1. Depreciation, Cost Recovery, Amortization and Depletion
Chapter 10
Depreciation, Cost Recovery, Amortization and Depletion 1

2. Learning Objectives
Understand the general concepts of tax depreciation
Classify property and calculate cost recovery under the MACRS rules 2

3. Learning Objectives
Calculate amortization for intangible assets and understand the difference between amortizable and non-amortizable assets
Apply cost and percentage methods and understand the treatment of intangible drilling costs 2

4. Introduction
Allows taxpayers to deduct a reasonable allowance for the exhaustion, wear and tear, and obsolescence.
Taxpayers must use specific depreciation methods depending on when an asset is placed into service.

5. Depreciation and Cost Recovery
Property placed into service prior to 1981
Property placed into after December 30, 1980 and before January 1, 1987
Property placed into service after December 31, 1986 3

6. Common Rules of All Systems
No depreciation may be claimed on land or other assets that have an indefinite life (works of art).
Depreciation is permitted in the year the asset is placed into service
Consistency is required, no matter which system is used

7. Types of Property Tangible Property Intangible Property Real Property
Personal Property vs. Personal-Use Property

8. Depreciation Methods 1986 and later years MACRS Personal property
Use 3, 5, 7, 10, 15, 20 year useful life
200% declining balance with a conversion to straight-line
Half-year convention(no matter when asset is placed into service, the first year can only take a half years depreciation)
Mid-Quarter convention is used when the aggregate basis of all personal property placed into service during the last three months of the year exceed 40%
No salvage value 5

9. Depreciation Methods Real Property
Residential rental property: 27.5 years
Nonresidential rental property: 39 years
Depreciation is calculated using the straight-line method
Mid-month convention –year of acquisition and year of disposition
Straight-line or Alternate Depreciation System(ADS)

10. Section 179 Expensing Election
May elect to expense up to $100,000 in years
Placed into service during the year
Not applicable to real estate, only applicable personal property. 9

11. Section 179 Expense 10

12. Bonus Depreciation
Additional first year depreciation deduction for certain qualified property.
Be acquired after September 10, 2001 and before September 11, 2004.
Non real estate
Recovery period of 20 years or less
Computer software
Qualified leasehold improvement property
Depreciation deduction is 30% of the adjusted basis of the property.
Increased to 50% for qualified property placed in service after May 5, 2003 and before January 1, 2005

13. MACRS Restrictions
Portion of asset used for personal use is not depreciable
Listed property rules
Recapture of excess cost-recovery
Luxury automobile limitation (see textbook for limits) 11

14. Amortization Intangible Assets
Definition of Section 197 – Goodwill and going concern value, covenants not to compete, franchise fees, trademarks, and trade names etc.
Classification and disposition of intangibles
A Sec. 197 asset is treated as depreciable property so that Sec treatment is accorded.
Research and experimental expenditures
Include experimental and laboratory costs incidental to the development of a product.
Computer software 14

15. Depletion and Intangible Drilling and Development Costs
Treatment of intangible drilling and development costs (IDCs)
Capitalized or deducted currently
Decision to expense or capitalize depends on taxpayer’s current position (profit or loss) 12

16. Depletion and Intangible Drilling and Development Costs
Depletion methods
Cost depletion method is calculated by dividing the adjusted basis of natural resource by expected quantity to be extracted
Percentage depletion method is calculated by multiplying the statutory depletion percentage times the gross income generated 13

17. Tax Planning Considerations
Alternative depreciation under MACRS
IDCs: CAPITALIZATION VS. EXPENSING
Units of Production Depreciation
Structuring a business combination 15

18. Compliance And Procedural Considerations
IDCs Election
Form 4562 is used to report depreciation, depletion, and amortization deductions.
Research and Experimental Expenditures 16