Long-term Asset Allocation

1. Long-term Asset Allocation Depreciation, Cost Recovery, Amortization, and Depletion

2. History • Has changed many times, • Usually operating under TRA 1986 • Additional first-year depreciation – timed 50% for 2008-2010 0n NEW property only • Real estate estimated lives change; watch euls for property placed in service 1986-1996

3. Overview • Generally using “MACRS” – DDB for personal property; S/L for real property • Zero salvage value • Due to past abuses, estimated useful lives are “given” • Separate, less-favorable calculation for AMT

4. What/When • Begin in the year the asset is placed in service, not acquired • Qualifying property must be • Income-producing • Finite life • Valued at cost or FMV when property was converted from personal use, if lower

5. Is it depreciable? • Valuable art? • No definite useful life (Rev. Rul. 68-232) • Antique violin? • If actually played in performances (Liddle v. Comm., 95-2 USTC ¶50,448)

6. MACRS %s • 3,5,7,10-year properties, DDB, HY • 15, 20-year properties, 150%DB, HY • Real property, S/L, MM • Residential real estate: 27.5 years • Non-residential real estate: 39 years

7. Mid-quarter Convention • More than 40% of property being depreciated is being placed in service during last quarter of year • Excludes property expensed under §179

8. Sample Question • During the year, Fine Furnishings, a manufacturer of furniture, pur­chased the following assets: • Date Asset Cost • February 15 Lathes $ 40,000 • March 3 Saws 50,000 • October 9 Warehouse 110,000 • In computing depreciation of these assets, which of the following conventions will be used? • a. Half‑year, mid‑month • b. Mid‑quarter, mid‑month • c. Half‑year, mid‑quarter, mid‑month • d. Mid‑quarter • e. Some combination other than those given above

9. Sample Question – Use Table in Book to Solve • On March 27 of the current year, T Inc., a greeting card manufacturer, placed a new building in service to house its operations. The portion of the cost allocated to the building was $200,000. T's maximum depreciation deduction for the year is • a. $3,970. • b. $4,060. • c. $3,214. • d. $5,128.

10. §179 – Small Business Write-offs for Depreciable Property • Direct write-off up to $250,000 in 2008 • Tangible new or used personal property only eligible • 179 amount reduces depreciable basis • Small company is one that puts $800k or less per year in production • 179 cannot be used to generate loss

11. Sample Question • Kay Smart operates a cosmetic manufacturing business. During the year, the business placed in service $296,500 of property eligible for limited expensing under § 179. Ms. Smart wisely elected § 179. The maximum amount that she can expense under § 179 is • a. $0. • b. $250,000. • c. $296,500. • d. $800,000.

12. Listed Property • Property that is likely both business and tempting to use for personal use • Computers, cars, cell phones • May only depreciate business use portion • If used less than 50% for business, must straight-line; no §179

13. Sample Question • Certain "listed property" is subject to limitations regarding capital recovery if it is not used more than 50 percent for business. What category below is not a kind of listed property? • a. Computer equipment not used exclusively at a regular business establishment • b. Passenger automobiles • c. Motorcycles • d. Photographic equipment • e. Furniture

14. Luxury Autos • Drive a hoopty! • Passenger vehicles with weight of 6,000# or less are limited to $10,960 for 2008 in first-year recovery, including §179 (less apportioned personal use) • Tip: weight is usually found on the sticker on the driver’s side door • Limit for SUVs, $25,000 but may also take special 50% bonus depreciation, putting the remainder under the luxury cap for regular depreciation limits. • If luxury auto (>$18,500-2009)is leased, lease payments are deductible by taxpayer, but luxury portion is added back in to taxpayer’s income

15. Change from Business to Personal Use • Cost recovery recapture is triggered • That is, the excess of MACRS over SL is added back as ordinary income • S/L used for remainder of asset’s EUL

16. Substantiation Rules • Amount of expense • Time and place of use • Business purpose • Business relationship

17. Alternative Depreciation System (ADS) • Used for AMT • S/L, longer lives real property • 150DB • $0 salvage

18. Amortization • Most are 15-year period, from month intangible is acquired • Self-created intangibles not amortized

19. Depletion • Small producers may use (standard rate) percentage depletion • Rates are universal per mineral type • All oil producers use one rate; but timber producers may use another • Any can use cost recovery, which is how it’s done using GAAP

20. Best of TaxLetter: Can I Depreciate My Cat? A brochure answers a complex question to motivate tax practitioners into buying the advertised book: "Livestock held for work, breeding or dairy purposes may be depreciated over its useful life subject to an allowance for salvage value. Livestock includes chinchillas, mink, foxes and other furbearing animals. If held for breeding (or draft) purposes, a cat is not inventory. Therefore, assuming the cat meets these tests, the cat will be depreciable unless the catbreeding activity is subject to the passive loss rules, at risk limitations, or the rules denying losses for activities not engaged in for profit. If you sell the cat it will be treated as Section 1231 property, and depreciation will have to be recaptured, unless the disposition is in connection with a divorce. To avoid recapture, it's best to contribute the depreciated cat to charity." (No. 71)