ch 10 tax pdf

Learning Objectives

• Cost Recovery Methods

  • Recover costs of personal property, real property, intangible assets, and natural resources.

  • Determine applicable cost recovery (depreciation) life, method, and convention for tangible assets under MACRS.

• Deductions Calculation

  • Calculate deductions under special cost recovery rules (e.g., §179, bonus depreciation, etc.).

  • Explain amortization deductions.

• Natural Resources Recovery

  • Explain cost recovery for natural resources and allowable depletion methods.

Cost Recovery Overview

• Businesses must capitalize costs for assets with a useful life exceeding one year on the balance sheet.

  • Cost recovery methods: depreciation, amortization, depletion.

  • Aim: Recover costs of assets due to wear, tear, and obsolescence.

Types of Cost Recovery

• Depreciation

  • Applicable for tangible personal and real property (excluding land) over a time period.

• Amortization

  • For intangible property costs over a specified time period.

• Depletion

  • For natural resource costs over time.

Basis for Cost Recovery

• Cost recovery deductions adjust an asset's initial basis, known as adjusted basis or tax basis:

  • Adjusted Tax Basis = Initial Basis - Accumulated Depreciation (or amortization/depletion).

Cost Recovery Methods by Asset Type

Basis Calculation Example

Example 1: Scrap-Happy Inc.

• Initial Basis of Building:

  • Purchase price: $175,000

  • Renovation: $15,000

  • Total: $190,000

• Effects on Basis:

  • Roof Replacement (Cost: $50,000): Added to basis (restoration).

  • Carpet Cleaning ($500 biannually): No effect (routine maintenance).

Depreciation Methods and Periods

• Depreciation Methods:

  • 200% declining balance

  • 150% declining balance

  • Straight-line

• Depreciation Recovery Period:

  • Based on estimated useful life for financial accounting.

  • IRS-determined recovery periods for tax purposes (Rev. Proc. 87-56).

Exhibit: Common Business Assets Recovery Periods

Depreciation Conventions

• Half-Year Convention:

  • Applies to first and last year of an asset's life.

• Mid-Quarter Convention:

  • Applicable if > 40% of property is placed in service in the last quarter of the tax year.

Immediate Expensing (Section 179)

• Immediate deduction of business assets up to certain limits (property limitations and taxable income limitation).

Bonus Depreciation

• Temporary bonus depreciation to stimulate economic growth.

• Varies by year (100% for 2017-2022; decreases afterwards).

Listed Property

• Assets used for both business and personal use; depreciation limited to business percentage.

Amortization of Intangible Assets

• Intangible assets amortized over specific periods (e.g., 15 years for §197 intangibles).

• Organizational expenditures and startup costs amortized likewise.

Depletion Methods for Natural Resources

• Determine annual depletion expense under cost and percentage methods.

• Use the method that yields a larger deduction.

Example of Cost Depletion

• Timber Calculation:

  • Original cost of timber assets = $60,000.

  • Cost depletion per board foot = $60,000 / 30,000 ft = $2/ft.

  • If 10,000 ft used, expense = 10,000 ft × $2/ft = $20,000.

Summary of Key Concepts

• Understanding the various methods of cost recovery is crucial for tax reporting and financial management. Knowing when and how to apply depreciation, amortization, and depletion will affect your organization’s financial statements and tax obligations.