10-1 ©2007 Prentice Hall, Inc.

10-2 ©2007 Prentice Hall, Inc. DEPR., COST RECOVERY, AMORTIZATION, & DEPLETION  Depreciation and cost recovery  Amortization  Depletion, intangible drilling an development costs  Tax planning considerations  Compliance and procedural considerations

10-3 ©2007 Prentice Hall, Inc. Depreciation and Cost Recovery  General considerations  Depreciation methods  Calculation of depreciation  MACRS restrictions

10-4 ©2007 Prentice Hall, Inc. General Considerations (1 of 3)  Taxpayers must use specific depreciation methods depending on when an asset is placed into service  Prior to 1981  After 12/30/80 and before 1/1/87 (ACRS)  After 12/31/96 (MACRS)

10-5 ©2007 Prentice Hall, Inc. General Considerations (2 of 3)  Common rules to all systems  No depreciation may claimed on land or other assets with an indefinite life  Depreciation permitted in year asset placed into service  Apply method consistently  Basis of property being depreciated reduced by amount of allowable depreciation each taxable year

10-6 ©2007 Prentice Hall, Inc. General Considerations (3 of 3)  Types of Property  Tangible Property (physical)  Intangible Property (non-physical)  Real Property  Personal Property vs. Personal-Use Property

10-7 ©2007 Prentice Hall, Inc. Depreciation Methods (1 of 2)  MACRS  Personal property  Use 3, 5, 7, 10, 15, 20 year useful life  DDB with conversion to straight-line  Half-year convention  ½ year depr in 1 st year and year of disposition  Mid-Quarter convention when aggregate basis of all personal property placed into service during last three months of year exceed 40%  No salvage value

10-8 ©2007 Prentice Hall, Inc. Depreciation Methods (2 of 2)  MACRS  Real property  Residential rental property 27.5 years  Nonresidential rental property 39 years  Straight-line depreciation method  Mid-month convention in year of acquisition and year of disposition  Straight-line or Alternate Depreciation System (ADS)

10-9 ©2007 Prentice Hall, Inc. Calculation of Depreciation §179 Expense  May elect to expense up to $108K in 2006 for certain tangible personal property placed into service during the year  $ for $ phaseout if qualified property placed into service during year >$430K  Limited to taxable ToB income

10-10 ©2007 Prentice Hall, Inc. Calculation of Depreciation Year of Disposition  MACRS allows depreciation to be taken in year of disposition based on convention  E.g., ½ year, mid-quarter, mid-month

10-11 ©2007 Prentice Hall, Inc. MACRS Restrictions (1 of 2)  Portion of asset used for personal use is not depreciable  Listed property rules  Must use straight-line of business use < 50%  Recapture of excess cost-recovery if MACRS claimed and business use falls below 50%

10-12 ©2007 Prentice Hall, Inc. MACRS Restrictions (2 of 2)  Luxury automobile limitation  Depreciation cannot exceed ceiling limitations (see page P10-14)  Trucks, vans and SUVs (>6,000 lb)  More generous rules  Leased vehicles  Income inclusion based on IRS tables to eliminate avoiding luxury auto rules

10-13 ©2007 Prentice Hall, Inc.Amortization  §197 intangibles  Research and experimental expenditures  Computer software

10-14 ©2007 Prentice Hall, Inc. §197 Intangibles  Goodwill and going concern value, covenants not to compete, franchise fees, trademarks, trade names, etc.  Classification and disposition of intangibles  §197 asset treated as depreciable prop so that § 1231 treatment accorded disposition if held > 1 year

10-15 ©2007 Prentice Hall, Inc. Research and Experimental Expenditures  Include experimental and laboratory costs incidental to the development of a product (see table I10-4)  Tax treatment options  Expense in year paid  Defer and amortize costs over 60 mo.  Capitalize and write-off when project abandoned or is worthless

10-16 ©2007 Prentice Hall, Inc. Computer Software  Developed computer software  Cost of developing software is qualified R&E under §174  Expense immediately or  Amortize over 60 months  Separately purchased software  Straight-line depreciation over 36 months

10-17 ©2007 Prentice Hall, Inc. Depletion, Intangible Drilling and Development Costs (1 of 2)  Depletion methods  Cost depletion  Similar to units of activity depreciation  Percentage depletion  Depletion rates based on statutory percentages  Can claim depletion deductions in excess of cost over the life of the asset

10-18 ©2007 Prentice Hall, Inc. Depletion, Intangible Drilling and Development Costs (2 of 2)  Treatment of intangible drilling and development costs  Capitalized or deducted currently  Decision to expense or capitalize depends on taxpayer’s current position  Expected marginal tax rates

10-19 ©2007 Prentice Hall, Inc. Tax Planning Considerations  Alternative depreciation under MACRS  Units of production depreciation  May use instead of MACRS  Structuring a business combination  Must consider amortization of goodwill

10-20 ©2007 Prentice Hall, Inc. Compliance and Procedural Considerations  Form 4562 is used to report depreciation, §179 expense, depletion, and amortization deductions

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