Chapter 7 - Property Acquisitions and Cost Recovery Deductions. Flashcards
Define Adjusted Basis
The initial tax basis of an asset reduced by cost recovery deductions allowable with respect to the basis.
Define Amortization
The ratable deduction of the capitalized cost of an intangible asset over its determinable life.
Define Bonus Depreciation
Accelerated deduction in the year placed in service of 50 percent (or 100 percent) of the cost of qualified tangible personal property.
Define Capitalization
An accounting requirement that an expenditure be charged to a balance sheet account rather than against the firm’s current income. This creates an asset.
Define Costs Basis
The purchase price of an asset including any sales tax paid by the purchaser and any incidental costs related to getting the asset in place and into production.
Define Cost of Goods Sold
The capitalized cost of inventory sold during the taxable year and subtracted from gross receipts in the computation of gross income.
Define Depreciation
The systematic deduction of the capitalized cost of tangible property over a specific period of time (their estimated useful life). As a result, the cost of an asset is expensed over the years in which the asset contributes to the firm’s revenue generating activity.
Define Expansion Costs
Costs of enlarging the scope of operations of an existing business.
Define FIFO
The inventory costing convention under which the first goods manufactured or purchased are assumed to be the first goods sold.
Define Going-Concern Value
Value attributable to the synergism of business assets working in coordination.
Define Goodwill
Value created by the expectancy that customers will continue to patronize a business.
Define Half-Year Convention
Property placed in service on any day of the taxable year is treated as placed in service halfway through the year for MACRS purposes.
Define Leasehold Costs
Up-front costs incurred to acquire a lease on tangible business property.
Define Leasehold Improvements
Physical improvements made by a lessee to leased real property
Define Leverage
The use of borrowed funds to create tax basis.
Define LIFO
The inventory costing convention under which the last goods manufactured or purchased are assumed to be the first goods sold.
Define Midmonth Convention
Property placed in service on any day of the month is treated as placed in service at the midpoint of the month for MACRS purposes
Define Midquarter Convention
Property placed in service on any day of a quarter is treated as place in service at the midpoint of the quarter for MACRS purposes.
-Compute depreciation separately for EACH quarter’s acquisitions using mid-quarter tables.
Define MACRS
Modified Accelerated Cost Recovery System - The statutory and regulatory rules governing the computation of depreciation for tax purposes.
Every depreciable asset is assigned to one of 10 recovery periods. For the most part, the MACRS recovery period is shorter than the asset’s estimated useful life.
! - This is used only in the tax depreciation, not necessarily the book depreciation.
Define Organizational Costs
Expenditures incurred in connection with the formation of a partnership or corporate entity.
-This includes legal and accounting fees attributed to the formation and any filing or registration fees required under state or local law.
Define Passenger Automobiles
Four-wheeled vehicles manufactured primarily for use on public roads with an unloaded gross vehicle weight of 6,000 pounds or less.
Define Percentage Depletion
An annual deduction based on the gross income generated by a depletable property multiplied by a statutory depletion rate.
Define Recovery Period
The number of years prescribed by statute over which the basis of tangible business property is depreciated under MACRS.
Define Research and Experimental Expenditures
A preferential deduction for costs of basic research designed to encourage business to conduct such research.
Define Section 179 Election
The election under which firms can expense a limited dollar amount of the cost of tangible personalty place in service during the taxable year, as opposed to capitalizing the cost over multiple years)
Define Specific Identification Method
An accounting method under which the cost of goods sold includes the actual cost of specific items of inventory sold during the year.
Define Start-Up Expenditures
Up-front costs of investigating the creation or purchase of a business and the routine expenses incurred during the preoperating phase of a business.
Define Tax Basis
A taxpayer’s investment in any asset or property right and the measurement of unrecovered dollars represented by the asset.
Define Uniform Capitalization (Unicap) Rules
The set of tax rules governing the type of current expenditures that must be capitalized to inventory.
Firms must capitalize all direct costs of manufacturing, purchasing, or storing inventory (direct materials and direct labor) and any indirect costs that “benefit or are incurred by reason of the performance of production or resale activities.”
What is Cost Recovery?
When you charge an asset (write) off the balance sheet as an expense on the income statement.
What is Recognition?
How a realized transaction is taxed.
What are the four basic methods of periodic cost recovery? What if none are applicable?
- Cost of goods sold
- Depreciation
- Amortization
- Depletion
-A cost is recoverable only when the firm disposes of the asset or when the asset ceases to exist.
When is it ideal to adopt LIFO? What is the downside?
During a period of rising prices, it is generally to a firm’s advantage to adopt LIFO because in an inflationary economy, the most recently acquired goods are the most expensive and if they are the first sold it maximized the cost of goods sold and minimizes the cost of ending inventory. This maximizes tax savings. But that is also mirrored by a reduction in accounting income and earnings per share reported to investors.
What does the concept of depreciation apply to?
Wasting assets that:
- Lose value over time because of wear and tear, physical deterioration, or obsolescence
- Have a reasonably ascertainable useful life.
What are two types of assets that don’t depreciate?
Land
Works of art
What system is in place that determines how fast businesses are allowed to depreciate assets?
MACRS
What happens when MACRS depreciation is greater than book depreciation?
- The excess tax depreciation is a favorable book/tax difference resulting in deferred tax liability.
- The temporary difference will reverse in future years when book depreciation exceeds MACRS depreciation.
- As the difference reverses, the deferred tax liability will be reduced. By the year in which book basis and tax basis of the asset are depreciated to zero, the deferred tax liability will be eliminated.
What two categories does MACRS apply to?
-Depreciable realty (buildings, improvements, etc)
-Personalty (any tangible asset not part of a building of other permanent structure)
-Both of which are used in a trade, business, or income-
producing activity
What is the formula to determine tax basis?
Tax Basis = Cost - Depreciation
What is cost recovery method for:
- Inventory
- Tangible Assets
- Intangible Assets
- Natural Resources
- Inventory - Cost of Goods Sold
- Tangible Assets - Depreciation
- Intangible Assets - Amortization
- Natural Resources - Depletion
When is the 200% declining balance method used?
For depreciating assets with MACRS that have a recovery period of 3, 5, 7, or 10 years.
When is the 150% declining balance method used?
For depreciating assets with MACRS that have a recovery period of 15 or 20 years.
What are the three Inventory Methods?
FIFO
LIFO
Specific ID
What is the general convention used in MACRS? What assets does it apply to?
Half-Year convention.
Applies to assets with recovery periods from 3-20 years
When is the Straight Line Method used in MACRS? How long are the recovery periods?
For Realty
27.5 years for residential
39 years for non-residential (specialty realty 20, 25, 50)
What is the convention used for Realty under MACRS?
Mid-month convention
When does the Anti-Abuse provision kick in? What does it do?
- It kick in if 40% of personalty acquired during the year was bought in the last quarter of the year.
- It makes you use the Mid-Quarter convention
In the instance of a 5 year - 200% declining balance method, how is it computed?
If the item were a straight line item, it’d depreciate 20% a year. But a 200% means it depreciates the basis, calculated anew each year, by 40%, until the straight line method would be greater, in which case that is used.
Example
Year Basis Method Convention Deprec.
1 38,000 200% DB Half-year 7,600
2 30,400 200% DB 12,160
3 18,240 200% DB 7,296
4 10,944 200% DB 4,378
5 6,566 SL 4,378
6 2,188 SL 2,188
Mid Period conventions are used in the year of acquisition. When else are they used?
In the year of sale if that sale happens before the item depreciates to zero.
- In this case you half the % the relevant table says in the year of the sale.
What type of assets can’t be included in a Section 179 election?
Real Property & Vehicles
What type of asset can’t be included in getting bonus depreciation?
Real Property
Vehicles limited to $8,000 bonus.
Compare and contrast expensing vs. capitalizing.
.
What is the phase-out for Section 179 in 2013?
The amount of the allowed Section 179 depreciation is reduced dollar for dollar for total qualifying property purchases over $2,000,000
When is amortization allowed? How is it calculated?
When an intangible asset has a determinable life.
Purchase price / Determinable life left in months
Ex. $10mil/157 months = $63,694 per month
Which assets are subject to the 15 year amortization rule?
Licenses, permits, and similar rights granted by a government Franchises Trademarks Trade names
How are organizational & start up costs amortized?
- Immediately deduct up to $5,000 (lessor if costs are less than $5k).
- Remainder amortized over 180 months
- The $5k max is reduced by the amount by which total costs exceed $50,000.
- The entity must capitalize any nondeductible organizational cost and may elect to amortize such cost over a 180-month period starting with the month in which the business began.
How are leases amortized?
The cost of acquiring the lease is amortized over the period of the lease.
What is the cost recovery method applicable to leasehold improvements?
Improvements are capitalized and depreciated according to the type of property. This applies even when the MACRS recovery period is longer than the lease.
How are expansion costs treated?
They are generally deductible in the year incurred.
When are copyrights and patents treated as acquisition intangibles?
Only if they are acquired as part of the purchase of an entire business.
What are some examples of business acquisition intangibles? 7
- Goodwill
- Going-Concern Value
- Information-based intangibles (customer lists, etc)
- Customer-based or supplier based intangibles (favorable contacts)
- Know-how intangibles (designs, formulas, etc)
- Workforce intangibles (loyalty of company employees)
- Covenants not to compete
How are business acquisition intangibles treated?
They are amortized over 15-years.
