Deductions for the Costs of Earning Income Flashcards
How are capital expenditures treated?
Section 263 - No deduction shall be allowed for any amount paid out for new buildings or for permanent improvements or betterments made to increase the value of any property or estate.
• Cannot take a deduction at the time of the expense, but it will be added to the basis. Realized upon sale of the property
How are repairs treated?
Repairs for property fall under Section 162 and can be deducted immediately.
What is the different in tax treatment between capital expenditures and repairs?
If the expense is a permanent improvement that are made to add value to the property, they are added to basis and used to calculate gain upon transfer of the property.
Expenditures that so not add value or prolong the expected life of the property over what it was before the event occurred which made the repairs necessary, are deductible immediately as repairs.
What is the two step rule for deducting for repairs?
• The taxpayer must determine the “unit of property” to which an expense relates.
○ Unit of property is generally either a building, or real and
○ Determining whether the expense results in a “betterment” to the unit of property, a “restoration,” or an “adaption to new or different use.” Expenses that have any of these properties must be capitalized.
§ If the expenditure is required by an unexpected event (e.g. Flood or fire), then it is a current deduction (Section 162). Regular maintenance (“ordinary expenses”) also fall under Section 162.
§ Natural aging of an asset, would go more towards capitalization (Section 263). E.g., a roof that has naturally reached the end of its natural life and must be replaced.
What is the difference in treatment between rent payments and installment purchases?
- Rent payments are deductible immediately.
- Installment purchases are capitalized and added to basis in the property. Can only deduct depreciation.
Court found that the practical effect rather than the legal can be taken into account by the Commissioner. Substance of the transaction was a purchase, not a lease, and thus was required to be capitalized. (fire sprinkler system case)
What is an “ordinary and necessary” business expense?
Ordinary and necessary does not mean regular. It must be a type of expense that is ordinary and necessary for the type of business the taxpayer participates in.
Businesses can deduct reasonable compensation for their employees. What is reasonable compensation?
IRS limits deductions to $1 million a year for CEOs or any other of its four highest paid employees. (§ 162(m)).
• Performance-based compensation is exempt under certain conditions.
When are depreciation deductions allowed?
Tax Code § 167 - There shall be allowed as a depreciation deduction a reasonable allowance for the exhaustion, wear and tear (including a reasonable allowance for obsolescence)—
• of property used in the trade or business, or
• of property held for the production of income.
What is recapture?
portion of gains from property sold that was depreciated will be taxed at the normal rate.
What type of assets can receive depreciation?
Can only take depreciation on “wasting assets”, or assets that are used up.
What is amortization?
Deduction of an intangible asset
