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Chapter 10

Chapter 10. Depreciation, Cost Recovery, Amortization, and Depletion. Learning Objectives. Understand the general concepts of tax depreciation Classify property and calculate depreciation under the MACRS rules

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Chapter 10

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  1. Chapter 10 • Depreciation, Cost Recovery, Amortization, and Depletion

  2. Learning Objectives • Understand the general concepts of tax depreciation • Classify property and calculate depreciation under the MACRS rules • Calculate amortization for intangible assets and understand the difference between amortizable and non-amortizable assets • Apply cost and percentage depletion methods and understand the treatment for intangible drilling costs

  3. Introduction • Allows taxpayers to deduct a reasonable allowance for the exhaustion, wear and tear, and obsolescence. • Taxpayers must use specific depreciation methods depending on when an asset is placed into service.

  4. Depreciation and Cost Recovery • Property placed into service prior to 1981 • Property placed into after December 30, 1980 and before January 1, 1987 • Property placed into service after December 31, 1986

  5. Common Rules of All Systems • No depreciation may be claimed on land or other assets that have an indefinite life (works of art). • Depreciation is permitted in the year the asset is placed into service • Consistency is required, no matter which system is used

  6. Types of Property • Tangible Property • Intangible Property • Real Property • Personal Property vs. Personal-Use Property

  7. Depreciation Methods 1986 and later years • MACRS • Personal property • Use 3, 5, 7, 10, 15, 20 year useful life • 200% declining balance with a conversion to straight-line • Half-year convention(no matter when asset is placed into service, the first year can only take a half years depreciation) • Mid-Quarter convention is used when the aggregate basis of all personal property placed into service during the last three months of the year exceed 40% • No salvage value

  8. Depreciation Methods • Real Property • Residential rental property: 27.5 years • Nonresidential rental property: 39 years • Depreciation is calculated using the straight-line method • Mid-month convention –year of acquisition and year of disposition • Straight-line or Alternate Depreciation System(ADS)

  9. Section 179 Expensing Election • May elect to expense up to $24,000 in 2001 Placed into service during the year • Not applicable to real estate, only applicable personal property.

  10. Section 179 Expense

  11. MACRS Restrictions • Portion of asset used for personal use is not depreciable • Listed property rules • Recapture of excess cost-recovery • Luxury automobile limitation (see textbook for limits)

  12. Amortization Intangible Assets • Definition of Section 197 – Goodwill and going concern value, covenants not to compete, franchise fees, trademarks, and trade names etc. • Classification and disposition of intangibles • A Sec. 197 asset is treated as depreciable property so that Sec. 1231 treatment is accorded. • Research and experimental expenditures • Include experimental and laboratory costs incidental to the development of a product.

  13. Depletion and Intangible Drilling and Development Costs • Treatment of intangible drilling and development costs (IDCs) • Capitalized or deducted currently • Decision to expense or capitalize depends on taxpayer’s current position (profit or loss)

  14. Depletion and Intangible Drilling and Development Costs • Depletion methods • Cost depletion method is calculated by dividing the adjusted basis of natural resource by expected quantity to be extracted • Percentage depletion method is calculated by multiplying the statutory depletion percentage times the gross income generated

  15. Tax Planning Considerations • Alternative depreciation under MACRS • IDCs: CAPITALIZATION VS. EXPENSING • Structuring a business combination

  16. Compliance And Procedural Considerations • IDCs Election • Form 4562 is used to report depreciation, depletion, and amortization deductions.

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