1. Business Assets Chapter 7 pp. 209-252
2012 National Income
Tax Workbook™

2. Business Assets pp. 209-252 Depreciation basics
First-year cost recovery
Sales of business assets
Installment sales
Like-Kind Exchanges
Casualty Gains and Losses

3. Learning Objectives p. 209 Determine if property is depreciable
Explain first-year options
Prepare Form 4797 to report sale
Compute installment sale gain
Decide if exchange is like-kind
Calculate casualty gain or loss

4. Depreciation Basics p. 210 Useful life that can be estimated
Owned by taxpayer
Used in trade or business, or held for production of income
Asset placed in service (ready and available for use)

5. Depreciation Methods pp. 210-212
MACRS assigns recovery periods and depreciation methods
GDS generally shorter than ADS
ADS is always straight-line
Figure 7.1: Comparisons
ADS is required for some assets

6. Listed Property pp
Assets with sizeable potential for personal as well as business use
ADS required unless asset is used more than half the time in business
Assets include vehicles, audio and video equipment, computers used outside a business, and so forth

7. Conventions pp
First and last years’ deductions are less than a full year’s cost recovery
Tangible personal property usually limited to a half-year deduction, but substantial purchases late in year trigger mid-quarter convention
Real estate treated as placed in service in middle of month

8. Mid-Quarter Convention p. 213
Look at non-real estate assets placed in service during last 3 months of tax year, no matter how short the year is
If the depreciable basis of those assets > 40% of the basis of all such property placed in service during the year, mid-quarter convention must be used for all of the new non-real estate assets

9. Avoiding MQ Convention p. 213
Use of I.R.C. § 179 deduction removes assets from calculation
Example 7.1: Taxpayer must use MQ convention (40.59%)
Example 7.2: Small § 179 election gives taxpayer HY depreciation for other property (40%)

10. Applying MQ Convention p. 214
Divide tax year into quarters and assign assets (Example 7.3)
Middle of quarter is 1½ months
Pub. 947 includes tables
Early disposition requires full-year depreciation modification (Examples 7.4 and 7.5)

11. MACRS pp
Determine recovery class, select GDS or ADS, choose method, establish convention, use tables (Example 7.6)
Early disposition requires adjustment (Example 7.7)

12. First-Year Options p. 216 I.R.C. § 179 deduction
Up to 100% of cost
Dollar and investment limits
Business income limitation
Additional first-year depreciation
Up to 50% of cost for 2012
Can create net operating loss

13. I.R.C. § 179 pp. 216-217 More than 50% use in active business
New or used tangible § 1245 property
Acquired by purchase from unrelated party (trade-in basis is not eligible)
Generally cannot be used for assets purchased for lease to others (two exceptions) or by lodging enterprise
Exceptions:
Taxpayer that is lessor is a C corporation
Noncorporate lessor has related business expense deductions in first 12 months that exceed 15% of rental income (depreciation is not included in those expenses)

14. I.R.C. § 179 pp. 217 2012 dollar limit is $139,000
Dollar-for-dollar phaseout begins at $560,000 of eligible asset acquisitions (Example 7.8)
Election made at entity level; dollar limit─but not investment limit─also applies at owner level (Example 7.9)
Exceptions:
Taxpayer that is lessor is a C corporation
Noncorporate lessor has related business expense deductions in first 12 months that exceed 15% of rental income (depreciation is not included in those expenses)

15. I.R.C. § 179 pp
Separate purchases by partners who contribute only the use of property can boost total deduction (Example 7.10)
Elections by multiple flow-through entities can result in lost deductions (Example 7.11)
For tax years 2003–2012, changes can be made on amended returns
Exceptions:
Taxpayer that is lessor is a C corporation
Noncorporate lessor has related business expense deductions in first 12 months that exceed 15% of rental income (depreciation is not included in those expenses)

16. I.R.C. § 179 pp
Business income limit uses aggregate of all business income, such as wages
If joint return is filed, both spouses’ net business income is considered
Taxpayer can elect larger amount, but excess carries forward (indefinite number of years)
Exceptions:
Taxpayer that is lessor is a C corporation
Noncorporate lessor has related business expense deductions in first 12 months that exceed 15% of rental income (depreciation is not included in those expenses)

17. I.R.C. § 179 pp
Active trade or business income does not include passive activity or hobby
“Meaningful participation” in business’s management or operation
Examples include Schedule C or F profit or loss, partnership/S corporation flow-through, Form 4797 gains and losses, salaries and wages
Exceptions:
Taxpayer that is lessor is a C corporation
Noncorporate lessor has related business expense deductions in first 12 months that exceed 15% of rental income (depreciation is not included in those expenses)

18. I.R.C. § 179 p. 220
Elected amount reduces asset’s basis, basis in flow-through entity
Recapture required if business use drops to 50% or less
Recapture amount is the excess of the deduction over allowable MACRS
Reported on Form 4797 and business income schedule
Exceptions:
Taxpayer that is lessor is a C corporation
Noncorporate lessor has related business expense deductions in first 12 months that exceed 15% of rental income (depreciation is not included in those expenses)

19. Additional First-Year Depreciation pp. 220-223
Qualifying MACRS property
New property (original user)
Acquired by purchase after 2007
Placed in service before 2013
AFYD is default; taxpayer must elect out to avoid its application
Some corporations may use credit

20. Comparison pp. 221-222 Used property: § 179 only
20-year property: AFYD only
Transferred basis: AFYD only
Trigger MQ convention: § 179 only
Limits on amounts: § 179 only
Year (calendar/AFYD; tax/§ 179)
Recapture (all/§ 179; listed/AFYD)

21. Example 7.12 pp
Cost of asset $439,000 § 179 election (139,000) Basis for MACRS $300,000 AFYD (150,000) Remaining basis 150, % MACRS (21,435) Total deduction $310,435

22. Sales of Business Assets p. 223
§ 1231 is best of both worlds
Net gain is treated as capital
Net loss is treated as ordinary
Depreciable and nondepreciable assets if holding period is met
Net all sales on Form 4797

23. Sales of Business Assets p. 224
5-year recapture period if gains follow losses (gain is ordinary income to extent of prior loss)
Example 7.13: Sales in same year are netted; tax benefit is maximized by timing gain in Year 1 and loss in Year 2

24. § 1245 Property pp
Most depreciable or amortizable property except for buildings
Includes other land improvements
Gain on disposition is ordinary income to extent of prior basis reductions (not just depreciation)

25. § 1250 Property pp
Depreciable real property that was never and is not § 1245 property
Gain equal to basis reductions in excess of straight-line depreciation is ordinary income
Top tax rate on capital gain equal to straight-line depreciation is 25%

26. § 1250 Property pp
Gain due to appreciation is taxed at regular capital gain rate
Example 7.14: Gain on pole barn includes ordinary income, § 1250 gain, and other capital gain
Corporations must treat 20% of §.1250 gain as ordinary income

27. §§ 1252 and 1255 Property pp
10-year recapture period for soil and water conservation expenses (Example 7.15)
20-year recapture period for conservation payment exclusion

28. Form 4797 pp. 227-230 Part I: § 1231 gains and losses
Part II: Ordinary gains and losses
Part III: Basis reduction recapture (§§ 1245, 1250, 1252, 1254, 1255)
Part IV: § 179, §280F recapture
Examples 7.16 and 7.17
§ 1254 is recapture of depletion, intangible drilling costs, exploration, and development expenditures for oil, gas, geothermal, or other mineral properties.

29. Related Issues p. 231
Allowable depreciation must be recaptured even if not deducted
File Form 3115 to deduct catch-up amount in year of disposition
Below-market sale is partly a gift
Prorate basis on Form 4797
File Form 706 to start statute

30. Installment Sale Rules pp. 231-232
Seller-financing can spread out taxation of gain on eligible sale
Need to balance tax, credit risks
At least 1 payment in later year
Ordinary income not deferred, regardless of payment received

31. Installment Sales p. 232 Selling price: Total value received
Contract price: Sales price minus debt assumed by buyer (not > than basis)
Gross profit: Gain on sale reduced by ordinary income recapture and (for sale of main home) excludable gain
Gross profit percentage: Gross profit divided by contract price

32. Payments in Year of Sale pp. 232-233
Debt relief in excess of basis
Buyer’s payment of seller’s costs
Buyer’s note only if is payable on demand or readily tradable
Prior deposit (earnest money)

33. Installment Sales pp
Example 7.18: Sale of machinery Gain $ 150,000 Depreciation (60,000) Gross profit $ 90,000 Gross profit percentage $90,000 ÷ $350,000 = %

34. Installment Sales pp
Example 7.18: Sale of machine $100,000 × % $ 25,714 Depreciation recapture* 60,000 Gross income for 2012 $ 85,714 (See Figures 7.12 and 7.13) * Recognized even if no payment

35. Unstated and Imputed Interest p. 238
Sellers usually prefer capital gain
Buyers usually want deduction instead of capital expense
Arm’s length transaction generally results in adequate interest so that buyer gets some deduction and seller gets FMV for property

36. Unstated and Imputed Interest p. 238
I.R.C. §§ 483 and 1274 require interest on installment sales
IRS publishes AFRs each month
If stated interest is inadequate, part of principal is recharacterized
Lower sales price reduces gross profit, but difference is interest paid by buyer and received by seller

37. Related Party Resale Rule pp. 238-239
Installment sale made to related party
Buyer resells property within 2 years but does not pay off installment debt
Seller is deemed to receive resale price up to amount due on contract, thus accelerating gain recognition
Waived if no tax avoidance motive

38. Like-Kind Exchanges pp. 239
I.R.C. § 1031 mandates deferral of realized gain in like-kind exchange
Used in business or for income
Not held for personal use
Same nature or character
Report transaction on Form 8824

39. Like-Kind Exchanges p. 240 Basis transfers to new property
Boot = cash or unlike property
Boot received is taxable to extent of realized gain
Boot paid increases basis of property received in exchange

40. Example 7.19 pp
FMV received $1,500,000 Basis in old asset $ 800,000 Boot (cash) paid 250,000 Basis transferred (1,050,000) Gain realized $ 450,000 Deferred gain $ 450,000

41. Example 7.20 pp
FMV relinquished $1,250,000 FMV received $1,000,000 Boot received 250,000 Basis transferred (800,000) Gain realized $ 450,000 Gain recognized $ 250,000

42. Like-Kind Exchange p. 244
Potential depreciation recapture transfers to new property
I.R.C. § 1031 is not elective
Separate sale can avoid deferral of built-in loss or lower basis for depreciation of new asset
Example 7.21 (Rev. Rul )

43. Casualty Gains and Losses pp. 244-245
Sudden, unexpected, or unusual
Loss if business asset is destroyed is tax basis minus any recovery
Loss if business asset is damaged is lesser of decrease in FMV or tax basis, minus any recovery

44. Example 7.22 p. 245
FMV before fire $225,000 Adjusted basis $212,377 Insurance settlement (155,000) Casualty loss $ 57,377 Report on: Form 4684 (Form 4797) Form 1040

45. Example 7.23 pp
FMV before fire $225,000 Adjusted basis $212,377 Insurance settlement (225,000) Casualty gain $ 12,623 If no reinvestment, report on: Form 4684, Form 4797, Form 1040
Text has digits transposed for $12,263 gain; forms are correct.

46. Example 7.24 pp
Cost of bulldozer $125,000 FMV before loss $142,000 Basis (after § 179) 0 Insurance settlement $142,000 § 1245 recapture $125,000 § 1231 gain $ 17,000

47. Postponement of Gain p. 251
Reinvest entire proceeds to avoid recognizing any gain
Similar or related in service or use
Attach statement to tax return in gain year and replacement year
Time limits vary from 2 to 5 years

48. Example 7.25 p. 252
Replacement property $185,000 Insurance settlement (deferred gain) (142,000) Additional cost $ 43,000 Basis in lost asset 0 Basis in replacement $43,000

49. Questions?