Chapter 10: Property Acquisition & Cost Recovery

When must an asset be capitalized?

In general, when the useful life is > 1 year

What is included in an assets cost basis (depreciable basis)?

All expenses incurred to ourchase the asset, prepare it for use, and place it into service

• e.g. Sales tax, Shipping, instalation, and renovation costs

How is the basis calculated when multiple assets are purchased together?

Relative FMV (Proportionally based on FMV)

How is the basis calculated when an asset is converted from personal use to business use?

Cost basis = Lesser of cost or FMV on date of conversion

How is the basis calculated when an asset is received as a gift?

Cost basis = donor’s basis in asset (i.e., carryover basis)

How is the basis calculated when an asset is acquired through inheritance?

Cost basis = FMV on date of death

How is the basis calculated when an asset is acquired through a nontaxable like-kind exchange

Cost basis = carryover basis in asset transfer

When do businesses start recovering the cost of an asset?

Once it is placed into service

Once an asset is placed into service, are additonal expenses capitalized?

No

What is the formula for an Asset’s adjusted basis (tax basis)?

Tax basis = cost basis - accumulated depreciation

What are the three types of recovery methods?

Depreciation, amortization, and depletion

What are the steps to calculate depreciation for personal property (all business assets other than real property)

• Identify personal properties and their recovery periods

• Deduct section 179 expenses

• Decide depreciation convention (half-year or mid-quarter)

• Deduct bonus depreciation

• Multiply the remaining balance (depreciable basis) by the MARCS rate given in the depreciation tables

What are the allowed depreciation methods for personal property?

200% (double) declining balance

• Default method

• Annual depreciation = [(cost basis - AD) × 2] / recovery period

150% declining balance (150DB)

• Used to compute AMT depreciation

• Annual depreciation = ([(cost basis - AD) × 1.5] / recovery period

Straight line

• Annual depreciation = cost basis/recovery period

• 200DB and 150DB eventually switch to SL when SL provides greater depreciation

When is a depreciation method selected and when can it change (if at all)

It is first selected when an asset is placed into service

• It only changes when the annual SL becomes greater

Each year, businesses decide which depreciation method to use for all assets of one asset class placed into service that year

What are the convention options for personal property?

half-year and mid-quarter

What is the default convention for personal property?

Half-year

In what year(s) will depreciation convention affect annual depreciation for personal property?

The year in which asset is first placed into service and the year when the asset is disposed or last year of depreciation

Conceptually, why do the conventions exist?

It would be hard for the IRS to audit when assets where placed into service, so this serves to standarize it

Under the half-year convention, if an asset is placed into service on January 1st, what date will be used to calculate annual depreciation expense?

7/1, it doesn’t matter. Under HY, all assets are treated as if they were placed into service on 7/1

When is mid-quarter convention used for personal property depreciation?

When >40% of personal property placed in service during the year was placed into service during the fourth quarter

• >40% of the $ of the assets placed into service

How is the mid-quarter ratio calculated for early disposal?

The asset is treated as if it were placed into service in the middle of the quarter that it was actually placed into service

• e.g., Placed into service on:

  • Jan. 1 → 0.5/4 (1/8)

  • Q2 → 1.5/4 (3/8)

  • Q3 → 2.5/4 (5/8)

  • Q4 → 3.5 (7/8)

For residential rental property, how is the final annual depreciation calculated for early disposal?

Depreciation=annual dep. × (month of disposition - 0.5/12)

• It is treated like it is disposed in the middle of the previous month because you are unlikely to be generating revenue in the final weeks before disposal

What is the section 179 special rule?

Immediate expensing

• Taxpayers can deduct up to $2,500,000 of the aggregate cost of tangible personal property and qualified improvements to real property placed into service in current year

  • Intangible and real property is not eligible

• Subject to limitations

Can section 179 be applied to a warehouse?

No, real property is not eligible for section 179

What are the Section 179 limitations?

• Maximum section 179 expense (after phase-out): Section 179 deduction is reduced by a dollar for each dollar of tangible personal property over 4 million

• Business income limitation: Sec. 179 deduction limited to taxable income before the deduction; excess is carried forward indefinitely

  • Sec. 179 can not generate a loss

How does Section 179 affect MACRS depreciation?

• Taxpayers may choose which assets are expensed under Sec. 179

  • Normally best to apply to assets with the longest useful life

• Must reduce basis of assets by Sec. 179 deduction before computing MACRS depreciation

• Must reduce basis of assets by Sec. 179 deduction before determining whether mid-quarter convention applies

Go over examples that combine HY, Mid-quarter, and Sec. 179 over many years

Sorry, but you need to :)