Solution Manual (‘Individuals’ Section) for

Prentice Hall’s Federal Taxation 2013, 26/E 26th

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Solution Manual (‘Individuals’ Section) for Prentice Hall’s Federal Taxation 2013, 26/

Chapter I:10

Depreciation, Cost Recovery,

Amortization, and Depletion

Discussion Questions
I:10-1 a. An automobile held for personal use is not eligible for depreciation or
amortization.
b. Goodwill is a Sec. 197 intangible asset amortizable ratably over a 15-year period
beginning with the month of acquisition.
c. Since the cost of the customer list represents a Sec. 197 intangible, its cost is
amortizable on a ratable basis over a 15-year period beginning with the month of acquisition.
d. A patent is amortizable over its legal life of seventeen years since the cost of the
patent has a definite and limited life. The patent does not qualify for 15-year amortization under
Sec. 197 because it was not acquired in connection with a transaction that involves the
acquisition of a trade or business or a substantial portion of a trade or business.
e. Land is not eligible for depreciation or amortization.
f. A covenant not to compete is a Sec. 197 intangible amortizable ratably over a
15-year period despite the fact that the period under the agreement may be different (e.g., five
years). In such case no loss is recognized and the basis of retained Sec. 197 intangibles is
increased by the unrecognized loss. pp. I:10-2 through I:10-4, I:10-17, and I:10-18.

I:10-2 Depreciation deductions are not discretionary. The basis of property must be reduced by
the amount of depreciation that should have been taken (allowable depreciation) even if no
depreciation was claimed. The basis of the property must be reduced on a consistent basis by
depreciation computed using one of several accounting methods provided under the tax law. If
no method had previously been used, allowable is defined as the slowest possible method
allowed by law (e.g., straight-line using the longest permissible recovery period). So, Rick could
wind up recognizing a gain to the extent the asset is sold for more than its adjusted basis.
p. I:10-3.

I:10-3 The basis of property converted from personal-use to business or investment use is the
lesser of the adjusted basis or the FMV of the property (at the date of conversion). The decline
in value of $20,000 ($120,000 - $100,000) represents a nondeductible personal loss and is not
depreciable. Therefore, the depreciable basis is $100,000 of which a portion must be allocated to
land. This lower of cost or market rule is intended to prevent taxpayers from depreciating
unrealized nondeductible personal losses. pp. I:10-3 and I:10-4.

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I:10-4 a.
Subject to Subject to Sec. 197
MACRS Depreciation Amortization b. Recovery Period

Furniture Yes No 7 years

Plumbing fixtures Yes No 7 years
Land No No N/A
Trademark No Yes 15 years
Goodwill No Yes 15 years
Automobile Yes No 5 years
Heavy Truck Yes No 5 years
Machinery Yes No 7 years
Building used in
manufacturing Yes No 39 years

pp. I:10-5 and I:10-17 through I:10-19.

I:10-5 a. Regular MACRS Depreciation in 2013 (Year 1) would be $7,145 ($50,000 x

0.1429). Depreciation in 2014 (Year 2) would be $12,245 ($50,000 x 0.2449). The percentages
come from Table 1 (HY convention) in Appendix C.

b. Depreciation in 2013 (Year 1) would be as follows:

Bonus depreciation ($50,000 x 50%) $25,000

MACRS Depreciation in 2013 ($25,000 x 0.1429) 3,573
MACRS Depreciation in 2014 (Year 2) would be as follows:
($25,000 x 0.2449) = $ 6,123

c. If Robert had elected Sec. 179 in 2013, he would have deducted the entire
$50,000 as taxpayers were permitted to expense up to $500,000 in 2013. Because
he deducted the entire $50,000 in 2013, no depreciation is allowable in 2014.

pp. I:10-5 through I:10-7.

I:10-6 a. Neither machine was placed in service in the fourth quarter, so the half-year
convention (Table 1) applies. Depreciation on Machine C would be $81,453 ($570,000 x
0.1429), and depreciation on Machine D would be $10,000 ($50,000 x 0.20).
b. If Roberta elects Sec. 179, she can expense up to $500,000 in 2013. She can
choose the assets on which she takes the Sec. 179 deduction. To maximize the depreciation
deduction, assets with longer recovery lives generally should be selected first. So, Roberta can
elect to expense $500,000 of Machine C. Thus, total depreciation for 2013 would be $520,003
[$500,000 + ($70,000 x 0.1429) + ($50,000 x 0.20)]. pp. I:10-5 through I:10-7.

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I:10-7 Yes, Depreciation for real estate is computed using tables that follow the mid-month
convention, so depreciation is allowed in the year of disposal. The amount of depreciation is
computed by taking one-half month for the month the asset is sold plus the number of full
months held prior to sale, divided by 12 months. Thus, one-half of a month’s depreciation is
allowed in the year of disposal regardless of the day of the month the disposal occurred. For
example, if property is disposed of on October 30, the table percentage must be multiplied by the
fraction 9.5/12 (nine full months plus one-half month for October). p. I:10-10.

I:10-8 a. No. The salesman is incorrect. The maximum amount of depreciation, (Sec. 179
and regular MACRS) is limited to $3,160 in 2013 due to the Section 280F luxury auto limits. If
Sec. 179 is not elected, the total depreciation deduction of $9,000 still would be greater than the
maximum luxury car amount. Thus, the maximum depreciation deduction in the initial year is
substantially less than claimed by the salesperson. As one may observe, Sec. 179 is not
recommended for luxury automobiles. If Jose did not elect out of bonus depreciation, the limit
would be $11,160.
b. The maximum depreciation deduction under Sec. 280F in the first year would be
$1,896 ($3,160 limit x 0.60 business).
c. Jose could deduct the lease payments. However, he must reduce the deduction by
a lease inclusion amount from tables published by the IRS. See Tables 13 and 14 of Appendix
C. Jose is not eligible for the Sec. 179 deduction.
d. The salesman’s claims are a bit more correct in this case, but still overstated.
Because the SUV has a GVWR of greater than 6,000 pounds, the ceiling limitations do not
apply. However, the Sec. 179 deduction is limited to $25,000. So, in this case, Jose may claim a
Sec. 179 deduction of $25,000 and a regular MACRS deduction of $4,000 [($45,000 - $25,000)
x 0.20], for a total of $29,000 in 2013. While the 2004 Jobs Act reduced the Sec. 179 deduction
to a maximum of $25,000, SUVs still may claim depreciation deductions far in excess of
passenger automobiles that are subject to the ceiling limitation. pp. I:10-13 through I:10-16.

I:10-9 a. Straight-line depreciation would be preferable to regular MACRS in this case to

reduce depreciation deductions in current years. This would have the effect of increasing taxable
income, which could be offset against the NOLs. The alternative depreciation system (ADS)
employs the straight-line method of depreciation (versus 200% DB under MACRS) and a longer
recovery period.
b. Straight-line (ADS) depreciation would be preferable to MACRS in this case
because it will give Rhonda lower deductions and higher taxable income in the years when her
marginal tax rate is low. MACRS would accelerate deductions into the low-rate years and
reduce deductions in the high rate years, causing higher taxable income. pp. I:10-11.

I:10-10 Section 179, allows for an ordinary deduction in the year placed in service of up to
$500,000 (in 2013) of the cost of tangible personal business property. Its primary advantage is
the time value of the tax benefits that result from a larger depreciation deduction in the first year
and the corresponding deferral of tax. pp. I:10-6 and I:10-7.

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I:10-11 Qualified leasehold improvement property (QLIP) placed in service after December 31,
2005 and before January 1, 2014 can be depreciated over 15 years using the straight-line method.
Prior to this provision, taxpayers depreciated QLIP over the nonresidential real property recovery
period of 39 years. pp. I:10-10 and I:10-11.

I:10-12 a. The taxpayer may use MACRS for the business-use portion of the cost of both
assets. Thus, he generally is entitled to claim depreciation on $25,600 of the auto’s cost ($32,000
x 0.80) and $4,000 of the computer’s cost. Both have a recovery period of five years. However,
the maximum depreciation that may be deducted in 2013 on the auto is limited to $2,528 ($3,160
x 0.80) under the so-called “luxury car rules.”
b. If the taxpayer is an employee and the auto and computer are not required as a
condition of employment, no depreciation is allowed.
c. If the business use percentage decreases to 50% or less in a subsequent year, the
property is subject to depreciation recapture and the depreciation for all subsequent years is
recomputed using the ADS. When the business use first falls to 50% or below, depreciation
must be recaptured to the extent that MACRS depreciation exceeds the recomputed depreciation
using the ADS. pp. I:10-12 through I:10-14.

I:10-13 a. Qualified property for bonus depreciation includes (1) MACRS property with a
recovery period of 20 years or less, (2) computer software (other than computer software that
must be amortized under Sec. 197), or (3) qualified leasehold improvement property. The
qualified property must have been placed in service by the taxpayer after September 8, 2010 and
before January 1, 2014. The original use of the property must have begun with the taxpayer.
b. Sec. 179 depreciation is generally taken before any bonus depreciation.

pp. I:10-7 and I:10-8.

I:10-14 No. Sarah may deduct the automobile lease payments made during the year. However,
she must reduce the deduction by a “lease inclusion amount” (found in Table 13 of Appendix C).
This reduction prevents Sarah from avoiding the luxury auto depreciation limits that apply to
purchased vehicles. Sarah’s lease payment deduction is computed as follows:

Lease payments ($600/month x 10 months) $6,000

Minus: Lease inclusion amount from Table 13 ($23 x 306/365) (19)
Deductible lease payments in 2013 $5,981

p. I:10-16.

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I:10-15 Intangible assets acquired in connection with the purchase of a trade or business are
Sec. 197 intangibles, amortizable ratably over a 15-year period. Gain on disposition will be
given Sec. 1231 treatment, but a loss on disposition is not deductible if other intangibles acquired
in the same asset purchase are retained. Internally created intangibles and intangibles acquired
by the purchase of an individual asset are subject to amortization only if they have both a definite
and limited life (e.g., an internally created patent with a 17-year legal life). pp. I:10-17 and
I:10-18.

I:10-16 a. The internally created patent should be amortized over the legal life of 17 years,
$2,000 ($34,000 ÷ 17 years) in the current year. Goodwill and going concern value, the
covenant not to compete, licenses, and customer lists are Sec. 197 intangibles and are
amortizable on a straight-line basis over 15 years, $20,000 in the current year ($300,000 ÷
15 years).
b. The purchaser should attempt to allocate as much of the total purchase price as
possible to inventory, because gross profit is reduced when inventory is sold. Next, allocate as
much of the remaining purchase price as possible to the assets with the shortest recovery periods
(e.g., the equipment and the Sec. 197 intangibles). The smallest amount possible should be
allocated to the land because land is not depreciable. pp. I:10-17 through I:10-19 and I:10-24.

I:10-17 Research and experimental expenditures are usually expensed in the current year
because the taxpayer wants the immediate tax benefit. The deferral and amortization method
would be advantageous if the taxpayer is in a low tax bracket or expects a net operating loss.
pp. I:10-19 and I:10-20.

I:10-18 Buyers generally prefer a liberal allocation of the purchase price to ordinary assets such
as inventory because gross profit is reduced when the inventory is sold. Allocations to short-
lived depreciable assets and Sec. 197 intangibles are preferred over allocations to land and other
nondepreciable assets due to the tax benefits obtained from the depreciation and amortization.
p. I:10-24.

I:10-19 Cost depletion is the systematic allocation of the cost of a natural resource property over
the property’s expected recoverable life. Cost depletion is similar to the units-of-production
method of depreciation and is calculated by dividing the asset’s adjusted basis by the estimated
recoverable units to arrive at a per-unit depletion amount. This per-unit amount is then
multiplied by the number of units sold to determine the cost depletion deduction. Percentage
depletion, on the other hand is computed by multiplying the percentage depletion rate times the
gross income from the property. While there are limitations on percentage depletion based upon
a taxpayer’s taxable income, percentage depletion may be taken in excess of the taxpayer’s basis
in the property. Percentage depletion will generally provide larger deductions than cost
depletion, especially when measured over the life of the property. pp. I:10-22 and I:10-23.

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I:10-20 a. Assuming Simon wants to maximize his deductions in the initial year, he would
elect expensing, because the total deduction is $25,000 ($15,000 percentage depletion + $10,000
IDC) if the IDC is expensed, but only $20,000 if the IDC is capitalized.
b. Intangible drilling costs (IDCs) are generally expensed because of the greater
current tax benefit over capitalizing and deducting the costs in future periods. If percentage
depletion is expected to be greater than cost depletion, it is more beneficial to deduct the IDCs.
The capitalization and amortization of IDC merely increases the cost depletion amount and
produces limited or no tax benefit. Expensing IDCs reduces gross income, thereby lowering
taxable income. pp. I:10-23 and I:10-24.

Issue Identification Questions

I:10-21 The principal tax issue is whether depreciation may be started in the year of acquisition
or in the year the automobile is placed into service. Other issues are the use of MACRS methods
and whether the luxury auto limits apply. pp. I:10-3, I:10-13, and I:10-14.

I:10-22 The following tax issues need to be addressed:

• The regular MACRS depreciation amounts each year

• The luxury auto limitations on depreciation each year
• The inclusion amount under tables published by the IRS for the initial year and
subsequent years if the automobile is leased.
• The effect of depreciation recapture and the required use of the ADS when the use of
the auto falls to 50% or less.
• Paula's increased marginal tax rate and the impact of her changed tax situation on the
decision. pp. I:10-13 through I:10-17.

I:10-23 The principal tax issue is whether Sec. 197 amortization applies to the intangible assets
and to what extent the purchase agreement will establish tax basis for the acquired properties.
Generally, under Sec. 1060, an agreement between the purchasing and selling parties is binding
unless the IRS determines the allocations are not appropriate. p. I:10-24.

I:10-24 The principal issue is the applicability of the mid-quarter convention. The issue is
complicated by the interaction of the Sec. 179 deduction and the 40% test. For purposes of the
40% mid-quarter convention test, the Sec. 179 deduction is subtracted from the cost of tangible
personal property placed in service. If the CPA elects $200,000 on the March 1 purchase and
$300,000 on the September 18 purchase, the mid-quarter convention will apply because more
than 40% of tangible personal property was placed in service in the last quarter of the year
[($140,000 – $0) ÷ ($700,000 - $500,000) = 0.700]. pp. I:10-8 and I:10-9.

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Problems
I:10-25 a. Even though Sandy did not claim any depreciation in 2011 through 2013, she is
required to reduce her basis for the amount of allowable depreciation. The adjusted basis of the
machine is computed as follows:

2010: ($10,000 x 0.1429) $ 1,429

2011: ($10,000 x 0.2449) 2,449
2012: ($10,000 x 0.1749) 1,749
2013: ($10,000 x 0.1249 x 0.50) 625
Total allowable depreciation $ 6,252

Acquisition cost $10,000

Minus: Allowable depreciation ( 6,252)
Adjusted basis $ 3,748

Sandy may file amended returns for 2011 and 2012 to claim depreciation for
those years. Her 2013 return should be corrected before she files it to claim
depreciation for 2013.

Note: If any of Sandy’s prior years are closed by the statute of limitations, she
could get relief by requesting a change of accounting method under Rev. Proc.
2007-16. With this change, all prior allowable depreciation deductions missed
(even for closed years) can be taken in the year of change as a Sec. 481
adjustment (see Chapter I:11 for changes in accounting methods).

b. Sandy recognizes a $2,252 gain upon the sale of the asset, computed as follows:

Sales price $ 6,000

Minus: Adjusted basis ( 3,748)
Recognized gain $ 2,252

pp. I:10-3, I:10-5, and I:10-6.

I:10-26 a. The automobile's basis for depreciation is $6,000. When personal use property is
converted to business-use, the property's basis for depreciation is the lesser of its adjusted basis
or FMV on the date of conversion.

b. Depreciation for 2013 is $1,200 ($6,000 x 0.20) (Table 1, Appendix C.).

pp. I:10-3, I:10-4, and I:10-7.

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I:10-27 Small Corporation can depreciate only the truck, the machinery, and the building in
2013. The equipment was not placed into service until 2014, so no depreciation is allowable in
2013. The 40% test was used to determine which convention (half-year or mid-quarter) applied
for MACRS depreciation of the truck and the machinery. The 40% test showed that both assets
use half-year depreciation because no tangible personal property placed in service in 2013 was
placed in service in the last three months. Total depreciation in 2013 was $40,680, computed as
follows:

2013 Truck Machinery Building

Bonus depreciation $10,000 $25,000 n/a

MACRS depreciation 2,000a 3,573b $107c
Total 2012 depreciation $12,000 $28,573 $107
a
($20,000-$10,000) X 0.20 (Table 1, Year 1)
b
($50,000 - $25,000) X 0.1429 (Table 1, Year 1)
c
$100,000 X 0.00107 (Table 9, Year 1, 12th month)

In 2014, Small depreciates the truck, the machinery, the building, and the equipment.
The 40% test on the equipment shows that it also uses the half-year MACRS depreciation
because no tangible personal property placed in service in 2014 was placed in service in the last
three months. Total depreciation in 2014 is $19,887, computed as follows:

2014

Truck [$10,000 X 0.32 (Table 1, Year 2)] $ 3,200

Machinery [$25,000 X 0.2449 (Table 1, Year 2)] 6,123
Equipment [$40,000 X 0.20 (Table 1, Year 1)] 8,000
Building [$100,000 X 0.02564 (Table 9, Year 2, 12th month)] 2,564
Total 2014 depreciation 19,887

pp. I:10-4 through I:10-10

I:10-28 a. Large Corporation can depreciate only the truck, machinery, and building in 2013.
The 40% test was used to determine which convention (half-year or mid-quarter) applied for
MACRS depreciation of the truck and the machinery. The 40% test showed that both assets use
mid-quarter depreciation, because more than 40% of all tangible personal property placed in
service in 2013 was placed in service in the last three months ($85,000 ÷ $121,000 = 70.2%).
Total depreciation in 2013 is $15,935, computed as follows:

Truck [$36,000 x 0.35 (Table 2, Year 1)] $12,600

Machinery [$85,000 x 0.0357 (Table 5, Year 1)] 3,035
Building [$280,000 x 0.00107 (Table 9, Year 2, 12th month)] 300
Total 2013 depreciation $15,935

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 b. Because the MACRS table percentages are full-year percentages, Large must
adjust depreciation in the year of disposition. Adjusted bases for the machinery and the building
are computed as follows:
Machinery Building

Original cost $85,000 $280,000

Accumulated depreciation:
2013 (from above) $ 3,035 $ 300
2014 23,418a 7,179c
2015 2,091b 5,085d
( 28,544) (12,564)
Adjusted Basis: $56,456 $267,436
a
$85,000 x 0.2755 (Table 5, Year 2)
b
$85,000 x 0.1968 x 0.5/4 (Table 5, Year 3)
c
$280,000 x 0.02564 (Table 9, Year 2, 12th month)
d
$280,000 x 0.02564 x 8.5/12 (Table 9, Year 3, 12th month)

pp. I:10-4 through I:10-10.

I:10-29 a. Ted must use the 40% test to determine which convention (half-year or mid-
quarter) applies for MACRS depreciation of the equipment and the machinery. The 40% test
shows that both assets will use half-year depreciation because no more than 40% of all tangible
personal property placed in service in 2013 was placed in service in the last three months
($200,000 ÷ $550,000 = 36.4%). Total depreciation in 2013 is $96,834, computed as follows:

Furniture [$350,000 x 0.1429 (Table 1, Year 1)] $50,015

Equipment [$200,000 x 0.20 (Table 1, Year 1)] 40,000
Building [$300,000 x 0.02273 (Table 7, Year 1, 5th month)] 6,819
Total 2013 depreciation $96,834

b. When Ted elects Sec. 179 and expenses the entire furniture cost and part of the
equipment cost, the 40% test shows that the furniture and equipment use the mid-quarter
convention because more than 40% of all the tangible personal property placed in service during
2013 (after Sec. 179 expensing) was placed in service in the last three months [($200,000 -
$150,000) ÷ ($550,000 - $500,000)] = 100%. Total depreciation in 2013 is $509,319, computed
as follows:

Furniture Equipment Building

Sec. 179 expensing $350,000 $150,000 n/a

MACRS depreciation -0-a 2,500b $6,819c
Total 2010 depreciation $350,000 $152,500 $6,819
a
Ted expenses the entire cost, leaving nothing for MACRS depreciation.
b
($200,000 - $150,000) x 0.05 (Table 5, Year 1)
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 c
$300,000 x 0.02273 (Table 7, Year 1, 5th month)
c. When Ted elects Sec. 179 and expenses all the equipment cost and only part of
the furniture cost, the 40% test now shows that the furniture and equipment use the half-year
convention because no tangible personal property placed in service during 2013 (after Sec. 179
expensing) was placed in service in the last three months [($200,000 - $200,000) ÷ ($550,000 -
$500,000)] = 0%. Total depreciation in 2013 is $513,964, computed as follows:

Furniture Equipment Building

Sec. 179 expensing $ 300,000 $ 200,000 n/a

MACRS depreciation 7,145a -0-b $6,819c
Total 2013 depreciation $ 307,145 $ 200,000 $6,819
a
($350,000 - $300,000) x 0.1429 (Table 1, Year 1)
b
Ted expenses the entire cost, leaving nothing for MACRS depreciation.
c
$300,000 x 0.02273 (Table 7, Year 1, 5th month)

Thus, with these facts, Ted obtains more total depreciation in 2013 by expensing the
entire equipment cost and using the half-year convention than he obtains by expensing the entire
furniture, which results in the mid-quarter convention. This outcome occurs even though the
equipment is 5-year property. In this case, the value of the half-year convention outweighs the
detriment of expensing a large portion of 5-year property.
For a complete analysis, however, one also would have to compute the present value of
the remaining depreciation deductions for each asset and determine which depreciation pattern
results in the greater present value. If tax rates were not constant throughout the recovery period,
to get a proper comparison, one would have to multiply the depreciation deductions by the
applicable tax rate to obtain the present value of tax savings from each alternative.
Also, the outcome in this situation is particular to the given facts. Other facts can provide
other outcomes. For example, in Problem I:10-33, the mid-quarter convention gives the better
first-year result. Thus, the tax planner must analyze each particular situation before reaching a
conclusion.

pp. I:10-4 through I:10-10.

I:10-30 a. Tish’s Sec. 179 deduction is $310,000. The maximum Sec. 179 expense
($500,000 in 2013) is first reduced dollar-for-dollar when the total cost of eligible property
placed in service exceeds $2,000,000 (in 2013). Tish’s reduction is $100,000 ($2,100,000 -
$2,000,000), so the maximum she could expense under Sec. 179 is $400,000 ($500,000 -
$100,000). She cannot carry this $100,000 reduction over to other years. However, this amount
remains as basis subject to MACRS depreciation. Next, Sec. 179 is limited to business taxable
income before the Sec. 179 and 50% of SE deductions. In Tish’s case, this limitation is
$310,000. Thus, her unused Sec. 179 expense of $90,000 ($400,000 - $310,000) carries over to
2014.

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 b. Tish’s total depreciation deduction in 2013 is $647,145, computed as follows:

Machine Equipment

Sec. 179 expense $310,000 $ -0-

MACRS depreciation 7,145a 330,000b
Total 2011 depreciation: $317,145 $330,000
a
$50,000 x 0.1429 (Table 1, Year 1)
b
$1,650,000 x 0.20 (Table 1, Year 1)

Note: The $50,000 MACRS basis in footnote a above is determined as follows: $450,000 -
$400,000 = $50,000, where the $400,000 includes the $310,000 Sec. 179 expense allowed in
2013 and the $90,000 Sec. 179 carryover to 2014. For MACRS depreciation, the machine’s
basis must be reduced by the $90,000 disallowed because of the taxable income limitation as
well as reduced by the $310,000 Sec. 179 expense allowed in 2013. This rule insures that
taxpayers do not double-depreciate assets when they use the Sec. 179 carryover in subsequent
years.

c. To use the $90,000 carryover in 2014, Tish must have sufficient business taxable
income and also not have the dollar limitation next year be reduced below $90,000 because of
the total cost limitation.

d. If Tish’s business taxable income were $525,000, the taxable income limitation
on Sec. 179 would not apply. Tish would be able to expense $400,000 of the machine’s cost
because the total cost limitation and resultant reduction still apply. The remaining $50,000
would be subject to MACRS depreciation. Thus, her total depreciation deduction in 2013 would
be $737,145 computed as follows:

Machine Equipment

Sec. 179 expense $400,000 $ -0-

MACRS depreciation 7,145a 330,000b
Total 2011 depreciation: $407,145 $330,000
a
$50,000 x 0.1429 (Table 1, Year 1)
b
$1,650,000 x 0.20 (Table 1, Year 1)

pp. I:10-4 through I:10-10.

I:10-31 a. Depreciation for 2013 is computed as follows:

Automobile [$9,000 x 0.1152 x 1/2 (Table 1, Year 4)] $ 518

(Note that the luxury auto ceiling does not apply.)
Equipment [$20,000 x 0.1249 x 1/2 (Table 1, Year 4)] 1,249
Building [$100,000 x 0.02564 x 11.5/12 (Table 9, Year 11, 4th month)] 2,457

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Total depreciation for 2013 $4,224

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 b. Gain or loss on each asset sold in 2013 is computed as follows:

Automobile: Sales price $ 1,200

Cost $ 9,000
Accum. depr. 2010 $1,800
2011 2,880
2012 1,728
2013 518 (6,926) (2,074)
Loss on sale $ (874)

Equipment: Sales price $ 9,500

Cost $ 20,000
Accum. depr. 2010 2,858
2011 4,898
2012 3,498
2013 1,249 (12,503) (7,497)
Gain on sale $ 2,003

Building: Sales price $240,000

Cost $100,000
Accum. depr. 2003 $ 1,819
2004-12 23,076
2013 2,457 (27,352) (72,648)
Gain on sale $167,352

pp. I:10-4 through I:10-10.

I:10-32 a. Thad’s 2013 depreciation deduction is computed as follows:

Sec. 179 expense $500,000

MACRS depreciation ($2000 x 0.1429) 286
Total $500,286

b. Depreciation for the three years is as follows:

2013 (above) $500,286

2014 ($2000 x 0.2449) 490
2015 ($2000 x 0.1749 x 1/2) 175
Accumulated depreciation $500,951

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 Adjusted basis and loss on sale are computed as follows:

Sale price $ 80,000

Adjusted basis:
Cost $502,000
Accumulated depreciation (500,951) ( 1,049)
Gain on sale $ 78,951

pp. I:10-4 through I:10-10.

I:10-33 a. If Rita allocates the entire $500,000 Sec. 179 expense to Asset A, the
mid-quarter convention applies, as follows:

Cost of property in 4th quarter (after Sec. 179) $ 505,000 ($505,000 - $0)
Cost of all property (after Sec. 179) 1,105,000 ($1,605,000 - $500,000)
Percentage of cost placed in service in 4th quarter 45.7% ($505,000 ÷ $1,105,000)

Asset A:
Sec. 179 expense $500,000
MACRS depreciation 150,000
[($1,100,000 - $500,000) x 0.25 (Table 2, Year 1)]
Asset B:
MACRS depreciation 18,029
[$505,000 x 0.0357] (Table 5, Year 1)
Total depreciation in 2013 $668,029

b. If Rita allocates the entire $500,000 Sec. 179 expense to Asset B, the half-year
convention applies, as follows:

Cost of property in 4th quarter (after Sec. 179) $ 5,000 ($505,000 - $500,000)
Cost of all property (after Sec. 179) 1,105,000 ($1,605,000 - $500,000)
Percentage of cost placed in service in 4th quarter 0.45% ($5,000 ÷ $1,105,000)

Asset A:
MACRS depreciation $ 157,190
[$1,100,000 x 0.1429 (Table 1, Year 1)]
Asset B:
Sec. 179 expense 500,000
MACRS depreciation 715
[($150,000 - $139,000) x .1429 (Table 1, Year 1)]
Total depreciation in 2013 $657,905

Thus, with these facts, Rita is slightly better off expensing Asset A and using the mid-
quarter convention. This result occurs because a high percentage of the cost (after Sec. 179)
occurs in the first quarter, allowing that property to be depreciated at the higher (25%) mid-
quarter percentage for property placed in service in the first quarter.
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ScholarStock
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 The outcome in this situation is particular to the given facts. Other facts can provide
other outcomes. For example, in Problem I: 10-29, the half-year convention gives the better
first-year result. Thus, the tax planner must analyze each particular situation before reaching a
conclusion.

pp. I:10-4 through I:10-10.

I:10-34 a. All of Long Corporation’s assets are depreciated under the alternative
depreciation system (ADS) using straight-line and the half-year convention.
Depreciation for 2013 is computed as follows:

Equipment [$40,000 x 0.0714 (Table 11, Year 1)] $2,856

Truck [$30,000 x 0.20 x 1/2 (Table 11, Year 5)] 3,000
Furniture [$10,000 x 0.1429 (Table 11, Year 5)] 1,429
Automobile [$12,000 x 0.20 x 1/2 (Table 11, Year 4)] 1,200
(Note that the luxury auto ceiling does not apply.)
Total depreciation for 2013 $8,485

b. Gain on each asset sold in 2013 is computed as follows:

Truck: Sales price $ 8,000

Cost $30,000
Accum. depr. 2009 $3,000
2010 6,000
2011 6,000
2012 6,000
2013 3,000 (24,000) (6,000)
Gain on sale $ 2,000

Automobile: Sales price $10,000

Cost $12,000
Accum. depr. 2010 $1,200
2011 2,400
2012 2,400
2013 1,200 (7,200) (4,800)
Gain on sale $ 5,200

pp. I:10-4 through I:10-10.

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I:10-16
I:10-35 Both assets are "listed property" and are subject to the special rules contained in
Sec. 280F. Both assets are 5-year MACRS property (see p. I: 10-5). (Some instructors may want
to specify this information for their students, while other instructors may want students to
determine it on their own.) The MACRS depreciation deductions are computed as follows:

Automobile:
When business use is greater than 50% of total use, the taxpayer may use regular MACRS
depreciation for the business-use portion of the asset's cost.

Cost $21,000
Times: MACRS rate (Table 1, 5-year recovery) 0.20
Regular MACRS depreciation $ 4,200
Times: Business-use percentage 0.60
2013 depreciation before the luxury auto ceiling limitation: $ 2,520

The luxury automobile limitation for 2013 is $3,160 (Table 6 in Appendix C). Because
Trish’s business-use percentage is 60%, the luxury limitation is $1,896 ($3,160 x 0.60). Trish
must use the lower of the MACRS depreciation or the luxury car limit. Therefore, Trish’s
depreciation on the automobile for 2013 is $1,896.

Computer:
When business use is 50% or less of total use, the taxpayer must use the alternative depreciation
system (ADS), which is five-year straight-line depreciation for automobiles and computers.

Cost $4,000
Times: Business-use percentage 0.40
Business portion $ 1,600
Times: rate from Table 11, Appendix C 0.10
2013 depreciation: $ 160
pp. I:10-12 and I:10-13.

I:10-36 No depreciation is allowed for either the automobile or the computer. In addition to the
50% business use test, the employee’s asset use must be for the convenience of the employer and
required as a condition of employment. Since that is not the case, Trish’s use is deemed to be
personal rather than business. pp. I:10-12 and I:10-13.

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I:10-37 a. Tammy’s depreciation deductions for 2010-2013 are computed as follows:
2010: Regular MACRS depreciation (100% business use): $20,000 x 0.20 = $4,000
Luxury limit (100% business use) = $2,960
Depreciation for 2010: 70% of the lesser of $4,000 or $2,960; $2,960 x 0.70 = $2,072

2011: Regular MACRS depreciation (100% business use): $20,000 x 0.32 = $6,400
Luxury limit (100% business use): $4800
Depreciation for 2011: 70% of the lesser of $6,400 or $4,800; $4,800 x 0.70 = $3,360

2012: ADS depreciation (100% business use): $20,000 x 0.20 = $4,000. Business use fell to
50% or below, so ADS is required.
Luxury limit (100% business use) = $2,850
Depreciation for 2012: 40% of the lesser of $4,000 or $2,850; $2,850 x 0.40 = $1,140

2013: ADS depreciation (100% business use): $20,000 x 0.20 = $4,000

Luxury limit (100% business use): $1,775
Depreciation for 2013: 35% of the lesser of $4,000 or $1,775; $1,775 x 0.35 = $621

Thus, depreciation deductions are:

2010 $2,072
2011 3,360
2012 1,140
2013 621

b. Depreciation recapture: When business-use percentage for listed property

decreases to 50% or below, as it did in 2012, the property becomes subject to depreciation
recapture. The alternative depreciation system must be used to recompute all prior year
depreciation deductions. The excess depreciation is included in the taxpayer's gross income in
the year in which the percentage falls to 50% or below. ADS depreciation for the prior years
2010 and 2011 is computed as follows:

Year ADS Depreciation (Table 11)

2010 $1,400 ($20,000 cost x 0.10 x 0.70 business-use)

2011 $2,800 ($20,000 cost x 0.20 x 0.70 business-use)

Total recapture in 2012 is $1,232 ($5,432 MACRS depreciation for 2010 and 2011 - $4,200 ADS
depreciation for 2010 and 2011). The $1,232 must be included in Tammy’s gross income in
2012. The recapture does not affect 2013 gross income.

pp. I:10-5, I:10-12 through I:10-14.

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I:10-18
I:10-38 Depreciation deductions are computed as follows:

Ceiling
MACRS Deduction (Table 1) Limit Allowed
Year (5- year recovery) (Table 6) Deduction*
2013 Bonus depreciation: $64,000 x 50% = $32,000
MACRS depreciation: $64,000 - $32,000 = $32,000 x 0.20 = $6,400
Total depreciation in 2012 = $38,400 $11,160 $11,160
2014 $32,000 x 0.32 = $10,240 5,100 5,100
2015 $32,000 x 0.192 = $6,144 3,050 3,050
2016 $32,000 x 0.1152 = $3,686 1,875 1,875
2017 $32,000 x 0.1152 = $3,686 1,875 1,875
2018 $32,000 x 0.0576 = $1,843 1,875 1,843
*The allowed deduction is the lesser of (1) the regular MACRS deduction or (2) the ceiling
amount.

Note: For subsequent years, a $1,875 (times business-use percentage) ceiling limitation applies
until the automobile is fully depreciated. pp. I:10-13 through I:10-15.

I:10-39 Depreciation deductions are computed as follows:

Ceiling
MACRS Deduction (Table 1) Limit Allowed
Year (5-year recovery) (Table 6) Deduction*
2013 $36,000 x 0.20 = $7,200 $3,160 $3,160
2014 $36,000 x 0.32 = $11,520 $5,100 $5,100
2015 $36,000 x 0.192 = 6,912 $3,050 $3,050
*The allowed deduction is the lesser of (1) the regular MACRS deduction or (2) the ceiling
amount.
Note: For subsequent years, a $1,875 (times business use percentage) ceiling limitation applies
until the automobile is fully depreciated. pp. I:10-13 and I:10-14.
I:10-40 a. Depreciation for 2013-2018, and subsequent years is computed as follows:
100% Business-Use
Deduction
MACRS Ceiling Allowed Unrecovered
Deduction Limit 70% of lesser Basis
2013: MACRS depreciation:
$36,000 x 0.20 = $7,200 $7,200 $3,160 $2,212 $32,840
(36,000 – 3,160)
2014: MACRS depreciation:
$36,000 x 0.32 = $11,520 11,520 5,100 3,570 27,740
(32,840 - 5,100)
2015: MACRS depreciation:
$36,000 x 0.192 = $6,912 6,912 3,050 2,135 24,690
(27,740 - 3,050)
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I:10-19
 2016 and 2017: MACRS depreciation:
$36,000 x 0.1152 = $4,147 4,147 1,875 1,313 22,815
(24,690 - 1,875)
2018: MACRS depreciation:
$36,000 x 0.0576 = $2,074 2,074 1,875 1,313 20,940
(22,815 - 1,875)
2019 & MACRS depreciation:
subsequent years: (until $25,200 (70% of cost) 0 1,875 1,313 19,065
has been depreciated) (20,940 - 1,875)

b. If the SUV has a GVWR of over 6,000 pounds, the luxury auto depreciation
rules do not apply. These vehicles are permitted to expense up to $25,000
under Sec. 179. However, only $25,200 ($36,000 x 0.70) of the cost can be
depreciated because personal-use assets are not depreciable. Therefore, 2013
depreciation will be:
$25,200 – $25,000 = $200 x 0.20 = $40
$25,000 + $40 = $25,040
c. When the taxpayer elects to use bonus depreciation, the maximum amount that
can be deducted in 2013 for 100% business use of a luxury automobile
increases to $11,160. Because the taxpayer is using the automobile 70% for
business, the taxpayer will be able to deduct $7,812 ($11,160 x 70%) in 2013.
In 2014, the taxpayer will take the lesser of the MACRS deduction of $5,760
($18,000 x .32) or the luxury automobile limit of $5,100. Because the limit of
$5,100 is less, the taxpayer will be able to deduct $3,570 ($5,100 x 70%) in
2014.
pp. I:10-13 through I:10-16.

I:10-41 a. 80% of the $7,200 ($600 x 12) lease payment, or $5,760, is deductible as a
business expense in each of the two years.
b. Troy must reduce his annual lease payment deduction by $10 ($13 x 0.80) in 2012
and by $23 ($29 x 0.80) in 2013. (Table 13, Appendix C)
c. Rental payments of $1,920 ($200 x 12 months x 80%) are deductible. No
reduction is required because the FMV is below the minimum amount designated as a luxury
auto. p. I:10-16.

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I:10-20
I:10-42 a. Vicki's assets would be recorded by Palm Corporation as follows:
Tangible assets: $400,000
Intangible assets:
Covenant not to compete 50,000
Goodwill 70,000
Patents 30,000
Customer list 50,000
Total: $600,000
b. All except the tangible assets are Sec. 197 intangible assets and are amortized as
follows:
• Covenant: $3,333 ($50,000 ÷ 15 years) even though the covenant is for a
period of 5 years.
• Goodwill: $4,667 ($70,000 ÷ 15 years).
• Patent: $2,000 ($30,000 ÷ 15 years) even though the remaining legal life is
only 12 years.
• Customer list: $3,333 ($50,000 ÷ 15 years).
The tangible assets would be depreciated under the MACRS rules.
pp. I:10-17 through I:10-19.
I:10-43 The only expenditures that are deductible as research and experimental costs under Sec.
174 are materials and supplies for research laboratory, utilities and depreciation on research
laboratory and equipment, and research costs subcontracted to a local university. Costs of
acquiring another entity’s patent, market research surveys, and labor and supplies for quality
control tests do not qualify. pp. I:10-19 and I:10-20.
I:10-44 a. If the expensing method is elected, Phoenix's deduction for R&E expenditures in
2013 is $170,000 [($40,000 + $80,000 + $30,000 + $20,000 depreciation ($100,000 x 0.20)] and
in 2014 is $32,000 depreciation ($100,000 x 0.32).
b. If the deferral and amortization method is elected and the amortization period is
60 months, there would be no amortization allowed in 2013 and $34,000 [($170,000 ÷ 60) x 12]
in 2014. The remaining equipment cost ($100,000 - $20,000) will be depreciated using MACRS
beginning in 2014. pp. I:10-19 and I:10-20.
I:10-45 Phillips Corporation can deduct the cost of computer software as follows:
• The cost of software included in the cost of the computer hardware may be
depreciated with the hardware as long as the taxpayer consistently follows this
treatment. Therefore, the total computer system would be considered 5-year
property and the depreciation deduction would be ($15,000 x 0.20) = $3,000. The
portion of the depreciation deduction attributable to the software would be $600
($3,000 x 0.20) although it would not be separately stated.
• The bookkeeping software was acquired separately and would be depreciated over
36 months on a straight-line basis. Since the software was purchased on
September 1, 2013, the deduction would be $640 ($5,760/36 months x 4 months).
• The computer software acquired in connection with a purchase of other assets
would be considered a Sec. 197 intangible and amortized over 15 years. Therefore,
the amortization deduction for 2013 would be $1,944 ($50,000/15 years x 7/12).
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I:10-21
pp. I:10-20 and I:10-21.
I:10-46 a. If the IDCs are expensed, the cost depletion amount is $40,000, computed as
follows:

Acquisition cost $200,000

Divided by: Estimated recoverable units 20,000
Cost depletion per unit $ 10
Times: Units sold 4,000
Depletion amount $ 40,000
b. If the IDCs are capitalized, the cost depletion amount is $44,000. The basis for
cost depletion purposes is $220,000. ($200,000 cost + $20,000 IDCs)

Basis $220,000
Divided by: Estimated recoverable units 20,000
Cost depletion per unit $ 11
Times: Units sold 4,000
Depletion amount $ 44,000
c. The greater of cost depletion or percentage depletion, not to exceed 100% of
taxable income before depletion. Therefore, cost depletion of $44,000 is deducted
if the IDCs are capitalized, and $40,000 if the IDCs are expensed, because
percentage depletion is only $25,000.
d. Assuming Tina has substantial gross income, the immediate expense method is
preferable because $20,000 of IDCs may be expensed in the initial year while also
deducting $40,000 of cost depletion. Under the capitalization method, only
$44,000 can be deducted. pp. I:10-21 through I:10-24.
I:10-47 a. If the IDCs are expensed the percentage depletion amount is $75,000 ($500,000 x
0.15). The limitation is $200,000 (taxable income before depletion) and,
therefore, is not applicable.
b. If the IDCs are capitalized, the percentage depletion amount is still $75,000.
Taxable income before depletion is $300,000 ($500,000 - $200,000) so, again, the
limitation does not apply.
c. If the IDCs are expensed, the depletion deduction is $75,000 (the greater of
$75,000 percentage depletion or $20,000 of cost depletion).
d. The percentage depletion method should be used because the taxpayer may
deduct the $75,000 plus the $100,000 of IDCs in the current year. pp. I:10-21
through I:10-24.

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I:10-22
Comprehensive Problem

I:10-48

Interest income $ 275

Business income: Sales income ($8,000 u. @ $15/u.) $120,000
Service income 64,000 $184,000
Cost of sales 45,000(1)
Gross profit 139,000

Expenses:
Auto, gas, oil, etc. 3,800
Depreciation 16,122(2)
Interest on business loans 4,000
Lease expense 5,992
[(12 months x $500) = $6,000 - $8 lease inclusion amount]
Taxes and licenses 3,300
Salaries 24,000
Utilities 2,800
60,014 $78,986
Gain on sale of 7-year equipment:
Amount realized $ 12,000
Adjusted basis:
Cost $ 30,000
Accumulated depreciation (24,645)(3) (5,355) 6,645

Total income: 85,906

One-half SE tax [($78,986 x 0.9235 x 0.133) = $9,701 x 0.5751] (5,579)

Adjusted gross income: $80,327

Itemized deductions:
Medical expenses [($4,500 - ($80,327 x 0.10)] $ 0
Real estate taxes 3,800
State income taxes 4,000
Home mortgage interest 5,000
Charitable contributions 600 (13,400)
Personal exemptions ($3,800 x 2) ( 7,600)

Taxable income: $59,327

Income tax per 2012 MFJ rate schedule $ 8,029

Self-employment tax ($78,987 x .9235 x .133) 9,702
Total tax 17,731
Estimated taxes paid ( 20,000)
Overpayment (refund) $ (2,269)

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I:10-23
 Detailed Computations
(1)
Cost of goods sold: Beginning Inventory (4,000 u. @ $20,000
$5/u.)
Purchase #1 (3,000 u. @ $6/u.) 18,000
Purchase #2 (4,000 u. @ $7/u.) 28,000
Ending Inventory (3,000 u. @ $7/u.) ( 21,000)
COGS $45,000
(2)
Depreciation for 2012:
Equipment (7-year recovery) Table 1, Year 6: ($30,000 x 0.0892 x ½ year) $ 1,338
Old store building ($100,000 x .02564) Table 9, Year 11 2,564
New store building ($60,000 x .02033) Table 9, Year 1 1,220
Equipment (5-year recovery) expensed under Sec. 179 11,000

$16,122
(3)
Accumulated depreciation on 7-year 2007 ($30,000 x 0.1429) $ 4,287
recovery equipment: 2008 ($30,000 x 0.2449) 7,347
2009 ($30,000 x 0.1749) 5,247
2010 ($30,000 x 0.1249) 3,747
2011 ($30,000 x 0.0893) 2,679
2012 ($30,000 x 0.0892 x ½ yr) 1,338
Total $24,645

Tax Strategy Problem

I:10-49 Based on present value analysis, Stan would be better off purchasing the car. The
difference in the two alternatives is relatively small. The analysis is presented below.

Purchase the car: Stan will be able to deduct both interest and depreciation on the car. Luxury
auto limits (Appendix C, Table 6) will apply.

Deductible Deductible Tax Savings @ PV of Tax Savings

Year Depreciation Interest Total 28% @ 8%
2013 $ 3,160 $2,216 $ 5,376 $1,505 $1,394
2014 5,100 1,794 6,894 1,930 1,655
2015 3,050 1,337 4,387 1,229 976
2016 1,875 843 2,718 761 559
2017 1,875 305 2,180 610 415

Total $15,060 $6,495 $21,555 $6,035 $4,999

When Stan sells the car at the end of five years for $10,000, he would generate a loss of $4,940
[$10,000 - ($30,000 - $15,060)]. At a 28% tax rate, this loss would yield an additional financial
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I:10-24
benefit of $941 ($4,940 x 0.28 = $1,383; PV @ 8%, 5 years = $941). Finally, the $10,000
received from the sale of the car will be worth $6,806 (PV $10,000 @ 8% for 5 years). So, the
present value of purchasing the car would be:

Cash outlay to purchase car (PV) ($30,000)

Tax savings from deductions (PV) 4,999
Tax savings from loss on sale (PV) 941
Cash received from sale of car (PV) 6,806
Present value of purchasing the car: $(17,254)

Lease the car: Stan can deduct the lease payments, net of the lease inclusion amounts.*
Present value of $450 monthly lease payment for 60 months at 8% per year ($22,193)
(0.6667% per month):
Present value of tax benefits:
Monthly lease payment $ 450
Payments per year x12
Annual lease payments $5,400
Annual lease inclusion amount (230)*
Annual net lease deduction 5,170
Payments per year ÷12
Monthly deductible payment 431
Tax savings ($431 x .28) $ 121
PV of $119 @ 8% per year 5,968
(0.6667% per month) for 60 months
Present value of leasing the car: $(16,225)

Conclusion: Our analysis concludes that Stan would be better off leasing the car rather than
purchasing it. Over a five-year period, Stan would save $1,029 ($17,254 - $16,225). Leasing is
generally advantageous if a taxpayer uses the car primarily in business and wants to upgrade to a
new car every 3-5 years. The purchase option could be better if Stan keeps the car for longer
than five years.

Tax Form/Return Preparation Problems

I:10-50 (See Instructor’s Resource Manual)

I:10-51 (See Instructor’s Resource Manual)

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I:10-25
Case Study Problems

I:10-52 The following points should be mentioned in the client memo.

1. The tangible assets should be recorded at their FMV of $400,000. Appraisals

should be obtained to establish credibility for the individual asset allocations. It is preferable to
allocate cost liberally to the inventory and depreciable assets. The sale of inventory results in an
immediate tax benefit in the form of an increase in cost of goods sold, whereas allocations of
cost to land affect only gain or loss upon a future sale.
2. It makes no difference for tax purposes whether the $600,000 excess amount is
allocated to a covenant not to compete or to goodwill, because both types of assets are Sec. 197
intangibles and are amortizable over a 15-year period. Section 197 applies to intangible assets
acquired in connection with a transaction that involves the acquisition of a trade or business.

I:10-53 For 2011 and 2012 the corporation should have reported the value of the officer’s
personal-use benefit to the IRS by including such amounts on the officer's Form W-2. SSTS No.
6 states that ... "A CPA shall advise the client promptly upon learning of an error in a previous
return." The CPA, however, is not obligated to inform the IRS, nor may he do so without the
client's permission. If the error is a material misstatement of tax liability, the CPA should
consider whether to proceed in the preparation of the return for the current year. In this instance,
the error has not been repeated in 2013 and affects only the officer’s personal return (although
the corporation may be liable for penalties). Unless the amount is deemed to be a constructive
dividend to the officer, the taxable income of the corporation is not affected. The CPA should
advise the client as to potential penalty consequences. All reasonable steps should be taken to
ensure that the error is not repeated. However, the primary responsibility for a true, correct, and
complete return rests with the taxpayer, not the tax consultant or preparer.

Tax Research Problem

I:10-54 Depreciation of works of art has been controversial. The IRS takes the position in Rev.
Rul. 68-232, 1968-1 C.B. 79, that assets that automatically increase in value with age are not
depreciable. In Associated Obstetricians and Gynecologists v. Comr., 46 TCM 613 (1983), affd.
762 F.2d. 38 (6th Cir. 1985), the court agreed with the IRS that pieces of artwork for their office
had no useful life and were not subject to depreciation. Likewise, in Shauna C. Clinger, 60
TCM 598 (1990), the Tax Court held that artwork was not depreciable because it did not have a
useful life. However, in two more recent cases, the requirement of a useful life has been
diminished to some degree. In Simon v. Comr., 103 T.C. 247 (1994), affd. 95-2 USTC 50,552
(2d Cir. 1995) and Liddle v. Comr., 103 TC 285 (1994), affd. 95-2 USTC 50,488 (3d Cir. 1995),
the taxpayers were allowed to depreciate violins because the taxpayer played the instruments as
opposed to using them as passive objects displayed for admiration of their aesthetic qualities. In
Timothy Couch’s situation, it appears that the artworks will not be eligible for depreciation.

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I:10-26
“What Would You Do In This Situation?” Solution

Ch. I:10, p. I:10-26. Focused Marketing or Unethical Hustle?

Ruth Less' solicitation of your client, Widgets R Us, Inc., is clearly unethical under the
AICPA's Code of Professional Conduct. Rule 302 prohibits contingent fees by stating,
"professional services shall not be offered or rendered under an arrangement whereby no fee will
be charged unless a specified finding or result is attained, or where the fee is otherwise
contingent upon the findings or results of such services. Thus, Ruth Less' fees being based
solely on the amount of savings resulting from the R&E write-offs would constitute a contingent
fee under the Code of Professional Conduct. Further, the solicitation by Ruth Less of your client
may be a violation of Rule 502, which deals with false, misleading, or deceptive acts in
advertising or solicitation.
While the arrangement as proposed by Ruth Less is clearly unethical, a slightly different
approach would probably be acceptable and is done routinely in business today. Many CPA
firms provide consulting services for clients who have another CPA do audit and general tax
work. Thus, if Ruth Less was proposing an R&E study and not an attempt to take the client
away from your firm, the R&E study would not be unethical. However, the fee structure would
have to be modified to avoid contingent fee status.

Finally, if the claims of Ruth Less are valid (or even somewhat valid), your CPA firm
should improve its update of tax laws because at present, you are not providing the necessary
advice for your client to pay the minimum income tax allowable under the law.

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I:10-27
Solution Manual (‘Individuals’ Section) for Prentice Hall’s Federal Taxation 2013, 26/

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