Chapter 2 Property Acquisition and Cost Recovery Flashcards
Cost Recovery
Cost Recovery is the method by which a company expenses the cost of acquiring capital assets.
Cost Recovery can take the form of
1.) Depreciation
2.) Amortization
3.) Depletion
Name the 3 Methods of Cost Recovery
The method of Cost Recovery depends on the nature of the underlying asset.
1.) Depreciation- is the method of deducting the cost of Tangible Personal (equipment, vehicles, computers, furniture, etc.) and Real Property means Real Estate (other than land) over time.
2.) Amortization- is the method of deducting the cost of Goodwill, Patents, Copyrights (Intangible Assets).
3.) Depletion- the method of deducting the cost of natural resources over time.
Tax Basis
Tax basis is the amount of money a taxpayer has invested in an asset that hasn’t been recovered yet
What does TAX BASIS of an ASSET MUST be REDUCED by the COST RECOVERY DEDUCTIONS ALLOWED or allowable mean?
EXAMPLE
What does if a business fails to deduct the allowable amount of depreciation for the year, the business still must reduce the asset’s tax basis by the depreciation the taxpayer could have deducted under the method the business is using to depreciate the asset mean?
This means that even if a business forgets to or chooses not to claim the depreciation deduction on its tax return for a given year, the asset’s tax basis still has to be reduced by the amount of depreciation that could have been claimed. EXAMPLE.
What does the amount of an asset’s cost that has yet to be recovered through cost recovery deductions is called the asset’s ADJUSTED BASIS or TAX BASIS mean?
EXAMPLE
MACRS Modified Accelerated Cost Recovery System
MACRS is the primary method of depreciation used for tax purposes in the US. It was introduced in 1986 as part of the Tax Reform Act to provide a standardized system for calculating depreciation of tangible property.
Recovery Period or Depreciable Life
The Recovery Period or Depreciable Life is the time over which an asset’s cost will be allocated or depreciated.
It’s the time range/spread of an asset’s useful life.
Length of time business property is depreciated or amortized.
What are the 3 Personal Property Depreciation Methods?
MACRS provides three acceptable methods for depreciating personal property:
1) 200% (double) declining balance DB
DDB is the default method
2) 150% declining balance
3) Straight-line.
Businesses elect One Depreciation Method for all similar assets they acquire that year.
If a business acquires several different machines during the year, it must use the Same Method to Depreciate ALL of the Machines.
What does the 200% declining method takes twice the straight-line percentage on the asset’s declining basis until switching to the straight-line method in the year that the straight line method over the remaining life provides a greater depreciation expense mean?
EXAMPLE
Example with Full 5-Year Depreciation of DDB & SL
EXAMPLE
The depreciation continues over the full 5-year useful life. The switch from the double-declining balance to the straight-line method happens in Year 4 when the straight-line method yields a higher depreciation expense than the DDB method.
For Tax Planning Purposes/Strategy, taxpayers that currently have lower marginal tax rates but expect their marginal tax rates to increase in the near future may elect to use the straight-line method because that method generates less depreciation in the early years of the asset’s life, relatively, more depreciation in the later years when their marginal tax rates may increase.
Strategic Reasoning: The strategy is to use straight-line depreciation when the taxpayer’s marginal tax rates are lower, resulting in less depreciation expense (and thus less deduction) in those early years. As the taxpayer’s marginal rates increase in the future, the depreciation expenses (deductions) will become more valuable since they will reduce taxable income at a higher rate
EXAMPLE
The 4 steps to depreciate an asset, a business must determine:
1) Original Basis
2) Depreciation Method
3) Recovery Period
4) Depreciation Convention
Personal Property Convention
Real Property Convention
EXAMPLE
Assume that Teton holds the tangible personal property it acquired and placed in service in 2023 until the assets are fully depreciated.
Using the IRS-provided tables (MACRS table), how would Teton determine its depreciation expense for 2023 through 2023?
–See p.36 Applying Half-year Convention.
–See MACRS Table
Half-Year Convention is built into the depreciation tables provided by IRS.
Mid-Quarter Convention
Mid-Quarter Convention is used when more than 40% of TOTAL PURCHASES of personal properties are made in the Q4 (Oct, Nov, Dec) of the tax year.
1) First determine if more than 40% of the total purchased occurred in Q4.
2) If more than 40% of the TOTAL PURCHASES occurred in Q4, then ALL purchases regardless of what quarter purchases were made will be TREATED as if placed in Service in the MIDDLE OF THAT QUARTER.
Q1 February 15
Q2 May 15
Q3 August 15
Q4 November 15
Section 179 allows companies to expense properties immediately.
Section 179 is geared towards small businesses. The image is a Phase Out
Section 179 lets businesses deduct the cost of certain assets (like equipment) immediately instead of spreading the deduction over many years.
To limit section 179 to smaller businesses, Congress enacted a PHASE-OUT of section 179.
When a business spends more than $3,050,000 but less than or equal to $4,270,000 on qualifying assets in a tax year, Section 179 deduction is gradually reduced.
This reduction is called a PHASE-OUT.
Bonus Depreciation was enacted by Congress when the economy was having problems, recession, etc, such as 911 and Covid.
Bonus Depreciation allows businesses to depreciate or take a large portion of their asset purchases as expense IN the CURRENT YEAR year rather than depreciating them over a number of years.
Summary of Amoritzable Assets
Summary of Amortizable Assets Table Example
Amortization
Assume that on January 30,2024 Teton acquires a competitor’s assets for $350,000. Of the $350,000 purchase price, $125,000 is allocated to tangible assets and $225,000 is allocated to Section 197 intangible assets (patent $25,000, customer listing w/3 year year life $50,000, and goodwill $150,000). For each of the first three years, Teton would deduct one-fifteenth of the basis of each asset as amortization expense. What is Teton’s accumulated amortization and remaining basis in each of these section 197 intangibles after three years?
What is Teton’s accumulated amortization and remaining basis in each of these section 197 intangibles after three years?
Intangible assets (Amortization) has a recovery period of 180 months (15 years).
Suppose Teton is a corporation and it wants to maximize its first-year organizational expenditure deduction.
Teton incurred $53,000 of organizational expenditures in year 1. How much of the organizational expenditures can Teton immediately deduct in year 1?
EXAMPLE
assuming that Teton is a corporation and that it incurred $41,000 of organizational expenditures in year 1, how much of the organizational expenditures could Teton immediately expense in year 1?
EXAMPLE
Assuming that Teton is a corporation and it incurred $60,000 of organizational expenditures in year 1, how much of the organizational expenditures could Teton immediately expense in year 1?
EXAMPLE
Assume Teton is a corporation and it amortizes the $51,000 or organizational expenditures remaining after it immediately expenses $2,000 of the costs. If Teton began business on February 1 of year 1, how much total cost recovery expenses for the organizational expenditures is Teton able to deduct in year 1? How much cost recovery expense will Teton be able to deduct in year 2?
EXAMPLE
