Ch. 7: Property Acquisitions and Cost Recovery Deductions

Capitalization

An accounting requirement that an expenditure be charged to a balance sheet account rather than against the firm’s current income.

Research and Experimental Expenditures

A preferential deduction for costs of basic research designed to encourage businesses to conduct such research.

• Must be capitalized and amortized over 5/ 15 years

Intangible Drilling and Development Costs (IDCs)

Expenses such as wages, fuel, repairs to drilling equipment, hauling, and supplies associated with locating and preparing oil and gas wells for production

• Deductible for federal tax purposes.

Tax Basis

A taxpayer’s investment in any asset or property right and the measure of unrecovered dollars represented by the asset.

Adjusted Basis

The initial tax basis of an asset reduced by cost recovery deductions allowable with respect to the basis.

Cost Basis

The purchase price of an asset, including any sales tax paid by the purchaser and any incidental costs related to getting the asset in place and into production.

Leverage

The use of borrowed funds to create a tax basis.

Cost of Goods Sold

The capitalized cost of inventory sold during the taxable year and subtracted from gross receipts in the computation of gross income.

Uniform Capitalization (UNICAP) Rules

The set of tax rules governing the type of current expenditures that must be capitalized to inventory.

Specific Identification Method

An accounting method under which cost of goods sold includes the actual cost of specific items of inventory sold during the year.

FIFO (First In, First Out)

The inventory costing convention under which the first goods manufactured or purchased are assumed to be the first goods sold.

LIFO (Last In, First Out)

The inventory costing convention under which the last goods manufactured or purchased are assumed to be the first goods sold.

• Maximizes cost of goods sold and minimizes cost of ending inventory

Depreciation

The systematic deduction of the capitalized cost of tangible property over a specific period of time.

Modified Accelerated Cost Recovery System (MACRS)

The statutory and regulatory rules governing the computation of depreciation for tax purposes.

• Estimated useful life of asset is irrelevant

Recover Periods

The number of years prescribed by statute over which the basis of tangible business property is depreciated under MACRS.

Qualified Improvement Property

Certain nonstructural improvement to the interior of nonresidential real property, qualifying for a 15-year recovery life and the Section 179 election.

Half-Year Convention

Property placed in service on any day of the taxable year is treated as placed in service halfway through the year for MACRS purposes.

• First year of recovery period, 6 months of depreciation is allowed, regardless of when the asset was placed in service

  • Also applied to the year in which asset is disposed (6 months of depreciation)

• EXCEPTION: If 40%+ of assets is placed in service within the 4th quarter, use midquarter convention

Midquarter Convention

Property placed in service on any day of a quarter is treated as placed in service at the midpoint of the quarter for MACRS purposes.

Midmonth Convetion

Property placed in service on any day of a month is treated as placed in service at the midpoint of the month for MACRS purposes.

Passenger Automobiles

Four-wheeled vehicles manufactured primarily for use on public roads with an unloaded gross vehicle weight of 6,000 pounds or less.

• Exception to MACRS depreciation

Section 179 Election

The election under which firms can expense a limited dollar amount of the cost of tangible personalty placed in service during the taxable year.

• Maximum deduction amount= $1,220,000

• ONLY includes tangible depreciable personalty

• Threshold= $3,050,000

Bonus Depreciation

Accelerated deduction in the year placed in service of 50 percent or 100 percent of the cost of qualified tangible personal property.

• Section 179 is applied first

• Remainder goes to bonus depreciation

Amortization

The ratable deduction of the capitalized cost of an intangible asset over its determinable life

• Amortization is ONLY allowed it asset has deteriminable life

Organizational Costs

Expenditures incurred in connection with the formation of a partnership or corporate entity.

• Can deduct the lesser of it’s costs or $5000

  • If total costs exceed $50,000, you must reduce the $5000 number

Start-Up Expenditures

Up-front costs of investigating the creation or purchase of a business and the routine expenses incurred during the pre-operating phase of a business.

• Firm may deduct the lesser of it’s actual expenditures or $5000

• Firm must capitalize any non-deductible expenditures and amortize it over 180 months, starting with month where business begins

Expansion Costs

Costs of enlarging the scope of operations of an existing business.

Leashold Costs

Up-front costs incurred to acquire a lease on tangible business property.

• Must be capitalized and amortized

Leasehold Improvements

Physical improvements made by a lessee to leased real property.

• Must be capitalized to asset account, assigned to MACRS recovery period, and depreciated under MACRS rules

Goodwill

Value created by the expectancy that customers will continue to patronize a business.

Going-Concern Value

Value attributable to the synergism of business assets working in coordination.

• Amortize over 180 months, starting with month where intangible asset is acquired

Cost Depletion

The method for recovering the capitalized cost of an exhaustible natural resource.

• Equals unrecovered basis in the resource (mine or well) multiplied by the ratio of units of production sold during the year to the estimated total units of production at the beginning of the year.

Percentage Depletion

An annual deduction based on the gross income generated by a depletable property multiplied by a statutory depletion rate.