3.5 - Cost Recovery Flashcards
What is an annual allowance given to a trade or business for exhaustion, wear and tear, and normal obsolescence of assets used in trade or business?
Depreciation
What is the depreciation method typically used for federal income tax purposes?
Modified Accelerated Cost Recovery Systems (MACRS)
What is the definition of real property?
What is the definition of personal property?
Real = lan and al items permanently affixed to the land (buildings, paving)
Personal = tangible, movable property not affixed to the land (machinery and equipment and automobiles)
What personal proprty assets are included in each of the following life cycles:
3 year
5 year
7 year
10 year
15 year
20 year
3 = special tools and racehorses
5 = automobiles, light trucks, computers, and copiers
7 = furniture & fixtures, machinery, and equipment
10 = boats and water transportation equipment
15 = improvements to the interior of existing nonresidential buildings and improvements to land
20 = farm buildings and municipal sewers
What is the MACRS depreciation rules method for 3, 5, 7, and 10 year property?
What is the MACRS depreciation rules method for 15 and 20 year property?
- Computed using 200% declining balance
- Computed using the 150% declining balance method
How is salvage value on machinery and equipment treated under MACRS?
It is ignored
Personal property is allowed what two types of depreciation conventions?
Half-year convention
Mid-quarter convention
Real property is allowed what type of depreciation conventions?
Mid-month convention
What is the half-year convention?
A personal property asset is allowed 6 months of depreciation in the year of acquisition and disposition regardless of the date on which it is acquired or disposed
If more than 40% of depreciable personal property is placed in service in the last quarter of the year, a mid quarter convention applies and the mid-quarter MACRS table are used to calculate depreciation. If personal property is disposed of before the last year, the full year MACRs rate must be multiplied by a mid-quarter ratio for the mid-quarter convention in the year of disposition. What are the ratios/percentages used for each quarter?
Q1 = .5/4 = 12.5%
Q2 = 1.5/4 = 37.5%
Q3 = 2.5/4 = 62.5%
Q4 = 3.5/4 = 87.5%
How is residential rental property depreciated? How is nonresidential real property depreciated?
Residential rental = 27.5 year straight line
Nonresidential real = 39 years
What is residential rental property? What is nonresidential real property?
- Apartment buildings and rental homes
- Office buildings and warehouses
Each tax year, a taxpayer may elect to deduct a fixed amount of depreciable personal property and qualified real property. What are the limitations to this section 179 expense deduction?
The 2022 allowance is $1,080,000
The max amount is reduced dollar for dollar by the amount of property that exceeds 2,700,000
Cannot create a loss
Limit for SUVs is 27,000
Nicholas placed into service $50,000 of 5 year property in year 1. Year 1 rate for 5 year property from MACRS depreciable tables is 20%. Compare the MACRS depreciation expense to its section 1790 expense.
50,000 X 20% = 10,000 MACRS depreciation expense
Or
Full 50,000 179 expense
Take the 179 expense deduction because its larger than the MACRS deduction
Under this rule, a taxpayer can expense an additional percentage of qualified property that is place into service in the current year.
Bonus depreciation rule
What is the qualifying property that can take advantage of the bonus depreciation rule?
Personal property (machine and equipment) with a recovery period of 20 years or less that is NEW not previously used
What is the bonus depreciation percentage?
100% of property placed into service during the years 2018 - 2022 and phased to 80% in 2023, 60% in 2024, 40% in 2025, and 20% in 2026. And an additional 8,000 first year depreciation for vehicles.
Company A places into service $2,750,000 of seven year MACRS property. Determine the total cost recovery deduction for the year on the property.
2,750,000 - 2,700,000 (179 expense max) = 50,000
1,080,000 - 50,000 = 1,030,000 179 expense deduction
2,750,000 - 1,030,000 = 1,720,000 X 100% = 1,720,000 bonus depreciation deduction
Depletion is allowed on what?
Exhaustible natural resources such as timber, minerals, oil, and gas
What are the two methods of depletion?
Cost depletion
Percentage depletion
But must use the method that results in the larger deduction
Under this depletion method, the remaining basis of the property is divided by the remaining number of recoverable units to arrive at the unit replete on rate. The deduction for depletion is the depletion unit rate multiplied by the number of units sold for the year.
Cost depletion
Oil property having an estimated 1,000,000 recoverable barrels at the beginning of the year has a cost basis of $1,000,000. In year 1, 50,000 barrels were sold. Calculate the depletion deduction for year 1.
1,000,000 basis / 1,000,000 barrels recoverable = $1 per barrel
$1 X 50,000 barrels sold = $50,000 depletion deduction
Under this depletion method, you would multiply a certain percentage by gross income from the property during the tax year. The deduction is limited to 50% of taxable income from the natural resource. The allowable percentage ranges from 5% to 22% depending on the mineral or substance being extracted.
Percentage depletion method
This depletion deduction may be taken even after costs have been completely recovered and there is no remaining cost basis:
Percentage depletion
How are intangibles such as goodwill, licenses, franchises, and trademarks amortized?
Straight line basis over 15 years
How are business organization and start up costs expensed?
Each is permitted to first take off $5,000 to be expensed and the remainder is amortized over 180 months. The $5,000 is reduced dollar for dollar as total cost exceeds $50,000 per item.
How are the following expenses amortized:
Research expenses
Pollution control facilities
Reforestation costs
Geological and geophysical costs
Research = amortized over 60 months
Pollution = amortized over 60 months
Reforestation = amortized over 84 months
Geological = amortized over 24 months
Royal company acquired a patent with a cost of $50,000 in august year 1. Determine the amortization on the patent in year 1.
50,000 / 180 months = 278 per month
278 X 5 months = $1,390
What is the calculation for after-tax cash flow?
Earnings after tax + amortization + depletion + depreciation
Why must amortization, depreciation, and depletion be added back to n income for the calculation of after tax flows?
Because they represent declining economic value of an asset but not an actual cash flow
How can the tax savings associated with taking amortization, depletion, or depreciation be calculated?
The amount of the expense multiplied by the marginal income tax rate
On august 1 year , graham purchased and placed into service an office building costing $264,000 including $30,000 for the land. What was grahams MACRS deduction for the office building in year 1?
264,000 - 30,000 land = 234,000 / 39 years = 6,000 per year
4.5 / 12 months (mid-month convention) X 6,000 = 2,250
