South Western Federal Taxation 2010 Comprehensive Volume 33rd Edition Willis Solutions Manual

South Western Federal Taxation 2010
Comprehensive Volume 33rd Edition

Willis Solutions Manual
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CHAPTER 8
DEPRECIATION, COST RECOVERY, AMORTIZATION, AND DEPLETION
SOLUTIONS TO PROBLEM MATERIALS
Status: Q/P
Question/ Learning Present in Prior
Problem Objective Topic Edition Edition
1 LO 1 Cost recovery Unchanged 1

2 LO 1 Cost recovery “allowable” Unchanged 2
3 LO 1 Cost recovery of land Unchanged 3
4 LO 2 Eligibility for cost recovery Unchanged 4
5 LO 2 Mid-quarter versus half-year convention Unchanged 5
6 LO 2 Half-year convention New
7 LO 2 Half-year convention: year of sale Unchanged 7
8 LO 2 Mid-quarter convention: determining Unchanged 8
whether it applies
9 LO 2 Mid-quarter convention: year of sale Unchanged 9
10 LO 2 Mid-month convention Unchanged 10
11 LO 2 Straight-line method: applicable convention New
12 LO 2 Farm property New
13 LO 2 Farm property Unchanged 13
15 LO 2 Leasehold property owned by lessor Modified 15
16 LO 2 Leasehold property owned by lessee Unchanged 16
17 LO 2 Leasehold property owned by lessee Unchanged 17
18 LO 3 Section 179 expensing: production of Unchanged 18
income property
19 LO 3 Section 179 expensing: effect on MACRS Unchanged 19
cost recovery
20 LO 3 Section 179 expensing: carryforward Unchanged 20
21 LO 3 Section 179 expensing: taxable income Unchanged 21
limitation
22 LO 2, 3 Inventory versus in a trade or business Unchanged 22
23 LO 3, 4 Listed property: passenger auto Unchanged 23
Instructor: For difficulty, timing, and assessment information about each item, see p. 8-4.
8-1
© 2010 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
8-2 2010 Comprehensive Volume/Solutions Manual
Status: Q/P
24 LO 4 Listed property: passenger auto and cost Unchanged 24

recovery limit
25 LO 4 Leased passenger automobiles and lease Unchanged 25
inclusion amount
26 LO 7 Amortization: § 197 intangibles Unchanged 26
27 LO 7 Covenant not to compete Unchanged 27
28 LO 7 Start-up expenditures Unchanged 28
29 LO 7 Start-up expenditures Unchanged 29
30 LO 8 Percentage depletion Unchanged 30
*31 LO 1, 2 Cost recovery allowed and allowable Unchanged 31
32 LO 1, 2 Personal residence converted to rental Unchanged 32
property
*33 LO 2 MACRS for personalty New
*34 LO 2 MACRS for personalty Unchanged 34
*35 LO 2 MACRS for personalty: half-year convention Unchanged 35
*36 LO 2 MACRS for personalty: mid-quarter Unchanged 36
convention
*37 LO 2 MACRS for realty Modified 37
*38 LO 2 MACRS for realty Unchanged 38
*39 LO 2 MACRS for realty Modified 39
*40 LO 2 MACRS for realty Unchanged 40
41 LO 2 Farm property Modified 41
43 LO 2 Leasehold improvement property Unchanged 43
44 LO 2 Leasehold improvement property Unchanged 44
*45 LO 2, 3, 9 MACRS and § 179 expensing Modified 45
*46 LO 2, 3 MACRS and § 179 expensing Unchanged 46
*47 LO 2, 3, 9 MACRS for personalty: mid-quarter Unchanged 47
convention and § 179 expensing
*48 LO 3, 4 Listed property and § 179 deduction: not Unchanged 48
passenger automobile
*49 LO 2, 4 Listed property: luxury auto Unchanged 49
*50 LO 4 Listed property: luxury auto Modified 50
*51 LO 2, 3, 4 Listed property: not passenger automobile Modified 51
*52 LO 2, 4 Listed property: recapture and luxury auto Unchanged 52
*53 LO 2, 4, 9 Listed property Unchanged 53
*54 LO 2, 4, 9 Listed property: lease versus purchase for Unchanged 54
luxury auto
55 LO 2, 5 Alternative minimum tax cost recovery Unchanged 55
*56 LO 2, 5, 9 Alternative depreciation system versus Unchanged 56
MACRS
*57 LO 2, 7, 9 Amortization of goodwill versus MACRS Unchanged 57
on building
*58 LO 7 Start-up expenditures Unchanged 58
*59 LO 7 Start-up expenditures Unchanged 59
*60 LO 8 Depletion: cost versus percentage Unchanged 60
Depreciation, Cost Recovery, Amortization, and Depletion 8-3
Status: Q/P
*61 LO 8, 10 Intangible drilling costs: capitalized versus Unchanged 61

expensed
*62 Cumulative Modified 62
*63 Cumulative Modified 63
*The solution to this problem is available on a transparency master.
Status: Q/P
Research Present in Prior
Problem Topic Edition Edition
1 Depreciation of aircraft parts Unchanged 1

2 Cost recovery: asset class New
3 Internet activity Unchanged 3
Est'd Assessment Information

Question/ completion AICPA* AACSB*
Problem Difficulty time Core Comp Core Comp
1 Easy 5 FN-Reporting Analytic

2 Easy 5 FN-Measurement Analytic
4 Medium 10 FN-Reporting Analytic
14 Easy 5 FN-Measurement | Analytic
FN-Reporting
FN-Reporting
22 Medium 10 FN-Measurement | Analytic
FN-Reporting
FN-Reporting
FN-Reporting
FN-Reporting
36 Medium 10 FN-Measurement Analytic
*Instructor: See the Introduction to this supplement for a discussion of using AICPA and
AACSB core competencies in assessment.
Est'd Assessment Information

Question/ completion AICPA* AACSB*
Problem Difficulty time Core Comp Core Comp

45 Medium 15 FN-Measurement Analytic | Reflective
Thinking
46 Hard 15 FN-Measurement Analytic
48 Medium 15 FN-Measurement | FN- Communication |
Reporting Analytic
52 Hard 15 FN-Measurement Analytic
54 Hard 25 FN-Measurement Communication |
Analytic
57 Hard 20 FN-Measurement Communication |
Analytic
62 Hard FN-Measurement | FN- Analytic
Reporting
63 Hard FN-Measurement | FN- Analytic
Reporting
*Instructor: See the Introduction to this supplement for a discussion of using AICPA and
AACSB core competencies in assessment.
CHECK FIGURES
31. Gain $2,243. 47.a. $28,666.

32. $175,000 basis; $5,038 cost 47.b. $266,166.
recovery. 47.c. $78,375.
33. $114,290. 48. $35,000.
34.a. $2,678. 49. $1,200.
34.b. $12,914. 50. $10,960 in 2009; $3,200 in 2010.
35.a. $120,000. 51 $47,200.
35.b. $16,000. 52. Deduction in 2009 $8,768; deduction
36. $78,213. in 2010 $3,360; recapture in 2010
37.a. $19,795. $6,400.
37.b. $51,387. 53. $174.
38. $38,640. 54. Leasing provides a greater tax benefit.
39. 2009 $28,890; 2019 $46,152. 55. Regular tax deduction $2,800; AMT
40.a. $23,640. deduction $2,100.
40.b. $38,178. 56. $3,192.
41. $12,000. 57. The first option produces a $12,617
42. $3,500. greater deduction.
43. $12,500. 58. $3,222.
44. $65,980 loss. 59 $5,828.
45.a. $292,859. 60 $4,360,000 taxable income.
45.b. $294,286. 61. Capitalized $1,880,000; expensed
45.c. Allocate to furniture. $1,024,000.
46. Cost recovery $155,000; § 179 62. Refund due for 2008 $618.
carryforward $137,885. 63. AGI without purchase $391,000; AGI
with purchase $385,040.
DISCUSSION QUESTIONS
1. Conceptually there is no difference between depreciation and cost recovery. Both represent a
deduction for the consumption of the cost of an asset. The Internal Revenue Code generally
uses the term depreciation for assets placed in service prior to 1981 and the term cost recovery
for assets placed in service after 1980. p. 8-3
2. The basis of the property must be reduced by the amount of cost recovery that should have
been deducted (i.e., the cost recovery “allowable”). p. 8-4
3. Land does not have a determinable useful life. So it is not eligible for cost recovery. p. 8-4
4. The relevant issues for Henry are:
• Can a portion of the purchase costs of a ski resort, which are allocated to the construction
costs of the resort’s mountain roads, trails, and slopes, be depreciated?
• If such costs can be depreciated, what is the correct recovery period?
• Can costs incurred subsequent to the purchase, attributable to maintenance of such

mountain roads, trails, and slopes, be depreciated?
pp. 8-4 and 8-5
5. The asset purchase date is irrelevant in determining whether the mid-quarter convention
applies rather than the half-year convention. The “placed in service date” is the critical date in
determining whether the mid-quarter or half-year convention applies. pp. 8-9 and 8-10
6. The actual recovery period is a year longer than the MACRS recovery period (i.e., the cost of
three-year property is recovered over four years). This results from the use of the half-year
convention (i.e., a half-year in the first year and a half-year in the final year). p. 8-8
7. The asset is treated as if it were sold in the middle of the year, and hence, one-half year of
cost recovery is allowed for the year of the sale. p. 8-8 and Concept Summary 8.2
8. Real property does not enter into the 40% test to determine whether the mid-quarter
convention must be used for personalty. In addition, only personalty that is purchased in the
fourth quarter is included in making the 40% determination. p. 8-9
9. The asset is treated as if it were sold in the middle of the quarter, and hence, one-half quarter
of cost recovery is allowed in the quarter of the sale. If the sale is in the first quarter, the
fraction is 0.5/4; in the second quarter 1.5/4; in the third quarter 2.5/4; and in the fourth
quarter 3.5/4. p. 8-10
10. The mid-month convention applies to real property. The convention provides for a half month
of cost recovery in the month the asset is placed in service and a half month of cost recovery
in the month the asset is sold or otherwise disposed of. p. 8-10
11. Even if MACRS straight-line is elected for the 7-year class assets, the cost recovery on the 5-
year class assets will be computed using regular MACRS with a half-year convention unless a
separate election is made to use MACRS straight-line for the 5-year class assets. p. 8-11
12. The general cost recovery method for new farming equipment is the 150% declining-balance
method. However, the straight-line method is required for any tree or vine bearing fruits or
nuts. The recovery period is 5 years. pp. 8-11 and 8-12
13. If an election is made to not have the uniform capitalization rules apply, the straight-line
method is required. p. 8-12
14. The following issues are relevant for Jim:
• What is the cost of a self-produced animal for purposes of computing its cost recovery?
• What is the proper placed in service date relating to self-produced breeding animals?
pp. 8-11 and 8-12
15. The recovery methods and periods for lessor owned qualified leasehold improvement property
are the same as 15-year MACRS. pp. 8-12 and 8-13
16. The recovery methods and periods for lessee owned leasehold improvement property are the
same as generally used for non-leasehold property. This means that the cost recovery period is
determined without regard for the lease term. pp. 8-12 and 8-13
17. Any unrecovered basis in the leasehold improvement property is written off at the termination
of the lease. p. 8-13
18. An asset used in connection with an individual’s personal investments would not be an asset
used in a trade or business. Therefore, the asset would not qualify for the § 179 expensing
election. Neither investment property nor personal use property is eligible for the § 179
expensing election. Investment property is eligible for cost recovery, however. pp. 8-13
and 8-14
19. The basis of the asset is reduced by the § 179 limited expensing deduction (after applying the
$800,000 limitation and before the taxable income limitation) before computing the MACRS
cost recovery. pp. 8-14 and 8-15
20. The § 179 amount eligible for expensing in a carryforward year is limited to the lesser of (1)
the statutory dollar amount of $250,000 reduced by the cost of § 179 property placed in
service in excess of $800,000 in the carryforward year or (2) the business income limitation in
the carryforward year. p. 8-14
21. Taxable income, for § 179 purposes, is defined as the aggregate amount of taxable income of
any trade or business of the taxpayer without regard to the amount expensed under § 179.
Therefore, the taxable income computation for purposes of the § 179 limit includes the
deduction for MACRS. p. 8-14
22. The following issues are relevant for Ana:
• Is the new motor home inventory?

• Is the new motor home an asset subject to cost recovery?
• Does the new motor home qualify for the § 179 expensing election?
pp. 8-3, 8-4, and 8-14
23. An automobile is listed property and consequently must pass the predominantly business use
test to be eligible for MACRS statutory percentage cost recovery. However, by weighing
more than 6,000 pounds, the automobile is not subject to the statutory dollar limits on cost
recovery. However, legislation enacted in 2004 provides that SUVs with a GVW between
6,000 pounds and 14,000 pounds are subject to a $25,000 ceiling in calculating the § 179
expense rather than the normal ceiling for 2009 of $250,000. p. 8-18
24. A taxicab is excluded from the passenger automobile definition and hence, the limits on cost
recovery do not apply to taxicabs. p. 8-16
25. The purpose of the lease inclusion amount is to prevent taxpayers from circumventing the cost
recovery dollar limitations by leasing instead of purchasing an automobile. The dollar amount
is taken from an IRS table and is prorated for the number of days of the lease term included in
the taxable year. This amount is then adjusted to reflect the business and income producing
use of the automobile. p. 8-19
26. The amortization period for a § 197 intangible is 15 years regardless of the actual useful life.
p. 8-22
27. The following issues are relevant for Orange Motors:
• Does the noncompete agreement come under § 197 for intangibles?

• Was the noncompete agreement in connection with the acquisition of a trade or business?
• Can the cost of the noncompete agreement be amortized over a period other than the
normal statutory period if the noncompete agreement is legally enforceable for a shorter
period of time?
• What is the normal statutory period for amortizing intangibles?
pp. 8-22 and 8-23
28. The elective treatment for start-up expenditures allows the taxpayer to deduct the lesser of: (1)
the amount of start-up expenditures with respect to the trade or business or (2) $5,000,
reduced, but not below zero, by the amount by which the start-up expenditures exceed
$50,000. Any start-up expenditures not deducted may be amortized ratably over a 180-month
period beginning in the month in which the trade or business begins. pp. 8-23 and 8-24
29. The following issues are relevant for George.
• Are all of the expenditures qualifying expenditures?

• Which of the expenditures must be capitalized?
• Which of the expenditures will qualify for amortization under § 195?
• What is the amount that may be deducted under § 195 for the year 2009?
pp. 8-23 and 8-24
30. Percentage depletion is based on a percentage of gross income from the property and makes
no reference to the cost of the property. Percentage depletion is not limited by the adjusted
basis. Therefore, it is possible to deduct more depletion than the cost of the asset. pp. 8-26
and 8-27
PROBLEMS
31. Cost of asset $100,000
Less: Greater of allowed and allowable cost recovery:

2007 $ 455
2008 3,636 (4,091)
Basis at the end of 2008 $ 95,909
Less: Cost recovery for 2009 ($100,000 × 3.636% × .5/12) (152)
Basis on date of sale $ 95,757
Gain on sale of asset ($98,000 – $95,757) $ 2,243
p. 8-4
32. José’s basis for cost recovery is $175,000 because the fair market value of the house at the
date of the conversion from personal use to rental property ($255,000) is greater than the
$175,000 adjusted basis. The cost recovery is $5,038 [$175,000 × 2.879% (Table 8.6)].
p. 8-5
33. Additional first-year depreciation ($200,000 × .50) $100,000

MACRS cost recovery [($200,000 – $100,000) × 14.29%] (Table 8.1) 14,290
The property is 7-year property. Exhibit 8.1 $114,290
pp. 8-5 to 8-8
34. a. The mid-quarter convention must be used. The office machine is 7-year class property.
2009
MACRS cost recovery [$75,000 × .0357 (Table 8.2)] $2,678
b. 2010
MACRS cost recovery {$75,000 × [.2755 × (2.5/4)]} $12,914
pp. 8-5 to 8-8
35. a. 2009
Additional first-year depreciation ($200,000 × .50) $100,000
MACRS ($100,000 × 20%) (Table 8.1) 20,000
$120,000
b. 2010
MACRS cost recovery [$100,000 × 32% (Table 8.1) × 1/2] $16,000
pp. 8-5 to 8-8
36. The mid-quarter convention must be used because the cost of the computers acquired in the
4th quarter exceeds 40% of the cost of all the personal property acquired during the year
($60,000/$140,000 = 43%).
Furniture (7-year class)
Additional first-year depreciation ($50,000 × .50) $25,000

MACRS cost recovery
[($50,000 – $25,000) × .1785] (Table 8.2) 4,463
Trucks (5-year class)
Additional first-year depreciation ($30,000 × .50) 15,000

MACRS cost recovery
[($30,000 – $15,000) × .15] (Table 8.2) 2,250
Computers (5-year class)

MACRS cost recovery
[($60,000 – $30,000) × .05] (Table 8.2) 1,500
Total cost recovery $78,213
pp. 8-5 to 8-9
37. a. The building was placed in service in October.
2009: $3,700,000 × .00535 (Table 8.6) = $19,795
b. 2013: $3,700,000 × [.02564 × (6.5/12)] = $51,387
pp. 8-10 and 8-11
38. The building meets the 80% gross receipts from dwelling units test. Therefore, it is classified
as residential real property. The building’s depreciable basis is $1,500,000 [$2,000,000 (cost)
– $500,000 (land)].
$1,500,000 × 2.576% (Table 8.6) = $38,640

pp. 8-10 and 8-11
39. 2009: $1,800,000 × .01605 (Table 8.6) = $28,890
2019: $1,800,000 × .02564 (Table 8.6) = $46,152
pp. 8-10 and 8-11
40. The building’s depreciable basis is $1,200,000 [$1,400,000 (cost) – $200,000 (land)].
a. 2009: $1,200,000 × .0197 (Table 8.6) = $23,640

b. 2015: $1,200,000 × .03636 (Table 8.6) × 10.5/12 = $38,178
pp. 8-10 and 8-11
41. The 150% declining-balance method must be used under these circumstances with a 5-year
cost recovery period.
MACRS cost recovery ($80,000 × .15) (Table 8.4) $12,000
pp. 8-11 and 8-12
42. Under these circumstances, the straight-line method must be used.
MACRS cost recovery ($70,000 × .05) (Table 8.5) $3,500
pp. 8-11 and 8-12
43. $250,000 × .05 (Table 8.1) = $12,500

pp. 8-12 and 8-13
44. Cost of leasehold improvement $80,000

Less: Cost recovery
2003 (.02247 × $80,000) (1,798)
2004-2008 (.02564 × $80,000 × 5) (10,256)
2009 [.02564 × (11.5/12) × $80,000] (1,966)
Loss (unrecovered cost) $65,980
pp. 8-12, 8-13, and Table 8.6
45. a. Copier
Immediate expense deduction under § 179 $ 50,000
Furniture
Immediate expense deduction under § 179 200,000
($250,000 – $50,000)
Additional first-year depreciation [($275,000 – $200,000) × .50] 37,500
MACRS cost recovery
[($275,000 – $200,000 – $37,500) × .1429] 5,359
Total deduction $292,859
b. Furniture
Immediate expense deduction under § 179 $250,000
Additional first-year depreciation [($275,000 – $250,000) × .50] 12,500
MACRS cost recovery [($275,000 – $250,000 – $12,500) × .1429] 1,786
Copier
Immediate expense deduction under § 179 –0–
MACRS cost recovery
[($50,000 – $25,000) × .20] 5,000
c. The deduction for the year would be $1,427 ($294,286 – $292,859) larger if § 179
expense is first allocated to the furniture (i.e., the longer lived asset).
pp. 8-5 to 8-15 and Table 8.1
46. Section 179 limit [$250,000 – ($850,000 – $800,000)] $200,000
Cost recovery for 7-year class assets

[($850,000 – $200,000) × .1429] $ 92,885
Income limitation
Income before § 179 and cost recovery $250,000
Cost recovery ($95,000 + $92,885) (187,885)
Income before § 179 amount $ 62,115
Section 179 amount of $200,000 (limited to $62,115) 62,115

Total deduction with respect to the 7-year assets in 2009 $155,000
Section 179 carryforward ($200,000 – $62,115) $137,885
pp. 8-14 and 8-15
47. a. Yoon must use the mid-quarter convention.

3-year class ($20,000 × 58.33%) $11,666
5-year class ($340,000 × 5%) 17,000
b. Section 179 amount on 5-year class property $250,000

3-year class ($20,000 × 58.33%) 11,666
5-year class [($340,000 – $250,000) × 5%] 4,500
c. Section 179 election—total deduction $266,166

No § 179 election—total deduction (28,666)
Increase in deduction from § 179 election $237,500
Tax benefit (.33 × $237,500) $ 78,375
pp. 8-5 to 8-10, 8-14, 8-15, and Table 8.2

48. Hoffman, Maloney, Raabe, and Willis, CPAs
5191 Natorp Boulevard
Mason, OH 45040
December 20, 2008
Mr. John Johnson

100 Morningside Drive
Clinton, MS 39058
Dear Mr. Johnson:
I am responding to your inquiry concerning the amount of cost recovery you may deduct in
the first year of operation of a new taxi. If the automobile is purchased at the beginning of
2009 for $35,000, the total recovery in the first year would be $35,000.
Because the car will be used as a taxi, it is not subject to the cost recovery limitations imposed
on passenger automobiles. This $35,000 recovery assumes that your income from your taxi
business before considering this recovery would be at least $35,000 and an election is made
under § 179 to expense the maximum allowable amount.
If you need additional information or need clarification of our calculations, please contact me.
Sincerely yours,
John J. Jones, CPA

Partner
TAX FILE MEMORANDUM
December 20, 2008
FROM: John J. Jones
SUBJECT: John Johnson: Calculations for cost recovery in year of acquisition
Facts. John Johnson is considering purchasing an automobile at the beginning of 2009 to be

used 100% as a taxi. The cost of the automobile is $35,000. John wants to know the total
recovery for the year of acquisition of the car.
Calculations. Because the automobile will be used as a taxi, it is not subject to the cost
recovery limitations for passenger automobiles. Therefore, John can elect § 179 expensing. In
deducting the §179 amount of $35,000, the assumption is made that John’s income from the
taxi business before considering the § 179 expense will equal or exceed $35,000.
pp. 8-15 to 8-17

49. MACRS cost recovery:
Cost $30,000
Statutory percentage (mid-quarter convention) × 5%
Cost recovery but subject to the limitation $ 1,500
Recovery limit (limited to $2,960*) $ 1,500

Less: Personal usage (20% × $1,500) (300)
Cost recovery $ 1,200
*These cost recovery limits are indexed annually. The 2008 amounts are used because the
2009 amounts were not available yet.
50. Deduction for 2009

{($20,000 × 50%) + [($20,000 – $10,000) × 20%]
= $12,000 (limited to $10,960*)} $10,960
Deduction for 2010

[($20,000 – $10,000) × 32%] limited to $4,800* $ 3,200
51. Because the Hummer has a GVW rating in excess of 6,000 pounds, it is not a passenger
automobile and hence is not subject to the cost recovery limitations.
However, since the vehicle is an SUV with a GVW between 6,000 and 14,000 pounds, the
§ 179 expense amount is limited to $25,000.
§ 179 expense $25,000
Additional first-year depreciation [($62,000 – $25,000) × .50] = 18,500
MACRS cost recovery [($62,000 – $25,000 – $18,500) × 20%] 3,700
pp. 8-16 to 8-19
52. Deduction for 2009
Additional first-year depreciation {($40,000 × 50%) + [($40,000 –
$20,000) × 20%] = $24,000} (limited to $10,960* × 80%) $8,768
Deduction for 2010

Straight-line ($40,000 × 20% = $8,000) limited to $4,800* × 70% $3,360
Cost recovery recapture in 2010

2009 deduction $8,768
Straight-line [($40,000 × 10% = $4,000)
limited to $2,960* × 80%] (2,368)
Excess $6,400
pp. 8-16 to 8-19, and Tables 8.1 and 8.5
53. 100% business use

[$4,000 × 20% (Table 8.1)] × 100% $800
45% business use
[($4,000 × 10%) (Table 8.5)] × 45% (180)
Reduced cost recovery if personal use occurs $620
Tax cost ($620 × 28%) $174

pp. 8-16 to 8-19
54. Hoffman, Raabe, and Willis, CPAs

Mason, OH 45040
December 20, 2008
Mr. Dennis Harding

150 Avenue I
Memphis, TN 38112
Dear Mr. Harding:
I am writing in response to your request concerning the tax consequences of purchasing
versus leasing an automobile. Our calculations are based on the data you provided in our
telephone conversation.
If the automobile is purchased, the total cost recovery deductions for the five years would be
$22,160. If the automobile is leased, lease payment deductions would total $22,500. In
addition, you also would have to include $1,957 in your gross income.
If you need additional information or need clarification of our calculations, please contact us.
Sincerely yours,
John J. Jones, CPA

Partner
TAX FILE MEMORANDUM
December 20, 2008
FROM: John J. Jones
SUBJECT: Dennis Harding: Calculation of lease versus purchase
Facts. Dennis Harding is considering purchasing or leasing an automobile on January 1, 2009.

The purchase price of the automobile is $35,000. The lease payments for five years would be
$375 per month. The inclusion dollar amounts for the next five years would be $131, $288,
$430, $515, and $593. Dennis wants to know the effect on his adjusted gross income for the
purchase versus the lease of the automobile for five years.
Calculations
Purchase: cost recovery deductions

2009 {($35,000 × 50%) + [($35,000 – $17,500) × 20%] = $21,000}
(limited to $10,960*) $10,960
2010 [$17,500 × 32% (limited to $4,800*)] 4,800
2011 [$17,500 × 19.2% (limited to $2,850*)] 2,850
2012 [$17,500 × 11.52% (limited to $1,775*)] 1,775
2013 [$17,500 × 11.52% (limited to $1,775*)] 1,775
Total cost recovery deductions $22,160
Lease:
Lease payments ($375 × 60) $22,500
Inclusion dollar amounts ($131 + $288 + $430 + $515 + $593) $ 1,957

pp. 8-16 to 8-20
55. For regular income tax liability

MACRS cost recovery ($14,000 × .20) $2,800
For AMT liability

($14,000 × .15) $2,100
pp. 8-20 to 8-22 and Tables 8.1 and 8.4
56. MACRS:
Year 1 [$100,000 × 14.29% (Table 8.1)] $14,290
Year 2 ($100,000 × 24.49%) 24,490
Year 3 ($100,000 × 17.49%) 17,490
ADS:
Year 1 [$100,000 × 10.71% (Table 8.4)] $10,710
Year 2 ($100,000 × 19.13%) 19,130
Year 3 ($100,000 × 15.03%) 15,030
Total cost recovery
(44,870)
Cost recovery lost by electing ADS $11,400
Tax cost of election ($11,400 × 28%) $ 3,192

pp. 8-4 to 8-7, 8-20 to 8-22
57. Hoffman, Maloney, and Willis, CPAs

Mason, OH 45040
October 15, 2009
Mr. Mike Saxon

200 Rolling Hills Drive
Shavertown, PA 18708
Dear Mr. Saxon:
This letter is in response to your request concerning the tax consequences of allocating the
purchase price of a business between the two assets purchased: a warehouse and goodwill.
If the purchase price of $2,000,000 is allocated $1,200,000 to the warehouse and $800,000 to
goodwill, the total recovery in the first year of operations would be $82,865. Cost recovery on
the warehouse would be $29,532 and amortization of the goodwill would be $53,333. If the
purchase price is allocated $1,500,000 to the warehouse and $500,000 to goodwill, the total
recovery in the first year of operations would be $70,248. Cost recovery on the warehouse
would be $36,915 and amortization of the goodwill would be $33,333.
Therefore, under the first option, your deductions in the first year would be $12,617 greater
($82,865 – $70,248). The building is written off over 39 years, while the goodwill is written
off over 15 years. Thus, the higher the allocation to goodwill, the faster the write-off will be.
Should you need more information or clarification of calculations, please contact us.
Sincerely yours,
John J. Jones, CPA

Partner
TAX FILE MEMORANDUM
October 15, 2009
FROM: John J. Jones
SUBJECT: Mike Saxon: Calculations of amount of recovery depending on the allocation of

purchase price between a warehouse and goodwill
Facts. Mike is negotiating the purchase of a business. The final purchase price ($2 million)
has been determined, but the allocation of the purchase price between a warehouse and
goodwill is still subject to discussion. Two alternatives are being considered. The first
alternative would allocate $1,200,000 to the warehouse and $800,000 to goodwill. The second
alternative would allocate $1,500,000 to the warehouse and $500,000 to goodwill. Mike
wants to know the total recovery during the first year of operations from the two alternatives.
Calculations
Alternative 1
Warehouse [$1,200,000 × 2.461% (Table 8.6)] $29,532
Goodwill ($800,000/15 years) 53,333
Total recovery $82,865
Alternative 2
Warehouse [$1,500,000 × 2.461% (Table 8.6)] $36,915
Goodwill ($500,000/15 years) 33,333
Total recovery $70,248
Additional deductions in first year under alternative 1

($82,865 – $70,248) $12,617
pp. 8-9, 8-10, 8-22, and 8-23
58. Deductible amount [$5,000 – ($58,000 – $50,000)] $ –0–

Amortizable amount [($58,000/180) × 10 months] 3,222
Total deduction for start-up expenditures $3,222
pp. 8-23 and 8-24
59. Deductible amount [$5,000 – ($51,000 – $50,000)] $4,000

Amortizable amount {[($51,000* – $4,000)/180] × 7 months} 1,828
Total deduction for start-up expenditures $5,828
*Startup expenses do not include interest expense.
pp. 8-23 and 8-24
60. Gross income $12,000,000

Less: Expenses (5,000,000)
Taxable income before depletion $ 7,000,000
Cost depletion ($10,000,000/250,000 × 45,000) = $1,800,000
Percentage depletion (22% × $12,000,000 = $2,640,000, limited
to 50% × $7,000,000 = $3,500,000) (2,640,000)
Taxable income $ 4,360,000
pp. 8-25 to 8-27
61. Not expensed
Gross income $3,840,000

Less: Expenses (1,240,000)
Taxable income before depletion $2,600,000
Cost depletion ($6* × 120,000) $720,000
Percentage depletion (15% × $3,840,000) $576,000
Greater of cost or percentage depletion (720,000)
Taxable income $1,880,000
Expensed
Gross income $3,840,000

Less: Expenses, including IDC (2,240,000)
Taxable income before depletion $1,600,000
Cost depletion ($4** × 120,000) $480,000
Percentage depletion (15% × $3,840,000) $576,000
Greater of cost or percentage depletion (576,000)
Taxable income $1,024,000
*Oil interest cost plus IDC ($2,000,000 plus $1,000,000) ÷ 500,000 equals $6.
**Oil interest cost of $2,000,000 ÷ 500,000 equals $4.
pp. 8-25 to 8-27 and Example 39
CUMULATIVE PROBLEMS
62. Net income from Writers Anonymous (Note 1) $60,471

Interest income 5,000
Self-employment tax (Note 2) (4,272)
Adjusted gross income $61,199
Less: Itemized deductions (Note 3) (11,700)
Personal exemption (3,500)

Taxable income $45,999
Tax on $45,999 from 2008 Tax Table $ 7,838
Self-employment tax 8,544
Less: Estimated tax payments (17,000)
Net tax payable (or refund due) for 2008 ($ 618)
See the tax return solution beginning on page 8-25 of the Solutions Manual.
Notes
(1) The net income of Writers Anonymous is calculated as follows:

Income from sales $105,000
Less: Rent $16,500
Utilities 7,900
Supplies 1,800
Insurance 5,000
Travel excluding meals ($3,500 – $1,200) 2,300
Meals ($1,200 – $600) 600

Depreciation (Note 4) 10,429 (44,529)
Net income $ 60,471
(2) The self-employment tax is calculated as follows (see Ch. 13):
1. Net earnings from self-employment $60,471
2. Multiply line 1 by 92.35% 55,845
3. If the amount on line 2 is $102,000 or less,
multiply the line 2 amount by 15.3%.
This is the self-employment tax. $ 8,544
One-half of the self-employment tax, or $4,272, is a deduction for AGI.
(3) The itemized deductions are as follows:
State income tax $ 3,000
Home mortgage interest 6,000
Property taxes on home 1,500
Charitable contributions 1,200
Total itemized deductions $11,700
(4) Furniture and fixtures:
MACRS [$17,000 × 14.29% (Table 8.1)] $ 2,429
Computer equipment:
MACRS [$40,000 × 20% (Table 8.1)] 8,000
63. Hoffman, Raabe, and Willis, CPAs
Mason, OH 45040
December 21, 2009
Mr. John Smith

1045 Center Street
Lindon, UT 84059
Dear Mr. Smith:
I am writing in response to your request concerning the effects on your 2009 adjusted gross
income of selling IBM stock and using some of the proceeds to purchase an automobile to be
used in your business.
If the stock is not sold and the car is not purchased, your adjusted gross income would be
$391,000. If the stock is sold and the car purchased, your adjusted gross income would be
$385,040. The supporting calculations follow:
No sale of stock and no purchase of car

Fees for services $912,000
Less: Business expenses
Building rental $36,000
Office furniture and equipment rental 9,000
Office supplies 2,500
Utilities 4,000
Salaries ($34,000 + $42,000) 76,000
Payroll taxes 7,000
Fuel and oil 21,000
Cost recovery (Note 3):
Front-end loaders 84,000
Dump truck 51,000
Total business expenses (290,500)
Business income before § 179 deduction $621,500
Less: § 179 deduction (Note 1) (250,000)
Business income $371,500
Dividend income 9,500
Notes
(1) Section 179 deduction of $250,000.
(2) The inheritance of IBM stock worth $110,000 from Aunt Mildred is excludible under
§ 101.
(3) Cost recovery
Front-end loaders
Additional first-year depreciation [($390,000 – $250,000)
× 50%] (Note 1) $70,000
Regular MACRS [($390,000 – $250,000 – $70,000) × 20%] (Note 1) 14,000
Dump truck
Additional first-year depreciation ($85,000 × 50%) $42,500
Regular MACRS [($85,000 – $42,500) × 20%] 8,500

Sale of stock and purchase of car
Utilities 4,000
Salaries ($34,000 + $42,000) 76,000
Payroll taxes 7,000
Fuel and oil 21,000
Dump truck 51,000
Car 10,960
Gain on stock sale (Note 2) 5,000
Notes
§ 101. John’s recognized gain on the sale of the IBM stock is $5,000 ($115,000
amount realized – $110,000 adjusted basis) and is automatically classified as a long-
term capital gain.
(3) Cost recovery
Front end loaders
Additional first-year depreciation [($390,000 – $250,000) × 50%] (Note 1) $70,000
Regular MACRS [($390,000 – $250,000 – $70,000) × 20%] 14,000
Dump truck
Regular MACRS [($85,000 – $42,500) × 20%] 8,500
Car
{($75,000 × 50%) + [($75,000 – $37,500) × 20%] (limited to $10,960*)} $10,960
*The cost recovery limits are indexed annually. The 2008 amounts are used because
the 2009 amounts were not available yet.
Should you need more information or need for us to clarify our calculations, please contact us.
Sincerely,
John J. Jones, CPA
Partner
TAX FILE MEMORANDUM
December 20, 2009
FROM: John J. Jones
SUBJECT: John Smith: Calculation of adjusted gross income for (1) no sale of stock or
purchase of car versus (2) sale of stock and purchase of car
Facts. John is considering selling inherited IBM stock with an adjusted basis to him of
$110,000 for $115,000 on December 29, 2009. He would use $75,000 of the proceeds to
purchase a car that would be used 100% for business. John wants to know the effect these
transactions would have on his adjusted gross income.
No sale of stock and no purchase of car

Utilities 4,000
Salaries ($34,000 + $42,000) 76,000
Payroll taxes 7,000
Fuel and oil 21,000
Dump truck 51,000
Notes

§ 101.
(3) Cost recovery
Front-end loaders
Additional first-year depreciation [($390,000 – $250,000)

× 50%] (Note 1) $70,000
Regular MACRS [($390,000 – $250,000 – $70,000) × 20%] (Note 1) 14,000
Dump truck
Regular MACRS [($85,000 – $42,500) × 20%] 8,500
Sale of stock and purchase of car

Utilities 4,000
Salaries ($34,000 + $42,000) 76,000
Payroll taxes 7,000
Fuel and oil 21,000
Dump truck 51,000
Car 10,960
Gain on stock sale (Note 2) 5,000
Notes

§ 101. John’s recognized gain on the sale of the IBM stock is $5,000 ($115,000
amount realized – $110,000 adjusted basis) and is automatically classified as a long-
term capital gain.
(3) Cost recovery
Front-end loader
Additional first-year depreciation [($390,000 – $250,000) × 50%] (Note 1) $70,000
Regular MACRS [($390,000 – $250,000 – $70,000) × 20%] 14,000
Dump truck
Regular MACRS [($85,000 – $42,500) × 20%] 8,500

Car
{($75,000 × 50%) + [($75,000 – $37,500) × 20%] (limited to $10,960*)} $10,960
*The cost recovery limits are indexed annually. The 2008 amounts are used because the
The answers to the Research Problems are incorporated into the Instructor’s Guide with Lecture
Notes to accompany the 2010 Annual Edition of SOUTH-WESTERN FEDERAL TAXATION:
COMPREHENSIVE VOLUME.
62.
62. continued
62. continued
62. continued
62. continued
62. continued
62. continued

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South Western Federal Taxation 2010 Comprehensive Volume 33rd Edition Willis Solutions Manual

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South Western Federal Taxation 2010

Comprehensive Volume 33rd Edition

DEPRECIATION, COST RECOVERY, AMORTIZATION, AND DEPLETION

SOLUTIONS TO PROBLEM MATERIALS

1 LO 1 Cost recovery Unchanged 1

24 LO 4 Listed property: passenger auto and cost Unchanged 24

*61 LO 8, 10 Intangible drilling costs: capitalized versus Unchanged 61

*The solution to this problem is available on a transparency master.

1 Depreciation of aircraft parts Unchanged 1

Est'd Assessment Information

1 Easy 5 FN-Reporting Analytic

Est'd Assessment Information

40 Easy 10 FN-Measurement Analytic

31. Gain $2,243. 47.a. $28,666.

4. The relevant issues for Henry are:

• Can costs incurred subsequent to the purchase, attributable to maintenance of such

pp. 8-4 and 8-5

14. The following issues are relevant for Jim:

22. The following issues are relevant for Ana:

• Is the new motor home inventory?

27. The following issues are relevant for Orange Motors:

• Does the noncompete agreement come under § 197 for intangibles?

• Are all of the expenditures qualifying expenditures?

31. Cost of asset $100,000

Less: Greater of allowed and allowable cost recovery:

33. Additional first-year depreciation ($200,000 × .50) $100,000

pp. 8-5 to 8-8

pp. 8-5 to 8-8

pp. 8-5 to 8-8

Furniture (7-year class)

Additional first-year depreciation ($50,000 × .50) $25,000

Trucks (5-year class)

Additional first-year depreciation ($30,000 × .50) 15,000

Computers (5-year class)

pp. 8-5 to 8-9

37. a. The building was placed in service in October.

2009: $3,700,000 × .00535 (Table 8.6) = $19,795

b. 2013: $3,700,000 × [.02564 × (6.5/12)] = $51,387

pp. 8-10 and 8-11

$1,500,000 × 2.576% (Table 8.6) = $38,640

39. 2009: $1,800,000 × .01605 (Table 8.6) = $28,890

2019: $1,800,000 × .02564 (Table 8.6) = $46,152

pp. 8-10 and 8-11

a. 2009: $1,200,000 × .0197 (Table 8.6) = $23,640

pp. 8-10 and 8-11

MACRS cost recovery ($80,000 × .15) (Table 8.4) $12,000

pp. 8-11 and 8-12

42. Under these circumstances, the straight-line method must be used.

MACRS cost recovery ($70,000 × .05) (Table 8.5) $3,500

pp. 8-11 and 8-12

43. $250,000 × .05 (Table 8.1) = $12,500

44. Cost of leasehold improvement $80,000

pp. 8-12, 8-13, and Table 8.6

Cost recovery for 7-year class assets

Section 179 amount of $200,000 (limited to $62,115) 62,115

pp. 8-14 and 8-15

47. a. Yoon must use the mid-quarter convention.

b. Section 179 amount on 5-year class property $250,000

c. Section 179 election—total deduction $266,166

Tax benefit (.33 × $237,500) $ 78,375

pp. 8-5 to 8-10, 8-14, 8-15, and Table 8.2

December 20, 2008

Mr. John Johnson

Dear Mr. Johnson: