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Chapter 09 - Property Acquisition and Cost Recovery

Chapter 9 Property Acquisition and Cost Recovery SOLUTIONS MANUAL Discussion


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uestions

[LO 1] E p!ain the reasonin" #hy the ta !a#s require the cost o$ certain assets to %e capita!i&ed and recovered over ti'e rather than i''ediate!y e pensed. Assets with an expected life of more than one year must be capitalized and recovered through depreciation, amortization, or depletion deductions depending on the type of underlying asset. The policy attempts to match the revenues and expenses for these assets because the assets have a useful life of more than one year.

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[LO 1] E p!ain the di$$erences and si'i!arities %et#een persona! property) rea! property) intan"i%!e property) and natura! resources. A!so) provide an e a'p!e o$ each type o$ asset. Personal property, real property, and natural resources are all tangible property than can be seen and touched. Natural resources are assets that occur naturally e.g. timber or coal!. "eal property is land and all property that is attached to land e.g. buildings!. Personal property is all tangible property that is not a natural resource or real property. #ntangibles are all intellectual property rights e.g. patents and copyrights! and any other value not assigned as a tangible assets during a purchase e.g. goodwill!. $ach of these has an expected useful life of more than one year. Asset Type Personal property Real property Intangibles Natural Resources Examples Auto'o%i!es) equip'ent) $urniture) and 'achinery Land and ite's attached to !and such as %ui!din"s *#arehouse) o$$ice %ui!din") and residentia! d#e!!in"s+ ,tart-up and or"ani&ationa! costs) copyri"hts) patents) covenants not to co'pete and "ood#i!! Co''odities such as oi!) coa!) copper) ti'%er) and "o!d

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[LO 1] E p!ain the si'i!arities and dissi'i!arities %et#een depreciation) a'orti&ation) and dep!etion. .escri%e the cost recovery 'ethod used $or each o$ the $our asset types *persona! property) rea! property) intan"i%!e property) and natura! resources+. There are three types of cost recovery% depreciation, amortization, and depletion. $ach is similar in that they recover the cost basis of long&lived

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assets. 'epreciation for real property, amortization, and cost depletion are on a straight&line basis. Taxpayers may elect straight&line on tangible personal property as well.! The primary difference is that they are used for property with uni(ue characteristics. 'epreciation of tangible personal property is done on an accelerated most often double&declining balance! method. Percentage depletion assigns a statutory rate that may recover more than the original cost of the asset. Asset Type Personal property Cost Recovery Type, Characteristics /ACR, depreciation) characteri&ed %y dou%!e dec!inin" %a!ance 'ethod *a!thou"h 1001 .2 or strai"ht-!ine 'ay %e e!ected+) ha!$-year convention *a!thou"h 'id-quarter 'ay %e required+) and shorter recovery periods. /ACR, depreciation) characteri&ed %y strai"ht-!ine 'ethod) 'id-'onth convention) and !on"er recovery periods. A'orti&ation) characteri&ed %y strai"ht-!ine 'ethod) $u!!-'onth convention) various recovery periods *usua!!y not %ased on actua! !i$e+ dependin" on intan"i%!e type. .ep!etion *cost or percenta"e+) cost dep!etion a!!ocates the cost o$ a natura! resource %ased on resource esti'ates *tons) ounces) %arre!s) etc.+) strai"ht-!ine 'ethod) %ased on actua! e traction quantities) percenta"e dep!etion a!!ocates a statutory e pense *dependin" on resource type+ %ased on "ross inco'e) %ut !i'ited to 001 o$ net inco'e) and is the on!y cost recovery 'ethod that a!!o#s a ta payer to recover 'ore than the ori"ina! %asis o$ an asset.

Real property Intangibles

Natural Resources

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[LO 1] 4s an asset5s initia! or cost %asis si'p!y its purchase price6 E p!ain. The initial basis of any purchased business asset is historical cost. This is generally the purchase price, plus any other expenses e.g. sales tax and installation costs! incurred to get the asset in wor)ing condition. This does not include costs which substantially improve or extend the life of an asset such as a building addition.

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[LO 1] Co'pare and contrast the %asis o$ property acquired via purchase) conversion $ro' persona! use to %usiness or renta! use) a nonta a%!e e chan"e) "i$t) and inheritance. The basis of purchased assets is historical cost. The basis rules for other ac(uisitions depend on whether the transaction was taxable or not. *or
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taxable transactions there is usually a step&up in basis to fair mar)et value. *or non&taxable transactions, there is usually a carryover basis. +onversion of assets from personal use gets the lesser of the two values. The specific rules are as follows% Acquisition Type Purchase Conversion rom personal use Non!taxable exchange "i t Basis Rules 7he initia! %asis is historica! cost) p!us a!! costs incurred to "et the asset to its destination and in #or8in" order. 7he deprecia%!e %asis #ou!d %e the !esser o$ the $air 'ar8et va!ue o$ the asset on the date o$ conversion or the ad9usted %asis o$ the trans$eror. 7he %asis is a carryover %asis o$ the trans$eror since there is no reco"nition o$ "ain or !oss on the trans$er *not a ta a%!e transaction+. 7he %asis is "enera!!y a carryover %asis) %ecause these transactions usua!!y aren5t ta a%!e. 4$ "i$t ta is paid) the %asis 'ay %e increased %y a portion o$ the "i$t ta paid. 7he %asis is the $air 'ar8et va!ue on the date o$ death or the a!ternate va!uation date si 'onths !ater *i$ e!ected %y the estate+. 7he $air 'ar8et va!ue is used %ecause the trans$er arises $ro' a ta a%!e transaction.

Inheritance

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[LO 1] E p!ain #hy the e penses incurred to "et an asset in p!ace and opera%!e shou!d %e inc!uded in the asset5s %asis. Additional expenses, including sales tax, shipping, installation costs, and the li)e are capitalized into an asset,s basis because all costs re(uired to place an asset into service are re(uired to be included into its basis. That is, without these costs, the taxpayer would not be able to place in service or use the asset in a business.

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[LO 1] <ra%er Corporation runs a !on"-hau! truc8in" %usiness. <ra%er incurs the $o!!o#in" e penses= rep!ace'ent tires) oi! chan"es) and a trans'ission overhau!. >hich o$ these e penditures 'ay %e deducted current!y and #hich 'ust %e capita!i&ed6 E p!ain. An expense that extends the useful life of an asset will be capitalized as a new assetdepreciated over the same -A+". recovery period of the original asset rather than the remaining life of the existing asset. Alternatively, expenses that constitute routine maintenance should be expensed immediately. An engine overhaul is li)ely to be a capitalized expense. Tires and oil changes are li)ely to be expensed currently. /owever, all expenses are sub0ect to a facts and circumstances test.

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[LO (] /ACR, depreciation requires the use o$ a recovery period) 'ethod) and convention to depreciate tan"i%!e persona! property assets. 2rie$!y e p!ain #hy each is i'portant to the ca!cu!ation. -A+". depreciation calculations are straightforward once you )now the recovery period life!, method, and convention for the asset. "ecovery period is the statutory life or the period over which a taxpayer will allocate the depreciation expense. Profitable taxpayers prefer the recovery period to be as short as possible so that they may recoup the basis as (uic)ly as possible. The method is generally the double&declining 1223 '4! method. /owever, taxpayers may elect to use either the 5623 '4 method useful if they are sub0ect to A-T, to avoid calculating both regular and A-T depreciation! or straight&line method to lengthen depreciation expense for taxpayers in an expiring N78 situation!. The convention determines how much depreciation is ta)en in both the year of ac(uisition and the year of disposition. The half&year convention is used to simplify calculating depreciation based on the number of days an asset was owned during the year, but the mid&(uarter convention is re(uired if more than 923 of the tangible personal property placed in service during the year was placed in service during the fourth (uarter.

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[LO (] Can a ta payer #ith very !itt!e current year inco'e choose to not c!ai' any depreciation e pense $or the current year and thus save depreciation deductions $or the $uture #hen the ta payer e pects to %e 'ore pro$ita%!e6 Taxpayers must reduce the basis of depreciable property by the depreciation allowed or allowable :5255!. Therefore, taxpayers must reduce their basis whether or not they claim the depreciation expense. As a result, taxpayers are better off ta)ing the depreciation expense even if it creates a net operating loss or is taxed at a relatively low marginal tax rate.

10. [LO (] [P!annin"] >hat depreciation 'ethods are avai!a%!e $or tan"i%!e persona! property6 E p!ain the characteristics o$ a %usiness !i8e!y to adopt each 'ethod. Taxpayers may elect to use the 1223 '4, 5623 '4, or the straight&line method for tangible personal property. #t is important to note that all three methods allow the same depreciation expense over the same recovery period. Nevertheless, profitable taxpayers will elect to use the 1223 '4 method because it minimizes the after&tax cost of the asset by maximizing the present value of the depreciation expensesthrough accelerating the depreciation expenses. Taxpayers traditionally sub0ect to the A-T may elect to use the 5623 '4 method because it saves them the administrative inconvenience of calculating depreciation under both methods when the resulting expense under the 5623 '4 method re(uired by A-T. Taxpayers

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may elect to use the straight&line method if they want to slow down depreciation expense

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which is counterintuitive but often occurs for companies that regularly incur N78s and would li)e to preserve these losses for a time when they expect profitability or will be ac(uired by another taxpayer that may be able to utilize the N78s. 11. [LO (] 4$ a %usiness p!aces severa! di$$erent assets in service durin" the year) 'ust it use the sa'e depreciation 'ethod $or a!! assets6 4$ not) #hat restrictions app!y to the %usiness5s choices o$ depreciation 'ethods6 Taxpayers may generally choose the depreciation method used for assets placed in service. The -A+". general depreciation system generally uses the 1223 '4 method for tangible personal property and the straight line method for real property. /owever, taxpayers may elect either the 5623 '4 or straight&line method for tangible personal property on an asset class by asset class basis :5;< g! =!!. *or example, if a taxpayer places in service a computer 6&year property!, a delivery truc) 6&year property!, and machinery =&year property! an election could be made to use the straight& line method for all 6 year property and continue to use the 1223 '4 method for the =&year property. Alternatively, an election could be made to use the straight line method for only the =&year property or all tangible personal property placed in service during the year. 7nce made, the method choice is an accounting method election and is irrevocable. 1(. [LO (] .escri%e ho# you #ou!d deter'ine the /ACR, recovery period $or an asset i$ you did not a!ready 8no# it. "ev. Proc. <=&6; is the definitive authority for determining the recovery period of all assets under -A+".. This guidance divides assets into asset classes groups of similar property! upon which the recovery period is determined as the midpoint of the asset depreciation range A'"! the system developed by the #". for pre&A+". property!. /owever, the ><=? in the citation indicates that the "ev. Proc. was issued in 5@<=. As a result, taxpayers, or their advisors, must verify that the guidance is still valid. *or example, (ualified restaurant property, (ualified leasehold improvement property, and (ualified Alas)a natural gas pipeline are examples of assets to which +ongress has given preferential recovery periods since 5@<=. 1-. [LO (] [Research] Co'pare and contrast the recovery periods used %y /ACR, and those used under "enera!!y accepted accountin" princip!es *<AAP+. "ev. Proc. <=&6; is the definitive authority for determining the recovery period of all assets under -A+".. /owever, +ongress in :5;< has recently modified the recovery period of some assets. *inancial accounting rules are vague at best. *A.4 +oncept .tatement 6 indicates that assets should be recognized over the accounting period of their life. *A.4 +oncept

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.tatement ; defines an asset as a probable future benefit. A"4 9A indicates that the

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cost should be spread over the assets useful life in a systematic and rational manner. AP4 51 re(uires companies, through financial statement disclosure, to disclose to investors current depreciation expense, depreciation method, and recovery period used for assets. As a result, companies could use any rational recovery period for financial accounting purposes. 13. [LO (] [Research] @ast and @urious Corporation *@A@+ decided that it shou!d cash in on the current popu!arity o$ stoc8 car racin". @A@ desi"ned and %ui!t a trac8 and re!ated $aci!ities inc!udin" "randstands) "ara"es) concession stands) !andscapin") and a hote! on the property. a. >hat does Rev. Proc. ?;-0: !ist $or the recovery period o$ the !and i'prove'ents such as !andscapin"6 %. Bo#) conduct research *hint= use a ta service and the ter' C'otorsports entertain'ent co'p!e D+) to deter'ine the recovery period $or the various assets i$ the entire pro9ect #as co'p!eted in Eu!y (00; and the $irst race #as he!d on Octo%er 10) (00;. c. >ou!d your ans#ers chan"e i$ there #ere a one-year de!ay in construction6 4$ so) ho# #ou!d it chan"e and #hy6 a. "ev. Proc. <=&6; lists land improvement as asset class 22.A and indicates that the recovery period is 56 years. b. :5;< e! A! +! ii! lists >motorsports entertainment complex? as =&year property. :5;< i! 56! defines a motorsports entertainment complex as a racing trac) facility, including ancillary and support facilities sidewal)s, par)ing lots, retailing and non&lodging accommodations, grandstands, and buildings! where a motorsport racing event is held within A; months of the date the complex was placed in service. The provision originally expired for property placed in service after 'ecember A5, 122=. /owever, the provision was extended through 'ecember A5, 122@. #f the delay extended the property placed in service date into 1252, all of *B*,s assets would (ualify as =&year property with the exception of the hotel which is not (ualified motorsports property and would receive A@&year recovery period. c. #f the construction of properties placed in service was delayed three years, then the entire property would fail to (ualify as a motorsports entertainment complex because the extended provision expires on 'ecember A5, 122@. 8and improvements would then have a 56&year recovery period and buildings would receive a A@&year recovery period. 10. [LO (] >hat are the t#o depreciation conventions that app!y to tan"i%!e persona! property under /ACR,6 E p!ain #hy Con"ress provides t#o 'ethods. The two depreciation conventions that apply to tangible personal property under -A+". are the half&year convention and the mid&(uarter convention. -A+". uses a simplifying half&year convention. The half&year convention

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allows one&half of a full year,s depreciation in the year the asset is placed in service, regardless of when it was actually placed in service. *or example, when the half&year convention applies, an asset placed in service on either Canuary A2 or 'ecember 5= is treated as though it was placed in service on Culy 5 which is the middle of the calendar year. The original A+". system included only the half&year conventionD however, +ongress felt that some taxpayers were abusing the system by purposely ac(uiring assets at the end of the year that they otherwise would have ac(uired at the beginning of the next taxable year allowable tax planning under A+".!. #n 5@<=, as part of -A+"., the mid&(uarter convention was implemented. The mid&(uarter convention treats assets as though they were placed in service during the middle of the (uarter in which the business actually placed the asset into service. *or example, when the mid&(uarter convention applies, if a business places an asset in service on 'ecember 5 in the fourth (uarter! it must treat the asset as though it was placed in service on November 56, which is the middle of the fourth (uarter. 1:. [LO (] A %usiness %uys t#o identica! tan"i%!e persona! property assets $or the sa'e identica! price. 4t %uys one at the %e"innin" o$ the year and one at the end o$ year. Fnder #hat conditions #ou!d the ta payer5s depreciation on each asset %e e act!y the sa'e6 Fnder #hat conditions #ou!d it %e di$$erent6 -A+". has two conventions% half&year and mid&(uarter conventions. The half&year convention is the general rule and simplifies the depreciation process by allowing one half year of depreciation ta)en on all assets placed in service during the year. The mid&(uarter convention is re(uired if more than 923 of a taxpayer,s tangible personal property is placed in service during the fourth (uarter of the year. The depreciation on the two assets would be the same if the taxpayer was using the half&year convention which would apply if the taxpayer purchased and placed in service other assets during the year so that the 923 placed in service fourth (uarter test is failed. The depreciation on the two assets would be different if the two assets were the only assets placed in service during the yearso that 623 was placed in service during the 9th (uarter and the mid&(uarter convention was re(uired to be used. 1;. [LO (] AAA) 4nc.) acquired a 'achine in year 1. 4n /ay o$ year -) it so!d the asset. Can AAA $ind its year - depreciation percenta"e $or the 'achine on the /ACR, ta%!e6 4$ not) #hat ad9ust'ent 'ust AAA 'a8e to its $u!! year depreciation percenta"e to deter'ine its year - depreciation6 The applicable depreciation convention applies in the year of disposal as well as the year of ac(uisition. The -A+". tables cannot anticipate an assets disposal and therefore assume the asset was used in a trade or business for the entire year. As a result, AAA must apply the applicable convention to the table percentage upon disposal to arrive at the correct

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percentage. #f the half&year convention applies, then multiplying the -A"+". table full year depreciation by 623 one&half of a year,s depreciation! will help you arrive at the correct percentage. Alternatively, if the mid&(uarter convention applies, the asset is treated as though it is sold in the middle of the (uarter of which it was actually sold. The simplest process for calculating mid&(uarter convention depreciation for the year of sale is to use the following four step approach% 5! determine the amount of depreciation expense for the asset as if the asset were held for the entire yearD 1! subtract one&half of a (uarter from the (uarter in which the asset was sold if sold in Ard (uarter subtract .6 from A to get 1.6!D A! divide the outcome from .tep 1 by 9 (uarters! 1.6E9! this is the fraction of the full year,s depreciation the taxpayer is eligible to deduct, and 9! multiply the .tep A! outcome by the full depreciation determined in .tep 5!. 1?. [LO (] .iscuss #hy a s'a!! %usiness 'i"ht %e a%!e to deduct a "reater percenta"e o$ the assets it p!aces in service durin" the year than a !ar"er %usiness. The tax law allows for expensing of tangible personal property for certain businesses. The deduction is phased out for taxpayers that place more than a certain amount of property in service during the year. .ince most large businesses place more than the limit of property in service, they are ineligible for the expensing election. 19. [LO (] E p!ain the t#o !i'itations p!aced on the G1;9 e pense deduction. Ho# are they si'i!ar6 Ho# are they di$$erent6 The :5=@ expense deduction has two limitations% the property placed in service and the taxable income limitation. The property placed in service deduction of F162,222 for 1252! phases out the expense amount dollar for dollar for property placed in service over the F<22,222 limit for 1252!. After being limited by the property placed in service limitation, the expense deduction is further limited to the taxpayer,s taxable income. The two limitations are similar in that they both limit the :5=@ expense deduction. /owever, the first limitation was designed to limit the amount of property that can be expensed as a means of defining small businesses while the second limitation prevents the expense from creating a loss for the taxable year. (0. [LO (] Co'pare and contrast the types o$ %usinesses that #ou!d %ene$it $ro' and those that #ou!d not %ene$it $ro' the G1;9 e pense. The availability of the :5=@ expense is limited by the property placed in service and income limitations. The property placed in service limitation phases out the section 5=@ expense F162,222! dollar for dollar for tangible personal property placed in service over the F<22,222 threshold. Thus,

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firms that place F5,262,222 of property in service during the year are ineligible to

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deduct section :expense. As a result, firms that place in service smaller amounts of property are eligible for the expensing election while those that place large amounts of property in service an ineligible. The second limitation is that firms can only currently expense assets up to net income before the deduction, but after the regular -A+". depreciation expense!. As a result, profitable firms are eligible for the :5=@ expense while firms in a loss position are currently ineligible but may carry the amount forward. +onse(uently, profitable firms that place a relatively small amount of property in service are able to elect the :5=@ expense. #n contrast, firms that place in service too much property or are unprofitable are unable to currently expense property under : 5=@. (1. [LO (] >hat strate"ies #i!! he!p a %usiness 'a i'i&e its current depreciation deductions *inc!udin" G1;9+6 >hy 'i"ht a ta payer choose not to 'a i'i&e its current depreciation deductions6 There are several planning strategies that will help a taxpayer maximize its current depreciation expenses. *or example, if a taxpayer is close to exceeding the 9th (uarter placed in service limitation, which would re(uire the mid&(uarter convention resulting in less depreciation, the taxpayer could put off purchases to the beginning of the next taxable year. A taxpayer can elect to expense under :5=@ assets that are =&year assets rather than 6&year assets because the first year depreciation percentage is lower for =&year assets 59.1@3 versus 123!. As another example, a taxpayer otherwise eligible for :5=@ expensing can elect to expense assets placed in service during the 9th (uarter because expensed assets are not included in the mid& (uarter test. ((. [LO (] >hy 'i"ht a %usiness e!ect on!y the G1;9 e pense it can deduct in the current year rather than c!ai'in" the $u!! a'ount avai!a%!e6 4usinesses can elect to expense :5=@ currently, and carry over the expense to future years if they meet the placed& in& service limitation but do not have sufficient income to expense the assets currently. /owever, a business may elect to expense only the amount it can currently deduct if it believes that maximizes the present value of current and future depreciation expenses. This may occur because carryovers of :5=@ expense are sub0ect to future placed& in& service and income limitations. *or example, they could elect the expense in the current year which reduces current and future -A+". depreciation expenses! and not be able to deduct the expense under :5=@ because the business is also limited in future yearsso business that are generally limited would be wise not to ma)e the election. Additionally, if taxpayers typically elect the maximum :5=@ expense annually, the amount would be suspended anyway.

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(-. [LO (] .escri%e assets that are considered to %e !isted property. >hy do you thin8 the 4nterna! Revenue ,ervice requires the' to %e C!istedD6 8isted property comprises business assets that taxpayers may wish to use for both business and personal purposes. *or example, automobiles, planes, boats, recreation vehicles, computer e(uipment and peripherals, and cell phones are considered to be listed property. The #". wants to trac) both the personal and business use of these assets to limit depreciation to the business use portion. Additionally, if the business use portion dips below 623, then taxpayers must use the straight&line method and potentially recapture excess depreciation deductions. (3. [LO (] Are ta payers a!!o#ed to c!ai' deprecation e pense on assets they use $or %oth %usiness and persona! purposes6 >hat are the ta consequences i$ the %usiness use drops $ro' a%ove 00 percent in one year to %e!o# 00 percent in the ne t6 Ges, taxpayers may depreciate mixed use assets those used for both business and personal use!. /owever, the otherwise allowable depreciation is reduced by the non&business use, so that depreciation is only allowed to the extent of the business use. #f the business use falls below 623 in any subse(uent year, then the taxpayer must recompute depreciation for all prior years as if it had been using the straight line method over the A'. recovery period. #f the prior depreciation expenses exceed both the prior depreciation expenses and the current year expense then the taxpayer must recapture the difference into income during the current year. (0. [LO (] .iscuss #hy Con"ress !i'its the a'ount o$ depreciation e pense %usinesses 'ay c!ai' on certain auto'o%i!es. Automobiles have historically been the most abused, as well as expensive, type of listed property. To prevent subsidizing business owners, automobiles through deductible depreciation expenses, +ongress decided to place a maximum allowable depreciation amount on them. 7ne exception to this rule is that during 1225&1229 there was bonus depreciation, an additional expense, of F9,;22 that taxpayers could deduct in the first year. 4onus depreciation was part of the 122< stimulus pac)age as well. /owever, one important exception from the luxury auto rules are that vehicles weighing more than ;,222 pounds are not sub0ect to the limit and are also allowed to expense up to F16,222 during the first year under :5=@. (:. [LO (] Co'pare and contrast ho# a Land Rover ,FI and a /ercedes 2en& sedan are treated under the !u ury auto ru!es. A!so inc!ude a discussion o$ the si'i!arities and di$$erences in avai!a%!e G1;9 e pense. A -ercedes 4enz sedan is less than ;,222 pounds and (ualifies as a luxury automobile. This limits depreciation to the restrictive luxury auto amounts.

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#n contrast, the 8and "over is more than ;,222 pounds and escapes the luxury auto rules. This is advantageous for two reasons% 5! the buyer may currently expense F16,222 under :5=@ and 1! the property is not sub0ect to the luxury auto limits. (;. [LO (] 7here are t#o recovery period c!assi$ications $or rea! property. >hat reasons 'i"ht Con"ress have to a!!o# residentia! rea! estate a shorter recovery period than nonresidentia! rea! property6 Non&residential property currently has a recovery period of A@ years while residential property has a recovery period of 1=.6 years. Non&residential has longer lives because the construction methods are more substantial which results in longer lives. *or example, non&residential often uses steel frame with concrete andEor bloc) floors and walls. #n contrast, residential uses balloon construction using 1x9 timbers for structure. The non& residential components often are built with more substantial materials as well. .ome argue that residential property receives higher use percentages and is sub0ect to more wear and tear. (?. [LO (] .iscuss #hy Con"ress has instructed ta payers that rea! property %e depreciated usin" the 'id-'onth convention as opposed to the ha!$-year or 'idquarter conventions used $or tan"i%!e persona! property. The purpose of -A+". conventions is to simplify the calculation of depreciation. "eal property is characterized by higher basis and less fre(uent ac(uisition than tangible personal property. These two reasons suggest that mid&month convention approximates actual wear and tear on real property better than the half&year and mid&(uarter conventions would. *or example, if a building was purchased in Canuary or 'ecember it would be entitled to 55.6 or .6 months, respectively, of depreciation under the mid& month convention&&which is close to the actual time the asset was placed in service. This contrasts with the half&year convention that would allow ; months or the mid&(uarter convention that would allow 52.6 or 5.6 months, respectively, of depreciation. (9. [LO (] [Research] 4$ a ta payer has o#ned a %ui!din" $or 10 years and decides that it shou!d 'a8e si"ni$icant i'prove'ents to the %ui!din") #hat is the recovery period $or the i'prove'ents6 -A+". generally classifies additions to property as a new asset placed in service sub0ect to the same depreciable life as the original asset. *or example, if a F1,222,222 addition is made to an office building non& residential property! then the asset,s basis is F1,222,222 and its recovery period is A@ years. /owever, if the improvements are in the form of minor repairs that simply maintain the integrity of the structure they would be expensed. A third alternative is that all or a portion of the improvements

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Chapter 09 - Property Acquisition and Cost Recovery

could represent non&structural components such as leasehold improvements! of the non&residential property and, therefore, (ualify as tangible personal property which is generally sub0ect to accelerated methods and shorter recovery periods. -0. [LO (] Co'pare and contrast the di$$erences %et#een co'putin" depreciation e pense $or tan"i%!e persona! property and depreciation e pense $or rea! property under %oth the re"u!ar ta and a!ternative ta syste's. -A+". allows the 1223 '4 method to be used whereas A-T re(uires the 5623 '4 method to be used for tangible personal property. 4oth -A+". and A-T re(uire the straight&line method for real property. Therefore, the A-T ad0ustment for tangible personal property is the difference between depreciation calculated under the 1223 '4 and the 5623 '4 methods. There is no A-T ad0ustment re(uired for real property. *or taxpayers that elect either the 5623 '4 or straight&line method for tangible personal property there is no A-T ad0ustment re(uired with respect to that property. -1. [LO -] >hat is a G19; intan"i%!e6 Ho# do ta payers recover the costs o$ these intan"i%!es6 Ho# do ta payers recover the cost o$ a G19; intan"i%!e that e pires *such as a covenant not to co'pete+6 A :5@= intangible is a purchased intangible including% goodwill, going concern value, wor)force in place, patents, customer lists, and similar assets. :5@= intangibles are amortized over 5<2 months 56 years! using the straight&line method, and the full&month convention. To prevent game& playing among the basis allocations of various :5@= intangibles ac(uired together, no loss is allowed on a :5@= intangible until the last intangible purchased together is disposed of. *or example, in the past, taxpayers would allocate substantial basis to a A&year covenant not to compete or some other short&live intangible rather than goodwill with a longer recovery period!. #f a :5@= intangible expires or is disposed of before the 5<2 month amortization period expires any remaining basis of the disposed intangible is allocated among the remaining intangibles purchased at the same time. -(. [LO -] Co'pare and contrast the ta and $inancia! accountin" treat'ent o$ "ood#i!!. Are ta payers a!!o#ed to deduct a'ounts associated #ith se!$-created "ood#i!!6 .*A. 591 re(uires that goodwill be capitalized and tested annually for impairment. #f and when the goodwill is impaired, the difference between the boo) value and the new fair value will be expensed. *or tax purposes, goodwill is treated li)e any other :5@= intangible. :5@= intangibles are amortized over 5<2 months 56 years! using the straight&line method, and the full&month convention.

9-10

Chapter 09 - Property Acquisition and Cost Recovery

Hith respect to self&created assets taxpayers must amortize any capitalized costs any unamortized research and experimentation expenses and with fees necessary to create the asset! over the life of the asset. *or financial accounting these costs are normally expensed. --. [LO -] Co'pare and contrast the si'i!arities and di$$erences %et#een or"ani&ationa! e penditures and start-up costs $or ta purposes. 7rganizational expenditures and start&up costs are sometimes confused because both expense types are similar in that they are both incurred about the time the business begins. Additionally, they are both eligible for F6,222 of expensing with a threshold of F62,222. +onversely, the expenses relate to different concerns. .tart&up costs are costs that would be deductible as ordinary trade or business expense under :5;1, except for the fact that the trade or business had not started. An example of start&up costs is employee wages incurred before actual production begins at the factory. Alternatively, organizational expenditures relate to professional fees related to creating the entity. An example of organizational expenditures is attorney fees incurred for preparation of the corporate charter or partnership agreement. Additionally, all businesses can deduct start&up costs, but only corporations and partnerships can deduct organizational expenditures. -3. [LO -] .iscuss the 'ethodo!o"y used to deter'ine the a'ount o$ or"ani&ationa! e penditures or start-up costs that 'ay %e i''ediate!y e pensed in the year a ta payer %e"ins %usiness. .tart&up costs and organizational expenditures can each be expensed, up to F6,222, in the year the business begins. /owever, the current expense is reduced dollar for dollar if the expenses exceed a F62,222 threshold. Any remaining expenses can be amortized over 56 years 5<2 months!. *or example, if a taxpayer incurs F1A,222 it may currently expense F6,222 since the total expense is less than the F62,222 threshold. The remaining F5<,222 F1A,222 & F6,222 expense! may be amortized at a rate of F522 per month F5<,222 E 5<2 months!. -0. [LO -] E p!ain the a'orti&ation convention app!ica%!e to intan"i%!e assets. -A+". uses the half&year, mid&(uarter, and mid&month conventions. These simplifying conventions assume that the asset was placed in service during the middle of the year, (uarter, or month, respectively. #ntangibles are amortized using the full&month convention. This convention allows a full or entire month of amortization in each month the asset is ownedbeginning with the month the intangible is placed in service.

9-1:

Chapter 09 - Property Acquisition and Cost Recovery

-:. [LO -] Co'pare and contrast the recovery periods o$ G19; intan"i%!es) or"ani&ationa! e penditures) start-up costs) and research and e peri'entation e penses. All intangibles are amortized using the full&month convention over the applicable recovery period. :5@= assets must be amortized over a 56&year recovery period. 7rganizational expenditures and start&up costs are eligible for up to F6,222 of expensing in the year the business begins. This expense is reduced dollar for dollar over a F62,222 threshold. The remaining expenses are amortized over a 56&year recovery period. "esearch and experimentation expenses may be capitalized or amortized over the determinable useful life, or if no determinable life, not less than ;2 months. Any unamortized expense that is allocable to a self&created intangible such as a patent is amortized over the intangible,s life. -;. [LO 3] Co'pare and contrast the cost and percenta"e dep!etion 'ethods $or recoverin" the costs o$ natura! resources. >hat are the si'i!arities and di$$erences %et#een the t#o 'ethods6 4oth cost and percentage depletion methods are used to recoup the cost of natural resources. A taxpayer is allowed to deduct the depletion method that results in the largest deduction in the current year. +ost depletion is a cost recovery method based on the amount of the estimated raw materials used during the year. The basic premise is that a business ratably recovers the cost basis of the resource as it is used up. +ost depletion is ta)en until the basis of the asset is recovered. #f the natural resource is exhausted before the basis is recovered then the remaining basis is expensed. #n contrast, percentage depletion is a statutory method that allows an expense based on the lesser of 623 of net income from the activity or a percentage statutorily determined! of the gross receipts from the business during the current year. Percentage depletion is allowed to continue even after the asset,s basis has been fully recovered. -?. [LO 3] E p!ain #hy percenta"e dep!etion has %een re$erred to as a "overn'ent su%sidy. Percentage depletion is often referred to as a government subsidy because it is an expense designed to encourage production of specific resources. *or example, oil and gas, coal, and many other natural resources are assigned specific percentage depletion rates between 63 and 113!, while timber is excluded from resources applicable to the method. To encourage development of a certain resource, +ongress can simply raise the statutory percentage for the resource type. #n addition, percentage depletion expense can transcend reality. /ow many expenses are allowed to exceed the taxpayer,s basis in an assetI Jery few expenses, if any are allowed in excess of basis. .avvy taxpayers can underestimate the estimate of a

9-1;

Chapter 09 - Property Acquisition and Cost Recovery

natural resource, accelerate its cost recovery through cost depletion, and then continue to receive depletion benefits through percentage depletion. *or these reasons, percentage depletion is referred to as a subsidy.

Pro!"e#s
-9. [LO 1] Eose purchased a de!ivery van $or his %usiness throu"h an on!ine auction. His #innin" %id $or the van #as J(3)000. 4n addition) Eose incurred the $o!!o#in" e penses %e$ore usin" the van= shippin" costs o$ J:00K paint to 'atch the other $!eet vehic!es at a cost o$ J1)000K re"istration costs o$ J-)(00 #hich inc!uded J-)000 o$ sa!es ta and a re"istration $ee o$ J(00K #ash and detai!in" $or J00K and an en"ine tune-up $or J(00. >hat is Eose5s cost %asis $or the de!ivery van6 F1@,562, cost basis in the delivery van, computed as follows%
Amount Description
Purchase price .hipping costs Paint .ales tax Total cost basis F19,622 ;62 5,222 A,222 F1@,562 4usiness preparation cost 4usiness preparation cost 4usiness preparation cost

Explanation*

KNote that the registration fee, washing and detailing, and engine tune&up are costs that repairs and maintenance or that are not re(uired to be capitalized. 30. [LO 1] E'i!y purchased a %ui!din" to store inventory $or her %usiness. 7he purchase price #as J;:0)000. 2eyond this) E'i!y incurred the $o!!o#in" necessary e penses to "et the %ui!din" ready $or use= J10)000 to repair the roo$) J0)000 to 'a8e the interior suita%!e $or her $inished "oods) and J-00 in !e"a! $ees. >hat is E'i!y5s cost %asis in the ne# %ui!din"6 F=;6,A22 cost basis, computed as follows%
Amount Description
Purchase price #mprovements 8egal fees F=;2,222 6,222 A22 4usiness preparation costs 4usiness preparation costs

Explanation

9-1?

Chapter 09 - Property Acquisition and Cost Recovery

+ost basis in building

F=;6,A22K

KNote that the F52,222 repair for the roof was not capitalized. The repair is li)ely a routine maintenance expenditure rather than a capitalized cost. /owever, if the expense improved or prolonged the life of the asset beyond what would be considered maintenance to )eep it in its wor)ing condition, it would be capitalized. 31. [LO 1] .ennis contri%uted %usiness assets to a ne# %usiness in e chan"e $or stoc8 in the co'pany. 7he e chan"e did not qua!i$y as a nonta a%!e e chan"e. 7he $air 'ar8et va!ue o$ these assets #as J(?;)000 on the contri%ution date. .ennis5s ori"ina! %asis in the assets he contri%uted #as J13-)000) and the accu'u!ated depreciation on the assets #as J;?)000. a. >hat is the %usiness5s %asis in the assets it received $ro' .ennis6 %. >hat #ou!d %e the %usiness5s %asis i$ the transaction qua!i$ied as a nonta a%!e e chan"e6 a. 4ecause this exchange is a fully taxable transaction, the business,s basis in 'ennis,s assets is the F1<=,222 fair mar)et value of the assets. b. #f the transaction (ualified as a nontaxable exchange, the business would ta)e the same ad0usted basis in the assets that 'ennis had. That is, the business will receive a exchanged basis of F;6,222 F59A,222 original basis minus accumulated depreciation of F=<,222! in the assets. 3(. [LO 1] 2rittany started a !a# practice as a so!e proprietor. ,he o#ned a co'puter) printer) des8) and $i!e ca%inet she purchased durin" !a# schoo! *severa! years a"o+ that she is p!annin" to use in her %usiness. >hat is the deprecia%!e %asis that 2rittany shou!d use in her %usiness $or each asset) "iven the $o!!o#in" in$or'ation6 Asset Co'puter Printer .es8 @i!e ca%inet Purchase Price J()000 J-00 J1)(00 J(00 #$% at Time Converte& to Business use J?00 J100 J1)000 J((0

The basis of assets converted from personal use to business use is the lesser of 5! fair mar)et value on date of conversion or 1! basis on the date of conversion. The basis of each asset is as follows%

9-19

Chapter 09 - Property Acquisition and Cost Recovery

(1) FMV Asset

(2) Basis on Date of Conversion

Lesser of (1) or (2) Deprecia le Basis

+omputer Printer 'es) *ile cabinet

F<22 F562 F5,222 F116

F1,622 FA22 F5,122 F122

!"## !1$# !1%### !2##

3-. [LO 1] /e" O52rien received a "i$t o$ so'e s'a!!-sca!e 9e#e!ry 'anu$acturin" equip'ent that her $ather had used $or persona! purposes $or 'any years. Her $ather ori"ina!!y purchased the equip'ent $or J1)000. 2ecause the equip'ent is out o$ production and no !on"er avai!a%!e) the property is current!y #orth J3)000. /e" has decided to %e"in a ne# 9e#e!ry 'anu$acturin" trade or %usiness. >hat is her deprecia%!e %asis $or depreciatin" the equip'ent6 The basis of a gift is a carryover basis from the donor. Therefore -eg,s depreciable basis in the property is F5,622. 33. [LO 1] <ary inherited a /aine su''er ca%in on 10 acres $ro' his "rand'other. His "randparents ori"ina!!y purchased the property $or J000 in 1900 and %ui!t the ca%in at a cost o$ J10)000 in 19:0. His "rand$ather died in 19?0 and #hen his "rand'other recent!y passed a#ay) the property #as appraised at J000)000 $or the !and and J;00)000 $or the ca%in. ,ince <ary doesn5t current!y !ive in Be# En"!and) he decided that it #ou!d %e %est to put the property to use as a renta!. >hat is <ary5s %asis in the !and and in the ca%in6 The basis of inherited property is the fair mar)et value on the date of death or, if elected by the estate, the alternate valuation date if less. +onse(uently, Lary,s basis will be F622,222 in the land and F=22,222 for the cabin. 30. [LO 1] >antin" to $ina!i&e a sa!e %e$ore year-end) on .ece'%er (9) >R Out$itters so!d to 2o% a #arehouse and the !and $or J1;0)000. 7he appraised $air 'ar8et va!ue o$ the #arehouse #as J;0)000) and the appraised va!ue o$ the !and #as J100)000. a. >hat is 2o%5s %asis in the #arehouse and in the !and6 %. >hat #ou!d %e 2o%5s %asis in the #arehouse and in the !and i$ the appraised va!ue o$ the #arehouse is J00)000) and the appraised va!ue o$ the !and is J1(0)0006 c. >hich appraisa! #ou!d 2o% !i8e!y pre$er6

9-(0

Chapter 09 - Property Acquisition and Cost Recovery

a. 4ob,s cost basis in the land is F522,222 and the cost basis in the land is F=6,222 because the purchase price must be allocated between the land and the warehouse. b. 4ob,s cost basis in the land is F516,222 and the cost basis in the land is F62,222 because the purchase price must be allocated between the land and the warehouse. c. 4ob would li)ely prefer the appraisal from part a!, because the appraisal allows him to allocate more basis to the warehouse which is depreciable. 3:. [LO (] At the %e"innin" o$ the year) Pop!oc8 %e"an a ca!endar-year do" %oardin" %usiness ca!!ed <ri$$5s Pa!ace. Pop!oc8 %ou"ht and p!aced in service the $o!!o#in" assets durin" the year= Asset Co'puter equip'ent .o" "roo'in" $urniture Pic8up truc8 Co''ercia! %ui!din" Land *one acre+ 'ate Acquire& -L(0L1( 9L1; 10L11 10L11 Cost Basis J0)000 J;)000 J10)000 J(;0)000 J?0)000

Assu'in" Pop!oc8 does not e!ect G1;9 e pensin" or %onus depreciation) ans#er the $o!!o#in" questions= a. >hat is Pop!oc85s year 1 depreciation e pense $or each asset6 %. >hat is Pop!oc85s year ( depreciation e pense $or each asset6 c. >hat is Pop!oc85s year 1 depreciation e pense $or each asset i$ the pic8up truc8 #as purchased and p!aced in service on 11L10 instead o$ 9L1;6 d. Assu'in" the pic8up truc8 #as purchased and p!aced in service on 11L10) #hat is Pop!oc85s year ( depreciation e pense $or each asset6 a. F6,996, under the half&year convention for personal property, calculated as follows% &urc'ase Date
1A&-ar 51&-ay 5=&.ep 55&7ct

(uarter
5st 1nd Ard 9th

Asset
+omputer e(uipment 'og grooming furniture Pic)up truc) 4uilding

)ecover* perio+
6 years

(1) ,ri-inal Basis


F6,222

(2) )ate
12.223 59.1@3 12.223 2.6A63

(1) x (2) Depreciation


F5,222 F5,222 F1,222 F5,996 F6,996

= years 6 years A@ years

F=,222 F52,222 F1=2,222

9-(1

Chapter 09 - Property Acquisition and Cost Recovery

Poploc) isn,t re(uired to use the mid&(uarter convention because no tangible personal property was placed in service during the 9th (uarter. b. F5A,9A=, calculated as follows% &urc'ase Date
1A&-ar 51&-ay 5=&.ep 55&7ct

(uarter
5st 1nd Ard 9th

Asset
+omputer e(uipment 'og grooming furniture Pic)up truc) 4uilding

)ecover* perio+
6 years

(1) ,ri-inal Basis


F6,222

(2) )ate
A1.223 19.9@3 A1.223 1.6;93

(1) x (2) Depreciation


F5,;22 F5,=59 FA,122 F;,@1A F5A,9A=

= years 6 years A@ years

F=,222 F52,222 F1=2,222

c. F9,@96, using the mid&(uarter convention for personal property, as calculated below. Poploc) is re(uired to use the mid&(uarter convention because more than 92 percent of its tangible personal property was placed in service during the 9th (uarter. Poploc) placed 96.963 F52,222 E F6,222 M F=,222 M F52,222!! of its tangible personal property in service during the 9th (uarter. &urc'ase Date
1A&-ar 51&-ay 56&Nov 55&7ct

(uarter
5st 1nd 9th 9th

Asset
+omputer e(uipment 'og grooming furniture Pic)up truc) 4uilding

)ecover* perio+
6 years

(1) ,ri-inal Basis


F6,222

(2) )ate
A6.223 5=.<63 6.223 2.6A63

(1) x (2) Depreciation


F5,=62 F5,162 F622 F5,996 F9,@96

= years 6 years A@ years

F=,222 F52,222 F1=2,222

d. F5A,;;;, using the mid&(uarter convention for personal property, calculated as follows% &urc'ase Date (uarter )ecover* perio+ (1) ,ri-inal Basis (2) )ate (1) x (2) Depreciation

Asset

9-((

Chapter 09 - Property Acquisition and Cost Recovery

+omputer e(uipment 'og grooming furniture Pic)up truc) 4uilding

1A&-ar 51&-ay 56&Nov 55&7ct

5st 1nd 9th 9th

6 years F6,222 = years 6 years A@ years F=,222 F52,222 F1=2,222 1;.223 1A.9=3 A<.223 1.6;93 F5,A22 F5,;9A FA,<22 F;,@1A F5A,;;;

3;. [LO (] Ever"reen Corporation acquired the $o!!o#in" assets durin" the current year *i"nore G1;9 e pense and %onus depreciation $or this pro%!e'+= Asset /achinery Co'puter Equip'ent Fsed .e!ivery 7ruc8M @urniture Place& in (ervice 'ate Octo%er (0 @e%ruary Au"ust 1; Apri! (( )riginal Basis J;0)000 J10)000 J(-)000 J100)000

M7he de!ivery truc8 is not a !u ury auto'o%i!e.

a. >hat is the a!!o#a%!e /ACR, depreciation on Ever"reen5s property in the current year6 %. >hat is the a!!o#a%!e /ACR, depreciation on Ever"reen5s property in the current year i$ %onus depreciation is ta8en *assu'e (009 ru!es app!y to (010+6 c. >hat is the a!!o#a%!e /ACR, depreciation on Ever"reen5s property in the current year i$ the 'achinery had a %asis o$ J1;0)000 rather than J;0)0006 d. >hat is the a!!o#a%!e /ACR, depreciation on Ever"reen5s property in the current year i$ the 'achinery had a %asis o$ J(;0)000 rather than J;0)0006 a. FA<,2A<, under the half year convention, calculated as follows% (1) Asset +omputer e(uipment 6 year! *urniture = year! Nsed delivery truc) 6 year! -achinery = year! Total &lace+ in .ervice *ebruary A April 11 August 5= 7ctober 16 ,ri-inal Basis F52,222 F562,222 F1A,222 F=2,222 F16A,222 (2) )ate 12.223 59.1@3 12.223 14.29% (1) x (2) Depreciation F1,222 F15,9A6 F9,;22 F52,22A FA<,2A<

$vergreen isn,t re(uired to use the mid&(uarter convention because only 1=.;=3 of its tangible personal property was placed in service during the 9th

9-(-

Chapter 09 - Property Acquisition and Cost Recovery

(uarter =2,222E16A,222!. Additionally, the delivery truc) is not considered to be a luxury auto. b. F5A;,A12, under the half year convention, calculated as follows% *+, Asset Co'puter Equip'ent *0 year+ Fsed .e!ivery 7ruc8 *0 year+ /achinery *; year+ @urniture *; year+ 7ota! 2onus depreciation Place& in (ervice @e%ruary Au"ust 1; Octo%er (0 Apri! ( )riginal Basis J10)000 J(-)000 J;0)000 J100)000 J(0-)000 J-0)000 J;0)000 J110)000 Bonus J0)000 Remain ing basis J0)000 J(-)000 J-0)000 J;0)000 *-, Rate (0.001 (0.001 13.(91 13.(91 *+, x *-, 'epreciat ion J1)000 J3):00 J0)00( J10);1? J110)000 J1-:)-(0

c. FA@,=@9, under the mid&(uarter convention, as computed below. $vergreen is re(uired to use the mid&(uarter convention because greater than 92 percent of tangible personal property was placed in service during the 9th (uarter. $vergreen placed 9<.13 OF5=2,222 E F52,222 M F1A,222 M F562,222 M F5=2,222!P of its tangible personal property in service during the 9th (uarter.
(1) Asset +omputer e(uipment 6 year! *urniture = year! Nsed delivery truc) 6 year! -achinery = year! Total &lace+ in .ervice *ebruary A April 11 August 5= 7ctober 16 (uarte r 5st 1nd Ard 9th ,ri-inal Basis F52,222 F562,222 F1A,222 F5=2,222 FA6A,222 (2) )ate A6.223 5=.<63 56.223 A.6=3 (1) x (2) Depreciation FA,622 F1;,==6 FA,962 F;,2;@ FA@,=@9

d. F9A,A;9, under the mid&(uarter convention, as computed below. $vergreen is re(uired to use the mid&(uarter convention because greater than 92 percent of tangible personal property was placed in service during the 9th (uarter. $vergreen

9-(3

Chapter 09 - Property Acquisition and Cost Recovery

placed 6@.;3 OF1=2,222 E F52,222 M F562,222 M F1A,222 M F1=2,222!P of its tangible personal property in service during the 9th (uarter.

9-(0

Chapter 09 - Property Acquisition and Cost Recovery

(1) Asset +omputer e(uipment 6 year! *urniture = year! Nsed delivery truc) 6 year! -achinery = year! Total &lace+ in .ervice *ebruary A April 11 August 5= 7ctober 16 (uarte r 5st 1nd Ard 9th ,ri-inal Basis F52,222 F562,222 F1A,222 F1=2,222 F96A,222 (2) )ate A6.223 5=.<63 56.223 A.6=3 (1) x (2) Depreciation FA,622 F1;,==6 FA,962 F@,;A@ F9A,A;9

3?. [LO (] NP!annin"O Par!ey needs a ne# truc8 to he!p hi' e pand Par!ey5s P!u'%in" Pa!ace. 2usiness has %een %oo'in" and Par!ey #ou!d !i8e to acce!erate his ta deductions as 'uch as possi%!e *i"nore G1;9 e pense and %onus depreciation $or this pro%!e'+. On Apri! 1) Par!ey purchased a ne# de!ivery van $or J(0)000. 4t is no# ,epte'%er (: and Par!ey) a!ready in need o$ another vehic!e) has $ound a dea! on %uyin" a truc8 $or J(()000 *a!! $ees inc!uded+. 7he dea!er te!!s hi' i$ he doesn5t %uy the truc8 *Option 1+) it #i!! %e "one to'orro#. 7here is an auction *Option (+ schedu!ed $or Octo%er 0 #here Par!ey %e!ieves he can "et a si'i!ar truc8 $or J(1)000) %ut there is a!so a J000 auction $ee. a. >hich option a!!o#s Par!ey to "enerate 'ore depreciation e pense deductions this year *the vehic!es are not considered to %e !u ury autos+6 %. Assu'e the ori"ina! $acts e cept that the de!ivery van #as p!aced in service one day ear!ier on /arch -1 rather than Apri! 1. >hich option "enerates 'ore depreciation e pense6 a. 7ption 5 generates more depreciation. 7ption 5 generates F@,922 of depreciation and 7ption 1 generates F=,A62. 7ption 5% /alf&year convention applies Date &lace+ in .ervice April 5 .eptember 1; (1) ,ri-inal Basis F16,222 F11,222 (2) )ate 12.223 12.223 (1) x (2) Depreciation F6,222 F9,922 F@,922

Asset 'elivery Jan 7ption 5 Total

7ption 1% -id&(uarter convention applies (1) x (2) Asset 'elivery Jan 7ption 1 Total Date &lace+ in .ervice April 5 7ctober 6 (uarte r 1nd 9th (1) ,ri-inal Basis F16,222 F11,222 (2) )ate 16.223 6.223 Depreciatio n F;,162 F5,522 F=,A62

9-(:

Chapter 09 - Property Acquisition and Cost Recovery

9-(;

Chapter 09 - Property Acquisition and Cost Recovery

b. 7ption 1 generates more depreciation expense F@,<62 vs. @,922!. Nnder 7ption 5, because the half&year convention applies, the depreciation expense is F@,922, the same as it is in part a. Nnder 7ption 1, because the mid&(uarter convention applies and the 'elivery Jan was placed in service in the first (uarter on -arch A5!, Parley is allowed to deduct more depreciation overall. The depreciation under 7ption 1 in this scenario is F@,<62, computed as follows% 7ption 1% -id&(uarter convention applies Date &lace+ in .ervice -arch A5 7ctober 6 (uarter 5st 9th (1) ,ri-inal Basis F16,222 F11,222 (2) )ate A6.223 6.223 (1) x (2) Depreciation F<,=62 F5,522 F@,<62

Asset 'elivery van 7ption 1 Total

39. [LO (] >ay Corporation disposed o$ the $o!!o#in" tan"i%!e persona! property assets in the current year. Assu'e that the de!ivery truc8 is not a !u ury auto. Ca!cu!ate >ay Corporation5s (010 depreciation e pense. Asset @urniture *; year+ /achinery *; year+ .e!ivery truc8M *0 year+ /achinery *; year+ Co'puter *0 year+
MFsed 100 percent $or %usiness.

'ate acquire& 0L1(L0: -L(-L0; 9L1;L0? 10L11L09 10L11L10

'ate sol& ;L10L10 -L10L10 -L1-L10 ?L11L10 1(L10L10

Convention HP /Q HP /Q HP

)riginal Basis J00)000 J;()000 J(0)000 J(;0)000 J?0)000

'epreciation is F65,<65, calculated as follows%


(uarter /f mi+ 0uarter n2a 5st n2a 9th n2a Depreciatio n Expense

Asset *urniture -achinery 'elivery truc) -achinery +omputer

,ri-inal Basis

)ate

&ortion of 1ear

F66,222 F=1,222 F12,222 F1=2,222 F<2,222

<.@A3 52.@A3 5@.123 1=.663 2.223

62.223 51.623 62.223 ;1.623 62.223

Total 'epreciation $xpense

F1,96; F@<9 F5,@12 F9;,9@5 F2QQQK F65,<65

9-(?

Chapter 09 - Property Acquisition and Cost Recovery

KNo depreciation for assets ac(uired and disposed of in the same year. 00. [LO (] NP!annin"O Assu'e that <reen Corporation has (010 ta a%!e inco'e o$ J-00)000 $or (010 %e$ore the G1;9 e pense *assu'e no %onus depreciation+) acquired the $o!!o#in" assets durin" (010= Place& in Asset /achinery Co'puter Equip'ent .e!ivery 7ruc8 @urniture 7ota! (ervice Octo%er 1( @e%ruary 10 Au"ust (1 Apri! ( Basis J3;0)000 J;0)000 J9-)000 J-?0)000 J1)01-)000

a+ >hat is the 'a i'u' a'ount o$ G1;9 e pense <reen 'ay deduct $or (0106 %+ >hat is the 'a i'u' tota! depreciation e pense) inc!udin" G1;9 e pense) that <reen 'ay deduct in (010 on the assets it p!aced in service in (0106 c+ >hat is the 'a i'u' tota! depreciation e pense) inc!udin" G1;9 e pense) that <reen 'ay deduct in (010 on the assets it p!aced in service in (010 i$ it does use %onus depreciation *assu'e the (009 ru!es app!y to (010+6 d+ >hat is the 'a i'u' tota! depreciation e pense) inc!udin" G1;9 e pense) <reen 'ay deduct in (010 on the assets it p!aced in service in (010 i$ the de!ivery truc8 #as purchased and p!aced in service on Octo%er (1 instead o$ Au"ust (16 a. The maximum :5=@ expense is FA=,222. 'escription *1+ Property p!aced in service in (009 *(+ 7hresho!d $or G1;9 phase-out *-+ Phase-out o$ 'a i'u' G1;9 e pense Amount Explanation J1)01-)00 7ota! o$ assets 0 *?00)000+ (010 a'ount [G1;9*%+*(+] J(1-)000 *1+ R *(+ *permanently disallowed+

9-(9

Chapter 09 - Property Acquisition and Cost Recovery

*3+ /a i'u' 1;9 e pense %e$ore phase-out *0+ Phase-out o$ 'a i'u' G1;9 e pense *:+ $aximum .+/0 expense a ter phase!out

J(00)000 (010 a'ount [G1;9*%+*1+] J(1-)000 @ro' *-+ 12/,333 *3+ R *0+

b. The maximum depreciation expense is F56<,=A< mid&(uarter convention!. 'epreciation is maximized by applying the :5=@ expense against =&year rather than 6& year property.
)riginal Asset /achinery *;-year+ Co'puter Equip'ent *0- year+ .e!ivery 7ruc8 *0 year+ @urniture *; year+ G1;9 E pense Basis .+/0 Expense Remaining Basis4 Rate 'epreciation Expense

J3;0)00 0 J;0)000 J9-)000 J-?0)00 0 J-;)000

J3--)000

-.0;1 J10)30?

J;0)000 J9-)000 J-?0)000

-0.001 10.001 1;.?01

J(3)000 J1-)900 J:;)?-0 J-;)000 J10?);-?

7ota! .epreciation E pense

c. The maximum depreciation expense is F6<6,<;@ mid&(uarter convention!. 'epreciation is maximized by applying the :5=@ expense against =&year rather than 6& year property.
)riginal Asset /achinery *;-year+ Co'puter Equip'ent *0- year+ .e!ivery 7ruc8 *0 year+ @urniture *; year+ G1;9 E pense Basis .+/0 Expense Remaining Basis Bonus 'epreciation Remaining Basis Rate 'epreciation Expense

J3;0)00 0 J;0)000 J9-)000 J-?0)00 0 J-;)000

J3--)000

J(1:)000

J1:0)000

-.0;1 J;);(9

J-0)000 J;0)000 J3:)000 J9-)000 J190)000 J-?0)000

J-0)000 J3:)000 J190)000

-0.00 1 10.00 1 1;.?0 1

J1()(00 J:)9;0 J--)900 J-;)000

9--0

Chapter 09 - Property Acquisition and Cost Recovery

2onus depreciation

J3-?)000

7ota! .epreciation E pense d. The maximum depreciation expense is F59@,9A< mid&(uarter convention applies!. 'epreciation is maximized by 5! applying the :5=@ expense against =&year rather than 6 year property and 1! applying against the =&year property placed in service in the 9th (uarter machinery! rather than the furniture that was placed in service in the second (uarter because, due to the mid&(uarter convention, the percentage for computing depreciation on the machine is only A.6=3 while it is 5=.<63 for the furniture. As a general rule, the taxpayer will maximize current year depreciation expense by applying the :5=@ expense against the asset with the lowest depreciation percentage.
)riginal Asset /achinery *;-year+ Co'puter Equip'ent *0- year+ .e!ivery 7ruc8 *0 year+ @urniture *; year+ G1;9 E pense Basis .+/0 Expense Remaining Basis4 Rate 'epreciation Expense

J3??)000 J0?0)?:9

J3;0)00 0 J;0)000 J9-)000 J-?0)00 0 J-;)000

J3--)000

-.0;1 J10)30?

J;0)000 J9-)000 J-?0)000

-0.001 0.001 1;.?01

J(3)000 J3):00 J:;)?-0 J-;)000 J139)3-?

7ota! .epreciation E pense

01. [LO (] Assu'e that 7i'%er!ine Corporation has (010 ta a%!e inco'e o$ J(0)000 %e$ore the G1;9 e pense *assu'e no %onus depreciation+.
Purchase Asset @urniture *;-year+ Co'puter Equip'ent *-0 year+ Copier *0-year+ /achinery *;-year+ 7ota! 'ate .ece'%er 1 @e%ruary (? Eu!y 10 /ay (( Basis J100)000 J90)000 J-0)000 J(?0)000 J000)000

9--1

Chapter 09 - Property Acquisition and Cost Recovery

a+ >hat is the 'a i'u' a'ount o$ G1;9 e pense 7i'%er!ine 'ay deduct $or (0106 %+ >hat #ou!d 7i'%er!ine5s 'a i'u' depreciation e pense %e $or (0106 c+ >hat #ou!d 7i'%er!ine5s 'a i'u' depreciation e pense %e $or (010 i$ the $urniture cost J;00)000 instead o$ J100)0006 a! The maximum section 5=@ expense would be F16,222% Description 5! Property placed in service 1! Threshold for :5=@ phase&out A! Phase&out of maximum :5=@ expense 9! -aximum 5=@ expense before phase&out 6! Phase&out of maximum :5=@ expense ;! Maximum 3145 expense after p'ase6out =! Taxable income before :5=@ deduction Maximum 3145 expense after taxa le income limitation7 b! The half&year convention applies because only 1=3 of its personal property was placed in service in the 9th (uarter F562,222E662,222!. Timberline,s depreciation expense is F52;,<=6 computed as follows%
Asset *urniture +omputer $(uipment +opier -achinery :5=@ $xpense ,ri-inal Basis 3145 Expense )emaininBasis* )ate Depreciation Expense

Amount Explanation F662,222 Total of assets <22,222! 1252 amount :5=@ b! 1!! F2 5! R 1! permanently disallowed! F162,222 1252 amount :5=@ b! 5!! F2 *rom A! !2$#%### 9! R 6! F16,222 Liven in problem !2$%### 8esser of ;! and =!

F562,22 2 F@2,222 FA2,222 F1<2,22 2 F16,222

F516,222

59.1@ 3 12.22 F5=,<;A F5<,222 F;,222 F92,251 F16,222

F@2,222 FA2,222 F1<2,222

3 12.22 3 59.1@ 3

9--(

Chapter 09 - Property Acquisition and Cost Recovery

F52;,<=6 Total 'epreciation $xpense 'epreciation expense is maximized by applying the :5=@ expense against =&year instead of 6&year property. c! The maximum section 5=@ expense would be F2, computed as follows% Description 5! Property placed in service 1! Threshold for :5=@ phase&out A! Phase&out of maximum :5=@ expense 9! -aximum 5=@ expense before phase&out 6! Phase&out of maximum :5=@ expense Maximum 3145 expense after p'ase6out Amount Explanation F5,1<2,22 Total of assets 2 <22,222! 1252 amount :5=@ b! 1!! F1<2,222 5! R 1! permanently disallowed! F162,222 1252 amount O:5=@ b! 5!P F162,222 *rom A! !# 9! R 6!

The maximum depreciation expense for 1252 would be F551,=66, computed as follows%
,ri-inal Asset *urniture +omputer $(uipment +opier -achinery :5=@ $xpense Basis 3145 Expense )emaininBasis* (uarter )ate Depreciation Expense

F=62,22 2

F=62,222 F@2,222

9th 5st A 1
rd

A.6=3 F1;,==6 A6.22 3 56.22 3 5=.<6 3

F@2,222 FA2,222 FA2,222 F1<2,22 2 F1<2,222


nd

FA5,622 F9,622 F9@,@<2 F2 F551,=66

Total 'epreciation $xpense

0(. [LO (] NP!annin"O .ain5s .ia'ond 2it .ri!!in" purchased the $o!!o#in" assets this year. Assu'e its ta a%!e inco'e $or the year #as J0-)000 %e$ore deductin" any G1;9 e pense *assu'e no %onus depreciation+. Purchase Asset .ri!! 2its *0-year+ 'ate Eanuary (0 )riginal Basis J90)000

9---

Chapter 09 - Property Acquisition and Cost Recovery

.ri!! 2its *0-year+ Co''ercia! 2ui!din"

Eu!y (0 Apri! ((

J90)000 J((0)00 0

a+ >hat is .ain5s 'a i'u' G1;9 e pense $or the year6 %+ >hat is .ain5s 'a i'u' depreciation e pense $or the year *inc!udin" G1;9 e pense+6 c+ 4$ the Eanuary dri!! %its5 ori"ina! %asis #as J9(0)000) #hat is .ain5s 'a i'u' G1;9 e pense $or the year6 d+ 4$ the Eanuary dri!! %its5 %asis #as J1)000)000) #hat is .ain5s 'a i'u' G1;9 e pense $or the year6 a! The maximum section 5=@ expense is F6A,222, computed as follows% 'escription *1+ Property p!aced in service in (009 *(+ 7hresho!d $or G1;9 phase-out *-+ Phase-out o$ 'a i'u' G1;9 e pense *3+ /a i'u' 1;9 e pense %e$ore phase-out *0+ Phase-out o$ 'a i'u' G1;9 e pense *:+ /a i'u' G1;9 e pense a$ter phase-out *;+ 7a a%!e inco'e %e$ore G1;9 deduction /a i'u' G1;9 e pense a$ter ta a%!e inco'e !i'itation. b! Timberline,s depreciation expense would be F<A,921, calculated as follows%
Asset .ri!! 2its *0 year+ .ri!! 2its *0 year+ Co''ercia! 2ui!din" *-9.0 year+ G1;9 E pense )riginal Basis J90)000 J90)000 J((0)000 .+/0 Expense J0-)000 Remaining Basis4 J-;)000 J90)000 J((0)000 Rate (0.001 (0.001 1.?191 'epreciation Expense J;)300 J19)000 J3)00( J0-)000

Amount Explanation J1?0)000 7ota! o$ assets *?00)000+ (010 a'ount *G1;9*%+*(++ J0 *1+ R *(+ *permanently disallowed+ J(00)000 J0 J(00)000 J0-)000 J0-)000
(010 a'ount *G1;9*%+*1++

@ro' *-+ *3+ R *0+ Assu'ed in pro%!e' Lesser o$ *:+ and *;+

9--3

Chapter 09 - Property Acquisition and Cost Recovery

7ota! .epreciation E pense

J?-)30(

c! The maximum section 5=@ expense would be FA2,222% 'escription *1+ Property p!aced in service in (009 *(+ 7hresho!d $or G1;9 phase-out *-+ Phase-out o$ 'a i'u' G1;9 e pense *3+ /a i'u' 1;9 e pense %e$ore phase-out *0+ Phase-out o$ 'a i'u' G1;9 e pense *:+ $aximum .+/0 expense a ter phase!out *;+ 7a a%!e inco'e %e$ore G1;9 deduction $aximum .+/0 expense a ter taxable income limitation5 d! The maximum section 5=@ expense would be F2% 'escription *1+ Property p!aced in service in (009 *(+ 7hresho!d $or G1;9 phase-out *-+ Phase-out o$ 'a i'u' G1;9 e pense *3+ /a i'u' 1;9 e pense %e$ore phase-out *0+ Phase-out o$ 'a i'u' G1;9 e pense *:+ /a i'u' G1;9 e pense a$ter phase-out *;+ 7a a%!e inco'e %e$ore G1;9 deduction $aximum .+/0 expense a ter taxable income limitation5 Amount Explanation J1)090)00 7ota! o$ assets 0 *?00)000+ (009 a'ount *G1;9*%+*(++ J(90)000 *1+ R *(+ *permanently disallowed+ J(00)000 J(90)000 J0 J0-)000 13
(009 a'ount *G1;9*%+*1++

Amount Explanation J1)0(0)00 7ota! o$ assets 0 *?00)000+ (009 a'ount *G1;9*%+*(++ J((0)000 *1+ R *(+ *permanently disallowed+ J(00)000 (009 a'ount *G1;9*%+*1++ J((0)000 123,333 J0-)000 123,333 @ro' *-+ *3+ R *0+ Assu'ed in pro%!e' Lesser o$ *:+ and *;+

@ro' *-+ *3+ R *0+ Assu'ed in pro%!e' Lesser o$ *:+ and *;+

9--0

Chapter 09 - Property Acquisition and Cost Recovery

0-. [LO (] Phi! o#ns a ranch %usiness and uses 3-#hee!ers to do 'uch o$ his #or8. Occasiona!!y) thou"h) he and his %oys #i!! "o $or a ride to"ether as a $a'i!y activity. .urin" year 1) Phi! put ;:0 'i!es on the 3->hee!er that he %ou"ht on Eanuary 10 $or J:)000. O$ the 'i!es driven) on!y 1;0 'i!es #as $or persona! use. Assu'e 3->hee!ers qua!i$y to %e depreciated accordin" to the 0-Pear /ACR, schedu!e and the 3->hee!er #as the on!y asset Phi! purchased this year. a. Ca!cu!ate the a!!o#a%!e depreciation $or the year 1 *i"nore the G1;9 e pense and %onus depreciation+. %. Ca!cu!ate the a!!o#a%!e depreciation $or year ( i$ tota! 'i!es #ere 9-0 and persona! use 'i!es #ere 300 *i"nore the G1;9 e pense and %onus depreciation+. a! The depreciation expense will be F5,22A in year 5, calculated as follows% Description 5! 7riginal basis of 9&wheeler 1! -A+". depreciation rate A! *ull -A+". depreciation expense 9! 4usiness use percentage Depreciation +e+uction for *ear Amount Explanation F;,622 Assumed in problem 123 6&yr prop, yr. 5, S yr. convention. F5,A22 5! x 1! ==.513 6@2 milesE=;6 miles !1%##8 A! x 9!

b! The depreciation expense will be F5,5<6 in year 1, calculated as follows% Description 5! 7riginal basis of 9&wheeler 1! -A+". depreciation rate A! *ull -A+". depreciation expense 9! 4usiness use percentage Depreciation +e+uction for *ear Amount Explanation F;,622 Assumed in problem A13 6&yr prop, yr. 5, S yr. convention. F1,2<2 5! x 1! 6;.@@3 6A2 milesE@A2 miles !1%1"$ A! x 9!

03. [LO (] Assu'e that Ernesto purchased a !aptop co'puter on Eu!y 10 o$ year 1 $or J-)000. 4n year 1) ?0 percent o$ his co'puter usa"e #as $or his %usiness and (0 percent #as $or co'puter "a'in" #ith his $riends. 7his #as the on!y asset he p!aced in service durin" year 1. 4"norin" any potentia! G1;9 e pense and %onus depreciation) ans#er the questions $or each o$ the $o!!o#in" a!ternative scenarios= a. >hat is Ernesto5s depreciation deduction $or the co'puter in year 16 %. >hat #ou!d %e Ernesto5s depreciation deduction $or the co'puter in year ( i$ his year ( usa"e #ere ;0 percent %usiness and (0 percent $or co'puter "a'in"6

9--:

Chapter 09 - Property Acquisition and Cost Recovery

c.

>hat #ou!d %e Ernesto5s depreciation deduction $or the co'puter in year ( i$ his year ( usa"e #ere 30 percent %usiness and 00 percent $or co'puter "a'in"6 d. >hat #ou!d %e Ernesto5s depreciation deduction $or the co'puter in year i$ his year ( usa"e #ere -0 percent %usiness and ;0 percent $or co'puter "a'in"6 a! The depreciation expense will be F9<2 in year 5, calculated as follows% Description 5! 7riginal basis of laptop 1! -A+". depreciation rate A! *ull -A+". depreciation expense 9! 4usiness use percentage Depreciation +e+uction for *ear Amount Explanation FA,222 Assumed in problem 123 6&yr prop, yr. 5, S yr. convention. F;22 5! x 1! <23 Assumed in the problem !9"# A! x 9!

b! The depreciation expense will be F=12 in year 1, calculated as follows% Description 5! 7riginal basis of laptop 1! -A+". depreciation rate A! *ull -A+". depreciation expense 9! 4usiness use percentage Depreciation +e+uction for *ear Amount Explanation FA,222 Assumed in problem A13 6&yr prop, yr. 5, S yr. convention. F@;2 5! x 1! =63 Assumed in the problem !42# A! x 9!

c! FA2. 4ecause his business usage is below 623, $rnesto must use the straight&line method to determine depreciation. Nsing this method, his depreciation expense for year 1 is F1=2. /owever, because his business usage dropped from above to below 623, he must also recalculate prior year depreciation using the straight line method. Any accelerated depreciation that he claimed in the prior year in excess of the straight&line amount for that prior year reduces the F1=2 of depreciation expense for year 1. #n this case, the excess F192 depreciation reduces the F1=2, leaving FA2 of depreciation expense as computed below. Description 5! .traight&line depreciation in current year 1! Prior year straight&line depreciation A! Prior year accelerated depreciation Amount Explanation F1=2 FA,222E6 years x 963 business F192 FA,222E6 x S year convention x F9<2
<23 business use percentage *rom part >a? above

9--;

Chapter 09 - Property Acquisition and Cost Recovery

9! $xcess accelerated depreciation Current *ear +epreciation +e+uction

F192 !8#

A! R 1! 5! R 9!.

d! #ncome of F;2 no depreciation deduction!. 4ecause his business usage in year 1 is below 623, $rnesto must use the straight&line method to determine depreciation. Nsing this method, his depreciation expense is F5<2 in year 1 because his business use is A23. -oreover, because the computer is listed property and fell below 623 business use, depreciation for year 5 must be recalculated using the straight&line method and any excess depreciation reduces the year 1 depreciation amount. #n this case, the excess depreciation of F192 is F;2 greater than the F5<2 straight line depreciation so $rnesto does not get to deduct depreciation expense in year 1, but instead he must recognize ordinary income of F;2. The F;2 of income is computed as follows% Description 5! .traight&line depreciation in current year 1! Prior year straight&line depreciation A! Prior year accelerated depreciation 9! $xcess accelerated depreciation Current *ear income Amount Explanation F5<2 FA,222E6 years x A23 business F192 FA,222E6 x S year convention x F9<2 F192 (!:#)
<23 business use percentage *rom part >a? above

A! R 1! 5! R 9!.

00. [LO (] Lina purchased a ne# car $or use in her %usiness durin" (009. 7he auto #as the on!y %usiness asset she purchased durin" the year and her %usiness #as e tre'e!y pro$ita%!e. Ca!cu!ate her 'a i'u' depreciation deductions *inc!udin" G1;9 e pense un!ess stated other#ise+ $or the auto'o%i!e in (009 *Lina didn5t e!ect %onus depreciation $or (009+ and (010 in the $o!!o#in" a!ternative scenarios *assu'in" ha!$-year convention $or a!!+= a. 7he vehic!e cost J10)000 and %usiness use is 100 percent *i"nore G1;9 e pense+. %. 7he vehic!e cost J30)000) and %usiness use is 100 percent. c. 7he vehic!e cost J30)000) and she used it ?0 percent $or %usiness. d. 7he vehic!e cost J30)000) and she used it ?0 percent $or %usiness. ,he so!d it on /arch 1 o$ year (. e. 7he vehic!e cost J30)000) and she used it (0 percent $or %usiness. $. 7he vehic!e cost J30)000 and is an ,FI that #ei"hed :)000 pounds. 2usiness use #as 100 percent.

9--?

Chapter 09 - Property Acquisition and Cost Recovery

a. The depreciation expense is F1,@;2 in 122@, calculated as follows% Description 5! 7riginal basis of auto 1! -A+". depreciation rate A! *ull -A+". depreciation expense 9! -aximum auto depreciation Depreciation +e+uction for *ear Amount F56,222 123 FA,222 F1,@;2 !2%5:# Explanation Assumed in problem
6&yr prop, yr. 5, S yr. convention.

5! x 1! 122@ luxury auto limit year 5 8esser of A! or 9!!

The depreciation expense will be F9,<22 in 1252, calculated as follows% Description 5! 7riginal basis of auto 1! -A+". depreciation rate A! *ull -A+". depreciation expense 9! -aximum auto depreciation Depreciation +e+uction for *ear Amount F56,222 A13 F9,<22 F9,<22 !9%"## Explanation Assumed in problem
6&yr prop, yr. 5, S yr. convention.

5! x 1! 122@ luxury auto limit year 1 8esser of A! or 9!

b. The depreciation expense will be F1,@;2 in 122@, calculated as follows% Description 5! 7riginal basis of auto 1! -A+". depreciation rate A! *ull -A+". depreciation expense 9! -aximum auto depreciation Depreciation +e+uction for *ear Amount F92,222 123 F<,222 F1,@;2 !2%5:# Explanation Assumed in problem
6&yr prop, yr. 5, S yr. convention.

5! x 1! 122@ luxury auto limit year 5 8esser of A! or 9!

The depreciation expense will be F9,<22 in 1252, calculated as follows% Description 5! 7riginal basis of auto 1! -A+". depreciation rate A! *ull -A+". depreciation expense 9! -aximum auto depreciation Depreciation +e+uction for *ear Amount F92,222 A13 F51,<22 F9,<22 !9%"## Explanation Assumed in problem
6&yr prop, yr. 5, S yr. convention.

5! x 1! 122@ luxury auto limit year 1 8esser of A! or 9!

c. The depreciation expense will be F1,A;< in 122@, calculated as follows% Description 5! 7riginal basis of auto 1! -A+". depreciation rate A! *ull -A+". depreciation expense Amount Explanation F92,222 Assumed in problem 123 6&yr prop, yr. 5, S yr. convention. F<,222 5! x 1!

9--9

Chapter 09 - Property Acquisition and Cost Recovery

9! -aximum auto depreciation 6! Depreciation +e+uction for *ear ase+ on 1##; usiness use ;! 4usiness use percentage Depreciation +e+uction for *ear

F1,@;2 122@ luxury auto limit year 5 !2%5:# 8esser of A! or 9! <23 Assumed in problem !2% 8:" 6! x ;!

The depreciation expense will be FA,<92 in 1252, calculated as follows% Description 5! 7riginal basis of auto 1! -A+". depreciation rate A! *ull -A+". depreciation expense 9! -aximum auto depreciation 6! Depreciation +e+uction for *ear ;! 4usiness use percentage Depreciation +e+uction for *ear Amount F92,222 A13 F51,<22 F9,<22 !9%"## <23 !8%"9# Explanation Assumed in problem
6&yr prop, yr. 5, S yr. convention.

5! x 1! 122@ luxury auto limit year 1 8esser of A! or 9! Assumed in problem 6! x ;!

d. The depreciation expense will be F1,A;< in 122@ as calculated in part c above!. The depreciation expense will be F5,@12 in 1252, calculated as follows% Description 5! 7riginal basis of auto 1! -A+". depreciation rate A! *ull -A+". depreciation expense 9! -aximum auto depreciation 6! 'epreciation for entire year ;! Partial year (4) Depreciation +e+uction for *ear <! 4usiness use percentage Depreciation +e+uction for *ear Amount F92,222 A13 F51,<22 F9,<22 !9%"## $#; Explanation Assumed in problem
6&yr prop, yr. 5, S yr. convention.

5! x 1! 122@ luxury auto limit year 1 8esser of A! or 9! /alf year of depreciation half&year convention!

!2%9## <23 Assumed in problem !1%52# =! x <!

e. The depreciation expense will be F6@1 in 122@, calculated as follows% Description 5! 7riginal basis of auto 1! -A+". .traight&line! depreciation rate A! *ull -A+". depreciation expense 9! -aximum auto depreciation Amount Explanation F92,222 Assumed in problem 523 6&yr straight&line, S yr.
convention.

F9,222 5! x 1! F1,@;2 122@ luxury auto limit year 5

9-30

Chapter 09 - Property Acquisition and Cost Recovery

6! Depreciation +e+uction for *ear ase+ on 1##; usiness use ;! 4usiness use percentage Depreciation +e+uction for *ear

!2%5:# 8esser of A! or 9! 123 Assumed in problem !$52 6! x ;!

The depreciation expense will be F@;2 in 1252, calculated as follows% Description 5! 7riginal basis of auto 1! -A+". .traight&line! depreciation rate A! *ull -A+". depreciation expense 9! -aximum auto depreciation 6! Depreciation +e+uction for *ear ase+ on 1##; usiness use ;! 4usiness use percentage Depreciation +e+uction for *ear Amount Explanation F92,222 Assumed in problem 123 6&yr straight&line year 1 F<,222 5! x 1! F9,<22 122@ luxury auto limit year 1 !9%"## 8esser of A! or 9! 123 Assumed in problem !5"# 6! x ;!

f. The depreciation expense will be F1<,222 in 122@, calculated as follows% Description 5! 7riginal basis of auto 1! .ection 5=@ expense A! 'epreciable basis 9! -A+". depreciation rate 6! *ull -A+". depreciation expense Depreciation +e+uction in inclu+in3145 expense for *ear Amount Explanation F92,222 Assumed in problem -aximum :5=@ expense for F16,222 .NJ F56,222 5! R 1! 123 6&yr prop, yr. 5, S yr. convention. FA,222 A! x 9! !2"%### 1! M 6!

The depreciation expense will be F9,<22 in 1252, calculated as follows% Description 5! 4asis of auto 1! -A+". depreciation rate A! *ull -A+". depreciation expense Amount Explanation F56,222 Assumed in problem A13 6&yr prop, yr. 5, S yr. convention. F9,<22 5! x 1!

Note that the depreciation is maximized in b R e even without the :5=@ expense.

9-31

Chapter 09 - Property Acquisition and Cost Recovery

0:. [LO (] On Bove'%er 10 o$ year 1 Eavier purchased a %ui!din") inc!udin" the !and it #as on) to asse'%!e his ne# equip'ent. 7he tota! cost o$ the purchase #as J1)(00)000K J-00)000 #as a!!ocated to the %asis o$ the !and and the re'ainin" J900)000 #as a!!ocated to the %asis o$ the %ui!din". a. Fsin" /ACR,) #hat is Eavier5s depreciation e pense on the %ui!din" $or years 1 throu"h -6 %. >hat #ou!d %e the year - depreciation e pense i$ the %ui!din" #as so!d on Au"ust 1 o$ year -6 c. Ans#er the question in part *a+) e cept assu'e the %ui!din" #as purchased and p!aced in service on /arch - instead o$ Bove'%er 10. d. Ans#er the question in part *a+) e cept assu'e that the %ui!din" is residentia! property. e. >hat #ou!d %e the depreciation $or (009) (010) and (011 i$ the property #ere nonresidentia! property purchased and p!aced in service Bove'%er 10) 199( *assu'e the sa'e ori"ina! %asis+6 a. The depreciation for the A years is computed as follows% )ecover* &erio+ A@ Date &lace+ in .ervice Nov. 52 (1) ,ri-inal Basis F@22,222 F@22,222 F@22,222 A (2) )ate 2.A15 3 1.6;9 3 1.6;9 3 (1) x (2) Depreciation F1,<<@ F1A,2=; F1A,2=;

1ear 5 1

Met'o+ .8

b. The depreciation for year A would be F59,91A and is computed as follows The building is sold in month < so depreciation for the year is for < minus one&half month T=.6 months.!% )ecover* &erio+ A@ Date &lace+ in .ervice Nov. 52 (2) )ate 1.6;9 F@22,222 3 Partial year (1) Basis (1) x (2) Depreciation F1A,2=; x =.6E51 F59,91A

1ear A

Met'o+ .8

c. The depreciation for years 5 R A is computed as follows note that years 1 and A are the same!% 1ear )ecover* Date &lace+ in (1) ,ri-inal (2) (1) x (2)

9-3(

Chapter 09 - Property Acquisition and Cost Recovery

Met'o+ .8 5 1

&erio+ A@

.ervice -arch A

Basis F@22,222 F@22,222 F@22,222

)ate 1.2AA 3 1.6;9 3 1.6;9 3

Depreciation F5<,1@= F1A,2=; F1A,2=;

9-3-

Chapter 09 - Property Acquisition and Cost Recovery

d. #f the property was residential real property, the building is depreciated over 1=.6 years instead of A@ years. The depreciation for years 5 & A is computed as follows% )ecover* &erio+ 1=.6 Date &lace+ in .ervice Nov. 52 (1) ,ri-inal Basis F@22,222 F@22,222 F@22,222 A (2) )ate 2.966 3 A.;A; 3 A.;A; 3 (1) x (2) Depreciation F9,2@6 FA1,=19 FA1,=19

1ear 5 1

Met'o+ .8

e. #f the property was nonresidential real property purchased in 5@@1, the depreciation for the A years is computed as follows for years 5<, 5@, and 12 in the depreciation table% )ecover* &erio+ A5.6 Date &lace+ in .ervice 5@@1 (1) ,ri-inal Basis F@22,222 F@22,222 F@22,222 1255 (2) )ate A.5=6 3 A.5=9 3 A.5=6 3 (1) x (2) Depreciation F1<,6=6 F1<,6;; F1<,6=6

1ear 122@ 1252

Met'o+ .8

0;. [LO (] Car! purchased an apart'ent co'p!e $or J1.1(0 'i!!ion on /arch 1; o$ year 1. J-00)000 o$ the purchase price #as attri%uta%!e to the !and the co'p!e sits on. He a!so insta!!ed ne# $urniture into ha!$ o$ the units at a cost o$ J:0)000. a. >hat is Car!5s a!!o#a%!e depreciation e pense $or his rea! property $or years 1 and (6 %. >hat is Car!5s a!!o#a%!e depreciation e pense $or year - i$ the property is so!d on Eanuary ( o$ year -6 a. The depreciation on the real property for the 1 years is computed as follows% )ecover* &erio+ 1=.6 Date &lace+ in .ervice -arch 5= (1) ,ri-inal Basis F<16,222 (2) )ate 1.<=@ 3 (1) x (2) Depreciation F1A,=61

1ear 5

Met'o+ .8

9-33

Chapter 09 - Property Acquisition and Cost Recovery

A.;A; 3 Note that the furniture is depreciable personal property. b. The depreciation for year A is computed as follows% )ecover* &erio+ Date &lace+ in .ervice (1) ,ri-inal Basis (2) )ate

F<16,222

F1@,@@=

(1) x (2) Depreciation

1ear

Met'o+

9-30

Chapter 09 - Property Acquisition and Cost Recovery

.8 A

1=.6 -arch 5=

F1@,@@= x .6E51 F5,162 Mmid&mid month convention applies to real property in year of ac(uisition and year of disposition. 0?. [LO (] [Research] Pau! Iote purchased the $o!!o#in" assets this year *i"nore G1;9 e pensin" and %onus depreciation #hen ans#erin" the questions %e!o#+= Asset /achinery Co'puters >arehouse Purchase 'ate /ay 1( Au"ust 1.ece'%er 1Basis J(-)000 J(0)000 J1?0)00 0

A.;A; F<16,222 3 Partial yearK

a. >hat is Pau!5s a!!o#a%!e /ACR, depreciation e pense $or the property6 %. >hat is Pau!5s a!!o#a%!e a!ternative 'ini'u' ta *A/7+ depreciation e pense $or the property6 Pou #i!! need to $ind the A/7 depreciation ta%!es to co'pute the depreciation. a. F=,665, under the half&year convention, calculated as follows%
Asset ,ri-inal Basis )ate Depreciation Expense

-achinery +omputers Nonresidential building

F1A,622 F12,222 F5<2,222

59.1@3 12.223 2.52=3

Total 'epreciation $xpense

FA,A6< F9,222 F5@AQQ F=,665

b. F6,=52, using the A-T table and the half year convention, calculated as follows%
Asset ,ri-inal Basis )ate Depreciation Expense

-achinery = year 5623 '4! +omputers 6 year 5623 '4! F12,222 F1A,622

52.=5 3 56.22 3

F1,65= FA,222

9-3:

Chapter 09 - Property Acquisition and Cost Recovery

Nonresidential building A@&year straight&line! Total 'epreciation $xpense F5<2,22 2 2.52= 3 F5@A F6,=52

09. [LO -] A$ter severa! pro$ita%!e years runnin" her %usiness) 4n"rid decided to acquire a s'a!! co'petin" %usiness. On /ay 1 o$ year 1) 4n"rid acquired the co'petin" %usiness $or J-00)000. 4n"rid a!!ocated J00)000 o$ the purchase price to "ood#i!!. 4n"rid5s %usiness reports its ta a%!e inco'e on a ca!endar-year %asis. a. %. Ho# 'uch a'orti&ation e pense on the "ood#i!! can 4n"rid deduct in year 1) year () and year -6 4n !ieu o$ the ori"ina! $acts) assu'e that J30)000 o$ the purchase price #as a!!ocated to "ood#i!! and J10)000 o$ the purchase price #as a!!ocated to a custo'er phone !ist that has an e pected !i$e o$ t#o years. Ho# 'uch a'orti&ation e pense on the "ood#i!! and the phone !ist can 4n"rid deduct in year 1) year () and year -6 Assu'e that the on!y intan"i%!e asset 4n"rid acquired #as the custo'er phone !ist #ith a use$u! !i$e o$ t#o years and that J10)000 o$ the purchase price #as a!!ocated to the custo'er !ist. Ho# 'uch a'orti&ation e pense $or the custo'er phone !ist can 4n"rid deduct in year 1) year () and year -) and ho# #i!! she account $or the $act that the phone !ist is no !on"er use$u! a$ter Apri! o$ year -6

c.

a. #ngrid could deduct F1,111 amortization expense on the goodwill in year 5 and FA,AAA of amortization expense on the goodwill in years 1 and A, computed as follows% Description 5! 4asis of Loodwill 1! "ecovery period A! -onthly amortization 9! -onths in year 5 6! 1ear 1 strai-'t6line amorti<ation ;! -onths in years 1 and A =! 1ears 2 an+ 8% annual strai-'t6line amorti<ation Amount F62,222 5<2 F1==.=< x < !2%222 x 51 !8%888 Explanation Provided in example. 56 years 5! E 1! -ay through 'ecember A! x 9! Canuary through 'ecember A! x ;!

9-3;

Chapter 09 - Property Acquisition and Cost Recovery

b. #ngrid,s amortization for the goodwill in years 5 is F5,==<, year 1 is F1,;;=, and for year A is FA,555D her amortization for the phone list for year 5 is F999, year 1 is F;;=, and year A is F111 computed as follows% Description 5! 4asis of Loodwill 1! "ecovery period in months A! -onthly amortization 9! -onths in year 5 6! 1ear 1 strai-'t6line amorti<ation ;! -onths in year 1 =! 1ear 2 strai-'t6line amorti<ation ;! *irst 9 months in year A =! &artial *ear 8 amorti<ation (?anuar* t'rou-' April) <! &artial *ear 8 amorti<ation (Ma* t'rou-' Decem er) .ee +iscussion elo> @otal *ear 8 amorti<ation =oo+>ill &'one List F92,222 F52,222 5<2 5<2 F111.11 F66.6; x < x < !1%44" !999 x 51 x 51 !2%::4 !::4 x 9 x 9 !""5 2%222 !8%111 !222 # !222

Hhen a :5@= intangible expires before it is fully amortized, the remaining basis is allocated to the other :5@= intangibles ac(uired in the same transaction 0ust the goodwill in this case!. After accounting for amortization of the phone list for a portion of year A, the remaining basis of the phone list is added to the remaining basis of the goodwill as follows% :5@= #ntangible Assets
4asis Accumulated amortization through April of year A see above! "emaining basis Allocated to the goodwill "evised basis Loodwill F92,222 F6,AA9! FA9,;;; F<,;;= F9A,AAAK Phone 8ist F52,222 F5,AAA! F<,;;=

K.ee computation of -ay through 'ecember amortization for goodwill below

9-3?

Chapter 09 - Property Acquisition and Cost Recovery

Description 5! "evised basis of section 5@= assets 1! "emaining recovery period in months 5<2 & 19! A! -onthly amortization 5! E 1! 9! < months of year A -ay through 'ecember! &artial *ear 8 amorti<ation (Ma* t'rou-' Decem er)

=oo+>ill F9A,AAA 56; F1==.=< x <

!2%222

c. #ngrid,s amortization for the phone list for year 5 is F999, year 1 is F;;=, and year A is F111, 0ust as in part b. /owever, because there were no other :5@= intangible assets ac(uired in the same transaction, #ngrid is allowed to deduct the unamortized F<,;;= basis F52,222 R 999& ;;= R 111! of the phone list in year A. :0. [LO -] Eu!iette $or'ed a ne# %usiness to se!! sportin" "oods this year. 7he %usiness opened its doors to custo'ers on Eune 1. .eter'ine the a'ount o$ start-up costs Eu!iette can i''ediate!y e pense *not inc!udin" a'orti&ation+ this year in the $o!!o#in" a!ternative scenarios. a. %. c. d. e. ,he incurred start-up costs o$ J()000. ,he incurred start-up costs o$ J30)000. ,he incurred start-up costs o$ J0-)000. ,he incurred start-up costs o$ J:0)000. Ho# #ou!d you ans#er parts *a-d+ i$ she $or'ed a partnership or a corporation and she incurred the sa'e a'ount o$ or"ani&ationa! e penditures rather than start-up costs *ho# 'uch o$ the or"ani&ationa! e penditures #ou!d %e i''ediate!y deducti%!e+6

a. F1,222, computed as follows% Description 5! -aximum immediate expense 1! Total start&up costs A! Phase&out threshold .tart6up costs Amount Explanation F6,222 :5@6 b! 5! ii! F1,222 Liven in problem 62,222 :5@6 b! 5! ii!

9-39

Chapter 09 - Property Acquisition and Cost Recovery

9! #mmediate expense phase&out Allo>a le imme+iate expense b. F6,222, computed as follows% Description 5! -aximum immediate expense 1! Total start&up costs A! Phase&out threshold 9! #mmediate expense phase&out Allo>a le imme+iate expense

1! R A! 8esser of 1! or O 5! !2%### minus R 9!P

F2

.tart6up costs Amount Explanation F6,222 :5@6 b! 5! ii! F96,222 Liven in problem 62,222 :5@6 b! 5! ii! F2 1! R A! 8esser of 1! or O 5! !$%### minus R 9!P

c. F5,622, computed as follows% Description 5! -aximum immediate expense 1! Total start&up costs A! Phase&out threshold 9! #mmediate expense phase&out Allo>a le imme+iate expense .tart6up costs Amount Explanation F6,222 :5@6 b! 5! ii! F6A,622 Liven in problem 62,222 :5@6 b! 5! ii! FA,622 1! R A! 8esser of 1! or O 5! !1%$## minus R 9!P

d. F2, computed as follows% Description 5! -aximum immediate expense 1! Total start&up costs A! Phase&out threshold 9! #mmediate expense phase&out Allo>a le imme+iate expense .tart6up costs Amount Explanation F6,222 :5@6 b! 5! ii! F;2,222 Liven in problem 62,222 :5@6 b! 5! ii! F52,222 1! R A! 8esser of 1! or O 5! minus R 9!P limited to !# F2!

9-00

Chapter 09 - Property Acquisition and Cost Recovery

e. The answers would be the same if these were organizational expenditures instead of start&up costs. Note, however, that organizational expenditures only apply to corporations and partnerships and do not apply to businesses organized as sole proprietorships. :1. [LO -] Bico!e or"ani&ed a ne# corporation. 7he corporation %e"an %usiness on Apri! 1 o$ year 1. ,he 'ade the $o!!o#in" e penditures associated #ith "ettin" the corporation started= Expense Attorney $ees $or artic!es o$ incorporation /arch 1 R /arch -0 #a"es /arch 1 R /arch -0 rent ,toc8 issuance costs Apri! 1 R /ay -0 #a"es 'ate @e%ruary 10 /arch -0 /arch -0 Apri! 1 /ay -0 Amount J-()000 J3)000 J()000 J(0)000 J1()000

a. >hat is the tota! a'ount o$ the start-up costs and or"ani&ationa! e penditures $or Bico!e5s corporation6 %. >hat a'ount o$ the start-up costs and or"ani&ationa! e penditures 'ay the corporation i''ediate!y e pense in year 16 c. >hat a'ount can the corporation deduct as a'orti&ation e pense $or the or"ani&ationa! e penditures and $or the start-up costs $or year 1 *not inc!udin" the a'ount it i''ediate!y e pensed+6 d. >hat #ou!d %e the a!!o#a%!e or"ani&ationa! e penditures) inc!udin" i''ediate e pensin" and a'orti&ation) i$ 4n"rid started a so!e proprietorship instead6 a. The only (ualifying organizational expenditure is the FA1,222 of attorney fees related to the drafting articles of incorporation. The start&up costs are the wages F9,622! and rent F1,222! before business began. Therefore, total start&up costs are F;,622. b. The corporation may immediately expense F6,222 of the organizational expenditure and F6,222 of the start&up costs because the amount of organizational expenditures is under F62,222 and the amount of start&up costs is under F62,222. c. F=6 amortization expense for start&up costs and F5,A62 for organizational expenditures, computed as follows%

9-01

Chapter 09 - Property Acquisition and Cost Recovery

.tart6up costs Description Amount 5! -aximum immediate expense F6,222 1! Total start&up costs F;,622 A! Phase&out threshold 62,222 9! #mmediate expense phase&out F2 6! Allo>a le imme+iate expense !$%### "emaining start&up costs F5,622 =! "ecovery period in months 5<2 <! -onthly straight&line amortization <.AA @! Teton business months during year 5 x @ 1ear 1 strai-'t6line amorti<ation for start6 up costs !4$

Explanation :5@6 b! 5! ii! Liven in problem :5@6 b! 5! ii! 1! R A! 5! R 9! 1! R 6! 56 years :5@6 b! 5! 4! ;! E =! -ay through 'ecember <! x @!

,r-ani<ational expen+itures Description Amount 5! -aximum immediate expense F6,222 1! Total organizational expenditures FA1,222 A! Phase&out threshold 62,222 9! #mmediate expense phase&out F2 6! Allo>a le imme+iate expense !$%### ;! "emaining organizational expenditures F1=,222 =! "ecovery period in months 5<2 <! -onthly straight&line amortization 562 @! Teton business months during year 5 x @ 1ear 1 strai-'t6line amorti<ation for or-ani<ational expen+itures !1%8$#

Explanation :19< a! 5! Liven in problem :19< a! 5! 4! 1! R A! 5! R 9! 1! R 6! 56 years :19< a! 1! ;! E =! April through 'ecember <! x @!

d. 7rganizational expenditures are only authorized for corporations section 19<! and partnerships section =2@!. They are not authorized for sole proprietorships. Typically, sole proprietorships do not incur many of the expenses that would (ualify as organizational expenditures anyway. :(. [LO -] 2ethany incurred J(0)000 in research and e peri'enta! costs $or deve!opin" a specia!i&ed product durin" Eu!y o$ year 1. 2ethany #ent throu"h a !ot o$ trou%!e and spent J10)000 in !e"a! $ees to receive a patent $or the product in Au"ust o$ year -.

9-0(

Chapter 09 - Property Acquisition and Cost Recovery

a. >hat a'ount o$ research and e peri'enta! e penses $or year1) year () and year - 'ay 2ethany deduct i$ she e!ects to a'orti&e the e penses over :0 'onths6 %. Ho# 'uch patent a'orti&ation e pense #ou!d 2ethany deduct in year - assu'in" she e!ected to a'orti&e the research and e peri'enta! costs over :0 'onths6 c. 4$ 2ethany chose to capita!i&e %ut not a'orti&e the research and e peri'enta! e penses she incurred in year 1) ho# 'uch patent a'orti&ation e pense #ou!d 2ethany deduct in year -6 a. The amortization of the research expenditures is F1,222 in year 5, F9,222 in year 1, and F1,AAA in year A, computed as follows% Description 5! )esearc' an+ experimental expenses 1! "ecovery period in months A! -onthly straight&line amortization 9! 4ethany,s business months during year 5 ($) 1ear 1 strai-'t6line amorti<ation ;! 4ethany,s business months during year 1 (4) 1ear 2 strai-'t6line amorti<ation (") Bet'an*As usiness mont's +urin- *ear 8 efore patent is issue+ in Au-ust (5) 1ear 8 strai-'t6line amorti<ation on researc' an+ experimentation costs (52! Accumulated amortization through Culy of year A 55! Nnamortized research and experimentation expenditures as of August, year A Amount Explanation !2#%### Liven in problem ;2 ;2 months :5=9 AAA.AA 5! E 1! x ; Culy through 'ecember !2%### A! x 9! Canuary through 51 'ecember !9%### A! x 6! Canuary through Culy, 4 year A 2%888 <,AAA A! x <! 6! M =! M @!

5! R 52! F55,;;= Nsed in answer to part b

b. The patent amortization is F6A5, computed as follows% Description 5! Nnamortized research and experimental expenses 1! 8egal expenses related to patent A! Amortizable expenses for patent 9! "ecovery period in months 6! -onthly straight&line amortization Amount Explanation

!11%::4 .ee 55! part a above F52,222 Liven in problem F15,;;= 5! M 1! 129 5= years :5;= f! 52;.15 A! E 9!

9-0-

Chapter 09 - Property Acquisition and Cost Recovery

;! 4ethany,s business months from August through 'ecember 1ear 8 strai-'t6line amorti<ation for patent x 6 !$81 6! x ;!

c. The patent amortization is F=A6, computed as follows% Description 5! )esearc' an+ experimental expenses 1! 8egal expenses related to patent A! Amortizable expenses 9! "ecovery period in months 6! -onthly straight&line amortization ;! 4ethany,s business months from August through 'ecember 1ear 8 strai-'t6line amorti<ation for patent Amount Explanation !2#%### Liven in problem not amortized! F52,222 Liven in problem FA2,222 5! M 1! 129 5= years :5;= f! 59=.2; A! E 9! x 6 !48$ 6! x ;!

:-. [LO 3] Last Chance /ine *LC+ purchased a coa! deposit $or J;00)000. 4t esti'ated it #ou!d e tract 1()000 tons o$ coa! $ro' the deposit. LC 'ined the coa! and so!d it reportin" "ross receipts o$ J1 'i!!ion) J- 'i!!ion) and J( 'i!!ion $or years 1 throu"h -) respective!y. .urin" years 1 R -) LC reported net inco'e *!oss+ $ro' the coa! deposit activity in the a'ount o$ *J(0)000+) J000)000) and J300)000) respective!y. 4n years 1 R -) LC actua!!y e tracted 1-)000 tons o$ coa! as $o!!o#s= *1+ 7ons o$ Coa! 1()000 'epletion *(+ *(+L*1+ 2asis Rate J;00)000 J:(.00 Tons extracte& per year Pear 1 ()000 Pear ( ;)(00 Pear -)?00

a. >hat is Last Chance5s cost dep!etion $or years 1) () and -6 %. >hat is Last Chance5s percenta"e dep!etion $or each year *the app!ica%!e percenta"e $or coa! is 10 percent+6 c. Fsin" the cost and percenta"e dep!etion co'putations $ro' the previous parts) #hat is Last Chance5s actua! dep!etion e pense $or each year6 a. 8ast +hance,s cost depletion is F516,222 for year 5, F962,222 for year 1, and F5=6,222 for year A, calculated as follows%
Gear 5 5! Tons extracted 1! 'epletion rate 1,222 F;1.62 Gear 1 =,122 F;1.62 Gear A A,<22 F;1.62 $xplanation Liven in problem Liven in problem

9-03

Chapter 09 - Property Acquisition and Cost Recovery

F516,22 Cost Depletion Expense 2

F962,22 2

F5=6,222 K

5! x 1!

KThis is the remaining basis. Nnder the cost depletion method, the taxpayer,s amortization is limited to the cost basis in the natural resource. The full amount of amortization would have been F1A=,622 if this were not the case. b. 8ast +hance,s percentage depletion for each year is calculated as follows%
Gear 5 5! Net income from activity before depletion expense! 1! Lross #ncome A! Percentage 9! Percentage 'epletion $xpense before limit 6! 623 of net income limitation Allo>a le percenta-e +epletion F12,222! F5,222,22 2 x 523 F522,222 F2 !# F622,222 FA,222,22 2 x 523 FA22,222 F162,222 !2$#%### F962,222 F1,222,22 2 x 523 F122,222 F116,222 !2##%### Liven in problem Liven in problem Liven in problem 1! x A! 5! x 623 8esser of 9! or 6! Gear 1 Gear A $xplanation

Note that percentage depletion is not limited to the basis in the property. c. 'epletion expense is the greater of cost depletion or percentage depletion calculated as follows%
@ax Depletion Expense 1ear 1 5! +ost depletion 1! Percentage depletion De+ucti le +epletion expense F516,222 F2 !12$%### 1ear 2 F962,222 F162,222 !9$#%### 1ear 8 F5=6,22 2 F122,22 2 !2##%## # Explanation Part a Part b Lreater of 5! or 1!

Co#prehensive Pro!"e#s
:3. 2ac8 in 2oston) ,teve has %een %usy creatin" and 'ana"in" his ne# co'pany) 7eton /ountaineerin" *7/+) #hich is %ased out o$ a s'a!! to#n in >yo'in". 4n the process o$ doin" so) 7/ has acquired various types o$ assets. 2e!o# is a !ist o$ assets acquired durin" (009= Asset O$$ice equip'ent /achinery Fsed de!ivery truc8M Cost J10)000 J(:0)000 J10)000 'ate Place in (ervice 0(L0-L(009 0;L((L(009 0?L1;L(009

9-00

Chapter 09 - Property Acquisition and Cost Recovery

MBot considered a !u ury auto'o%i!e) thus not su%9ect to the !u ury auto'o%i!e !i'itations

9-0:

Chapter 09 - Property Acquisition and Cost Recovery

.urin" (009) 7/ had hu"e success *and had no G1;9 !i'itations and ,teve acquired 'ore assets the ne t year to increase its production capacity. 7hese are the assets #hich #ere acquired durin" (010= Asset Co'puters A 4n$o. ,yste' Lu ury AutoMM Asse'%!y Equip'ent ,tora"e 2ui!din" MMFsed 1001 $or %usiness purposes. 7/ did e tre'e!y #e!! durin" (010 %y "eneratin" a ta a%!e inco'e %e$ore any G1;9 e pense o$ J3-()000. Require& A. Co'pute (009 depreciation deductions inc!udin" G1;9 e pense *i"norin" %onus depreciation+. 2. Co'pute (010 depreciation deductions inc!udin" G1;9 e pense *i"norin" %onus depreciation+. C. Co'pute (010 depreciation deductions inc!udin" G1;9 e pense *i"norin" %onus depreciation+) %ut no# assu'e that ,teve acquired a ne# 'achine on Octo%er (nd $or J-00)000 p!us J(0)000 $or de!ivery and setup costs. .. 4"norin" part c) no# assu'e that durin" (010) ,teve decides to %uy a co'petitor5s assets $or a purchase price o$ J-00)000. ,teve purchased the $o!!o#in" assets $or the !u'p-su' purchase price. Asset 4nventory O$$ice $urniture /achinery Patent <ood#i!! 2ui!din" Land E. Cost J(0)000 J-0)000 J00)000 J9?)000 J()000 J1-0)000 J(0)000 'ate Place& in (ervice 09L10L(010 09L10L(010 09L10L(010 09L10L(010 09L10L(010 09L10L(010 09L10L(010 Cost J30)000 J?0)000 J1;0)000 J300)000 'ate Place in (ervice 0-L-1L(010 00L(:L(010 0?L10L(010 11L1-L(010

Co'p!ete Part 4 o$ @or' 30:( $or part %.

a! 122@ depreciation is F166,<6<.


Description Cost Sec. 179 Expense MACRS Basis Current Expense EOY

9-0;

Chapter 09 - Property Acquisition and Cost Recovery

Office Equipment Mac"iner# )se* De+i,er# -ruc.

10 000 $%0 000 1( 000

10 000 $&0 000 $0 000 1( 000

! $ '(' / 000

10 000 $&$ '(' / 000

-ota+s

$'( 000

$(0 000

/( 000

( '('

$(( '('

b! 1252 depreciation is F11<,@91.


Description Office Equipment Mac"iner# )se* De+i,er# -ruc. Cost 10 000 $%0 000 1( 000 $0 000 1( 000 ! '0 000 17( 000 &00 000 ! Sec. 179 Expense MACRS Basis ! & '9' & '00 Current Expense !

Computers 0 1nfo. S#stem 2uxur# Auto Assem3+# Equipment Stora4e Bui+*in4

&0 000 '0 000 17( 000 &00 000

&0 000

&0 000 $ 9%0 17( 000 1 $'&

-ota+s

9'0 000

$1( 000

(1( 000

$$' 9&$

c! 1252 depreciation is F1@@,5<9.


Description Office Equipment Mac"iner# )se* De+i,er# -ruc. Cost 10 000 $%0 000 1( 000 A**itions Sec. 179 Expense 10 000 $&0 000 $0 000 1( 000 & '9' & '00 MACRS Basis Current Expense !

Computers 0 1nfo. S#stem 2uxur# Auto

&0 000 '0 000

&0 000 '0 000

1& 000 $ 9%0

9-0?

Chapter 09 - Property Acquisition and Cost Recovery

Assem3+# Equipment 5e6 Mac"ine Stora4e Bui+*in4

17( 000 /00 000 &00 000 $0 000 $(0 000

17( 000 70 000 &00 000

1' 7&/ $($ &99 1 $'&

-ota+s

1 $'0 000

$0 000

(00 000

'00 000

$99 1'&

d! 1252 depreciation is F1=6,6<9.


Description Office Equipment Mac"iner# )se* De+i,er# -ruc. Computers 0 1nfo. S#stem 2uxur# Auto Assem3+# Equipment Stora4e Bui+*in4 Cost 10 000 $%0 000 1( 000 Sec. 179 Expense 10 000 $&0 000 $0 000 1( 000 MACRS 7actor ! & '9' & '00 Current Expense !

&0 000 '0 000 17( 000 &00 000 17( 000

&0 000 '0 000 ! &00 000 n8a /0 000 &( 000 ( 000 9' 000 $ 000 1/0 000 n8a !

' 000 $ 9%0 17( 000 1 $'& ! /0 000 &( 71( $ 17' && 97& !

1n,entor# Office 7urniture Mac"iner# 9atent :oo*6i++ Bui+*in4 2an*

$0 000 /0 000 (0 000 9' 000 $ 000 1/0 000 $0 000

-ota+s

1 //0 000

(00 000

790 000

$7( '($

e+ Co'p!ete Part 4 o$ @or' 30:( $or part %.


9-09

Chapter 09 - Property Acquisition and Cost Recovery

:0. >hi!e co'p!etin" under"raduate schoo! #or8 in in$or'ation syste's) .a!!in 2ourne and /ichae! 2an8s decided to start a %usiness ca!!ed 4,ys Ans#ers #hich #as a techno!o"y support co'pany. .urin" year 1) they %ou"ht the $o!!o#in" assets and incurred the $o!!o#in" $ees at start up= 6ear + Assets Co'puters *0-year+ O$$ice equip'ent *;-year+ @urniture *;-year+ ,tart-up costs Purchase 'ate Octo%er -0) P1 Octo%er -0) P1 Octo%er -0) P1 Octo%er -0) P1 Basis J10)000 J10)000 J-)000 J;)000

4n Apri! o$ year () they decided to purchase a custo'er !ist $ro' a co'pany started %y $e!!o# in$or'ation syste's students preparin" to "raduate #ho provided virtua!!y the sa'e services. 7he custo'er !ist cost J10)000 and the sa!e #as co'p!eted on Apri! -0th. .urin" their su''er %rea8) .a!!in and /ichae! passed on internship opportunities in an atte'pt to rea!!y "ro# their %usiness into so'ethin" they cou!d do $u!! ti'e a$ter "raduation. 4n the su''er) they purchased a s'a!! van *$or transportation) not considered a !u ury auto+ and a pin%a!! 'achine *to he!p attract ne# e'p!oyees+. 7hey %ou"ht the van on Eune 10) P( $or J10)000 and spent J-)000 "ettin" it ready to put into service. 7he pin%a!! 'achine cost J3)000 and #as p!aced in service on Eu!y 1) P(. 6ear - Assets Ian Pin%a!! /achine *;-year+ Custo'er List Purchase 'ate Eune 10) P( Eu!y 1) P( Apri! -0) P( Basis J1?)000 J3)000 J10)000

Assu'e that 4,ys Ans#ers does not e!ect any G1;9 e pense or %onus depreciation. A!so assu'e that P1 is (00? and P( is (009. a. >hat are the 'a i'u' cost recovery deductions $or 4,ys Ans#ers *e c!udin" G1;9 e pensin"+ $or (00? and (0096 %. >hat is 4,ys Ans#ers5 %asis in each o$ its assets at the end o$ (00? and (0096 a. #.ys Answers, G5 cost recovery deductions are F;,19=, including the expensing of the start up costs. #.ys Answers, G1 cost recovery deductions are F59,2<;.
11 Cost )ecover* Expense )emaininBasis (uarter )ate

,ri-inal Asset +omputer $(uipment 7ffice $(uipment Basis

Depreciation Expense

F56,222 F52,222

F56,222 F52,222

9 9th

th

6.223 A.6=3

F=62 FA6=

9-:0

Chapter 09 - Property Acquisition and Cost Recovery

*urniture .tart&up costs .tart&up immediate expense

FA,222 F=,222 F6,222

FA,222 F1,222

9th NEA

A.6=3 .ee below

F52= FAA F6,222 F;,19=

Total +ost "ecovery $xpense .tart6up costs 11 Description Amount 5! -aximum immediate expense F6,222 1! Total start up costs F=,222 A! Phase&out threshold 62,222 9! #mmediate expense phase&out F2 6! Allo>a le imme+iate expense !$%### ;! "emaining start up costs F1,222 =! "ecovery period in months 5<2 <! -onthly straight&line amortization 55.55 @! Teton business months during year 5 1ear 1 strai-'t6line amorti<ation for start up costs
,ri-inal Asset +omputer $(uipment 7ffice $(uipment Basis

Explanation :5@6 Liven in problem :5@6 1! R A! 5! R 9! 1! R 6! 56 years :5@6 ;! E =! 7ctober through

x A 'ecember !88 <! x @!


Depreciation (uarter )ate Expense

11 Cost )ecover* Expense )emaininBasis

F56,222 F56,222 F52,222 F52,222 FA,222


*urniture

9th 9th

A<.22 3 1=.66 3 1=.66 3 F55.55 x 51 12.22 3 59.1@ 3 .ee

F6,=22 F1,=66

9th

FA,222 F=,222 F5<,222 /G F9,222 F52,222


9-:1

F<1= F5AA FA,;22 F6=1 F622

.tart&up costs

F6,222

F1,222

NEA /G

'elivery van

Pinball machine +ustomer 8ist

Chapter 09 - Property Acquisition and Cost Recovery

NEA

below

9-:(

Chapter 09 - Property Acquisition and Cost Recovery

Total +ost "ecovery $xpense Description 5! +ustomer list section 5@= intangible! 1! "ecovery period in months A! -onthly straight&line amortization 9! April through 'ecember 1ear 1 strai-'t6line amorti<ation for customer list b. #.ys Answers, basis is as follows%
A+Buste+ Basis Expense 1ear 1 ,ri-inal Asset Basis Cost )ecover* 1ear 2 Cost )ecover* Depreciation Expense

F59,2<= Amount Explanation !1#%### Liven in problem 5<2 .ection 5@= 66.6; 5! E 1! x @ !$## A! x 9!

+omputer $(uipment 7ffice $(uipment *urniture .tart&up costs 'elivery van Pinball machine +ustomer 8ist Totals F56,222 F52,222 FA,222 F=,222 F5<,222 F9,222 F52,222 F;=,222 F=62 FA6= F52= FAA QQQQQQQ F;,19= F6,=22 F1,=66 F<1= F5AA FA,;22 F6=1 F622 F59,2<= F9;,;;; Total +ost "ecovery $xpense ::. .ia'ond /ountain #as ori"ina!!y thou"ht to %e one o$ the $e# p!aces in Borth A'erica to contain dia'onds) so .ia'ond /ountain 4nc. *./+ purchased the !and $or J1)000)000. Later) ./ discovered that the on!y dia'onds on the 'ountain had %een p!anted there and the !and #as #orth!ess $or 'inin". ./ en"ineers discovered a ne# survey techno!o"y and discovered a si!ver deposit esti'ated at 0)000 pounds on .ia'ond /ountain. ./ i''ediate!y %ou"ht ne# dri!!in" equip'ent and %e"an 'inin" the si!ver. F<,662 F ;,<<< F 1,2;; F 5,<A9 F59,922 FA,91< F@,622

F6,222

9-:-

Chapter 09 - Property Acquisition and Cost Recovery

4n years 1-- $o!!o#in" the openin" o$ the 'ine) ./ had net *"ross+ inco'e o$ J(00)000 *J;00)000+) J300)000 *J1)100)000+) and J:00)000 *J1)300)000+) respective!y. /inin" a'ounts $or each year #ere as $o!!o#s= ;00 pounds *year 1+) 1)300 pounds *year (+) and 1)?00 pounds *year -+. At the end o$ year () en"ineers used the ne# techno!o"y *#hich had %een i'provin" over ti'e+ and esti'ated there #as sti!! an esti'ated :)000 pounds o$ si!ver deposits. ./ a!so %e"an a research and e peri'entation pro9ect #ith the hopes o$ "ainin" a patent $or its ne# survey techno!o"y. .ia'ond /ountain 4nc. chooses to capita!i&e research and e peri'entation e penditures and a'orti&e the costs over :0 'onths or unti! it o%tains a patent on its techno!o"y. 4n /arch o$ year 1) ./ spent J90)000 on research and e peri'entation. ./ spent another J;0)000 in @e%ruary o$ year ( $or research and e peri'entation. 4n ,epte'%er o$ year () ./ paid J(0)000 o$ !e"a! $ees and #as "ranted the patent in Octo%er o$ year ( *the entire process o$ o%tainin" a patent #as unusua!!y $ast+. Ans#er the $o!!o#in" questions re"ardin" ./5s activities *assu'e that ./ tries to 'a i'i&e its deductions i$ "iven a choice+. a. >hat is ./5s dep!etion e pense $or years 1 - -6 %. >hat is ./5s research and e peri'entation a'orti&ation $or years 1 and (6 c. >hat is ./5s %asis in its patent and #hat is its a'orti&ation $or the patent in year (6 a. '-,s depletion expense is as follows, actual cost and percentage depletion are shown below% Actual Depletion 7riginal basis Gear 5 depletion cost depletion! Gear 5 $nding basis Gear 1 depletion cost depletion! Gear 1 $nding basis Gear A depletion percentage depletion! Gear A $nding basis Cost Depletion Met'o+ Gear 5 4eginning basis $stimated pounds of silver in mine at beginning of year 4asis depletion per pound Pounds of silver mined in year 1ear 1 F5,222,222 6,222 F 122 F =62 1ear 2 F<62,222 =,962 F 559.2@ F5,962 1ear 8 F;<9,6;@ ;,222 F559.2@ 5,<22 F 5,222,222 F 562,222! F <62,222 F 5;6,9A5! F ;<9,6;@ F 15=,622! F 9;=,2;@

9-:3

Chapter 09 - Property Acquisition and Cost Recovery

Gear depletion 4asis at end of year

F562,222 F <62,222

F5;6,9A5 F ;<9,6;@

F126,A;1 F 9=@,12=

9-:0

Chapter 09 - Property Acquisition and Cost Recovery

&ercenta-e Depletion Met'o+ Net income Lross income Percentage Percentage depletion expense before limit 623 of net income limitation Allowable percentage depletion 1ear 1 F 122,222 F =22,222 563 F 526,222 F F 522,222 522,222 1ear 2 F 922,222 F5,522,222 563 F 5;6,222 F 122,222 F 5;6,222 1ear 8 F ;22,222 F 5,962,222 563 F 15=,622 F F A22,222 15=,622

b. '-,s research and experimentation amortization for years 5 and 1 are as follows% Description )esearc' an+ experimental expenses "ecovery period in months -onthly straight&line amortization '-,s business months during year 5 1ear 1 strai-'t6line amorti<ation '-Us business months during year 1 before the patent is issued 1ear 2 strai-'t6line amorti<ation Accumulated amortization through .eptember of year 1 Nnamortized "esearch and experimentation 1ear 1 Amount F@6,222 ;2 F5,6<A.AA 52 F56,<AA @ F59,162 FA2,2<A F;9,@5= 1ear 2 Amount F=6,222 ;2 F5,162 2 F & @ F55,162 F55,162 F;A,=62 F51<,;;=

c. '-,s basis in its patent and amortization for patent in year 1 are as follows% Description Nnamortized research and experimental expenses 8egal expenses related to patent Amortizable expenses for patent "ecovery period in months -onthly straight&line amortization '-Us business months from 7ctober through 'ecember 1ear 2 strai-'t6line amorti<ation for patent Amount !12"%::4 F12,222 F59<,;;= 129 =1<.=; A !2%1":

9-::