Cost Recovery Flashcards
What is the key provision for cost recovery?
162 allows the deduction of ordinary and necessary expenses incurred in connection with a trade or business
What does ordinary mean in 162?
Short term benefit (if you use it up in this tax year or next tax year, then it’s ordinary)
Ordinary does NOT mean commonplace
What does necessary mean in 162?
appropriate and helpful in the business
Welch v Helvering drew an analogy to McCulloch v Maryland and the necessary and proper clause
(court’s won’t usually second guess the judgment of the businesspeople making the decisions)
This is necessary to police the line between business expenditures and personal expenditures
What is the guiding principle of expensing
Match expenditures as closely as possible to the associated revenues (Rev Rul 94-38). For this reason, environmental remediation expenditures are always expensible (rev from polluting was in the past so expensing today is as close as we can get)
What was so revolutionary about INDOPCO?
Birfurcates the expensing analysis
1) Is this expensable this year? (must be ordinary and necessary) (if there is no long term benefit then expense it - the long term benefit of not getting sued might be long term)
2) IF NOT, where should I capitalize this expense?
(do not change answer to 1 based on 2. Maybe you add to basis)
Why did everyone hate INDOPCO?
it meant they had to wait a long time to recover the costs of capitalized expenditures (if they could recover them at all)
What are the INDOPCO rules?
They are products of lobbying that exempt expenditures segments from INDOPCO (and this make them immediately epensible)
What is the core (fact specific) holding of INDOPCO?
expenditures by a target in a friendly deal are capitalized
the bifurcated process also stands - just need to check for industry carveouts
What is the failed business doctrine?
If you spend money toward a venture that is either shut down pre-launch or launches and then fails, the expenditures on that project are deductible
(this is because there is no long-term benefit so the necessary and ordinary requirements of 162 are met
BUT if you spend $ researching 10 locations for a store and end up moving forward with 1, you can’t expense 9/10ths. You capitalize all into the one store
When are capitalized costs recovered?
Might be recovered gradually in depreciation, might be recovered all at once when property is sold, might never be recovered
What is the main case that says repairs are deductible as expenses?
Midland Empire Packing (not great logic but still)
What makes Midland so great for taxpayers?
If you classify an expenditure as a repair, you can expense it immediately regardless if it has a long term benefit
Why is Midland’s theory not great?
The idea that you can expense something with long term benefit undermines our understanding of the ordinary requirement in 162
When is an expenditure a repair?
An expenditure is a repair if 1) it does not add to the value of the property (as measured pre-break) AND 2) the expenditure does not extend the expected life of the property BUT if you are repairing a condition that existed prior to the taxpayer’s acquisition of the property
What would Abrams rather have instead of the Midland deduction for repair expenses?
Allow the firm to take a 165 loss when the break happens (which would allow them to deduct the value of the loss from basis) and capitalize the $ spent on the repair
The only difference between the Abrams method and the Midland method is that the 165 loss is capped at the basis in the property
Can you take the midland repair expense deduction and also claim the loss under 165?
No, if you do a midland repair expense, you cannot also deduct a 165 loss
What is the Norwest Project Rule?
If an expenditure is made as part of capital improvement, it must be capitalized (even if in isolation, it could be expensed)
Can you automatically expense all leases and capitalize all purchases?
No. The same 162 rules apply no matter if you call it a lease or a sale (ordinary and necessary)
Is there a high difference in the decision between a lease and a purchase?
Probably not (See estate of Starr v Commissioner - sprinkler provider was leasing custom installed sprinklers) - if the tax code was perfect, there would be no difference
How much of the cost of a lease can you deduct each year? How much of the cost of a purchase can you deduct each year?
If lease, can expense the portion of the lease payment that is used in the current year (can’t expense the whole amount paid automatically - mind 162)
If sale, can expense depreciation and any interest if it’s an installment sale (interest on an installment sale is the difference between the sum of the payments and the cash purchase price)
How to parse a sale form a lease
Purchaser retains title at the end of a sale. Leassor retains title at the end of a lease. If a lease is for the entire useful life of the asset, it starts to look like a sale
Remember, if a party has the right to do something and the economic incentive to do it, tax law presumes they will do it (so if you want something to look like a lease, don’t set a buyout price at less than what FMV will be)
What does the theoretical idea of depreciation look like?
It’s non-uniform (if income is uniform) where the depreciation increases each year (because the value of the property is declining by the value of the furthest out cash flow and compounding makes it non-uniform)
What are the 4 factors that should affect depreciation in an ideal tax system and why do we not use them?
1) The amount of future cash flows
2) the timing of future cash flows
3) The risk of those payments
4) the duration of the future cash flows
then depreciation is the decrease in the MV of the asset
It’s impossible to know all of these factors, so Congress approximates with arbitrary rules
What are a few of the assumptions Congress has made to reduce litigation?
Taxpayers no longer tailor the recovery period to the asset in the hands of that particular taxpayer
Salvage value is conclusively presumed to be $0
Taxpayers no longer need to prove date placed in service because of conventions
