2011 Pearson Education Inc Publishing as Prentice Hall

DEPR. , COST RECOVERY, AMORTIZATION, & DEPLETION ® Depreciation and cost recovery ® Amortization ® Depletion, intangible drilling an development costs ® Tax planning considerations ® Compliance and procedural considerations © 2011 Pearson Education, Inc. Publishing as Prentice Hall 10 -2

Depreciation and Cost Recovery ® General considerations ® Depreciation methods ® Calculation of depreciation

General Considerations (1 of 4) ® Taxpayers must use specific depreciation methods depending on when an asset is placed into service Prior to 1981 (pre-ACRS) 1981 through 1986 (ACRS) 1987 through present (MACRS) © 2011 Pearson Education, Inc. Publishing as Prentice Hall 10 -4

General Considerations (2 of 4) ® Common rules to all systems No depreciation may claimed on land or other assets with an indefinite life Depreciation permitted in year asset placed into service Apply method consistently Basis of property being depreciated reduced by amount of allowable depreciation each taxable year © 2011 Pearson Education, Inc. Publishing as Prentice Hall 10 -5

General Considerations (3 of 4) ® Types of Property Tangible Property (physical) Intangible Property (non-physical) Real Property Personal Property vs. Personal-use Property © 2011 Pearson Education, Inc. Publishing as Prentice Hall 10 -6

General Considerations (4 of 4) ® Capitalization vs. expense Materiality plays a role Frequent disputes between taxpayers and IRS ® Conversion Basis of personal-use property is lesser of adjusted basis or FMV ¬Prevents taxpayers from depreciating nondeductible decline in value of personal asset © 2011 Pearson Education, Inc. Publishing as Prentice Hall 10 -7

Depreciation Methods (1 of 3) ® MACRS Personal property ¬Use 3, 5, 7, 10, 15, 20 year useful life ¬DDB with conversion to straight-line ¬Half-year convention ª½ year depr in 1 st year and year of disposition ª Mid-Quarter convention when aggregate basis of all personal property placed into service during last three months of year exceed 40% 10 -8 ¬No salvage value © 2011 Pearson Education, Inc. Publishing as Prentice Hall

Depreciation Methods (2 of 3) ® MACRS Real property ¬Residential rental property 27. 5 years ¬Nonresidential rental property 39 years ¬Straight-line depreciation method ¬Mid-month convention in year of acquisition and year of disposition ¬Straight-line or Alternate Depreciation System (ADS) © 2011 Pearson Education, Inc. Publishing as Prentice Hall 10 -9

Depreciation Methods (3 of 3) ® MACRS (continued) Qualified leasehold improvements ¬Interior nonresidential improvements ¬ 15 -year straight-line recovery © 2011 Pearson Education, Inc. Publishing as Prentice Hall 10 -10

Calculation of Depreciation § 179 Expense ® May elect to expense up to $250 K for certain tangible personal property placed into service during year ® $ for $ phaseout if qualified property placed into service during year >$800 K ® Limited to taxable To. B income Unused portion carried over indefinitely and added future § 179 amounts © 2011 Pearson Education, Inc. Publishing as Prentice Hall 10 -11

Calculation of Depreciation Mid-quarter Convention ® Applies to personal property placed in service during the year Must use mid-quarter convention for ALL property if > 40% of cost of property placed in service during last three months of year ¬Does NOT include property expense under § 179 © 2011 Pearson Education, Inc. Publishing as Prentice Hall 10 -12

Calculation of Depreciation Year of Disposition ® MACRS allows ½ of last period of depreciation to be taken in year of disposition based on convention E. g. , mid-year, mid-quarter, mid-month © 2011 Pearson Education, Inc. Publishing as Prentice Hall 10 -13

MACRS Restrictions (1 of 3) ® Portion of asset used for personal use is not depreciable ® Listed property rules Must use straight-line of business use < 50% Recapture of excess cost-recovery if MACRS claimed and business use falls below 50% © 2011 Pearson Education, Inc. Publishing as Prentice Hall 10 -14

MACRS Restrictions (2 of 3) ® Luxury automobile limitation Passenger vehicles ≤ 6, 000 lb Depreciation can’t exceed ceiling limits ¬E. g. , $3, 060 in 1 st year ¬“Luxury” auto defined by 2009 ceiling limits is any passenger vehicle costing > $16, 235 © 2011 Pearson Education, Inc. Publishing as Prentice Hall 10 -15

MACRS Restrictions (3 of 3) ® Trucks, vans and SUVs (>6, 000 lb) Max § 179 expense is $25, 000 No ceiling limits like luxury autos ® Trucks, vans and SUVs (<6, 000 lb) Subject ¬Higher ® Leased to ceiling limits than for luxury autos vehicles Income inclusion based on IRS tables to eliminate avoiding luxury auto rules © 2011 Pearson Education, Inc. Publishing as Prentice Hall 10 -16

Amortization ® § 197 intangibles ® Research and experimental expenditures ® Computer software ©

§ 197 Intangibles ® Goodwill, going concern value, trademarks, trade names, etc. ® Classification and disposition of intangibles ® 15 -year straight-line § 197 asset treated as depreciable prop so that § 1231 treatment accorded disposition if held > 1 year © 2011 Pearson Education, Inc. Publishing as Prentice Hall 10 -18

Research and Experimental Expenditures ® Include experimental and laboratory costs incidental to the development of a product (see Table 4) ® Tax treatment options Expense in year paid Capitalize & amortize costs over 60 mo Capitalize and write-off when project abandoned or is worthless © 2011 Pearson Education, Inc. Publishing as Prentice Hall 10 -19

Computer Software ® Developed computer software Cost of developing software is qualified R&E under § 174 ¬Expense immediately or ¬Amortize over 60 months ® Separately purchased and non-§ 174 developed software Straight-line depreciation over 36 months © 2011 Pearson Education, Inc. Publishing as Prentice Hall 10 -20

Depletion, Intangible Drilling and Development Costs (1 of 2) ® Depletion Cost methods depletion ¬Similar to units of activity depreciation Percentage depletion ¬Depletion rates based on statutory percentages ªCan claim depletion deductions in excess of cost over the life of the asset © 2011 Pearson Education, Inc. Publishing as Prentice Hall 10 -21

Depletion, Intangible Drilling and Development Costs (2 of 2) ® Treatment of intangible drilling and development costs Capitalized or deducted currently Decision to expense or capitalize depends on taxpayer’s current position ¬Expected marginal tax rates © 2011 Pearson Education, Inc. Publishing as Prentice Hall 10 -22

Tax Planning Considerations ® Alternative depreciation under MACRS ® Units of production depreciation May use instead of MACRS ® Structuring Must a business combination consider amortization of goodwill © 2011 Pearson Education, Inc. Publishing as Prentice Hall 10 -23

Compliance and Procedural Considerations ® Form 4562 is used to report depreciation, § 179 expense, depletion, and amortization deductions © 2011 Pearson Education, Inc. Publishing as Prentice Hall 10 -24

Comments or questions about Power. Point Slides? Contact Dr. Richard Newmark at University of Northern Colorado’s Kenneth W. Monfort College of Business richard. newmark@Ph. Duh. com © 2011 Pearson Education, Inc. Publishing as Prentice Hall 10 -25