Chapter 10 Tax Notes
Chapter 10 Tax Notes ACCT 404
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This 5 page Class Notes was uploaded by Victoria Andreski on Saturday April 16, 2016. The Class Notes belongs to ACCT 404 at Clemson University taught by Sarah Martin in Spring 2016. Since its upload, it has received 7 views. For similar materials see Individual Taxation in Accounting at Clemson University.
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Date Created: 04/16/16
CHAPTER 10—Property Acquisition & Cost Recovery Cost Recovery • Businesses must capitalize the cost of assets w/ a useful life of more than 1 year on the balance sheet rather than expense the cost immediately • Aka depreciation (tangible property), amortization (intangibles), or depletion (natural resources)—depending upon the underlying nature of asset o Depreciation—deducting the cost of tangible personal & real property over a specific period of time (trucks, equipment, buildings, computers) § Land is NEVER depreciable b/c it is not subject to wear, tear, & obsolescence § Personal—equipment, computers, tractor that is used in a business § Real—land, building, & anything attached to the building o Amortization—deducting the cost of intangible property over a specific period of time (copyrights, patents, goodwill, organizational cots) o Depletion—deducting the cost of natural resources over time (natural gas, minerals, oil, timber) § Extracting something from the land • Businesses use these methods to recover cost of assets due to wear, tear, & obsolescence of assets • The basis of an asset must be reduced for tax purposes by the cost recovery deduction ALLOWED or ALLOWABLE o If a business doesn’t deduct the ALLOWABLE amount of depreciation for the year, it must still reduce the asset’s basis by the depreciation expense it could have deducted (ALLOWED) under the method it is using to depreciate the asset (even if it was a mistake) o Original Basis (Initial/Historical Cost) – Accumulated Depreciation = Adjusted Tax Basis o Taxpayer can start recovering the cost of an asset when the asset has ben PLACED IN SERVICE § Adjusted/tax basis—amount of an asset’s cost that has not been recovered yet through cost recovery § Initial basis—cost plus all expenses to purchase, prepare it for use, & begin using the asset • Includes: o Sales tax o Shipping o Installation expenses • Additional costs after the asset has been placed in service: o Routine maintenance—immediately deduct as ordinary business expense o Betterments, restoration, or new or different use— significantly extends asset’s useful life or increases the asset’s value—capitalize & depreciate • Basis for Cost Recovery o Personal property converted to business or rental use. Basis is lessor of: § 1. Cost basis or § 2. Fair market value on date of conversion to business use o Asset acquired by gift have carryover basis from the transferor (same basis the transferor had in the gift) o Asset acquired by inheritance generally has basis equal to fair market value on transferor’s data of death Depreciation • Before 1981, tax depreciation methods closely resembled financial accounting methods which required businesses to determine “salvage values” & “useful lives” • In 1981, ACRS (Accelerated Cost Recovery System) was introduced to depreciate assets over predetermined, fixed recovery periods • Today, businesses calculate their tax depreciation using the MACRS (Modified Accelerated Cost Recovery System) which is pronounced “makers” by tax accountants • To compute MACRS depreciation for an asset, the business needs to know the following: o Original cost o Applicable depreciation method o Recovery period (or depreciable “life”) o Applicable depreciation convention (depreciation deductible in the year of acquisition & the year of disposition) • Personal property depreciation o Includes all tangible property such as computers, automobiles, furniture, machinery and equipment, other than real property o Personal property (not real property) & personal use property (used for personal purposes) not the same • Depreciation method o 3 acceptable methods for depreciating personal property § 200% (double) declining balance—MACRS Method § 150% declining balance § Straight-line • Depreciation recovery period o Financial accounting—an asset’s recovery period (depreciable life) is based on its taxpayer-determined estimated useful life o Tax purposes—an asset’s recovery period is predetermined by categories in Rev. Proc. 87-56 based upon the property’s description § Determine the appropriate categories for assets, then use Rev. Proc. 87-56 to identify the recovery period for all assets in a particular category • Depreciation conventions o Half-year convention § One-half year’s depreciation is allowed in 1 & last year of an asset’s life § An IRS depreciation tables automatically account for the half-year convention in year of purchase & disposition § If an asset is disposed of before it is fully depreciated, only ½ of the table’s applicable depreciation percentage is allowed in the year of disposition o Mid-quarter convention § Steps to determine whether the mid-quarter convention applies • 1) Sum of the total basis of tangible personal property that was placed in service during the year • 2) Sum of the total basis of tathible personal property that was placed in service during the 4 quarter • 3) Divide step #2 by step #1 if the quotient is more than 40%, then the business must use this method; otherwise half-year convention is used • Calculating depreciation for personal property o Locate the applicable table provided in Rev. Proc. 87-57 o Select the column that corresponds w/ the assets recovery period o Find the row identifying the year of the assets recovery period • Applying the half-year & mid-quarter convention o Half-year convention for year of disposition o Mid-quarter convention for year of disposition • Real Property o It uses mid-month convention & depreciated using straight line method • Immediate Expensing o This incentive is commonly referred as Section 179 expense or immediate expensing election o Limits on immediate expensing o Choose the assets to immediately expense • Bonus depreciation o To stimulate the economy, policy makers occasionally implement bonus depreciation • Listed property o Business can use the following steps to determine its current depreciation expense for the asset § 1) Compute depreciation for the year if it drops to 50% or below using the straight-line method § 2) Compute amount to be deducted if straight-line method is used over ADS recovery period for all prior years (limited to business—use %) § 3) Compute the amount of depreciation, taxpayer actually deducted on the assets for all prior years § 4) Subtract amount of step 2 & 3, which is prior year accelerated depreciation in excess of straight-line depreciation § 5) Subtract amount of step 4 from step 1, which is business’s allowable depreciation expense on the asset for that year • Luxury Automobiles o Tax laws generally limit annual depreciation expense for automobiles so that businesses cannot take advantage of large depreciation deductions for “luxury” automobiles that cost much more money than ordinary autos, which would do the same job. o Maximum depreciation schedule is published each year for autos placed in service that year. o For 2010 – 2014 an extra $8,000 of bonus depreciation above the maximum is allowed. o To calculate depreciation for luxury autos deduct the lesser of: o Calculate regular MACRS depreciation using the appropriate convention. o The maximum depreciation amount for the first year of the recovery period based on the year the auto was placed in service o If the auto depreciation limits apply in the first year, the taxpayer must use the maximum auto depreciation table for all subsequent years. o For 2015, luxury auto tables apply to autos costing > $15,800 o Don’t apply if the auto weighs > 6,000 pounds o Section 179 for trucks and SUVs weighing over 6,000 pounds is $25,000 (part of the $500,000 Section 179 amount) • For intangible assets businesses recover cost of the asset through amortization • Intangible assets in the form of capitalized expenditures (capitalized research & experimentation-R&E costs or covenants) do no have physical characteristics • Intangible assets have one of the following characteristics: o Section 197 Intangibles § According to Section 197, these assets have a recovery period of 180 months (15 years), regardless of their actual life § Uses full month convention allows taxpayers to deduct an entire month’s worth of amortization for the month of purchase & all subsequent months in the year o Start-up expenditures & organizational costs § Organizational expenditures include expenditures to form & organize a business in the form of a corporation or a partnership & are incurred prior to the starting business § Start-up accosts are costs businesses incur to, start up a business o Research & experimentation costs § To stay competitive, businesses often invest in activities which will generate innovative products or significantly improve their current products or processes § Businesses may immediately expense these costs or they may elect to capitalize & amortize these costs using the straight-line method over a period of not less than 60 months, beginning in the month benefits are first derived from the research o Patents & Copyrights § It depends on if business directly purchases the patent or copyright or whether it creates the intangibles itself § Businesses directly purchasing patent or copyrights amortize the cost over the remaining life of the patents or copyrights § Businesses receiving “self-created” patents or copyrights amortize the cost or basis of the self-created intangible assets over their legal lives • Up to a maximum of 17 years for patents & 28 years for copyrights • Costs included in basis of self-created patent or copyright include: o Legal costs o Fees o Unamortized research & experimentation expenditures Depletion • A method used to recover capital investment in natural resources • Businesses compute annual depletion expense under both the cost & % depletion methods & they deduct the larger of the 2 o Cost depletion § Estimate or determine the # of units that remain at the beginning of the year & allocate a pro-rata share of the basis to each unit extracted during the year § Because cost depletion uses estimates of the # of units remaining, it is possible that it is inaccurate (may not extract what you estimate you will) o Percentage completion § Multiply gross income from the resource extracted during the year by a fixed % based on the type of natural resource § Cannot exceed 50% (100% for oil & gas) of TAXABLE INCOME from the natural resource before considering depletion § Reduce basis in the resource then % depletion is deducted § When basis in the natural resource is fully deducted, taxpayer is allowed to continue to deduct % depletion, but not cost depletion • Taxpayers must estimate or determine the # of units or reserves that remain at the beginning of the year & allocate a pro rata share of that basis to each unit that is extracted during the year • Once entire cost is recovered, businesses are not allowed to use cost depletion to determine depletion expense • The amount of % depletion for a natural resource business activity is determined by multiplying the gross income from the resource extraction activity by a fixed % based on the type of natural resource
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