1. 10-1 ©2007 Prentice Hall, Inc.

2. 10-2 ©2007 Prentice Hall, Inc. DEPR., COST RECOVERY, AMORTIZATION, & DEPLETION  Depreciation and cost recovery  Amortization  Depletion, intangible drilling an development costs  Tax planning considerations  Compliance and procedural considerations

3. 10-3 ©2007 Prentice Hall, Inc. Depreciation and Cost Recovery  General considerations  Depreciation methods  Calculation of depreciation  MACRS restrictions

4. 10-4 ©2007 Prentice Hall, Inc. General Considerations (1 of 3)  Taxpayers must use specific depreciation methods depending on when an asset is placed into service  Prior to 1981  After 12/30/80 and before 1/1/87 (ACRS)  After 12/31/96 (MACRS)

5. 10-5 ©2007 Prentice Hall, Inc. General Considerations (2 of 3)  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

6. 10-6 ©2007 Prentice Hall, Inc. General Considerations (3 of 3)  Types of Property  Tangible Property (physical)  Intangible Property (non-physical)  Real Property  Personal Property vs. Personal-Use Property

7. 10-7 ©2007 Prentice Hall, Inc. Depreciation Methods (1 of 2)  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 1 st 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

8. 10-8 ©2007 Prentice Hall, Inc. Depreciation Methods (2 of 2)  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)

9. 10-9 ©2007 Prentice Hall, Inc. Calculation of Depreciation §179 Expense  May elect to expense up to $108K in 2006 for certain tangible personal property placed into service during the year  $ for $ phaseout if qualified property placed into service during year >$430K  Limited to taxable ToB income

10. 10-10 ©2007 Prentice Hall, Inc. Calculation of Depreciation Year of Disposition  MACRS allows depreciation to be taken in year of disposition based on convention  E.g., ½ year, mid-quarter, mid-month

11. 10-11 ©2007 Prentice Hall, Inc. MACRS Restrictions (1 of 2)  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%

12. 10-12 ©2007 Prentice Hall, Inc. MACRS Restrictions (2 of 2)  Luxury automobile limitation  Depreciation cannot exceed ceiling limitations (see page P10-14)  Trucks, vans and SUVs (>6,000 lb)  More generous rules  Leased vehicles  Income inclusion based on IRS tables to eliminate avoiding luxury auto rules

13. 10-13 ©2007 Prentice Hall, Inc.Amortization  §197 intangibles  Research and experimental expenditures  Computer software

14. 10-14 ©2007 Prentice Hall, Inc. §197 Intangibles  Goodwill and going concern value, covenants not to compete, franchise fees, trademarks, trade names, etc.  Classification and disposition of intangibles  §197 asset treated as depreciable prop so that § 1231 treatment accorded disposition if held > 1 year

15. 10-15 ©2007 Prentice Hall, Inc. Research and Experimental Expenditures  Include experimental and laboratory costs incidental to the development of a product (see table I10-4)  Tax treatment options  Expense in year paid  Defer and amortize costs over 60 mo.  Capitalize and write-off when project abandoned or is worthless

16. 10-16 ©2007 Prentice Hall, Inc. Computer Software  Developed computer software  Cost of developing software is qualified R&E under §174  Expense immediately or  Amortize over 60 months  Separately purchased software  Straight-line depreciation over 36 months

17. 10-17 ©2007 Prentice Hall, Inc. 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

18. 10-18 ©2007 Prentice Hall, Inc. 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

19. 10-19 ©2007 Prentice Hall, Inc. 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

20. 10-20 ©2007 Prentice Hall, Inc. Compliance and Procedural Considerations  Form 4562 is used to report depreciation, §179 expense, depletion, and amortization deductions

21. Comments or questions about PowerPoint Slides? Contact Dr. Richard Newmark at University of Northern Colorado’s Kenneth W. Monfort College of Business richard.newmark@PhDuh.com 10-21 ©2007 Prentice Hall, Inc.