Tax Information for Small Businesses
CONSTRUCTION - Depreciation IRC Section 167(a), 168 &
179a
What is Depreciation?
• • • Property used for business Property expected to last more than one year Represents wear, decay, usage, obsolesce, or loss of value due to natural causes
What can be Depreciated?
Real Property: Any building or structure built on land; plants or trees grown on land; and attachments or improvements to land Personal Property: Cars, trucks, machinery, furniture, equipment, and all other tangible items which are not real property
What cannot be Depreciated?
• • • • Property placed in service and disposed of in the same year Inventory Land Repairs and replacements that do not increase the value of your property; make it more useful; or lengthen its useful life
How to Figure Depreciation
• • • • • Basis Class Life Placed in Service Date Convention Method
Definitions
• • COST BASIS: Usually the purchase price, including sales tax, freight, and installation charges. ADJUSTED BASIS: Increase cost basis by improvements. Decrease basis by depreciation deductions.
Compute Basis
Example: Adam bought a dump truck from a local contractor. He paid $2,000 cash, borrowed $3,000 from the bank, and agreed to dig the foundation for the contractor’s lake cabin (worth $1,000). The cost basis for the dump truck is $5,000.
Class Life
• • 3-year Property o Tractor units used over the road. 5-year Property o Any construction property that does not have a class life. o Automobiles, taxis, buses & trucks. o Computers & peripheral equipment. o Office machinery, such as typewriters, calculators, & copiers. o Property used in research & experiments. 7-year Property o Office furniture & fixtures 15-year Property o Land improvements, such as shrubbery, fences, roads, & bridges. o Service stations, but not the pumps. 39-year o Nonresidential real property.
• • •
Placed In Service Date
Depreciation is taken when the property is ready and available for use in your trade or business, even if the property is idle or currently not in use.
Conventions
Half-Year: • Treat property placed in service during the year as if it started at the midpoint of the year • This convention is used for most property Mid-Month: • • Treat property placed in service during a month as if it started at the middle of the month This convention is used for real property
Mid-Quarter Convention: • Treat personal property placed in service during a quarter as if it started at the middle of the quarter
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Must be used when more than 40 percent of all personal property placed in service during the year was placed in service in the last three months of the year
Computing Your Depreciation Deduction
Multiply the basis of the asset by predetermined percentages set by the class life, convention, and method.
General Depreciation System (GDS); 200% Declining Balance (DB); Half-Year Convention (HY)
Year 1 3-Year: 33.33% 5-Year: 20.00% 7-Year: 14.29% Year 2 3-Year: 44.45% 5-Year: 32.00% 7-Year: 24.49% Year 3 3-Year: 14.81% 5-Year: 19.20% 7-Year: 17.49% Year 4 3-Year: 7.41% 5-Year: 11.52% 7-Year: 12.49% Year 5 3-Year: n/a 5-Year: 11.52% 7-Year: 8.93% Year 6 3-Year: n/a 5-Year: 5.76% 7-Year: 8.92% Year 7 3-Year: n/a 5-Year: n/a 7-Year: 8.93% Year 8 3-Year: n/a 5-Year: n/a 7-Year: 4.46%
Example
Shawn bought a used pickup for $15,000 in March 1998. His depreciation deduction for each year is computed by multiplying Cost with GDS. The example is as follows: 1998: Cost of $15,000 multiplied by 20.00% is equal to a depreciation of $3,000 1999: Cost of $15,000 multiplied by 32.00% is equal to a depreciation of $4,800 2000: Cost of $15,000 multiplied by 19.20% is equal to a depreciation of $2,880 2001: Cost of $15,000 multiplied by 11.52% is equal to a depreciation of $1,728 2002: Cost of $15,000 multiplied by 11.52% is equal to a depreciation of $1,728 2003: Cost of $15,000 multiplied by 5.76% is equal to a depreciation of $864 The total depreciation equals to $15,000.
Listed Property
• • • • Any four-wheeled passenger vehicle used primarily for public streets, roads, and highways that weighs 6,000 lbs or less unloaded Entertainment, recreation, or amusement property (Includes photographic, phonographic, communication, and video-recording equipment) Computer and related peripheral equipment Any cellular telephone
Section 179 Election
Allows you to elect to deduct all or part of the cost of certain qualifying property in the year you place it in service.
Section 179 Property
Includes: Property purchased new (if a trade-in is used, only the cash amount can be used) Does Not Include: Leased, real, or rented property; Listed property whose business use for the year is 50% or less of the total use
Deduction Limitations
Maximum Dollar Limit: • For 2003 to 2005, it is $100,000. After 2005, it is scheduled to go down to $25,000.
Investment Limit: • If the total cost of the Section 179 property exceeds $400,000 (the “threshold figure”), the amount of excess reduces the maximum dollar limit dollar for dollar. The threshold figure returns to $200,000 after 2005.
Taxable Income Limit: • • The amount you deduct each year cannot exceed the taxable income from all active trade or business conducted during the year. Wages and salaries paid as an employee are included.
New Law
• • • • • Additional 50 percent special depreciation deduction on property’s depreciable basis taken after Section 179 deduction. Newly purchased property with class life of 20 years or less. Acquisition Date: Purchased after 5/5/2001, but before 1/1/2005 Placed in Service Date: Must be used in your business after 5/5/2003 and before 1/1/2005 Original Use: Began with you after 5/5/2003
Computation Example
• • • • Property purchased 5/17/2003. Original cost is $200,000. Section 179 deduction taken is $100,000. What is the special depreciation deduction?
Answer
Cost: $200,000 Less Section 179 deduction (100,000) Multiply remaining depreciable basis by 50%: $100,000 multiplied by 50% Special Depreciation Allowance: $50,000 Regular Depreciation Basis: $50,000
Thank You!