Chapter 10: Depreciation and Cost Recovery Flashcards
Depreciation rules for property placed into service after 12/32/86
MACRS
Depreciation rules for property placed into service after 12/30/80 and before 1/1/87
ACRS
Depreciation rules for property placed into service before 1981
Section 167 rules (basically financial accounting rules)
Depreciation vs cost recovery
Used interchangeably
When is property considered to be “placed into service”
When it is in a condition or state of readiness and is available for a specifically assigned function
What assets are depreciable
- 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
When is first year depreciation allowed
In the year the asset is placed into service (not necessarily when purchased)
Can depreciation method be changed?
No. Must be used consistently unless the IRS approves a change in accounting methidb
Depreciation allowed
Actual depreciation claimed by the taxpayer for a particular tax year
Allowable depreciation
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)
Reducing the basis of property
Must be reduced by the amount of depreciation that is ALLOWABLE for the year (not just the depreciation claimed)
Real property
Tangible property that is land or any structure permanently attached to the land (buildings)
Personal property
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)
Expensing depreciable property
Allowed for tax purposes may annually expect to expense otherwise depreciable property costing $2,500 or less ($3,000 for some criteria)
Conversion of personal-use property to business property
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
MACRS specific rules
- 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
Half year convention
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
Mid-quarter convention
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
Mid-month convention
Assumes all asset acquisitions or dispositions are made at the midpoint of the month in which the transaction occurs
Used for real estate
Tangible personal property MACRS classifications
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
Property excluded from MACRS depreciation
- property depreciated under a method not expressed in terms of years (units of production)
- intangible assets (goodwill, copyrights)
- films, videotapes, sound recordings
Section 179 expensing election
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
Limitations on section 179 election
- 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
Section 179 if property is no longer predominantly used in trade or business
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
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)
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)
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
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
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
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
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
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)
Nonresidential real property
Real property other than residential real property
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