Solutions to Chapter 6 Problem Assignments
NOTE: These solutions are before the new tax bill was passed.
Check Your Understanding
1. Basis
Linda inherited a car from her Uncle Ted. Ted purchased the car two years ago for $38,000.
The car had a value of $30,000 at the date of Ted’s death. What is Linda's basis for the car?
Solution: Linda’s basis is $30,000, the fair market value at the date of death.
2. Depreciation
Cynthia, a sole proprietor, has incurred a loss this year and would like to claim no depreciation
this year and then take double depreciation next year. Can she elect to do this?
Solution: No, depreciation must be taken in the year to which it is allocated; if not taken, basis
is still reduced for the allowable depreciation.
3. Section 179 Expensing and Bonus Depreciation
What limits are placed on the amount and type of property that can be expensed under Section
179? Compare the characteristics of Section 179 expensing to bonus depreciation.
Solution: Only tangible business personalty is eligible for Section 179 expensing and there is
an annual limit on expensing. For 2009 and 2010 the limit is $250,000. This limit
must be reduced dollar-for-dollar for qualifying investments that exceed $800,000.
The amount expensed is also limited to taxable income for the year.
Section 179 expensing can be claimed on both new and used personalty and
continues to be in effect for property acquired after 2010. Bonus depreciation could
only be claimed for new (not used) personalty acquired in 2009. Unlike Section 179
expensing, bonus depreciation was not phased out based on the dollar amount of
qualifying investments. The taxpayer must elect to claim any Section 179 expensing
but bonus depreciation was assumed to be claimed unless the taxpayer elected not to
claim it.
5. Section 179 Expensing
Delta Corporation purchased three assets during the current year: an automobile costing
$60,000, office furniture costing $260,000, and a warehouse costing $750,000. Which asset(s)
should Delta Corporation elect Section 179 expensing for and why?
Solution: The corporation should expense $250,000 of the furniture’s cost because it is 7-year
property and because the amount of depreciation expensed under Section 179 for
automobiles is subject to the ceiling limitations. The warehouse is not eligible for
Section 179 expensing because it is not personalty.
6. Limitations on Automobile Depreciation
Carl purchases a Jaguar automobile for $60,000. Carl plans to use the automobile exclusively
in his business and boasts that he intends to recover his cost through MACRS depreciation
deductions over five years. What restrictions have been imposed to reduce the tax benefits of
2 Solutions Manual for Taxation for Decision Makers
purchasing a luxury automobile for business use? Explain how the restrictions work. Will he
be able to circumvent these restrictions by leasing the vehicle?
Solution: Carl’s depreciation deductions on the automobile are subject to ceiling limits that
restrict maximum annual depreciation deductions to an amount set by the
government. He cannot use the normal 5-year recovery period percentages to
determine depreciation. His first year depreciation is limited to $3,060, the second
to $4,900, the third to $2,950, and the fourth and all succeeding years to $1,775
using the tables for 2010.
He cannot completely circumvent these limits by leasing the auto because the
deductions for lease expenses are partially offset by a lease inclusion amount (from
IRS tables) that is based on the fair market value of the auto at lease inception; this
is designed to prevent taxpayers from taking advantage of leasing to avoid the
depreciation limits. Taxpayers can compare the after-tax cost of leasing versus
buying using present value concepts.
7. Mixed Use of Auto
An employee uses her employer’s auto 75 percent for business use and 25 percent for personal
use. The personal use is taxed to her as income. What percentage of the auto can the employer
consider used for business and depreciate? Will your answer change if the employee’s
business use decreases to only 35 percent?
Solution: As long as the employer includes the value of the personal use of the auto in the
employee’s income, the employer may treat the auto as used 100 percent for
business and is not required to allocate depreciation to the business-use portion. The
answer will not change if business use decreases to 35 percent as long as the value
of personal use is included in the employee’s income. This would only make a
difference if the auto was the employee’s and the employee was taking the
depreciation deduction.
Crunch the Numbers
16. Basis for Depreciation
Two years ago, Warren purchased a computer for $4,000. Until this year, he used it
exclusively for personal purposes. At the beginning of the current year, Warren opened a
consulting business and began using the computer solely for business purposes. At the time
he began his business, Warren’s computer was worth $600. What basis must Warren use in
calculating his depreciation on the computer?
Solution: $600. Warren uses the lower of his basis or fair market value at the date the asset is
converted from personal to business use.
17. Basis for Depreciation
Last year, Anne purchased a condo unit for $125,000. She used the condo as her personal
residence. In the current year, when the condo unit appraises at $132,000, Anne moves out
and converts the condo to rental property. What basis can Anne use when computing her
depreciation on the rental condo unit?
Solution: $125,000. Anne uses the lower of her basis or fair market value at the date the
condo is converted from personal to rental property.
Chapter 6: Property Acquisitions and Cost Recovery Deductions 3
18. Gift Basis
David received a gift of stock from Ted this year when the stock was worth $24,000. Ted
purchased the stock for $18,000 five years ago and paid $2,000 of gift taxes on the gift. What
is David’s basis for the stock?
Solution: $18,500. David uses Ted’s basis increased by a portion of the gift tax related to the
appreciation on the gift determined as follows:
$2,000 gift tax x [($24,000 - $18,000)/$24,000] = $500 gift tax related to
appreciation.
$18,000 carryover basis from donor + $500 gift tax = $18,500.
19. Gift Basis
Ellen received a gift of stock from Gisela this year when the stock was worth $50,000. Gisela
purchased the stock for $60,000 four years ago. Calculate Ellen’s basis for the stock if she
sells it
a. for $65,000
b. for $45,000
c. for $55,000
Solution: a. $60,000. The donor’s basis is always used to determine a gain.
b. $50,000. Fair market value (when it is lower than the donor’s basis) is used to
determine loss.
c. $55,000. When the selling price is between the donor’s basis and the lower fair
market value, there is no gain or loss. Effectively, basis equals the selling price.
20. MACRS Depreciation/Averaging Conventions
Azona Corporation (a calendar-year taxpayer) purchased only one business asset during the
current year, used 7-year property that cost $1,080,000. Compute Azona’s MACRS
depreciation assuming that
a. the asset was purchased and placed in service on September 30, 2010.
b. the asset was purchased and placed in service on October 1, 2010.
Solution: a. Azona’s first-year depreciation is $154,332 ($1,080,000 x 14.29%) regular
MACRS depreciation. (Note that Azona is not eligible to claim Section 179
expensing because it placed more than $1,050,000 property in service this year.)
b. Azona’s first-year depreciation is $38,556 ($1,080,000 x 3.57% mid-quarter rate
for a 4th quarter acquisition).
21. Depreciation/Section 179 Expensing with Bonus Depreciation
In 2009, Lenux Corporation purchased $810,000 of new office furniture. Lenux claimed the
maximum allowable depreciation deduction (including having made any allowable
elections). Calculate Lenux’s total depreciation deduction for 2009 and 2010.
Solution: The total depreciation deduction for 2009 was $565,726.50. $240,000 is the
maximum that can be expensed under Section 179 ($250,000 less the excess of
$810,000 over $800,000); bonus depreciation = $285,000 [$810,000 - $240,000) x
50%]; regular MACRS depreciation = $40,726.50 [($810,000 - $240,000 $285,000) x 14.29%]. Office furniture is 7-year property.
The depreciation deduction for 2010 is $69,796.50 [($810,000 - $240,000 –
$285,000) x 24.49%].
4 Solutions Manual for Taxation for Decision Makers
22. Depreciation/Section 179 Expensing
Kondar Corporation spent $850,000 to purchase used machinery during 2010.
a. What is the maximum that Kondar may elect to expense under Section 179 for the year?
b. What is the basis for calculating regular MACRS depreciation on this machinery?
c. What is Kondar’s maximum depreciation deduction for 2010?
Solution: a. $200,000 ($250,000 less the excess of $850,000 over $800,000).
b. $650,000 ($850,000 - $200,000).
c. $292,885 ([$650,000 x 14.29%] + $200,000). The machinery is 7-year property.
23. Depreciation/Section 179 Expensing with Bonus Depreciation
Corando Corporation purchased $340,000 of new factory equipment at the beginning of the
year. Answer the following questions for the equipment if it was purchased in (1) 2009 or (2)
2010.
a. What is the maximum that Corando may elect to expense under Section 179 for the year?
b. What is the basis for calculating bonus and regular MACRS depreciation on this
equipment?
c. What is Corando’s maximum depreciation deduction?
Solution: a. $250,000 for 2009 and 2010.
b. $90,000 ($340,000 - $250,000) basis for bonus depreciation and $45,000
[$340,000 - $250,000 – ($90,000 x 50%) basis for regular depreciation for 2009.
No bonus depreciation in 2010 so the basis for regular MACRS depreciation is
$90,000 ($340,000 - $250,000).
c. $301,430.50 [($45,000 x 14.29%) + ($90,000 x 50%) + $250,000] for 2009.
$262,861 for 2010 [$250,000 + ($90,000 x 14.29%)].
24. Depreciation/Averaging Conventions for Fiscal-year Corporation
Kensington Corporation, Inc. (an October 31 fiscal year-end corporation) plans to purchase
$1,100,000 of used office fixtures (7-year property). This will be Kensington’s only
personalty acquired during the year. Kensington’s management is willing to purchase and
place the property in service anytime during the year to maximize its depreciation
deductions.
a. Compute the depreciation expense for the first year assuming all of the property is
purchased and placed in service on June 19, 2010.
b. Compute the depreciation expense for the first year, assuming all of the property is
purchased and placed in service on September 19, 2010.
c. What course of action do you recommend for Kensington?
Solution: a. $157,190. The property is not eligible for the Section 179 expensing because the
total investment exceeds $1,050,000. If placed in service in June, the half-year
convention is used: $1,100,000 x 14.29% = $157,190.
b. $39,270. The mid-quarter convention applies: $1,100,000 x 3.57% = $39,270.
c. To maximize the first-year deduction the property should be placed in service
sometime prior to August 1 to avoid the mid-quarter convention.
25. Depreciation of Realty
Tatum Corporation (a calendar-year taxpayer) purchases a building on June 6 of the current
Chapter 6: Property Acquisitions and Cost Recovery Deductions 5
year for $300,000, of which $60,000 is for the land. What is the depreciation for the first year
if the building is
a. a warehouse?
b. a rental apartment building?
Solution: a. $3,338 ($240,000 x 1.391%). This is 39-year property placed in service in
month 6.
b. $4,728 ($240,000 x 1.97%). This is 27½-year property placed in service in
month 6.
26. Depreciation in Disposal Year
At the beginning of 2010, AB Corporation (a calendar-year corporation) owned the following
assets:
Office Furniture Computer Equipment
Date placed in service
11/15/07
4/15/06
Initial cost
$20,000
$10,000
Accumulated depreciation
$10,160
$8,272
Recovery period
7-year
5-year
Averaging convention
Mid-quarter
Half-year
On February 1, 2010, AB sold its office furniture. On March 15, 2010, AB sold its computer
equipment. Compute AB Corporation’s depreciation deduction for 2010 for these two assets.
Solution: Office Furniture: $352 ($20,000 x 14.06% x 1.5/12)
Computer Equipment: $576 ($10,000 x 11.52% x ½)
27. Section 179 Expensing Limitation and Bonus Depreciation
On March 1, 2009, the Harry Corporation purchased and placed in service office furniture
costing $350,000. Compute the maximum amount Harry Corporation could elect to expense
under Section 179 and claim as bonus depreciation for this furniture in 2009 if
a. this is new furniture and it is the only asset placed in service this year by Harry
Corporation.
b. in addition to the $350,000 of new office furniture, Harry Corporation also acquired and
placed in service $950,000 of new factory equipment during the year.
c. this is used furniture and in addition to this $350,000 of used office furniture, Harry
Corporation also acquired and placed in service $600,000 of new factory equipment
during the year.
d. What is Harry Corporation’s total depreciation expense deduction for 2009 for each of the
above scenarios?
e. Determine the answers to a. through d. if Harry Corporation purchased the $350,000 of
equipment on March 1, 2010 instead of 2009.
Solution: a. $250,000 Section 179 expensing and $50,000 [($350,000 - $250,000) x 50%]
bonus depreciation.
b. $175,000 ($350,000 x 50%) bonus depreciation but no Section 179 expensing is
permitted because Harry Corporation placed more than $1,050,000 of eligible
property in service this year.
c. $100,000 ($250,000 - [($350,000 + $600,000) - $800,000] Section 179
expensing but no bonus depreciation is permitted because the furniture is used
property.
6 Solutions Manual for Taxation for Decision Makers
d.
e.
(a) Total depreciation for 2009 is $307,145 [($250,000 Section 179 +
$50,000 bonus depreciation + ($50,000 x 14.29% = $7,145 regular
MACRS depreciation)]
(b) Total depreciation for 2009 is $742,885. Depreciation for the new
office furniture is $200,007.50 [$175,000 bonus depreciation + ($175,000
x 14.29% = 25,007.50 regular MACRS depreciation)]. Depreciation for the
other $950,000 of new factory equipment acquired in 2009 is $542,877.50
[$950,000 x 50% bonus depreciation = $475,000) + ($475,000 x 14.29% =
67,877.50 regular MACRS depreciation).
(c) Total depreciation for 2009 is $478,595. Depreciation for the used
office furniture is $135,725 [$100,000 Section 179 expensing + ($250,000
x 14.29% = $35,725 regular MACRS depreciation)]. Depreciation for the
$600,000 of new factory equipment is $342,870 [($600,000 x 50% =
$300,000 bonus depreciation) + ($300,000 x 14.29% = $42,870 regular
MACRS depreciation].
(a) $250,000 Section 179 expensing; no bonus depreciation allowed in
2010.
(b) No Section 179 expensing is permitted because Harry Corporation
placed more than $1,050,000 of eligible property in service this year; no
bonus depreciation in 2010.
(c) $100,000 Section 179 expensing ($250,000 – [($350,000 + $600,000) $800,000]. No bonus depreciation in 2010.
(d) (a) Total depreciation for 2010 is $264,290 [($250,000 Section 179 +
($100,000 x 14.29% = $14,290 regular MACRS depreciation)]
(b) Total depreciation for 2010 is $185,770. Depreciation for the new
office furniture is $50,015 ($350,000 x 14.29% regular MACRS
depreciation)]. Depreciation for the other $950,000 of new factory
equipment acquired in 2010 is $135,755 ($950,000 x 14.29% regular
MACRS depreciation).
(c) Total depreciation for 2010 is $221,465. Depreciation for the used
office furniture is $135,725 [$100,000 Section 179 expensing +
($250,000 x 14.29% = $35,725 regular MACRS depreciation)].
Depreciation for the $600,000 of new factory equipment is $85,740
($600,000 x 14.29% regular MACRS depreciation).
28. Depreciation/Section 179 Expensing Limitation
David operates his business as a sole proprietorship. In 2010, he spends $20,000 for a new
machine (7-year property). His business income, before consideration of any Section 179
deduction, is $17,000. David elects to expense $20,000 under Section 179. Calculate his total
depreciation deduction for 2010.
Solution: $17,000. David’s current-year Section 179 expense deduction is limited to his
$17,000 of net income before the deduction. He will have a Section 179 carryover
of $3,000 that he can use in the following year subject to similar net income
limitations.
Chapter 6: Property Acquisitions and Cost Recovery Deductions 7
32. Auto lease
Trish entered into a 36-month lease of an automobile on January 1. She uses it 90 percent for
business use and 10 percent for personal use. The fair market value of the automobile at the
inception of the lease is $50,000. She made 12 monthly lease payments of $650 during the
year.
a. What Trish’s deduction for lease payments made during the year?
b. What is the lease inclusion amount that Trish must include in her gross income this year?
c. How would your answer to (b) change if the fair market value of the automobile was only
$15,000?
Solution: a. $650 x 12 x 90% = $7,020.
b. $67 x 90% = $60.30 (using the lease inclusion tables for 2010).
c. Trish would have no lease inclusion amount. The lease inclusion rules only
apply to autos with a fair market value exceeding $16,700 for 2010.
34. Intangible Asset Amortization
Orange Corporation acquires all of the assets of Apple Company for $10,000,000. The fair
market value of the tangible assets totaled $8,000,000. The $2,000,000 difference is
considered goodwill. Orange Corporation expects to continue its business operations for at
least 40 years. What is the annual amount of amortization for the goodwill?
Solution: $2,000,000/15 = $133,333 per year
36. Cost Depletion
Goldrush Corporation bought a mine in year 1 for $90,000 and estimated that there were
100,000 tons of ore to be extracted. In year 1, it mined 8,000 tons and sold 7,000 tons. In
year 2, it mined 7,000 and sold the remaining 1,000 tons from year 1 and 6,500 of the ore
mined in year 2. At the end of year 2, Goldrush Corporation estimated that, including the ore
extracted but unsold, there were 160,000 tons of ore remaining. Compute the allowable cost
depletion for year 1 and year 2.
Solution: Year 1 = $6,300; year 2 = $3,748
$90,000/100,000 tons = $.90 depletion rate;
Year 1 cost depletion = $.90 x 7,000 units sold = $6,300
($90,000 - $6,300)/167,500* = $.4997 adjusted depletion rate;
Year 2 cost depletion = $.4997 x 7,500 tons = $3,748
*The $7,500 sold during the year must be added to the ending estimate of ore
remaining to determine the depletion rate.
Think Outside the Text
These questions require answers that are beyond the material that is covered in this chapter.
45. Web Site Development Costs
Your friend is thinking about starting up a new Internet business and would like to know how
Web site development costs are treated for tax purposes. What are some of the costs involved
in Web site development and what are the issues involved in determining their tax treatment?
Solution: To operate a Web site, a business must acquire the appropriate computer hardware
by either purchasing a Web server or renting space on a Web server from a hosting
service or Internet service provider. If a business chooses to purchase the
8 Solutions Manual for Taxation for Decision Makers
hardware, the company can depreciate the cost of the hardware as five-year
recovery property. If a business chooses to outsource its hardware needs, then the
lease payments are ordinary and necessary business expenses and are currently
deductible.
Determining the proper treatment of software costs is a little more complex.
Software costs can be divided into two broad categories: developed software and
purchased software. Developed software is software that is custom designed by a
business for its own internal use. Purchased software may be a generic publicly
available product or a software package designed by an outside consultant under
circumstances where the consultant, rather than the company, bears the risk of
failure. However, if the consultant provides services but the company bears the
risk with regard to successful implementation, the expenses incurred should be
regarded as the company’s software development costs. The costs of developing
software are similar to research and experimental expenditures so the business can
choose to either immediately expense (which is usually preferred) or amortize over
60 months.
If the software was purchased as part of a package or bundled with new hardware
and not priced separately from the hardware, the business must recover the
software costs over the useful life of the hardware which usually means five years.
Therefore, buying software unbundled, meaning it is either not purchased with
hardware or it is but its price is separately stated, generally results in a faster write
off. The 2003 Tax Act made off-the-shelf software eligible to be expensed under
Section 179. Software acquired as part of a business purchase is usually
considered a Section 197 intangible and must be amortized over fifteen years.
Many taxpayers use a combination of purchased and developed software, making
it challenging to segregate the costs and apply the correct tax treatment. This can
be even further complicated when an outside consultant provides services. It is
important that expenses be carefully analyzed to determine whether the costs relate
to the modification of purchased computer software or are simply installation
costs. Costs incurred to modify purchased software are deductible, while
installation costs must be capitalized.
47. Goodwill
Is the treatment of purchased goodwill the same for tax and for GAAP? Explain.
Solution: The treatment of goodwill for tax and GAAP differs. For tax purposes, goodwill is
amortized over a period of 15 years.
For financial accounting, the income statement is not charged unless goodwill has
been impaired. To test for impairment, the fair value of the reporting unit is
compared to the carrying amount of its net assets including goodwill. If the fair
value of the reporting unit is greater, goodwill is considered not to be impaired and
the company does nothing. If, however, the fair value is less than the carrying
amount of the net assets, then the “implied value” of goodwill must be determined
and compared to the recorded goodwill to determine if a charge is necessary.
Chapter 6: Property Acquisitions and Cost Recovery Deductions 9
Develop Planning Skills
60. Depreciation
Herald Corporation, a calendar-year taxpayer, purchased and placed the following business
assets in service during 2010:
Asset
Date Placed in Service Initial Cost
New computer equipment
April 3
$ 50,000
Used office furniture
July 14
500,000
Used office fixtures
October 29
300,000
Herald Corporation is also considering the purchase of $180,000 of additional new office
furniture. It could wait until January to make the purchase, or it could buy the furniture and
place it in service in December to try to increase its current-year tax depreciation deduction.
What impact would this proposed purchase have on Herald's depreciation deduction for its
year ending December 31, 2010?
Solution: If the proposed new furniture purchase is made in December, Herald Corporation's
depreciation for 2010 will be $193,268 lower than if the furniture is purchased in
January. Therefore, the proposed purchase should be made in January.
If the proposed new furniture purchase is postponed until January of 2011, the
total depreciation deduction for 2010 is $295,740 computed as follows:
New computer
equipment
($50,000 x 20%) =
$10,000
Used office
$500,000 x 14.29% =
71,450
furniture
Used office fixtures $300,000 - $200,000 Sec. 179 expense = $100,000
x 14.29% = $14,290 + $200,000 Section 179 =
214,290
Total depreciation
$295,740
Only $200,000 can be expensed under Section 179 because Herald placed in
service $850,000 of eligible property ($850,000 - $800,000 = $50,000 reduction in
expensing limit). By electing to expense $200,000 of the used office fixtures under
Section 179, the mid-quarter convention can be avoided [($300,000$200,000)/($850,000 - $200,000) = 15.4%].
Total depreciation will decrease if the new office furniture is placed in service in
December. Herald will only be eligible for $20,000 [$250,000 – ($1,030,000 $800,000)] of Section 179 expensing because its asset purchases now total
$1,030,000. The mid-quarter convention will be required because more than 40
percent of personalty will be placed in service in the last quarter of the year
[($300,000 + $180,000 - $20,000)/($1,030,000 - $20,000) = 45.5%].
If the proposed purchase is made in December, the depreciation for the assets
using the mid-quarter convention would be as follows:
New computer
equipment
($50,000 x 25%) =
$12,500
Used office furniture $500,000 x 10.71% =
53,550
Used office fixtures
$300,000 - $20,000 Section 179 expense =
$280,000 x 3.57% = $9,996 + $20,000 Section
179 expense =
29,996
10 Solutions Manual for Taxation for Decision Makers
Subtotal
Proposed additional
new office furniture ($180,000 x 3.57%) =
Total depreciation
$96,046
6,426
$102,472
The $102,472 total depreciation is $193,268 less than the amount ($295,740) that
would be allowed if Herald Corporation postponed the purchase until January.
Therefore, Herald should wait until January to make the acquisition.