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Objectives. State the 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 depreciation recapture, and describe the election to expense certain depreciable business assets.. Objectives.
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1. The American College: HS 321Income Taxation Class 7: Chapters 11 and 12
Cost Recovery Deductions
2. Objectives State the 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 depreciation recapture, and describe the election to expense certain depreciable business assets.
3. Objectives Describe cost recovery limitations on certain depreciable assets collectively known as listed property, and explain the concept of amortizing certain intangible assets.
Explain the limitations on passive-activity losses and credits.
4. History of Depreciation Methods
5. History of Depreciation Methods Pre-1981
1971 class life system with ADR or facts and circumstances
1981–present: ACRS/MACRS
Eliminates estimates and salvage value
Shortens recovery period
1986 TRA ’86: MACRS effective 1/1/87
6. Calculating Depreciation
7. Calculating Depreciation Cost — $10,000
Useful life — 5 years
Recovery per year — $2,000
8. ACRS and MACRS
9. MACRS General concept
Statutory life-mandatory “cost recovery”
Prescribed depreciation rates
No salvage value
10. MACRS Property covered: MACRS applies to all T.P. (tangible property) that is
Used in T/B or for production of income
Subject to depreciation, i.e., determinable life and is subject to exhaustion, wear and tear, and obsolescence
11. ACRS/MACRS Application to real property
Apply recovery % from 15, 18, or 19, 27.5, 31.5, and 39 year tables to unadjusted basis.
12. ACRS/MACRS .01819 X $150,000 = $2,728.50
13. ACRS and MACRS(Continued)
14. Special 40% 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 midquarter convention will apply.
15. Quiz Questions
16. Short Quiz #1 A depreciation deduction for property placed in service before January 1981 may be claimed under one of several acceptable depreciation methods.
True
False
17. Short Quiz #1 Under the double-declining-balance method of depreciation, the annual amount of depreciation for an asset with a life of 5 years would be 40% of an asset’s unrecovered cost.
True
False
18. Depreciation and Recapture
19. Recapture When 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.
Rationale (Sections 1245 and 1250)
20. Recapture Rules
Sale of most TPP and real estate for a gain — recapture lesser of the realized gain or the depreciation already taken
Personal (Sec. 1245) Property: Full recapture
21. Section 1250
22. Section 1250 Rules
Realty (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.
23. Expensing: Section 179
24. A Key Deduction: Expensing Section 179 General rule for Section 179
Businesses may expense, rather than capitalize and depreciate, some TPP asset acquisitions (N/A to R/E). This is now the only graphic from this section.This is now the only graphic from this section.
25. Quiz Questions
26. Short Quiz #2 The expensing election is available for property held for investment.
True
False
27. Listed Property: Section 280F
28. Limitations for Some Property Used for Both Personal & Business Use(a.k.a. “Listed Property” Section 280F) Listed property
Passenger 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)
29. Limitations for Some Property Used for Both Personal & Business Use(a.k.a. “Listed Property” Section 280F) Listed property
Property used for entertainment, recreation or amusement, unless used in a regular business establishment
30. 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 service
No Sec. 179 expensing
ADS depreciation required(i.e., straight-line depreciation)
31. 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. 162 authorizes deductions)
But, use of assets for production of income is included in calculating depreciation
32. 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 approxAdded approx
33. 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 RemovedNumbers Removed
34. 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 costing approximately $16,000. Added approxAdded approx
35. 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).
36. Amortization of Intangibles
37. Amortization of Intangibles Amortize using SL method, over useful life (Sec. 197).
Examples: Goodwill and Covenants not to compete
Amortize over 15 years, SL
Effective as of August 11, 1993
38. Quiz Questions
39. Short Quiz #3 The dollar limits applicable to luxury automobiles prevent them from ever being fully depreciated for tax purposes.
True
False
40. Short Quiz #3 Certain intangible assets acquired after August 10, 1993, are eligible for amortization over a fixed period.
True
False
41. Chapter 12:“Passive” Activities
42. Chapter 12: “Passive” Activities Definition of “passive activity” turns on the term “material participation.”
Rental activities are “passive” regardless of participation unless taxpayer is a dealer or full-time property manager.
43. Chapter 12: “Passive” Activities Deductible passive-activity losses generally limited to taxpayer’s passive activity income.
44. General Features of Section 469Passive Activities Section 469 applies to individuals, estates, trusts, personal service corps., and closely held corporations.
45. General Features of Section 469Basic Tax Aspects Losses from passive activities cannot be deducted from active or portfolio income.
Unlimited carryovers of disallowed losses.
46. General Features of Section 469Basic Tax Aspects Accumulated (carryover) passive losses are deductible from active and/or portfolio income without limitation if the activity is completely disposed of in a taxable transaction to a nonrelated party. Deducted in order against:
Passive gains on the sale
Current year passive income
Active/portfolio income
47. General Features of Section 469Basic Tax Aspects For closely held corporations, passive losses can offset active income but not portfolio income. (Corporations not closely held are not subject to passive limitations.)
48. General Features of Section 469Basic Tax Aspects Tax credits produced from passive activities can offset only taxes attributable to passive income, with unlimited carryovers of unused credit.
49. Applying Section 469 If the sum of all passive activity = net loss, then apply passive-activity rules.
If the sum of all passive activity = net gain, then the passive-activity rules don’t apply that year.
Unlimited c/o of disallowed losses.
50. Exceptions to thePassive Activity Rules
51. Exception to Passive Activity Rules(Rental Activities) When is a rental activity not deemed “passive”?
Unlimited losses from the rental can be deducted if the TP meets 2 tests:
More than 50% of all personal services during the year must be for real property trade or business, and
The TP performs more than 750 hours in real property trades or businesses.
52. Exception to Passive Activity Rules(Rental Activities) When is a rental activity not deemed “passive”?
Unlimited losses from the rental can be deducted if the TP meets 2 tests:
More than 50% of all personal services during the year must be for real property trade or business, and
The TP performs more than 750 hours in real property trades or businesses.
53. Exception to Passive Activity Rules Individual TPs who “actively participate” in passive rental real estate businesses may deduct up to $25,000 in losses per year from nonpassive income.
This $25,000 allowance is reduced by 50% of the individual’s AGI in excess of $100,000 of nonpassive income.
54. “Active Participation” inPassive-Rental Activities TP must have > 10% ownership interest (in the value of the property).
TP must have “significant and bona fide” involvement.