Ch. 2 - Property Acquisition and Cost Recovery (Taxation)

What are the three types of cost recovery?

Depreciation = tangible property; Amortization = intangible property; Depletion = natural resources.

When is cost recovery generally allowed, and why isn't land depreciated?

Cost recovery is generally allowed for assets used in a trade/business or income-producing activity that have a determinable useful life. Land does not have a determinable useful life, so its cost is generally recovered when sold or disposed of.

How is cost recovery determined for property used for both personal and business purposes?

Only the portion used for business or income-producing activities qualifies for a cost recovery deduction.

What basis is used when personal property is converted to business use?

The lesser of (1) fair market value (FMV) or (2) adjusted basis at the time of conversion.

What depreciation system generally applies to assets placed in service after 1986?

MACRS — the Modified Accelerated Cost Recovery System.

What is the de minimis safe harbor rule and what are its limits?

It allows immediate deduction of qualifying low-cost tangible personal property. The limit is $5,000 per invoice/item with an audited financial statement and $2,500 without one.

What does the routine maintenance rule allow?

Immediate deduction of qualifying routine, preventative, or cyclical maintenance. Replacement of damaged/worn parts may qualify if expected more than once during the applicable period and not part of a major renovation, restoration, or improvement.

What are the major MACRS personal-property classes?

3-year = dies, small tools, racehorses; 5-year = computers, copiers, autos, trucks, airplanes, buses; 7-year = office furniture, fixtures, equipment; 10-year = manufacturing equipment; 15-year = roads, landscaping, qualified improvement property; 20-year = farm buildings, fuel stations, buried cables.

What are the MACRS recovery periods for real property?

Residential real property = 27.5 years straight-line; Nonresidential real property = 39 years straight-line.

What is the formula for the annual MACRS deduction?

Depreciable basis × applicable depreciation percentage = annual MACRS deduction.

What is adjusted basis (tax basis)?

The amount of an asset's cost that has not yet been recovered through cost recovery deductions.

What are the three MACRS conventions and when do they apply?

Half-year = generally personal property; Mid-quarter = personal property when >40% of its cost is placed in service during the last 3 months; Mid-month = real property.

What does the half-year convention do?

It allows one-half year of depreciation in both the year personal property is placed in service and the year it is disposed of.

How does the mid-quarter convention work?

It allows one-half quarter of depreciation in the quarter property is placed in service or disposed of. Section 179 property is excluded when performing the >40% test.

How does the mid-month convention work?

It allows one-half month of depreciation in the month real property is placed in service or disposed of.

What alternatives can taxpayers elect instead of accelerated MACRS?

MACRS straight-line or ADS. MACRS straight-line uses the same recovery periods and conventions but straight-line percentages; ADS generally uses longer recovery periods and less accelerated methods.

What does Section 179 allow?

It allows a taxpayer to elect to expense qualifying property in the year of acquisition instead of recovering all of its cost through annual depreciation.

What are the 2026 Section 179 dollar limits?

Maximum expense = $2,560,000; phase-out begins when qualifying property exceeds $4,090,000; purchases above $6,650,000 are completely ineligible.

How does the Section 179 phase-out work?

The maximum Section 179 deduction is reduced dollar-for-dollar by qualifying property placed in service above the phase-out threshold.

What property generally qualifies for Section 179?

Depreciable tangible personal property and qualified real property improvements that are used at least 50% in a trade/business and acquired by purchase from an unrelated party.

What are qualified real property improvements for Section 179?

Qualifying improvements include roofs, HVAC systems, fire-protection and alarm systems, and security systems installed on nonresidential real property.

What is the Section 179 taxable income limitation?

The amount expensed cannot exceed taxable income from all of the taxpayer's trades/businesses computed without the Section 179 deduction. Unused amounts can be carried forward.

How should Section 179 generally be allocated if a business wants to maximize its current depreciation deduction?

Allocate Section 179 to eligible assets with the longest MACRS lives first.

What happens when Section 179 property is converted to nonbusiness use?

The taxpayer must generally recapture as income the difference between the amount expensed and the MACRS deductions that would have been allowed during the actual business-use period.

What property generally qualifies for bonus depreciation?

Qualifying property may be new or used, but used property cannot have been used by the taxpayer during the previous 5 years, and qualifying property generally must have a recovery period of 20 years or less.

What is the bonus depreciation percentage for qualifying property placed in service after January 19, 2025 according to the slides?

100%.

Can taxpayers elect out of bonus depreciation?

Yes. Bonus depreciation is mandatory for taxpayers who qualify unless they elect out on a property-class basis by attaching a statement to the tax return.

In what order are Section 179, bonus depreciation, and regular MACRS applied?

1. Section 179 → 2. Bonus depreciation → 3. Regular MACRS depreciation.

What is the anti-churning rule?

Section 179 or bonus depreciation generally is not allowed unless both the owner and user change. Typical prohibited situations include sale-leasebacks, like-kind exchanges, and formation/liquidation of corporations or partnerships.

What is listed property?

Listed property includes passenger cars, certain transportation property with personal use, and certain entertainment/recreation property not used exclusively at a regular business establishment.

What happens when business use of listed property is 50% or less in its first year?

Section 179 is not allowed, bonus depreciation is not allowed, and depreciation must use the ADS straight-line method.

When does an employee's use of listed property count as trade or business use?

It must be for the convenience of the employer AND required as a condition of employment.

What happens if listed property's business use falls to 50% or less after previously exceeding 50%?

The excess of MACRS and special deductions over allowable ADS straight-line deductions must generally be recaptured and included in income.

What are the major Section 197 intangibles and their amortization period?

Examples include goodwill, going concern value, customer lists, patents, trademarks, trade names, and covenants not to compete. They are amortized over 15 years (180 months) or more using the full-month convention, as stated in the slides.

What are organization costs and start-up costs?

Organization costs include costs of forming/organizing a corporation or partnership, such as registration, accounting, and legal fees. Start-up costs include investigating, acquiring, and starting a business, such as pre-opening training, advertising, and supplier-contracting costs.