Chapter 7: Property Acquisitions and Cost Recovery Deductions - Comprehensive Flashcards

section of IRC covering MACRS

Section 168

deduction vs. capitalized cost

deduction = for ordinary + necessary bus. expenses (code section 162); prohibited for permanent improvements to increase value of property

capitalization = permanent improvements to inc. value of property; expenditure is recorded as an asset on the BS rather than as current expense on IS(meaning it can’t lowes its taxable income which decreases their tax liability)

- think abt. materiality (ex: lightbulb = permanent, but too small)

- firm likes to expense/deduct

capitalized cost

if expenditure creates/enhances identifiable asset w/ useful life > CY then Cap

- if not recovered via depreciation/amortization/depletion, then only recovered on disposition of asset (ex: landscape improvement to land)

-inventory, land cannot be recovered except through COGS, selling

what types of expenses can be deducted

- ordinary + necessary expenses

- regular + recurring, don't add material value/useful life

ex: repair + maintenance expense

tax subsidies

- permit immediate expensing of certain capex=indirect FEDERAL subsidy for taxpayers who make those tax-preferred expenditures

example of indirect federal subsidy

R&D - use to be fully deductibe, now post 2021 can capitalize + amortize over 5 yrs (domestic) or 15 years (foreign)

Advertising (LT benefit)

Industry-Specific: farmers can deduct soil + water conservation expenditures, fertilizer cost

Oil & gas producers deduct intangible drilling + development costs (IDC) of wells

tax basis

unrecovered dollars represented by an asset; the TP’s investment in any asset or property right

- initial basis = cost (fair market value of everything expended to acquire the asset, including sales tax + incidental costs to put it into service) like S&H

key to calculating cash flows because taxpayers recover basis @ no tax cost

adjusted tax basis

initial basis - depreciation, amortization, depletion

initial/adjusted tax basis might differ from the book #s, because the deductions are different

leverage

cost basis includes → use of debt to purchase assets aka borrowed funds; reduces the AT cost of the asset

ex: use $10 cash + $80 loan, cost basis = $90

interest on borrowed funds is deductible, so someone paying w/ all borrowed money will pay less than paying w/ all cash

when can you recover the cost of stock & land?

when they are sold

cost recovery methods

inventory = COGS

tangible assets = depreciation

intangible assets = amortization

natural resources = depletion

can depletion > tax bases?

yes

ex: extra costs associated with extraction

COGS: GAAP vs. Tax

Beginning Inventory + Capitalized Costs (purchases) = Inventory Available for Sale, - Ending Inventory = COGS

code section 263: UNICAP rules for capitalization of indirect costs (overhead) aka must capitalize overhead to reduce current expenses and put them to inventory

UNICAP rules for COGS

for capitalizing indirect costs into inventory

- capitalized costs may be > for tax than book => higher COGS + LOWER PERIOD EXPENSE => not all inventory gets sold => book income < tax

- temp unfavorable book/tax difference

- reverses through COGS

Inventory Valuation Methods

specific identification, FIFO, LIFO

- if using LIFO, need to be consistent w/ financial reporting (in rising prices, lower taxable income => lower reported income)

depreciation applies to tangible assets that...

lose value over time due to wear + tear, obsolescence (no land) + reasonable ascertainable useful life (no artwork)

why useful life is no longer relevant for tax depreciation

post-1981, useful life relevant; now use MACRS (recovery period < useful life)

• shorter lufe reduces after-tax cost of assets, incentive for capital acquisitions

MACRS + different categories

Modified Accelerated Cost Recovery System

- 3/5/7/10 year recovery property = 200% declining balance method

- 15/20 yr recovery property = 150% declining balance

— front loading further reduces AT cost of tangible property

- 25/27.5/39/50 yr recovery = straight-line

depreciation conventions for personalty

half-year convention for MACRS depreciation 20 yrs or less

- 1 half-yr depreciation allowed for year which property is placed in service (built into IRS tables)

- 1 half-yr depreciation allowed for year property is disposed of (sale, NOT built into IRS tables)

EXCEPTION: midquarter convention

applies if 40%+ personalty acquired in a year is placed in service in the 4th quarter ak if you buy it in thr last few months, diff tables used

depreciation convention for realty

25/27.5/39/50 yr recovery realty based on midmonth convention

- 1 half-month of dep. allowed for the month property is placed into service (built into IRS tables) month of aqui.

- 1 half-month of dep. allowed for month property is disposed of (not built into IRS tables) => manual calculation) month of sale

how to calculate limited dep. for passenger automobiles (no calculation on exam)

max. annual dep./vehicle placed into service in:

- '23 = $12, 200

- '24 = $19, 500

- '25 = $11,700

-’26 = $6960

Compute dep. using MACRS, then apply limit

Section 179 Expensing

- TP expense (instead of cap) a limited amt. of cost of qualifying property placed in service in a year

- limit = $1.22 mil; reduced by the aggregate cost of qualifying prop in excess of 3.05M threshold

- includes depreciable personalty, off-the-shelf software (not real estate but equip, computers, etc)

- unexpensed capitalized cost recovered through MACRS

- the deduction is limited to taxable bus. income bfore deduction; nondeductible expenses carried forward

(targeted towards small bus.)

Little Treat

God loves you

what tax form has Section 179 Expensing + depreciation

Tax Form 4562

bonus depreciation

immediate expensing of a certain % of the cost of qualifying property placed in service in that year

- 100% btw. 9/27/2017 - 1/1/2023

- 80% in 2023

- 60% in 2024

- 40% in 2025

- 20% in 2026

Bonus dep. longer-lived assets = more beneficial

Qualifying property = depreciable personalty, computer software, leasehold improvements

Intangible assets

no physical substance

- leases, patents, contractual rights

How are intangible assets amortized

straight-line basis over determinable life

- no determinable life = not amortizable (securities, partnership interests)

Organizational Costs (AM1)

include legal, accounting, filing fees attributed to forming the entity

Startup Costs (AM1)

include cost of investigating a new bus, expenses that occur before the business is operational

Deduction for Organizational & Startup Costs

sum total costs, first $5,000 can be recovered, deduction reduced by any amt. of cost in excess of $50k

ex: spend $51k, only $4k deductible; aka if its over 55k then its not deductible right away

capitalize + amortize 15 yrs of nondeductible costs

Leasehold costs (AM2)

- lease acquisition costs amortized over term of the lease

- physical improvements to leased property: capitalized + depreciated over appropriate MACRS recovery period

- applies even if lease term < MACRS recovery period

R&D Costs after 2021 (AM3)

- capitalize + amortize

- straight-line amortization w/ midyear convention

- domestic = 5 yr amort. foreign = 15 yr amort.

- used to be 100% deduction

When a firm buys another bus. for a lump sum price, must allocate cost to BOTH... (AM4)

tangible + intangible assets

- based on Fair Market Value of identifiable assets

- residual cost allocated to purchased goodwill

- capitalize cost of intangibles (+ goodwill) amortized over 15 yrs

how is purchased goodwill amortized for tax purposes

over 15 years

how is purchased goodwill amortized for book purposes

it's not - though amortized for tax purposes, so get a favorable tax < book income difference

GAAP: test for impairment annually

• write-down = nondeductible expense, book income < tax income (unfavorable)

depletion

recovers capitalized cost of productive mines/wells

- depletion deduction = whatever is greater: cost depletion OR % depletion

cost depletion

unrecovered basis x units of production sold/estimated total units in the ground

aka unrecovered cost x how much of all the stuff in the ground have you sold

ex: [$200k sales / 800k total barrels in the ground] x $500k unrecovered cost = $125k depletion

% depletion

statutory % of gross income (revenue from mine/well); allowed even after basis = 0 so valuable subsidy

-only independent producers and royalty owners entitled to this

which is more logical according to GAAP: cost vs. % depletion?

cost