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Survey Of Taxation > Chapter 10: Depreciation and Cost Recovery > Flashcards

Chapter 10: Depreciation and Cost Recovery Flashcards

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1
Q

Depreciation rules for property placed into service after 12/32/86

A

MACRS

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2
Q

Depreciation rules for property placed into service after 12/30/80 and before 1/1/87

A

ACRS

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3
Q

Depreciation rules for property placed into service before 1981

A

Section 167 rules (basically financial accounting rules)

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4
Q

Depreciation vs cost recovery

A

Used interchangeably

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5
Q

When is property considered to be “placed into service”

A

When it is in a condition or state of readiness and is available for a specifically assigned function

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6
Q

What assets are depreciable

A
  • property used in trade or business or for the production of income (not personal use property)

-land and other indefinite life assets (works of art) are generally NOT depreciable

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7
Q

When is first year depreciation allowed

A

In the year the asset is placed into service (not necessarily when purchased)

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8
Q

Can depreciation method be changed?

A

No. Must be used consistently unless the IRS approves a change in accounting methidb

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9
Q

Depreciation allowed

A

Actual depreciation claimed by the taxpayer for a particular tax year

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10
Q

Allowable depreciation

A

The depreciation the taxpayer is entitled to deduct, whether or not they take the deduction

(If not claimed depreciation previously is determined by the straight line method)

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11
Q

Reducing the basis of property

A

Must be reduced by the amount of depreciation that is ALLOWABLE for the year (not just the depreciation claimed)

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12
Q

Real property

A

Tangible property that is land or any structure permanently attached to the land (buildings)

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13
Q

Personal property

A

Tangible property that is not real property

(Vs personal-use property which is property not used in trade or business or otherwise in production of income)

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14
Q

Expensing depreciable property

A

Allowed for tax purposes may annually expect to expense otherwise depreciable property costing $2,500 or less ($3,000 for some criteria)

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15
Q

Conversion of personal-use property to business property

A

Property’s basis for depreciation is the lesser of adjusted basis or FMV at the conversion date

Any decline from basis to FMV is personal loss and not depreciable/deductible

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16
Q

MACRS specific rules

A
  • salvage value not considered for depreciation computation
  • uses specific asset classes defined by the IRS
  • depreciation methods are built into the MACRS tables (uses accelerated and straight-line methods, but accelerated is not permitted for real property)
  • uses conventions about when assets are placed into service or disposed of rather than actual dates
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17
Q

Half year convention

A

Assumes that all asset acquisitions or dispositions are made at the midpoint of the tax year

Required for all tangible personal property

Effectively has taxpayers taking a half year of depreciation on acquisition and a half year of depreciation on disposal

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18
Q

Mid-quarter convention

A

Special convention for some tangible personal property. Required when aggregate basis of all personal property placed in service during the last three months exceeds 40% of the cost of all personal property placed into service during the tax year (if applies use mid quarter convention for all property placed in use that year)

(40% rest applied after reducing basis by section 179 expensing but not bonus depreciation)

Requires use of mid quarter tables for depreciation

For purposes of test, property placed into service and disposed of during the year is not included

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19
Q

Mid-month convention

A

Assumes all asset acquisitions or dispositions are made at the midpoint of the month in which the transaction occurs

Used for real estate

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20
Q

Tangible personal property MACRS classifications

A

3-year (property with a class life of 4 years or less)
5-year (property with a class life of more than 4 but less than 10 years)
7-year (property with a class life of more than 10 but less than 16 years)
10-year (property with a class life of more than 16 but less than 20 years)
15-year (property with a class life of more than 20 but less than 25 years)
20-year (property with a class life of 25 years or more

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21
Q

Property excluded from MACRS depreciation

A
  • property depreciated under a method not expressed in terms of years (units of production)
  • intangible assets (goodwill, copyrights)
  • films, videotapes, sound recordings
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22
Q

Section 179 expensing election

A

Taxpayers may elect to expense up to $1.05 million (2021) of the acquisition cost as an ordinary deduction the year the property is placed into service

In lieu of depreciating
Not generally applicable to real estate
Election made annually for individual assets

MACRS will apply to about amounts in excess

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23
Q

Limitations on section 179 election

A
  • must be property purchased for use in an active trade or business (not simply acquired for production of income)
  • tangible personal property
  • not acquired from related party/ by gift/inheritance
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24
Q

Section 179 if property is no longer predominantly used in trade or business

A

Tax benefits must be recaptured

Taxpayer must include in gross income the amount previously expensed reduced by depreciation that would have been allowed for the period the property was held for business use

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25
Limitations on section 179 election
If total cost of qualified property placed into service during the year is more than $2,620,000 the $1.05M is reduced dollar for dollar (so no deduction if over $3.67M placed into use in one year) no carryforward on this limitation Deduction cannot exceed the taxpayer's taxable income from trade or business (excess here CAN be carried forward indefinitely)
26
Bonus depreciation
Taxpayer may deduct a percentage of the property's cost in the year it is placed into service. Percentage allowed varies by year (100% for property placed into service between 9/28/17 and 12/31/22, decreases 20% every year after 2022)
27
Tax treatment for bonus depreciation
Automatically deductible for both regular income tax and AMT. Taxpayers must elect out of bonus depreciation if they do not wish to pay it
28
Qualified property for bonus depreciation
1) MACRS property with a recovery period of 20 years or less 2) computer software (other than that which must be amortized) Generally non-real estate property
29
Property that qualifies for both section 179 expensing and bonus depreciation
- section 179 applied first - bonus depreciation applied next to the remaining cost after section 179 applied - if bonus depreciation rate is less than 100% anything remaining is depreciated using MACRS
30
Purpose of 40% rule for mid-quarter convention
Prevents taxpayers from using half year convention taking a half years depreciation when a substantial portion of the assets are placed into service during the last quarter of the tax year
31
Depreciation in the year of disposition
Must be based on the same convention applied at acquisition (half-year, mid-month, mid-quarter) so MACRS depreciation calculation must be adjusted in the year of disposal
32
Residential rental property
Property from which at least 80% of the gross rental income is rental income from dwelling units (for permanent not transient use)
33
Nonresidential real property
Real property other than residential real property
34
Cost recovery for real property
real property placed into service after 1986 - must use straight line depreciation - use mid-month convention in years of acquisition and disposition Residential recovery period; 27.5 years Nonresidential recovery period; 39 years
35
If taxpayer lives in their own rental property
In determining if 80% of gross rental income is rental of dwelling units must include fair rental value of own unit
36
Capital improvements to real property
Must he depreciated over the FULL MACRS recovery period of the improvement, NOT over the remaining recovery period of the building
37
Qualified improvement property
QIP Any improvement to an interior portion of nonresidential real property if the improvement is placed into service by the taxpayer after the date the real property is placed into service (certain improvements not included: enlargements, elevators, escalators, internal structural framework)
38
Tax treatment of QIP
- eligible for section 179 expensing and bonus depreciation - cost depreciable over 15 years using the straight line method
39
Straight line method election
Taxpayers may elect to use straight line depreciation for tangible personal property. Must use same depreciation period as MACRS or extended period based on alternative depreciation system
40
Alternative depreciation system
ADS May be elected on a year by year basis, but irrevocable for a specific piece of property once election is made. Required for tangible property used predominantly outside the US (which is not eligible for bonus depreciation) Generally elected by taxpayers who want to use the straight line method over a longer recovery period (if they anticipate being in a higher tax bracket in the future, since it shifts some deductions to future years)
41
ADS election for personal property
Election applies to all property within a recovery period class
42
ADS election for real property
Election made on an individual property basis
43
Mixed personal-use and income producing assets
Any portion of assets cost attributed to personal use is not depreciable
44
Listed property
Cars and property generally used for purposes of entertainment, recreation, or amusement
45
Listed property rules
If listed property's business use is > 50% of total use taxpayer may elect Section 179 expensing and use regular MACRS tables/bonus depreciation If business use is 50% or less taxpayer must use ADS and may not elect Section 179/use bonus depreciation
46
If listed property was depreciated under MACRS but then business use percentage decreased below 50%
Taxpayer subject to depreciation recapture. Must recompute all depreciation using ADS and recapture any excess depreciation deduction (including section179 and bonus depreciation) as ordinary income ADS must be used for all subsequent years even if business use percentage increases above 50% in a subsequent year
47
Deduction ceiling for passenger automobiles
Dollar limit for depreciation depending on year vehicle placed into service (see table)
48
Taking bonus depreciation with passenger automobile depreciation deduction limit
1st year depreciation = first year ceiling Subsequent 5 years: deduction is lesser of ceiling limit for year or cost above 1st year ceiling * MACRS depreciation percentage for year (safe harbor method) Remaining years: any cost exceeding the above amounts remains subject to ceiling limit
49
Depreciation for mixed use passenger vehicles
- compute regular MACRS depreciation - identify the ceiling amount -reduce each by the percentage of personal use - deduction for he year will be the lesser of the two reduced amounts BUT the taxpayer's basis in the car decrease by the lesser of the unreduced amounts
50
Depreciation deduction limitation for SUVs
Dollar limit of section 129 expense of an SUV with gross vehicle weight rating between 6,000 and 14,000 lbs ($26,000 in 2021)
51
Exemption from ceiling limitations for vehicles that are clearly not for personal use
Certain non-personal-use vehicle completely exempt from ceiling limitations it they are specifically modified so they are not likely to be used more than a de minimis amount for personal use
52
Increased ceiling limitations for light trucks and vans
For trucks and vans placed into service before 2017 in a truck chassis that has a gvwr of 6,000lbs ornless
53
Adjustment of rental payment deduction for leases automobile, light truck or van
Deduction for rental payment reduced by an exclusion amount obtained from an IRS table (based on vehicle's FMV, tax year of lease commencement, and prorated for percentage of business use/days used during year )
54
Amortization of intangible assets
Amortized on straight line basis - goodwill (purchased intangibles) - research and experimental expenditures - computer software - start up expenditures - organization expenditures - pollution control facilities
55
Section 197 intangibles
- goodwill and going concern value - purchased intangibles related to work force or information based (customer list, process, copyrights, formulas..) - licenses, permits, other rights granted by gov - covenant bit to compete (between buyer and seller of business: amortized over 15 years even if agreement is for less) - franchises, trade marks, trade names
56
Amortization of section 197 intangibles
Straight line basis over a 15-year (180-month) period beginning the month of acquisition PURCHASED intangibles amortized. Created intangibles are not (rather their expenses are deducted immediately as operating expenses)
57
Going concern value
Added value that attaches to acquired property because it is an integral part of a going concern
58
Tax treatment for capitalized cost for internally created intangibles
Code 167 Depreciation over useful life in straight line method? (Check this!)
59
Section 1231
When applied generally allows a net section 1231 gain to be treated as a long-term capital gain and a net sec. 1241 loss as an ordinary loss
60
Section 1245
Requires that gains be classified as ordinary income to the extent depreciation, amortization, or depletion was claimed as an ordinary deduction in a prior year
61
Disposition of intangible assets
If held for more than one year: - net gain = LTCG - net loss = ordinary loss - gain suspect to depreciation recapture under section 1245 - loss not deductible if other intangibles acquire in the same transaction are retained (bases of retained intangibles increases by disallowed loss)
62
Research and experimental expenditures
Include experimental and laboratory costs incidental to the development of a product
63
Tax treatment options for R&E expenses
- expense in the year paid or incurred - capitalism and amortize over 60 months or more beginning with the month in which benefits are realized - capitalize and write off costs when the project is abandoned or worthless Must make an election in initial year incurred and continue to use the same method unless IRS approval given to change. (If no election, default is capitalization) NOT VALID FOR EXPENSES IN 2022 and beyond
64
Expenses that qualify as R&E expenditures
- costs incidental to the development of an experimental or pilot model, a plant process, product, formula, or invention - Costs associated with product improvements - direct costs of obtaining a patent (attorney fees) - research contracted to others - depreciation or cost recovery amounts attributable to capitalized R&E items (research lab and equipment)
65
When is deferral and Amortization method preferred for R&E costs
If taxpayer currently in low tax rate or expects initials net operating losses during the start up period
66
R&E deductions vs tax credits
R&E expense deductions must be reduced by the amount of any credits claimed based on that expense
67
R&E expenses incurred in 2022 or later
Must be capitalized and amortized over the five year period beginning with the middle of the year in which they are paid or incurred (15 years for foreign research) Includes computer software development expenses
68
Options for cost recovery: internally developed computer software
Assuming costs are R&E costs, either: - expensed in year incurred - elected to be capitalized and amortized over 60 months beginning in the month in which the taxpayer first realizes benefits from the software (For costs incurred through 2021)
69
Options for cost recovery: internally developed computer software if costs are not R&E costs
Depreciated in a straight line basis over 36 months beginning with the date the software is placed into service
70
Options for cost recovery: purchased computer software
Software included in cost of hardware: software not stated as a separate asset and depreciated with computer under MACRS (5 year) Software purchased separately: depreciated on a straight line basis over 36 months Software purchased in connection with acquisition of other assets of existing trade or business: is a section 197 intangible - amortized over 15 years
71
Tax treatment of leased or licensed computer software
Deductible in full in the year paid
72
Major oil and gas property expenditures: payments for mineral interest
capitalized and recovered through depletion
73
Major oil and gas property expenditures: intangible drilling and development costs
Elect to capitalize or immediately expense
74
Major oil and gas property expenditures: tangible asset costs
Immediately capitalize and depreciate under MACRS
75
Major oil and gas property expenditures: operating costs after the well is producing
Deductable as ordinary and necessary business expenses
76
Depletion
- using up of natural resources - can be calculated with cost depletion or percentage depletion (can switch from year to year without consequence) - depletion claimed by taxpayer with economic interest in property being depleted (owns the property or retains a royalty interest)
77
Cost depletion
Adjusted basis of asset / estimated recoverable units = per unit depletion cost Per unit depletion cost x units sold = depletion deduction (If estimate is subsequently determined to be incorrect rate must be revised going forward but no amended return need be filed)
78
Royalty interest
Landowner receives a certain amount per unit extracted from the land
79
Percentage depletion method
Not available to all companies (small oil and gas: yes, large: no.) Depletion = Gross income from property * depletion rate for given mineral based on IRS table May not exceed 50% of taxable income on property (before deduction). 100% limit for oil and gas properties May not be calculated on any lease bonus, advance royalty or other amount payable without regard to production
80
Depletion expense after property basis reduced to 0
Cost depletion: no more expense allowed Percentage depletion: may continue to claim (though does not further reduce the value of the property below 0)
81
Intangible drilling and development costs
IDCs Acquisition costs of the underlying property that are incurred for the drilling and preparation of wells Apply only to oil, gas, band geothermal wells
82
Tax treatment of IDCs
Can be capitalized or deducted as an expense If capitalized: amounts added to property's basis for determining depletion & costs expenses through cost depletion Generally preferable to expense as do not tend to raise cost depletion deduction over that of percentage depletion
83
Tax treatment for capitalized IDCs if well nonproductive
Ordinary loss for any amount capitalized and not yet recovered via depletion
84
When might it be preferable to use ACRs rather than MACRs
If a taxpayer is in a low tax bracket but anticipates being in a higher tax bracket in the future (ACRs has a longer recovery period) In which case may also elect out of Section 179 expensing and bonus depreciation
85
When may taxpayers exclude property from MACRS system
If property is depreciated under units of production method or some other method not expressed in terms of year (may allow to depreciate over shorter time than MACRs allows)
86
Form to report depletion/depreciation/amortization
Form 4562 If multiple businesses must use one for each enterprise Not required if all depreciation is on property placed into service in the current year

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