Chapter

1. Chapter 7 Property Acquisitions and Cost Recovery Deductions

2. Expense vs. Capitalize • Deduction permitted for all “ORDINARY AND NECESSARY” business expenses • Deduction prohibited for “PERMANENT improvements to increase the value of property” • Some types of capitalized costs can be recovered through amortization or depreciation

3. Expense vs. Capitalize • Repairs and maintenance? Source of IRS dispute due to facts. • Capitalize expenditures that increase the value or useful life of an asset. • Environment cleanup and prevention costs: TRA1997 has a provision allowing firms to elect to deduct rather than capitalize expenditures to abate or control hazardous substances at contaminated areas.

4. Tax Basis • Tax basis = unrecovered cost (cost - depreciation). • Starting basis generally equals COST basis: • original purchase price regardless of whether acquired by debt, or • FMV of asset if cost more difficult to measure. • Cost recovery of • Inventory = cost of goods sold • Tangible assets = depreciation • Intangible assets = amortization • Natural resources = depletion

5. Cost of Goods Sold • Inventory Methods (must use accrual to account for COGS • 1) FIFO • 2) specific ID • 3) LIFO - If use LIFO for tax, must also use LIFO for books. • In times of inflation, LIFO decreases book and taxable income.

6. Depreciation • Depreciation applies to tangible assets (things you can touch versus intangibles like patents, goodwill) that: • Lose value over time due to wear and tear, obsolescence • Buildings depreciate even though real estate often increases in value. • Have a reasonably ascertainable useful life • Artwork is not generally depreciable.

7. Depreciation • MACRS - Modified Accelerated Cost Recovery System • Personalty: • DDB: 3, 5, 7, 10 • 150% DB:15, 20 • General rule is half year convention • Realty: SL method: 27.5 years residential, 39 years non-residential (specialty realty 20, 25, 50) • Mid Month convention

8. Depreciation Conventions - Personalty • Table 7-2 incorporates a half-year convention - provides only 1/2 of the regular rate in the year the property is put in service. • Anti-Abuse provision Mid-quarter convention • : IF > 40% personalty is acquired during the last quarter of the year, THEN • Compute depreciation separately for EACH quarter’s acquisition using mid-quarter tables in appendix of chapter 7

9. Automobiles • Maximum annual depreciation limit per vehicle, indexed for inflation. • Year 1 $3,160 (1st yr) with bonus $11,060 • Year 2 $5,100 (2nd yr) • Year 3 $3,050 (3rd yr) • Year 4 + $1,875 (4th +++ yrs). • Compute depreciation per MACRS, then limit above.

10. Expensing Election – Section 179 • Applies to tangible personalty. May expense $500,000 of assets purchased in year of acquisition • Expense cannot create a business loss. • Expense reduced $ for $ by purchases > $2,000,000 in 2014, $200K for 2015+ • 50% Bonus depreciation on personalty for tax years 2012-2019 none after • Planning - if buy a 3-year, 5-year and 7-year asset, which one should you expense?

11. Amortization of Intangibles • Generally requires a determinable useful life. • Organizational costs & Start up costs • Immediately deduct up to $5,000 • Amount over $5K amortized over 180 months. • Start-up costs & Organization costs are defined on pg. 177. • Expansion costs may be currently deductible.

12. Leasehold Costs and Improvements • Cost of acquiring lease is amortized over the period of lease. • Improvements to leased property are capitalized and depreciated according to type of property.

13. Purchased Intangibles • Allocate lump-sum price to assets by relative FMVs. • Residual = goodwill. • Tax = 15 years SL • GAAP = 40 years pre-2002. No GAAP amortization post-2001 - evaluate for impairment annually. Book-tax difference is permanent post-2001.