tax planning considerations Compliance and procedural considerations. Depreciation and Cost Recovery. General considerations

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©2010 Pearson Education, Inc. Publishing as Prentice Hall


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


Depreciation and cost recovery
Depreciation and Cost Recovery

  • General considerations

  • Depreciation methods

  • Calculation of depreciation

  • MACRS restrictions

©2010 Pearson Education, Inc. Publishing as Prentice Hall


General considerations 1 of 4
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
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
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
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
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
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
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
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 depreciation mid quarter convention
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 depreciation year of disposition
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
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
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
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


Amortization
Amortization

  • §197 intangibles

  • Research and experimental expenditures

  • Computer software

©2010 Pearson Education, Inc. Publishing as Prentice Hall


197 intangibles
§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
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
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, 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
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
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


Compliance and procedural considerations
Compliance and Procedural Considerations

  • Form 4562 is used to report depreciation, §179 expense, depletion, and amortization deductions

©2010 Pearson Education, Inc. Publishing as Prentice Hall



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