1. Chapter 7 Property Acquisitions and Cost Recovery Deductions

2. Expense vs. Capitalize  Deduction permitted for all “ORDINARY AND NECESSARY” business expenses  Deduction prohibited for “PERMANENT improvements to increase the value of property”  Some types of capitalized costs can be recovered through amortization or depreciation

3. Expense vs. Capitalize  Repairs and maintenance? Source of IRS dispute due to facts.  Capitalize expenditures that increase the value or useful life of an asset.  Environment cleanup and prevention costs: TRA1997 has a provision allowing firms to elect to deduct rather than capitalize expenditures to abate or control hazardous substances at contaminated areas.

4. Tax Basis  Tax basis = unrecovered cost (cost - depreciation).  Starting basis generally equals COST basis:  original purchase price regardless of whether acquired by debt, or  FMV of asset if cost more difficult to measure.  Cost recovery of  Inventory = cost of goods sold  Tangible assets = depreciation  Intangible assets = amortization  Natural resources = depletion

5. Cost of Goods Sold  Inventory Methods (must use accrual to account for COGS  1) FIFO  2) specific ID  3) LIFO - If use LIFO for tax, must also use LIFO for books.  In times of inflation, LIFO decreases book and taxable income.

6. DepreciationDepreciation  Depreciation applies to tangible assets (things you can touch versus intangibles like patents, goodwill) that:  Lose value over time due to wear and tear, obsolescence  Buildings depreciate even though real estate often increases in value.  Have a reasonably ascertainable useful life  Artwork is not generally depreciable.

7. DepreciationDepreciation  MACRS - Modified Accelerated Cost Recovery System  Personalty:  DDB: 3, 5, 7, 10  150% DB:15, 20  General rule is half year convention  Realty: SL method: 27.5 years residential, 39 years non-residential (specialty realty 20, 25, 50)  Mid Month convention

8. Depreciation Conventions - Personalty  Table 7-2 incorporates a half-year convention - provides only 1/2 of the regular rate in the year the property is put in service.  Anti-Abuse provision Mid-quarter convention  : IF > 40% personalty is acquired during the last quarter of the year, THEN  Compute depreciation separately for EACH quarter’s acquisition using mid-quarter tables in appendix of chapter 7

9. AutomobilesAutomobiles  Maximum annual depreciation limit per vehicle, indexed for inflation.  Year 1 $2,960 (1st yr)  Year 2 $4,800 (2nd yr)  Year 3 $2,850 (3rd yr)  Year 4 + $1,775 (4th +++ yrs).  Compute depreciation per MACRS, then limit above.

10. Expensing Election – Section 179  Applies to tangible personalty. May expense $128,000 of assets purchased after 2008 and $133,000 in 2009.  Expense cannot create a business loss.  Expense reduced $ for $ by purchases > $800,000..  Reduces recordkeeping, benefit for small businesses  Planning - if buy a 3-year, 5-year and 7-year asset, which one should you expense?

11. Amortization of Intangibles  Generally requires a determinable useful life.  Organizational costs & Start up costs  Immediately deduct up to $5,000  Amount over $5K amortized over 180 months.  Start-up costs & Organization costs are defined on pg. 177.  Expansion costs may be currently deductible.

12. Leasehold Costs and Improvements  Cost of acquiring lease is amortized over the period of lease.  Improvements to leased property are capitalized and depreciated according to type of property.

13. Purchased Intangibles  Allocate lump-sum price to assets by relative FMVs.  Residual = goodwill.  Tax = 15 years SL  GAAP = 40 years pre-2002. No GAAP amortization post-2001 - evaluate for impairment annually. Book-tax difference is permanent post-2001.