Depreciation, Cost Recovery, Amortization, and Depletion

Depreciation, Cost Recovery, Amortization, and Depletion
© 2019 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

The Big Picture (slide 1 of 2)
Dr. Cliff Payne purchases and places in service $612,085 of new fixed assets in his dental practice during the current year. Office furniture and fixtures $ 70,000 Computers and peripheral equipment 67,085 Dental equipment 475,000 Using his financial reporting system, he concludes that the depreciation expense on Schedule C of Form 1040 is $91,298. Office furniture and fixtures ($70,000 X 14.29%) $10,003 Computers and peripheral equipment ($67,085 X 20%) 13,417 Dental equipment ($475,000 X 14.29%) 67,878 $91,298 2 © 2019 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

The Big Picture (slide 2 of 2)
In addition, during the current year, Dr. Payne purchased another personal residence for $480,000 He converts his original residence to rental property. Has Dr. Payne correctly calculated the depreciation expense for his dental practice? Will he be able to deduct any depreciation expense for his rental properties? Read the chapter and formulate your response 3 © 2019 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

Cost Recovery Recovery of the cost of business or income-producing assets is through: Cost recovery or depreciation: tangible assets Amortization: intangible assets Depletion: natural resources 4 © 2019 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

Nature of Property Property includes both realty (real property) and personalty (personal property) Realty generally includes land and buildings permanently affixed to the land Personalty is defined as any asset that is not realty Personalty includes furniture, machinery, equipment, and many other types of assets Personalty (or personal property) should not be confused with personal use property Personal use property is any property (realty or personalty) that is held for personal use rather than for use in a trade or business or an income-producing activity Cost recovery deductions are not allowed for personal use assets © 2019 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

General Considerations (slide 1 of 3)
Basis in an asset is reduced by the amount of cost recovery that is allowed and by not less than the allowable amount Allowed cost recovery is cost recovery actually taken Allowable cost recovery is amount that could have been taken under the applicable cost recovery method If no cost recovery is claimed on property The basis of the property must still be reduced by the amount that should have been deducted i.e., The allowable cost recovery © 2019 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

If personal use assets are converted to business or income-producing use Basis for cost recovery and for loss is lower of Adjusted basis or Fair market value at time property was converted Losses that occurred prior to conversion can not be recognized for tax purposes through cost recovery © 2019 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

MACRS applies to: Assets used in a trade or business or for the production of income Assets subject to wear and tear, obsolescence, etc. Assets that have a determinable useful life or decline in value on a predictable basis Assets that are tangible personalty or realty © 2019 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

The Big Picture - Example 2 Cost Recovery Basis for Personal Use Assets Converted to Business Use
Return to the facts of The Big Picture p. 8-1 In 2007, Dr. Payne purchased his personal residence for $250,000 This year Dr. Payne found a larger home that he acquired for his personal residence Unfortunately, because of the downturn in the housing market, he cannot sell his original residence and recover his purchase price of $250,000 The residence was appraised at $180,000 Instead of continuing to try to sell the original residence, Dr. Payne converted it to rental property The basis for cost recovery of the rental property is $180,000 because the fair market value is less than the adjusted basis The $70,000 decline in value is deemed to be personal (since it occurred while the property was held for personal use by Dr. Payne) and therefore nondeductible 9 © 2019 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

MACRS-Personalty MACRS characteristics: MACRS Personalty
Class lives: , 5, 7, 10 years , 20 years Method: % DB % DB Convention: Half Year or Mid-Quarter DB = declining balance with switch to straight-line Straight-line depreciation may be elected 10 © 2019 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

Half-Year Convention General rule for personalty
Assets treated as if placed in service (or disposed of) in the middle of taxable year regardless of when actually placed in service (or disposed of) © 2019 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

Example: Half-Year Convention
Purchased and placed an asset in service on March 15 (Tax year end is December 31) Treated as placed in service June 30 Six months cost recovery in year 1 (and year disposed of, if within recovery period) © 2019 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

Mid-Quarter Convention
Applies when more than 40% of personalty is placed in service during last quarter of year Assets treated as if placed into service (or disposed of) in the middle of the quarter in which they were actually placed in service (or disposed of) © 2019 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

Example: Mid-Quarter Convention
Business with 12/31 year end purchased and placed in service the following used 5-year class assets Asset 1: on 3/28 for $50,000, and Asset 2: on 12/28 for $100,000 More than 40% placed in service in last quarter; therefore, mid-quarter convention used Asset 1: $50,000 × 0.35 (Exhibit 8.4) = $17,500 Asset 2: $100,000 × 0.05 (Exhibit 8.4) = $5,000 © 2019 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

The Big Picture - Example 7 Mid-Quarter Convention
15 © 2019 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

Qualified Improvement Property (slide 1 of 2)
Nonresidential realty has a 39-year life, and any improvements made to this property would normally have a 39-year life An exception to this general rule is provided for qualified improvement property Qualified improvement property is recovered over a 15-year life using the half-year convention and the straight-line method © 2019 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

Qualified Improvement Property (slide 2 of 2)
Any improvement to an interior portion of nonresidential real property made after the property is placed in service Includes leasehold improvements Does not include Costs of an elevator or escalator, or Improvements that enlarge a building or modify its internal framework © 2019 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

Optional Straight-line Election
May elect straight-line rather than accelerated depreciation on personalty placed in service during year Use the class life of the asset for the recovery period Use half-year or mid-quarter convention as applicable Election is made annually by class of property © 2019 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

The Big Picture - Example 9 Straight-Line Election

The Big Picture - Example 10 Straight-Line Election
Assume the same facts as in Example 9, except that Dr. Payne sells the computers and peripheral equipment on November 21, His cost recovery deduction for 2019 is $6,709 ($67,085 X .20 X ½ ) (Exhibit 8.5). 20 © 2019 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

MACRS-Realty (slide 1 of 2)
MACRS characteristics: MACRS Realty Residential Rental Nonresidential Realty Class lives: years 31.5 years or 39 years Method: Straight-line Convention: Mid-month Residential rental real estate Includes property where 80% or more of gross rental revenues are from nontransient dwelling units e.g., Apartment building Hotels, motels, and similar establishments are not residential rental property © 2019 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

MACRS-Realty (slide 2 of 2)
Mid-month Convention Property placed in service at any time during a month is treated as if it was placed in service in the middle of the month Example: Business building placed in service April 25 is treated as placed in service April 15 © 2019 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

Election to Expense Assets -Section 179 (slide 1 of 5)
General rules Can elect to immediately expense up to $1,000,000 of business tangible personalty placed in service in 2018 Cannot use § 179 for most realty or production of income property © 2019 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

Section 179 general rules Amount expensed reduces depreciable basis Any elected § 179 expense is taken before additional first-year depreciation is computed The base for calculating the standard MACRS deduction is net of the § 179 expense and the additional first-year depreciation (100% in 2018) © 2019 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

Annual limitations Expense limitation ($1,000,000 for 2018) is reduced by amount of § 179 property placed in service during year that exceeds $2,500,000 in 2018 Example: In 2018, taxpayer placed in service $2,575,000 of §179 property The § 179 expense limit is reduced to $925,000 [$1,000,000 – ($2,575,000 – $2,500,000)] © 2019 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

Annual limitations: Election to expense cannot exceed taxable income (before § 179) of taxpayer’s trades or businesses Any amount expensed under § 179 over taxable income limitation may be carried over to subsequent year(s) Amount carried over still reduces basis currently The § 179 amount eligible for expensing in a carryforward year is limited to the lesser of The statutory dollar amount ($1,000,000 in 2018) reduced by the cost of § 179 property placed in service in excess of $2,500,000 (in 2018) in the carryforward year The business income limitation in the carryforward year © 2019 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

Additional First-Year Depreciation (slide 1 of 3)
Additional first-year depreciation has been allowed for several years In a significant expansion of this provision, the TCJA of 2017 allows taxpayers to deduct 100% cost recovery in the year qualified property is placed in service © 2019 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

Additional first-year depreciation is taken in the year the qualifying property is placed in service It is computed after any immediate expense (§ 179) deduction is claimed After the additional first-year depreciation is determined, the regular MACRS cost recovery deduction is calculated by multiplying the remaining cost recovery basis by the appropriate MACRS percentage A taxpayer may elect not to take additional first-year depreciation 29 © 2019 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

Qualified property includes most depreciable assets other than buildings with a recovery period of 20 years or less For property placed in service after September 27, 2017, bonus depreciation applies to both new and used property Prior law restricted bonus depreciation to new property 30 © 2019 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

Example 23: Additional First-Year Depreciation

The Big Picture - Example 27 § 179 Deduction With Additional First-Year Depreciation (slide 1 of 2)

The Big Picture - Example 27 § 179 Deduction With Additional First-Year Depreciation (slide 2 of 2)

Listed Property (slide 1 of 4)
There can be substantial limits on cost recovery of assets considered listed property Listed property includes the following Passenger automobile Other property used as a means of transportation Property used for entertainment, recreation, or amusement Cellular telephone A computer or peripheral equipment placed in service after 12/31/17 (in a taxable year ending after 12/31/17) is not listed property © 2019 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

To be considered as predominantly used for business, business use must exceed 50% Use of asset for production of income is not considered in this 50% test However, both business and production of income use percentages are used to compute cost recovery © 2019 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

To be considered as predominantly used for business (cont’d) If 50% test is met, then allowed to use statutory percentage method of cost recovery with some limitations © 2019 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

If asset is not used predominantly for business i.e., business use does not exceed 50% Must use straight-line method If business use falls to 50% or lower after year property is placed in service, must recapture excess cost recovery © 2019 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

Passenger Auto Cost Recovery Limits (slide 1 of 7)
For autos placed in service in 2018, cost recovery limits are: Year Recovery Limitation $ 10,000 ,000 ,600 Succeeding years until the cost is recovered ,760 If a passenger auto used predominantly for business qualifies for additional first-year depreciation First-year recovery limitation is increased by $6,400 Limit increases from $10,000 to $16,400 ($10,000 + $6,400) © 2019 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

Limits are for 100% business use Must reduce limits by percentage of personal use Limit in the first year includes any amount the taxpayer elects to expense under § 179 © 2019 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

Example: Taxpayer acquired an auto in 2018 for $55,000, used it 80% for business, and elects not to take additional first-year depreciation 2018 cost recovery allowance ($55,000 × 20%) × 80% $ 8,800 But deduction is limited to $10,000 × Business use % × 80% Cost recovery allowance $ 8,000 © 2019 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

Limit on § 179 deduction For certain vehicles not subject to the statutory dollar limits imposed on passenger automobiles the § 179 deduction is limited to $25,000 The limit applies to sport utility vehicles with an unloaded GVW rating of more than 6,000 pounds and not more than 14,000 pounds © 2019 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

Listed property that fails the >50% business usage test the year it’s placed in service must be recovered using the straight-line method Such property does not qualify for additional first-year depreciation If the >50% business usage test is failed in a year after the property is placed in service, straight-line method must be used for remainder of property’s life Cost recovery of passenger auto under straight-line listed property rule still subject to annual limits © 2019 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

Change from predominantly business use: If the business use percentage falls to 50% or lower after the year the property is placed in service, the property is subject to cost recovery recapture The amount recaptured as ordinary income is the excess cost recovery Excess cost recovery is the excess of the cost recovery deductions taken in prior years using the statutory percentage method over the amount that would have been allowed if the straight-line method had been used © 2019 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

Leased autos subject to inclusion amount rule Using IRS tables, taxpayer has gross income equal to each lease year’s inclusion amount Purpose is to prevent avoidance of cost recovery dollar limits applicable to purchased autos by leasing autos, i.e., by converting cost recovery into rentals © 2019 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

Alternative Depreciation System (ADS) (slide 1 of 2)
ADS is an alternative depreciation system that is used in calculating depreciation for: Alternative minimum tax (AMT) Earnings and profits For residential and nonresidential real estate and any qualified improvement property placed in service after 2017 by a “real property trade or business” that opts out of the interest expense limitations of § 163(j) In general, the interest expense limitation rules only apply to businesses with annual gross receipts in excess of $25 million Generally, use straight-line recovery without regard to salvage value © 2019 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

Alternative Depreciation System (ADS) (slide 2 of 2)
For AMT, 150% declining balance is allowed for personalty Half-year, mid-quarter, and mid-month conventions still apply To simplify reporting, taxpayers may elect to use the 150% declining-balance method to compute cost recovery for the regular income tax If this election is made, there is no difference between the regular income tax and AMT cost recovery © 2019 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

Amortization (slide 1 of 2)
Can claim amortization deduction on § 197 intangibles Use straight-line recovery over 15 years (180 months) beginning in month intangible is acquired Section 197 intangibles include acquired goodwill, going-concern value, trademarks, trade names, etc © 2019 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

Amortization (slide 2 of 2)
Startup expenditures are also partially amortizable under §195 Treatment is available only by election Allows the taxpayer to deduct the lesser of: The amount of startup expenditures, or $5,000, reduced by the amount startup expenditures exceed $50,000 Any amounts not deducted may be amortized ratably over 180-months beginning in month trade or business begins © 2019 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

Depletion (slide 1 of 4) Two methods of natural resource depletion
Cost: determined by using the adjusted basis of the resource and allocating over the recoverable units Percentage: determined using percentage provided in Code and multiplying by gross income from resource sales © 2019 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

Depletion (slide 2 of 4) Cost depletion
Depletion is computed on a per unit basis Per unit amount is determined by dividing the basis of the resource by the estimated recoverable units of resource Number of units sold in year × per unit depletion = depletion for year Total depletion can not exceed total cost of the property © 2019 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

Depletion (slide 3 of 4) Percentage depletion
Depletion is computed by using the statutory percentage rate for the type of resource Rate is applied to the gross income from the property © 2019 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

Depletion (slide 4 of 4) Percentage depletion
Percentage depletion cannot exceed 50% of the taxable income (before depletion) from the property Percentage depletion reduces basis in property However, total percentage depletion may exceed the total cost of the property Example: Property with zero basis but still generating income © 2019 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

Refocus On The Big Picture
Evidently, Dr. Payne’s accounting system uses MACRS because $91,298 of depreciation is the correct amount The computers and peripheral equipment are 5-year property The furniture and fixtures and the dental equip. are 7-year property Based on the IRS tables, the following percentages are used to calculate first year depreciation expense: 5-year property % 7-year property % Dr. Payne will also be able to deduct depreciation on the house he converted from personal use to rental use and on the rental house that he purchased 53 © 2019 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

Dr. Donald R. Trippeer, CPA
If you have any comments or suggestions concerning this PowerPoint Presentation for South-Western Federal Taxation, please contact: Dr. Donald R. Trippeer, CPA SUNY Oneonta © 2019 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

Depreciation, Cost Recovery, Amortization, and Depletion

Similar presentations

Presentation on theme: "Depreciation, Cost Recovery, Amortization, and Depletion"— Presentation transcript:

Similar presentations

About project

Feedback

Log in

Auth with social network:

Depreciation, Cost Recovery, Amortization, and Depletion

Similar presentations

Presentation on theme: "Depreciation, Cost Recovery, Amortization, and Depletion"— Presentation transcript:

Similar presentations

About project

Feedback