Basis, Depreciation, and Cost Recovery Flashcards
Original basis
- taxpayers investment in asset or property
- increased by legal fees, commissions, sales tax, freight, and improvements
- not increased by repairs, real estate taxes, normal business expenses
- when basis is increased it becomes cost basis
Improvements vs Repairs
Improvement
- - must be capitalized: increase basis of property
- replace roof
- add a fence
- replace A/C
- pave driveway
- replace plumbing
- add a room
Repair
- pay liability insurance
- patch holes in driveway
- repair air conditioning system
- pay for lawn service
- pay for property management
- repair a fence
Adjusted basis
adj basis = cost basis - cost recovery (deductions)
- cost recovery produces a deduction for depreciation
- deduction generates a tax savings and reduces the basis of the asset
Amortization
- a business owns a variety of assets with no physical substance
- assets represent a valuable property right or economic attribute
- tax basis in intangibles may be recoverable
- intangibles generally amortized under section 197
- method similar to straight line method
Accretion
- at issue a bond is discounted from par value
- often zero coupon
- discount must be accreted over bonds life
- each year portion “earned” is included as taxable income and bonds basis is increased
- phantom income
Basis of property received by gift in nontaxable transactions
- FMV at date of gift is the value of gift
- if FMV on date of gift is greater than donors adjusted basis, then use donors adjusted basis (carryover basis)
- if FMV on date of gift is less than donors adjusted basis then following
1. a loss is measured using FMV on date of gift
2. a gain is measured using donors basis
3. if the sale price of the gift is between the donors basis and the FMV on date of gift, no gain or loss is recognized
Basis of inherited property
basis = FMV on date of death or alternative valuation date if selected
- community property state: full step up in basis if at least 1/2 of property is includible in deceased estate
- if noncommunity property, only half gets step up
- holding period always long term if acquired from decedent
Cost recovery/depreciation
- allowance for the exhaustion and presumed wear and tear of property used in a trade or business or held for the production of income
Modified Accelerated Cost Recovery System (MACRS)
applies to all recovery property (not land or intangibles) placed in service after 1986
- straight line is an option under MACRS but a half year convention must be used
- used to recover costs, depreciate
Property classes
CAT
O
R
N
- - 5 year : computers, autos, light duty trucks (1245 property)
- 7 year: office furniture and fixtures (1245 property)
- 27 1/2 : residential rental property (1250 property)
- 39 year : nonresidential real property (1250 property)
MACRS tables
MACRS
Recovery year 1: (20% for 5 year) (14.29% for 7 year)
Recovery year 2 : (32% for 5 year) (24.49% for 7 year)
Straight line
Recovery year 1: (10% for 5 year) (7.14% for 7 year)
Recovery year 2 : (20% for 5 year) (14.29% for 7 year)
- use MACRS unless stated, use basis to calculate
Expensing vs capitalizing
- tax law allows businesses to to expense a limited dollar amount of tangible property during a taxable year under section 179
179 deduction
- a business may expense up to $1,160,000 of qualifying property in the year of acquisition
- qualifying property is generally tangible personal property (1245 property) purchased for use in a trade or business
- max cost that can be annually expenses is reduced dollar for dollar by the cost of qualifying property that exceeds 2,890,000
- amount of expense deduction is limited to taxable income derived from active conduct of any trade or business
- cannot create loss with 179
- carryforward
- helps deduct cost of new assets and avoid burden of MACRS
Amortization
- recovery of certain capital expenditures that are not ordinarily deductible in a manner similar to straight line
