Section 1231 - Cost recovery

Question 1

Recovery for personalty vs realty

Answer 1

Recovery for personalty is computed as though assets are purchased at midyear (midyear convention), while recovery for realty uses a mid-month convention. For personalty, depreciation is allowed for half of the year in which it is purchased, regardless of when it is purchased. For realty, depreciation is allowed for half of the month in which it is purchased, regardless of the date it is purchased during the month.

Question 2

Class lives for personalty

Answer 2

3 years:
Certain manufacturing tools and tractor units for use over the road; and
Race horses two years old or younger

5 years:
Automobiles and light-duty trucks;
Computers;
Certain assets used in high-technology manufacturing;
Office equipment;
Appliances, furniture, carpets, etc. used in rental real estate (Note that office furniture and fixtures are not included in this category.); and
Machinery or equipment used in a farming business (if purchased after 2017; 7-year property before 2018) (grain bins (7 years), cotton ginning assets (7 years), fence (7 years), and other land improvements (15 years) are not 5-year property).

7 years:
Most equipment and machinery;
Office furniture, and fixtures; and
Default category for unspecified-class property.

Question 3

200% declining balance method

Answer 3

A 200% declining balance method is used for these classes, with the following exceptions.
Land improvements are included in the 15-year class and are depreciated using the 150% declining balance method.
15-year and 20-year property used in a farming business are depreciated using the 150% declining balance method.

Question 4

leasehold improvements

Answer 4

The cost of leasehold improvements made by a lessee generally must be recovered over the MACRS recovery period of the underlying property without regard to the lease term. Upon the expiration of the lease, any unrecovered adjusted basis in abandoned leasehold improvements is treated as a loss.

Question 5

Qualified improvement property

Answer 5

Qualified improvement property (i.e., an improvement to the interior portion of nonresidential real property after the building has been placed in service), is recovered over a 15-year recovery period using the straight-line method and half-year convention (unless the mid-quarter convention applies). This definition is broad enough to include qualified improvements to restaurant and retail property and other leasehold improvements.

Question 6

Residential realty

Answer 6

is depreciated over a 27.5-year straight line. Nonresidential realty is depreciated over a 39-year straight line.

Question 7

Bonus depreciation

Answer 7

Bonus depreciation of 100% is allowed for qualified property acquired and placed in service after September 27, 2017, and before January 1, 2023. Bonus depreciation applies unless the taxpayer elects not to do so. Qualifying property is new and used tangible property with a recovery period of less than or equal to 20 years, computer software, and qualified improvement property. Qualified improvement property is improvements to the interior of nonresidential property that is made after the building is placed in service.
A taxpayer can elect not to use bonus depreciation for a class of property (in which case the election applies to the whole class). The bonus depreciation is allowed for both regular and AMT purposes. No AMT depreciation adjustment is required for any property that is eligible to use bonus depreciation.
For productions placed in service after September 27, 2017, qualified property includes film, television, and live theatrical productions.

Question 8

Midquarter convention

Answer 8

A mid-quarter convention is used for all personalty (instead of the midyear convention) if more than 40% of personalty acquired during the year is purchased in the last quarter of the year. One-half quarter depreciation is allowed for the quarter the asset is purchased and one-half quarter for the quarter the asset is sold.

Question 9

Section 179 election

Answer 9

There is a Section 179 election to expense a limited amount of tangible personalty if used in a trade activity. It is not available for income-producing property (i.e., rental property) or real property (i.e., real estate).

The maximum amount expensed in any year is limited to the lesser of business income or $1,020,000 for 2019 ($1,000,000 for 2018).
The Section 179 expense cannot exceed the income from the business, reduced for all expenses except Section 179. Any election to expense in excess of the business income limit is carried forward (indefinitely) and used in a year when income is sufficient.
The Section 179 election is phased out (dollar for dollar) if qualified assets purchased exceed $2,550,000 for 2019 ($2,500,000 for 2018).
A carryforward is not allowed if the Section 179 deduction is reduced due to the excess purchase provision.
The taxpayer can revoke the Section 179 election in later years as long as the return is still eligible to be amended.
Property must be predominantly used for business (more than 50%) to be eligible for Section 179. If property for which Section 179 has been collected is converted to nonbusiness use, the Section 179 and MACRS deductions claimed in excess of what would have been allowed if Section 179 had not been elected must be recaptured as income.
Section 179 also provides a deduction for energy efficiency improvements to lighting, heating, cooling, ventilation, and hot water systems of commercial buildings.

Question 10

Organization and start up costs

Answer 10

Expenses incurred in connection with the organization of a corporation.
$5,000 of these expenses may be deducted, but the $5,000 is reduced by the amount of expenditures incurred that exceed $50,000. Expenses not deducted must be capitalized and amortized over 180 months (unless an election is made not to do so), beginning with the month that the corporation begins its business operations. Election must be filed with first corporate tax return.
Same rules apply for start-up costs. Start-up costs are expenditures that would be deductible except that the corporation has not yet started its trade or business operation.
Typical organizational expenses are legal services incident to organization, accounting services, organizational meetings of directors and shareholders, and fees paid to incorporate. They must be incurred before the end of the taxable year when the business begins (but they do not have to be paid, even if on a cash basis).
Costs of issuing and selling stock (syndication expenses) must also be capitalized, but cannot be amortized.