Presentation on theme: "The American College: HS 321 Income Taxation"— Presentation transcript:
1The American College: HS 321 Income Taxation ________________________________________________________________________The American College: HS 321 Income TaxationChapter 11 Cost Recovery DeductionsStudent Workbook for HS 321
2Chapter 11 OverviewState the pre-ACRS history of cost recovery, and explain how accelerated cost recovery systems (ACRS and MACRS) allow the recovery of investment capital for income tax purposes.Explain how the accelerated cost recovery systems of ACRS & MACRS allow the recovery of investment capital..
3Chapter 11 Overview - Continued Explain depreciation recapture and the election to expense certain depreciable business assets.Describe cost recovery limitations on certain depreciable assets collectively known as listed property, and explain the concept of amortizing certain intangible assets.
4Learning ObjectiveExplain what is meant by cost recovery, recovery method, and recovery period; identify the four basic conditions for the allowance of cost recovery deductions.
5Purpose of Depreciation Deduction Recovery of capital investment in qualifying property a) used in a trade or business or b) held for the production of income.Non qualifying property such as raw land, inventory.Date property placed in service determines the cost recovery method and cost recovery period.
6Learning ObjectiveDescribe methods for computing depreciation deduction for pre-ACRS assets and distinguish depreciation from obsolescence.
7History of Depreciation Methods 1971 class life system with ADR or facts and circumstances1981–present: ACRS/MACRSEliminates estimates and salvage valueShortens recovery periodTRA ’86: MACRS effective 1/1/87
9Four Methods for Calculating Depreciation Straight lineDeclining balanceSum of the years digits methodAny other consistent method
10Straight line Depreciation Cost of property divided by estimated useful life.EXAMPLE….20 year property purchased for $10,000 yields 20 equal depreciation deductions of $500.The adjusted basis is being reduced each year by the depreciation deduction of $500.
11Declining Balance Method Fixed percentage of the unrecovered cost of the asset is deducted each year.EXAMPLE 20 year asset would depreciate at 5%. Under declining balance method up to 10% is depreciation each year.In year 1, the deduction is 10% of basis.In year 2 and following it is 10% of remaining basis until full cost recovery.
12Sum of the Years Digits Similar to a declining balance method Numerator is number of years of useful life for the year of deduction.Denominator is the sum of the numbers representing each year of property’s useful life.Example 5 year property depreciates at5/15, 4/15, 3/15, 2/15, 1/15
13Any Other Consistent Method Any method so long as not resulting in depreciation greater than that under declining balance method during the first 2/3 of asset’s useful life.Must be based on actual use of the property.Used for assets undergoing initial intense periods of use.
14Obsolescence Deduction Loss of economic usefulness of property due to abnormal causes rather than usual wear and tear.Deduction is allowed in addition to depreciation.
15Learning ObjectiveExplain how the accelerated cost recovery systems of ACRS and MACRS allow the recovery of investment capital for income tax purposes.
17Cost Recovery Systems ACRS Property placed into service between 1/1/1981 – 12/31/86MACRSProperty placed into service after 12/31/1986.
18Recovery Periods for MACRS 5 year class…..autos, computers.7 year class…..business equipment, office furniture; most heavy machinery.27.5 year class…..residential real estate like apartment buildings.39 year class…..nonresidential real estate like office buildings.
19Recovery Method for MACRS Double Declining Balance MethodExample – Autos
20MACRS 150% Declining Balance Method Examples – 15 year property such as land improvements20 year property such as municipal sewers.
21MACRS Straight line depreciation Examples – Residential Real Estate Nonresidential real estate
22Operation of MACRSThe depreciation deduction for nonresidential real property placed into service during the month of April would be calculated per Table1.819% of $150,000 = $2,
24Cost Recovery Conventions Purpose is to determine how much cost recovery is allowed for the year the asset is placed into service.
25Cost Recovery Conventions –Half-Year Rule Half-Year Convention for Assets in property classes fewer than 20 year.The equivalent of 6 months depreciation (not 12) is allowed in year property placed in service; remaining 6 months are depreciated in year of disposition or in last year of the recovery period.
26Cost Recovery Convention –Mid-Quarter Rule If >40% of aggregate bases of all TPP placed in service during the year is placed in service in the last 3 months of the year, a mid-quarter convention will apply.Purpose of the rule is to prevent the taxpayer from claiming 6 months depreciation for property placed in service during the last 3 months of the year.
27Alternative Recovery Periods Under MACRS Taxpayer may elect straight line treatment if property otherwise eligible for the declining balance methodTaxpayer may elect 150% declining balance method for property otherwise eligible for 200% declining balance method.
28Implications of Depreciation on Basis to Property Basis must be reduced by allowable depreciation regardless of whether the taxpayer claims the depreciation deduction on the tax return.
29Learning ObjectiveExplain the concepts of depreciation recapture and the section 179 expensing of certain depreciable business assets.
31RecaptureWhen some assets are sold or disposed of at a gain, part of the gain may be “recaptured” by adding it to ordinary income.Depreciation recapture is limited to the lesser of the gain realized or the depreciation already taken.Recapture rules for personalty are under section 1245; real estate under section 1250.
32Recapture Rules under sections 1245 and 1250 Sale of most TPP and real estate for a gain — recapture is lesser of the realized gain or the depreciation already takenPersonal (Sec. 1245) Property: Full recapture
34Section 1250RulesRealty (Sec. 1250): Only excess depreciation recaptured on ACRS property.Post 1986 realty (Sec. 1250): “Special” 25% rate applies to capital gain attributed to depreciation upon sale.
36A Key Deduction: Expensing Section 179 ________________________________________________________________________A Key Deduction: Expensing Section 179General rule for Section 179Businesses may expense, rather than capitalize and depreciate, some asset depreciable personal property.Real estate ineligible for Section 179 Expensing.Property held for the production of income also ineligible for Section 179.This is now the only graphic from this section.Student Workbook for HS 321
37Expensing Under Section 179 Deductible amounts are $500K for 2011 and $125K for 2012.Phaseout begins at $2.0 M in 2011 and $500K in 2011.
42________________________________________________________________________ Limitations for Some Property Used for Both Personal & Business Use (a.k.a. “Listed Property” Section 280F)“Luxury” automobiles: Section 280F limits both MACRS depreciation and Section 179 expensing.A “luxury” auto is a passenger car excluding taxis and rental carsAdded approxStudent Workbook for HS 321
43________________________________________________________________________ Limitations for Some Property Used for Both Personal & Business Use (a.k.a. “Listed Property” Section 280F)“Listed property does NOT include: Trucks, vans, and “heavy land yachts” (i.e., Hummers) weighing over 6,000 pounds, ambulances, hearses, and vehicles used in transporting services (limo services).Student Workbook for HS 321
44________________________________________________________________________ Limitations for Some Property Used for Both Personal & Business Use (a.k.a. “Listed Property” Section 280F)Listed propertyPassenger automobiles (under 6,000 pounds)Other property used for transportation (motorcycles, boats, planes)Computer or peripheral equipment unless used exclusively in a regular business establishment (includes home offices under Sec. 280A)Student Workbook for HS 321
45________________________________________________________________________ Limitations for Some Property Used for Both Personal & Business Use (a.k.a. “Listed Property” Section 280F)Listed propertyProperty used for entertainment, recreation or amusement, unless used in a regular business establishmentStudent Workbook for HS 321
46________________________________________________________________________ Limitations for Some Property Used for Both Personal & Business Use (a.k.a. “Listed Property” Section 280F)Limitations:If “qualified business use” ≤50% in year the listed property is placed in serviceNo Sec. 179 expensingADS depreciation required (i.e., straight-line depreciation)Student Workbook for HS 321
47________________________________________________________________________ Limitations for Some Property Used for Both Personal & Business Use (a.k.a. “Listed Property” Section 280F)Limitations:“Qualified Business Use”Includes only T/B use (business for which Sec authorizes deductions)But, use of assets for production of income is included in calculating depreciationStudent Workbook for HS 321
48________________________________________________________________________ Limitations for Some Property Used for Both Personal & Business Use (a.k.a. “Listed Property” Section 280F)“Luxury” automobiles: Section 280F limits both MACRS depreciation and Section 179 expensing.Added approxStudent Workbook for HS 321
49________________________________________________________________________ Limitations for Some Property Used for Both Personal & Business Use (a.k.a. “Listed Property” Section 280F)Cost recovery limitations significantly limit depreciation. The maximum limitations represent 100% business/production use.Numbers RemovedStudent Workbook for HS 321