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DISCUSSION QUESTIONS
1. (LO 1) Property that is classified as personal use property is not used in a trade or business or a
transaction entered into for profit and, hence, is not subject to cost recovery.
2. (LO 1) Personal property is any asset that is not real property. Personal use property is any property
(realty or personalty) that is held for personal use rather than for use in a trade or business or income-
producing activity.
5. (LO 2) The three factors the MACRS tables take into account are (1) recovery period, (2) method,
and (3) convention.
6. (LO 2) The asset is treated as if it were placed in service in the middle of the quarter. The factors in
the table take this into account; hence, the cost of the asset is multiplied by the factor to determine the
first year’s cost recovery.
7. (LO 2) The asset is treated as if it were sold in the middle of the quarter; hence, one-half quarter of
cost recovery is allowed in the quarter of the sale. If the sale is in the first quarter, the ratio is .5/4; in
the second quarter, 1.5/4; in the third quarter, 2.5/4; and in the fourth quarter, 3.5/4.
8. (LO 2) Even if MACRS straight-line is elected for the 7-year class assets, the cost recovery on the
5-year class assets is computed using regular MACRS with a mid-quarter convention unless a
separate election is made to use MACRS straight-line for the 5-year class assets (the mid-quarter
convention also applies to the 7-year class assets). With respect to the mid-quarter convention, the
assumption is made that Robert is a calendar year taxpayer.
8-1
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8-2 2017 Individual Income Taxes/Solutions Manual
10. (LO 3) Ordinary income recapture is required anytime property on which an expense has been taken
under § 179 is no longer used predominantly in a trade or business.
11. (LO 3) The basis of the property for cost recovery purposes is reduced by the § 179 amount [after it is
adjusted for property placed in service in excess of the appropriate acquisition limit ($2,010,000 in
2016 and $2,000,000 in 2015)]. The business income limitation does not affect basis.
12. (LO 3) The § 179 amount eligible for expensing in a carryforward year is limited to the lesser of (1)
the statutory dollar amount ($500,000 in 2016 and 2015) reduced by the cost of § 179 property placed
in service in excess of the appropriate acquisition limit in the carryforward year ($2,010,000 for 2016
and $2,000,000 for 2015) or (2) the business income limitation in the carryforward year.
13. (LO 3) For § 179 purposes, taxable income 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 additional
first-year depreciation and MACRS.
14. (LO 2, 3) The following issues are relevant to John.
Is John entitled to a § 179 deduction?
How much, if any, can John deduct under § 179 on his own tax return?
What are the tax consequences of the reimbursements that John receives?
15. (LO 4) The cost of listed property that does not pass the more-than-50% business usage test must be
recovered using the straight-line method. If the listed property is an automobile, the cost recovery is
further limited by the cost recovery limitations.
16. (LO 4) The property is subject to cost recovery recapture, which is included in the taxpayer’s income
tax return as ordinary income. The amount of the inclusion is the excess cost recovery, which is the
excess of the cost recovery deduction taken in prior years using the statutory percentage method over
the amount that would have been allowed if the straight-line method had been used since the property
was placed in service.
17. (LO 7) The amortization period for a § 197 intangible is 15 years regardless of the actual useful life.
18. (LO 7) 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?
19. (LO 7) 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 amount may be deducted under § 195 for 2016?
20. (LO 8) The cost basis is divided by the estimated recoverable units of the asset to arrive at the
depletion per unit. The depletion per unit then is multiplied by the number of units sold during the
year to arrive at the cost depletion allowed.
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Depreciation, Cost Recovery, Amortization, and Depletion 8-3
COMPUTATIONAL EXERCISES
21. (LO 2) The IRS provides tables that specify cost recovery allowances for personalty and for realty. To
determine the amount of the cost recovery allowances, simply identify the asset by class and go to the
appropriate table for the percentage (or factor).
2016 $80,000 × .1429 = $11,432.
2017 $80,000 × .2449 = $19,592.
22. (LO 2) The mid-quarter convention applies if more than 40% of the value of property other than
eligible real estate is placed in service during the last quarter of the year. Hamlet acquired 100% of
assets in the last quarter of the year. Therefore mid-quarter convention applies.
2016 $100,000 × .0357 = $3,570.
2017 $100,000 × .2755 = $27,550.
23. (LO 2) The IRS provides tables that specify cost recovery allowances for personalty and for realty.
Under MACRS, the cost recovery period for residential rental real estate is 27.5 years, and the straight-
line method is used for computing the cost recovery allowance. Nonresidential real estate uses a
recovery period of 39 years; it also is depreciated using the straight-line method. Cost recovery is
computed by multiplying the applicable rate by the cost recovery basis.
a. Residential rental real estate: $1,000,000 × .03636 = $36,360.
b. Nonresidential rental real estate: $1,000,000 × .02564 = $25,640.
24. (LO 2) The IRS provides tables that specify cost recovery allowances for personalty and for realty.
The taxpayer may elect to use the straight-line method for depreciable personal property. The
property is depreciated using the class life (recovery period) of the asset with a half-year convention
or a mid-quarter convention, whichever applies. The election is available on a class-by-class and
year-by-year basis (see Concept Summary 8.3). The percentages for the straight-line election with a
half-year convention appear in Exhibit 8.5.
25. (LO 2) Additional first-year depreciation is taken in the year in which the qualifying property is
placed in service; it may be claimed in addition to the otherwise available depreciation deduction.
After the additional first-year depreciation is calculated, the standard MACRS cost recovery
allowance is calculated by multiplying the cost recovery basis (original cost recovery basis less
additional first-year depreciation) by the percentage that reflects the applicable cost recovery method
and convention. Because the asset was purchased during the last quarter of the year and is the only
asset purchased during the year, the mid-quarter convention applies.
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8-4 2017 Individual Income Taxes/Solutions Manual
Two additional limitations apply to the amount deductible under § 179. First, the ceiling amount on
the deduction is reduced dollar for dollar when § 179 property placed in service during the taxable
year exceeds a maximum amount ($2,010,000 in 2016). Second, the § 179 deduction cannot exceed
the taxpayer’s trade or business taxable income, computed without regard to the § 179 amount.
§ 179 deduction before adjustment $212,000
Less: Dollar limitation reduction ($212,000 < $2,010,000) (–0–)
Remaining § 179 deduction $212,000
§ 179 deduction allowed due to business income limitation $ 5,600
§ 179 deduction carryforward ($212,000 − $5,600) $206,400
27. (LO 4) The law places special limitations on cost recovery deductions for passenger automobiles. The
luxury auto limits are imposed before any percentage reduction for personal use. The cost recovery
limitations are maximum amounts. If the regular MACRS calculation produces a lesser amount of
cost recovery, the lesser amount is used.
28. (LO 7) Taxpayers can claim an amortization deduction on intangible assets called “amortizable § 197
intangibles.” The amount of the deduction is determined by amortizing the adjusted basis of such
intangibles ratably over a 15-year period beginning in the month in which the intangible is acquired.
The 2016 § 197 amortization deduction of $ $7,250 ($1,000 + $6,250) is computed as follows.
Patent: $60,000/15 years = $4,000 × 3/12 = $1,000.
Goodwill: $375,000/15 years × 3/12 = $6,250.
29. (LO 8) Cost depletion is determined using the adjusted basis of the asset. The basis is divided by the
estimated recoverable units of the asset (e.g., barrels and tons) to arrive at the depletion per unit. This
amount is then multiplied by the number of units sold (not the units produced) during the year to
arrive at the cost depletion allowed.
Parscale’s depletion per ton is $16 ($8,000,000 adjusted basis/500,000 estimated recoverable tons). If
75,000 tons are sold this year, the cost depletion is $1,200,000 ($16 depletion per ton × 75,000 tons
sold).
30. (LO 8) Percentage depletion (also referred to as statutory depletion) uses a specified percentage
provided by the Code. The percentage varies according to the type of mineral interest involved. The
rate is applied to the gross income from the property, but in no event may percentage depletion
exceed 50% of the taxable income from the property before the allowance for depletion.
Gross income $340,000
Less: Other expenses (229,000)
Taxable income before depletion $111,000
Depletion allowance $ 47,6001
1
[The lesser of $47,600 (14% × $340,000) or $55,500 (50% × $111,000)].
© 2017 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
Depreciation, Cost Recovery, Amortization, and Depletion 8-5
PROBLEMS
31. (LO 1, 2)
Cost of asset $200,000
Less: Greater of allowed and allowable cost recovery:
2014 $ 910
2015 7,272 (8,182)
Basis at the end of 2015 $191,818
Less: Cost recovery for 2016 ($200,000 × .03636 × .5/12) (303)
Basis on date of sale $ 191,515
Loss on sale of asset ($180,000 − $191,515) ($ 11,515)
32. (LO 1, 2) José’s basis for cost recovery is $300,000 because the basis of the house at the date of the
conversion from personal use to rental property ($300,000) is less than the $400,000 fair market
value. The cost recovery is $8,637 [$300,000 × .02879 (Exhibit 8.8)].
33. (LO 2) The office furniture qualifies for additional first-year depreciation. So part of the $130,000
cost can be deducted as additional first-year depreciation. The property is 7-year class property. Cost
recovery would be calculated as follows.
Additional first-year depreciation:
($130,000 × .50) $65,000
MACRS cost recovery:
[($130,000 − $65,000) × .1429 (Exhibit 8.3)] 9,289
Total cost recovery $74,289
34. (LO 2)
a. The mid-quarter convention must be used. The office machine is 7-year class property.
2015
Additional first-year depreciation
($75,000 × .50) $37,500
MACRS cost recovery
[($75,000 − $37,500) × .0357 (Exhibit 8.4)] 1,339
Total cost recovery $38,839
b. 2016
MACRS cost recovery [$37,500 × (.2755 × 2.5/4)] $6,457
35. (LO 2)
a. 2016
MACRS cost recovery ($200,000 × 20%) (Exhibit 8.3) $40,000
b. 2017
MACRS cost recovery [$200,000 × 32% (Exhibit 8.3) × 1/2] $32,000
36. (LO 2) The mid-quarter convention must be used because the cost of the computers acquired in the
fourth quarter exceeds 40% of the cost of all the personal property acquired during the year
($70,000/$150,000 = 47%).
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8-6 2017 Individual Income Taxes/Solutions Manual
37. (LO 2)
a. The building was placed in service in October.
38. (LO 2) 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)].
39. (LO 2)
2016 $10,800,000 × .01605 (Exhibit 8.8) = $173,340
40. (LO 2) The building’s depreciable basis is $1,300,000 [$1,600,000 (cost) − $300,000 (land)].
a. 2016 $1,300,000 × .0197 (Exhibit 8.8) = $25,610
41. (LO 2, 3, 9)
a. 5-year class property
Immediate expense deduction under § 179 $200,000
7-year class property
Immediate expense deduction under § 179 300,000
($500,000 − $200,000)
MACRS cost recovery
[($400,000 − $300,000) × .1429] 14,290
Total deduction $514,290
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