Chapter 10 Outline- Depreciation

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Chapter 10 Outline- Depreciation Powered By Docstoc
					                             Chapter 10 Outline- Depreciation

I. Depreciation- General Information
       A. Depreciation deduction is for wear, tear, and obsolescence of long term assets
       B. Depreciation expense is only allowed for business or income producing
               property – not land or personal use property (such as your house & car)
               1. if part business and part personal use, can only depreciate the business
                        portion so depreciable cost = cost X % business use
               2. Asset must have a limited useful life which can be estimated
       C. Use the depreciation method in effect at the time the asset was acquired and use it
               consistently for the entire useful life of the asset
               1. later changes in the law do not affect the depreciation method used
                        for assets acquired earlier
               2. reduce the adjusted cost basis of the asset by the greater of the depreciation allowable
                        (whether or not the taxpayer actually deducted it) OR the depreciation actually
                        taken
       D. Depreciation deductions are shown on Form 4562.
               Exception - Taxpayers with no current year asset additions who are not reporting
               depreciation on listed property (entertainment type assets such as cameras, computers,
               boats, cars, etc where Congress expects personal use) are not required to file a 4562 with
               their return.

II. Steps In the Regular Depreciation Calculation for tangible assets used in business
        A. Classify property as either real property (Land & buildings) or tangible personal property
                (anything except land or buildings so equipment, business vehicles, furniture, etc.)
        B. General Rules for personal property using MACRS (Modified Accelerated Cost Recovery
                System)
                1. Determine the estimated useful life or class (see page 10-5)
                2. Go to the appropriate table for that class life on page 10-6 or appendix C
                        a. these tables use double declining balance with a mid-year convention
                                and a conversion to straight-line depreciation in later years.
                                The computation is different from financial accounting declining
                                balance because the cost basis used does not change. Instead, the tax rates
                                in the tables have been adjusted to compensate for the declining balance
                        b. Cost basis for MACRS = original cost – any Section 179 expense taken this
                                year OR carried forward to later years – any bonus depreciation
                        c. depreciation expense = depreciable cost basis times % from the table
                        d. tax depreciation assumes zero salvage value
                        e. mid-year convention means in the year of acquisition and the year of
                                disposal of an asset you take ½ year of depreciation
                        f. the mid-year convention is built into the tables for the year of
                                acquisition and the last year of useful life but if you sell or disposal of the
                                asset in some other year, you need to take the % from the table X
                                depreciable cost to get the depreciation for the year, then times ½ year
                        g. If more than 40% of the personal property (tangible property besides land or



                                  Chapter 10 Outline - Page 1 of 4
               buildings) purchased during the year is acquired in the last quarter of the
               year, then the taxpayer must use a mid-quarter convention instead of a
               mid-year convention.
               i.       See tables 2,3,4 & 5 in Appendix C.
               ii.      If you immediately expense part of an item, that amount is NOT
                        included in determining whether the mid-qtr convention applies
               iii.     If the mid-qtr convention applies, it must be used for ALL
                        personal property put into service during the year, using the
                        appropriate table for the quarter each asset was placed in service
3. Once you pick a table for an asset, you use that same table to find the depreciation %
               for that asset in future years – just go down the column you used for year 1
4. Taxpayer can elect to use straight-line rather than accelerated depreciation methods
       a. MACRS straight-line uses the MACRS useful lives
       b. ADS (Alternative Depreciation System) uses longer recovery periods than
               MACRS – this method is mandatory for the Alternative Minimum Tax
               computation
5. Immediate Expensing (Section 179) option
       a. taxpayers can elect to immediately expense $250,000 of new or used tangible
               personal property (not real estate) and software used in an active (not
               passive) trade or business and placed in service during the year.
       b. this expense cannot exceed the taxable income from the business
       c. this is intended for small companies so the $250,000 deductible in any one
               year gets phased out at the rate of $1 for each $1 of investment in tangible
               personal property over $800,000 for a year
       d. if deductible amount is limited by income, taxpayer can carry the unused
               amount forward
       e. the depreciable basis of the property for MACRS is reduced by any amounts
               expensed or carried forward under section 179
       f. in the year of acquisitions, taxpayer can take a section 179 deduction AND
               regular MACRS depreciation on the depreciable basis left after the
               immediate expensing
       g. for sports utility vehicles over 6000 pounds, immediate expensing is limited to
               $25000. For other vehicles over 6000 pounds, up to $250000 can be
               immediately expensed.
6. Bonus Depreciation – from Economic Stimulus Act of 2008 –
               Optional so taxpayer must elect to take it
       a. Applies to:
               i) NEW (not used) tangible personal property with a recovery period of
                        20 years or less
               ii) computer software except if purchased as part of business acquisition
               iii) leasehold improvements
       b. Bonus Depreciation = 50% x (cost of asset - any Section 179 expensing)
       c. Regular MACRS depreciation can be taken using % from appropriate table and
                        cost = acquisition cost – Section 179 exp – bonus depreciation




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C. Limitations on General Depreciation Rules for Tangible Personal Property
             1. Listed property limitation
                    a. Listed property includes cars, computers, video equipment, phones, boats,etc,
                             anything usually used for recreation or entertainment
                    b. If 50% or less business use, depreciation on business use of listed assets is
                             limited to the alternative depreciation system (ADS) and straight-
                             line rather than double declining balance. No bonus deprec allowed
                    c. If taxpayer is an employee, the listed property limits apply AND the asset
                             MUST meet all of the following requirements:
                             i) used more than 50% of the time for business and
                             ii) for the convenience of the employer and
                             iii) required as a condition of employment
             2. Automobile & Truck depreciation limitations – see table 6 in Appendix C
                    a. limits placed on depreciation expense allowed on passenger cars because
                             luxury automobiles are not a necessary business expense
                    b. total depreciation on cars is limited to:
                                            2008                            2007
                         st
                        1 Year              2,960***                       $3,060
                        2nd Year            4,800                            4,900
                         rd
                        3 Year              2,850                            2,850
                        4th & later yrs     1,775                            1,775
                             *** first year limit in 2008 is $10960 if bonus dep is elected.

                     c. total depreciation on trucks and vans weighing less than 6000 pounds is
                        limited to $3160*** max 1st year depreciation
                         Limits for later years for assets acquired in 2008 are:
                                                    $5100 for the 2nd year
                                                    $3050 for the 3rd year
                                              and $1875 for the 4th and later years

                             *** first year limit in 2008 is $11160 if bonus depreciation is elected

                     d. the depreciation limits listed are for 100% business use vehicles – if used less
                            than 100% for business, the limit is computed as
                                    = (limit listed above) X % of business use

       D. Depreciation of Real Property
             1. Classify property as either residential or non-residential
             2. Look at year acquired to see if MACRS or ACRS (Accelerated Cost Recovery System)
                     will be used
                     a. ACRS useful lives apply to real property acquired 1981-1986
                             i) 15 years if acquired after 1980 and before 3/16/1984
                             ii) 18 years if acquired after 3/15/84 and before 5/9/85
                                      (low income housing acquired during this period
                                      still gets 15 year life)
                             iii) 19 years if acquired 5/8/85 through 12/31/86



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                                        (low income housing gets 15 year life)
                        b. MACRS useful lives apply to real property acquired after 1986
                                i) residential property is depreciation over 27.5 years (Table 7 in App C)
                                ii) non-residential real property is depreciated over
                                        31.5 years if acquired in 1987 through 5/12/93 and over (Table 8 in
                                                 App C)
                                        39 years if acquired 5/13/93 or later (Table 9 in App. C)
                3. Go to appropriate table in Appendix C and get %
                4. MACRS tables use straight-line depreciation with a mid-month convention
                        ( receive ½ month depreciation in the month buy or sell the asset).
                5. The mid-month convention is built into the table for the month of acquisition
                        but not the month of sale

 III. Intangible Assets (Section 197 assets) – such as goodwill, customer lists, licenses, franchises,
          trademarks, covenants not to compete, client files
          A. Amortize over 15 years using straight-line
          B. Asset must be used in a trade or business
          C. Patents and copyrights are NOT considered intangibles if created by the taxpayer – must be
                 purchased to fall under section 197

 IV. Natural Resources – timber, oil, other mineral deposits
       A. Two Methods - units of production method and percentage depletion method
               Compute depletion under each method and use the higher number
       B. Units of production method
               1. Depletion per unit = (Unrecovered Cost Basis/Estimated number of units of resource)
               2. Cost depletion per unit may change annually as estimated number of units changes
               3. Depletion expense for the year = Depletion per unit X number of units SOLD
       C. Percentage depletion = Gross income from sale of natural resource X % set by law
               % set by law is 15% for oil and gas

V. Other Assets
       A. Research and Experimental Expenditures – taxpayer can elect one of three treatments but
                Once pick a method must use it every year unless IRS permission to change
               1. immediately expense these expenditures
               2. capitalize and depreciate over 5 years or more
               3. capitalize and write-off when the project is worthless
       B. Computer Software Costs
               1. If developed by the taxpayer, taxpayer can elect to either expense the costs or
                       capitalize and amortize over 60 months
               2. If software developed by taxpayer but is not in experimental stage, depreciate over 3
                        years using straight-line
               3. Purchased software can either be immediately expensed or
                       a. depreciated over 5 years along with computer hardware it came with or
                       b. if purchased separately, depreciate over 3 years using straight-line




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