Murphy/Higgins
Concepts in Federal Taxation
Hiring Incentives to Restore Employment Act
The Hiring Incentives to Restore Employment Act (HIRE) increases the Section 179
deduction for 2010. This update explains the change, updates textbook problems that
illustrate the change, and updates relevant test bank questions to reflect the impact of
the HIRE. The student version includes the tax law explanations and problems so that
instructors can easily incorporate the new law into their courses.
Chapter 10
Section 179 Limits Increased
The Hiring Incentives to Restore Employment Act (HIRE) increases the Section 179
Election to Expense deduction for qualifying property placed in service during tax years
that begin after December 1, 2007 and before January 1, 2011. Property placed in
service in tax years beginning after 2010 are not eligible for the increased Section 179
deductions.
The Section 179 Election to Expense is increased to $250,000 (from $134,000). In
addition, the phase-out of the deduction for excess investment is increased from
$530,000 to $800,000. Thus, taxpayers who place less than $800,000 of qualifying
property in service during a tax year beginning in 2010 will be able to expense up to
$250,000 of the cost of the property.
Section 179 Election to Expense
Section 179 allows an annual current expense deduction for the cost of qualifying depreciable
property purchased for use in a trade or business. The deduction for expensed assets is treated
as a depreciation deduction. This election allows many small businesses to expense assets as
they are purchased instead of depreciating them over several years. The immediate deduction
promotes administrative convenience by eliminating the need for extensive depreciation
schedules for small purchases.
Qualified Taxpayers
2
In 2010, individuals, corporations, S corporations, and partnerships may elect to deduct as an
expense up to $250,000 in investment in qualified property to be used in an active trade or
business. A husband and wife are considered one entity for purposes of the election to
expense. Although the phrase ‘‘active trade or business’’ is not defined in the tax law, it appears
to have the same meaning as the phrase ‘‘trade or business’’ (Chapter 5). The elements of profit
motivation, regularity, and continuity of the taxpayer’s involvement in the activity and the
absence of hobby, amusement, and similar motivations are important factors to consider when
determining whether an activity qualifies for the Section 179 election. This interpretation is
supported by the fact that the deduction is not allowed for assets purchased for use in an
activity related to the production of income (an investment activity). However, the portion of a
mixed-use asset that is used in a trade or business does qualify for immediate deduction under
Section 179. Estates and trusts cannot use the Section 179 election to expense assets. The
election is not available to these entities because they are formed to protect and conserve the
entity’s assets for the benefit of the beneficiaries and not to operate an active trade or business.
Qualified Property
The Section 179 expense deduction is allowed only on depreciable, tangible, personal property
used in a trade or business. Examples of eligible property are trucks, machinery, furniture,
computers, and store shelving. Real property, such as buildings and their structural
components, does not qualify for the special election to expense. Also excluded from the
deduction are land and improvements made directly to the land, such as a parking lot,
sidewalks, or a swimming pool. In addition, qualifying property does not include intangible
assets such as patents, copyrights, and goodwill.
EXAMPLE 3 Kelly purchases a new computer and a new telephone system and installs
a new roof and an air-conditioning system in her office building. Which of the
expenditures qualify for the election to expense?
Discussion: The computer and the telephone system are depreciable, tangible,
personal property and therefore qualify under Section 179. The roof and the airconditioning system are integral parts of the office building. Therefore, they are real
property and do not qualify for immediate expensing.
Limitations on Deduction
The Section 179 election-to-expense deduction is subject to three limitations:
■
A taxpayer’s annual Section 179 deduction cannot exceed the maximum annual
limitation ($250,000 for 2010).
■
If the taxpayer’s investment in Section 179 property exceeds $800,000 for the tax year,
the annual deduction limit is reduced by one dollar for each dollar of investment over
$800,000 in 2010. For 2010, a taxpayer who purchases more than $1,050,000 of
qualifying property may not take any election-to-expense deduction for any of the
purchases.
■
The Section 179 deduction allowed for a tax year cannot exceed the taxable income
from the active conduct of all the taxpayer’s trade or business activities.
Annual Deduction Limit
3
The annual deduction limit does not have to be prorated according to the length of time an asset
is used during the year. The annual deduction limit applies to all tax entities entitled to use
Section 179. Thus, the annual limit applies separately to a partnership and to its individual
partners. The annual limit also applies separately to an S corporation and to its shareholders.
Because the partnership and S corporation are conduit entities, a portion of the entity’s total
deduction is allocated to each owner, who subtracts it as an expense on the owner’s personal
tax return. However, the Section 179 deduction allocated to the taxpayer from the conduit entity
plus the taxpayer’s Section 179 deduction from all other sources cannot exceed the annual limit.
Any excess Section 179 election resulting from allocations from several entities must be carried
forward to be used in subsequent years.
EXAMPLE 4 Roberto is a 50% shareholder and full-time employee of an S corporation.
During 2010, the S corporation invests $324,000 in equipment qualifying for the
Section 179 deduction. Roberto also owns a sole proprietorship that constructs kitchen
cabinets. The cabinet business qualifies as an active business for Roberto. During
2010, he purchases $200,000 worth of equipment to use in his cabinet business. What
is the maximum amount that Roberto can deduct as a Section 179 expense for 2010?
Discussion: Roberto’s deductible Section 179 expenditures are limited to $250,000.
The S corporation can elect to deduct $250,000 of its $324,000 in capital expenditures.
The remaining $74,000 is subject to regular depreciation. The S corporation allocates
$125,000 (50% × $250,000) of its Section 179 deduction to Roberto. Thus, Roberto’s
qualified Section 179 expenditures total $325,000 ($125,000 from the S corporation +
$200,000 from the cabinet business). However, the $250,000 annual deduction limit
applies at the shareholder level as well as at the S corporation level. Therefore,
Roberto may elect to deduct only $250,000 as a Section 179 expense.
A taxpayer may choose to use all, part, or none of the annual deduction. By electing to expense
less than the limit for a tax year, the taxpayer can avoid a Section 179 deduction carryforward
resulting from either the annual limitation or the trade or business income limitation.
EXAMPLE 5 Based on the information in example 4, how should Roberto allocate his
Section 179 deduction in 2010?
Discussion: Roberto should claim as a Section 179 deduction the $125,000 allocated
to him from the S corporation plus $125,000 of the cost of the equipment purchased for
use in the cabinet business. The remaining $75,000 cost of the equipment used in his
cabinet business is depreciated using regular depreciation methods.
If Roberto expenses the $200,000 worth of equipment he purchased for the
cabinet business, he will lose $75,000 of the deduction allocated to him from the S
corporation by exceeding the $250,000 annual limitation by $75,000 ($200,000 +
$50,000 = $250,000) this year. The $75,000 carries forward to be used in subsequent
years. Any amounts that flow to a taxpayer from a conduit entity should always be
expensed under Section 179 before any amount is elected from another trade or
business of the taxpayer.
After an asset’s basis is reduced by the amount expensed under Section 179, the remaining
basis is subject to regular depreciation under any valid method.
EXAMPLE 6 Devra Corporation purchases a machine costing $300,000 for use in its
business. Devra wants to expense $250,000 of the asset’s cost under Section 179. If
Devra makes the Section 179 election to expense $250,000 of the asset’s cost, what is
its depreciable basis in the machine?
4
Discussion: Devra’s depreciable basis for regular depreciation is $50,000. The
depreciable basis of the machine is its $300,000 cost, less the $250,000 it elects to
expense under Section 179. The reduction of depreciable basis by amounts expensed
under Section 179 is necessary to ensure that the total capital recovery on the machine
does not exceed the $300,000 invested.
The Section 179 deduction can be allocated to reduce the basis of qualifying assets in any
manner the taxpayer chooses. This allows the deduction to be allocated equally to all assets
acquired during the year or to specific assets. This option is important. Two general rules apply
to choosing assets to expense. First, do not use the Section 179 election to expense
automobiles. As discussed later, automobiles are subject to annual depreciation deduction
limits. For purposes of this annual limitation, the Section 179 expense is treated as a
depreciation deduction. Because MACRS depreciation on most automobiles exceeds the firstyear annual limitation amount, using the election to expense on an automobile does not result in
additional tax savings. Second, based on time value of money concepts, taxpayers should take
the depreciation deduction as early as possible. This is accomplished by expensing the assets
with the longest life and using regular depreciation methods to depreciate assets with the
shortest life.
EXAMPLE 7 Gwendolyn purchases equipment costing $250,000 and a computer system
that also costs $250,000 for use in her business in 2009. Under MACRS, the
equipment is 7-year property, and the computer system is 5-year property. How should
Gwendolyn allocate her $250,000 Section 179 expense deduction?
Discussion: If Gwendolyn wants to deduct the $250,000 maximum election to expense,
she should elect to expense the $250,000 cost of the equipment (7-year property). The
$250,000 cost of the computer system will be deducted over its 5-year life, resulting in
greater deductions sooner than if she elected to expense the computer.
Gwendolyn could elect to deduct less than the full $250,000 Section 179 limit. Because
Section 179 is elective, Gwendolyn can decide how much to deduct and the specific
assets to expense. This allows taxpayers who do not want or need the extra
deductions in the current year to spread the deductions out through depreciation
charges.
Annual Investment Limit
The annual deduction limit is reduced dollar for dollar by the amount of the investment in
qualifying property in excess of $800,000. As a result of this limitation, a taxpayer who
purchases $1,050,000 or more of qualified property during 2010 cannot expense any amount
under Section 179. Because of the $800,000 annual investment limitation, only relatively small
businesses can use the election to expense.
EXAMPLE 8 During 2010, the Allen Partnership places $828,000 of Section 179
property in service for use in its business. What is Allen’s maximum Section 179
deduction?
Discussion: Allen’s election to expense is reduced to $222,000 by the $800,000 annual
investment limit. Because the partnership invested $28,000 more than the $800,000
annual investment limitation ($828,000 - $800,000), it must reduce the annual
deduction limit dollar for dollar by the excess ($250,000 - $28,000 = $222,000). NOTE:
The $28,000 lost through the annual investment limit is not carried forward to future
years. It is lost forever.
5
EXAMPLE 13 Bomhoff Inc. purchases office equipment costing $400,000 on April 1,
2010. What is Bomhoff’s depreciable basis in the office equipment?
Discussion: To maximize the 2010 cost recovery deduction, Bomhoff should elect to
expense $250,000 of the cost of the office equipment. This reduces the adjusted basis
(and depreciable basis) of the equipment to $150,000 ($400,000 - $250,000).
Basis Subject to Cost Recovery
Depreciable basis is the asset’s original basis for depreciation less any amounts deducted
under the Section 179 election to expense assets. Therefore, the basis rules discussed in
Chapter 9 provide the starting point for computing the capital recovery deduction. An asset’s
basis for depreciation does not have to be reduced by its salvage value. The depreciable basis
of an asset is the amount of basis that is subject to depreciation and is the amount used to
determine the annual depreciation deduction. The depreciable basis does not change during an
asset’s tax life unless additional capital expenditures are made for the asset. The total capital
recovered as a depreciation deduction over an asset’s useful life may never be more than its
depreciable basis. Do not confuse the term depreciable basis with adjusted basis. Adjusted
basis refers to the unrecovered capital of an asset at any point in time. An asset’s adjusted
basis decreases as cost recovery deductions are taken. The capital recovery under MACRS
does not necessarily relate to the true remaining useful life and salvage value of the asset. That
is, an asset’s depreciable basis can be fully recovered, even though the asset remains in
service and salvage value exists.
EXAMPLE 14 In 2010, Estelle Corporation purchases office equipment costing
$280,000 for use in its repair business. Because equipment is eligible to be expensed
under Section 179, Estelle elects to expense $250,000 of the cost of the equipment.
What is Estelle Corporation’s depreciable basis in the equipment?
Discussion: Estelle’s initial basis in the equipment is $280,000. The election to expense
reduces the depreciable basis to $30,000 ($280,000 - $250,000). The corporation recovers
its $280,000 investment in the equipment through expensing $250,000 in the year of
purchase and $30,000 in depreciation charges over the life of the equipment.
If the office equipment had cost only $100,000 and Estelle elected to expense the
entire $100,000 cost under Section 179, the corporation would fully recover its capital
investment in 2010. The depreciable basis in the equipment then is zero, and the
corporation is allowed no further capital recovery deductions on its initial $100,000
investment. However, the equipment remains in service and may provide several years
of quality use.
Depreciation Method Alternatives
Under current tax law, taxpayers have three alternatives for calculating depreciation:
■
Regular MACRS
■
Straight-line over the MACRS recovery period
■
Straight-line over the Alternative Depreciation System (ADS) recovery period
6
Figure 10–2 illustrates these choices for depreciating personal property. A taxpayer decides
which to use by first choosing whether to maximize or minimize the depreciation deduction in
the year of acquisition. The taxpayer would maximize by using the Section 179 election,
claiming the additional first-year depreciation, and using regular MACRS for the remaining
depreciable basis. Regular MACRS depreciates property in the 3-, 5-, 7-, and 10-year classes
using the 200-percent declining balance method with an optimal, automatic switch to straightline in the IRS percentage tables. Assets in the 15- and 20-year classes are depreciated using
the 150-percent declining balance method. The taxpayer who needs a slower depreciation rate
can minimize the deduction by using straight-line (S-L) MACRS or ADS. Because of the longer
recovery period, ADS produces the smallest depreciation deduction. Taxpayers will need to
elect not to claim additional first-year depreciation to secure the smallest depreciation
deduction.
EXAMPLE 22 On March 14, 2010, Lorange Mining company purchases a bus costing
$400,000 to transport its employees from the parking area to the mines. What should
Lorange do if it wants to recover its $400,000 cost as quickly as possible (i.e.,
maximize the cost recovery)?
Discussion: To maximize cost recovery, Lorange should elect to expense $250,000 of
cost under Section 179, leaving a depreciable basis of $150,000 ($400,000 −
$250,000), which would be recovered using the regular MACRS 200% declining
balance method over the 5-year recovery period for buses. The recovery period is
found in Table A10–1 under the column labeled General Depreciation System. The
regular MACRS method (using Table 10–4) provides the fastest depreciation write-off
for the property’s depreciable basis:
Initial basis
Section 179 election
Adjusted basis
$ 400,000
(250,000)
$ 150,000
Depreciable basis
MACRS% (Table 10–4)
2010 depreciation
$ 150,000
×
20%
$ 30,000
Maximum cost recovery
$280,000 ($250,000 + $30,000)
EXAMPLE 23 Assume that in example 22, Lorange wants to recover the $400,000 cost
as slowly as possible (i.e., minimize the cost recovery). Which options should Lorange
elect?
Discussion: The slowest cost recovery is obtained by not using Section 179 and
electing to use straight-line depreciation over the ADS life of the property. The ADS
recovery period is always greater than or equal to the MACRS recovery period. Table
A10–1 shows that the ADS recovery period is 9 years for buses. Remember that the
MACRS recovery period is 5 years. Thus, the use of the ADS life generally stretches
the depreciation deductions over a longer period, thereby diminishing the deduction
amounts for each year in the recovery period:
Depreciable basis
$400,000
Full-year S-L deduction ($400,000 ÷ 9) $ 44,444
Mid-year convention
×
½
First-year depreciation
$ 22,222
7
Problems
25. Firefly, Inc., acquires business equipment in July 2010 for $815,000.
a. What is Firefly's maximum Section 179 deduction for 2010? Explain.
Because Firefly acquired over $800,000 of qualifying Section 179
property, the annual investment limit applies. The $250,000 annual
deduction is reduced dollar for dollar by the amount of the investment
in qualifying property in excess of $800,000. Firefly's Section 179
deduction is reduced by $15,000 ($815,000 - $800,000) and its Section
179 deduction is limited to $235,000 ($250,000 - $15,000).
b.
What happens to any portion of the annual limit not deducted in 2010?
Explain.
The $15,000 of the annual limit not deductible in 2010 is lost forever.
Annual investment limit rules provide for no carry forward provisions.
c. What is the depreciable basis of the equipment? Explain.
The depreciable basis of the equipment is $580,000 ($815,000 $235,000). The acquisition cost of the equipment is reduced by the
amount of the Section 179 election for the current year.
26. In 2010, Terrell, Inc., purchases machinery costing $820,000. Its 2010
taxable income before considering the Section 179 deduction is $240,000.
a. What is Terrell's maximum Section 179 deduction in 2010? Explain.
Because Terrell acquired over $800,000 of qualifying Section 179
property, the annual investment limit applies. The $250,000 annual
deduction is reduced dollar for dollar by the amount of the investment
in qualifying property in excess of $800,000. Terrell's Section 179
deduction is reduced by $20,000 ($820,000 - $800,000) and its Section
179 deduction is limited to $230,000 ($250,000 - $20,000). The taxable
income limit does not affect the amount of the 2010 Section 179
deduction because the $240,000 taxable income exceeds the $230,000
maximum election to expense.
b. What is the depreciable basis of the equipment?
The depreciable basis of the equipment is $590,000 ($820,000 $230,000). The acquisition cost of the equipment is reduced by the
amount of the Section 179 election for the current year.
8
30. Jennifer owns a 40% interest in the Thomas Partnership. She also owns
and operates an architectural consulting business. During the current year,
the partnership purchases $260,000-worth of property qualifying under
Section 179 and elects to expense $250,000.
Jennifer purchases
$180,000-worth of qualifying Section 179 property for use in her
architectural consulting business. Write a letter to Jennifer explaining what
she should do to maximize her cost recovery.
Each partner will be allocated his/her proportionate share of the
$250,000 expense election. Each partner is then subject to the
$250,000 limit on his or her personal return. Jennifer will be allocated
$100,000 ($250,000 x 40%) of the deduction. This leaves her a
maximum additional Section 179 election to expense of $150,000. Her
qualifying property purchases are $180,000, so she can expense
$150,000 ($250,000 - $100,000) of the excess Section 179 election.
Her Section 179 deduction is $250,000 ($100,000 + $150,000). The
depreciable basis of the purchased property becomes $30,000
($180,000 - $150,000). The first-year depreciation, assuming the
property is 7-year MACRS is $4,287 ($30,000 x 14.29%, from Table
A10-2). Therefore, Jennifer's total cost recovery would be $254,287
($100,000 + $150,000 + $15,000 + $4,287).
Allocation from the partnership
Section 179 deduction for property purchased
Maximum Section 179 deduction
$100,000
150,000
$250,000
Depreciable basis ($180,000 - $150,000)
1st year depreciation (Table A10-2)
Total current year cost recovery
4,287
$254,287
$30,000
x 14.29%
9
37. The United Express Company begins business in August 2010 by
purchasing the assets listed in the table below. Calculate the maximum
MACRS depreciation on the assets.
Asset
Trucks
Tractor units
Office equipment
Cost
$200,000
60,000
100,000
To claim the maximum MACRS depreciation, the company should
elect to expense the maximum $250,000 allowed under Section 179 for
2010. In addition, the company should elect to expense the assets
with the longest useful life. United's cost recovery deduction is
$280,000.
Office Equipment (7-year life):
Election to expense
$ 100,000
Trucks (5-year life):
Election to expense ($250,000 - $100,000)
Depreciable basis ($200,000 - $150,000) $50,000
First-year depreciation (Table A10-2)
x
20%
Cost-recovery on trucks
Tractor Units ( 3-year life):
Depreciable basis
First-year depreciation (Table A10-2)
Cost-recovery on tractor units
Total 2010 cost recovery
150,000
10,000
$60,000
x 33.33%
20,000
$ 280,000
10
38. Assume that in problem 37, the United Express Company sells a truck that
cost $30,000 in 2010 for $10,000 in June 2013. Assume that none of the
truck was expensed in 2010. Compute the adjusted basis of the truck and
the gain or loss from the sale.
The adjusted basis of the truck is $6,912, calculated by computing
depreciation for each year using Table A10-2. Under the mid-year
convention, only half a year's depreciation is allowed in the year of
sale.
Original basis
2010: ($30,000 x 20%)
2011: ($30,000 x 32%)
2012: ($30,000 x 19.2%)
2013: [($30,000 x 11.52%)  2]
Total depreciation
Adjusted basis
$ 30,000
$6,000
9,600
5,760
1,728
(23,088)
$ 6,912
The adjusted basis of $6,912 is subtracted from the $10,000 sales
price resulting in a gain of $3,088.
Sales price
Less: adjusted basis
Gain on sale
$10,000
(6,912)
$ 3,088
11
43. Dikembe purchases 4,000 breeding hogs for $320,000 in April 2010.
a. What is his maximum 2010 cost-recovery deduction for the hogs?
To maximize the current year's cost recovery deductions for personal
property, the general strategy is to elect the Section 179 expense
deduction and then use regular MACRS to depreciate the balance.
Hogs qualify for the Section 179 election to expense. Therefore,
$250,000 can be deducted. The depreciable basis of the 4,000
breeding hogs becomes $70,000 ($320,000 - $250,000). The hogs are
3-year MACRS recovery property (see Table A10-1, Asset Class 01.23).
Using Table A10-2, the first-year depreciation for the hogs is $23,331
($70,000 x 33.33%). This results in total first-year cost recovery of
$273,331 ($250,000 + $23,331).
Election to expense
Depreciable basis of hogs ($70,000 x 33.33%)
Total cost recovery deduction
$ 250,000
23,331
$ 273,331
b. Dikembe's farming operation incurs a net loss this year and probably will
next year before taking the cost recovery into consideration. What should
Dikembe do in regard to his cost-recovery deductions?
Because the election to expense is limited to the amount of taxable
income in a given year, Dikembe cannot benefit from the election
either this year or next year.
However, regular depreciation
deductions can create a net operating loss. Therefore, Dikembe has
two options.
Dikembe can choose a depreciation method that permits a larger
deduction after next year. To accomplish this, he should use the ADS
straight-line method. The ADS recovery period is 3 years for breeding
hogs.
Therefore, Dikembe’s first-year depreciation is $53,333
[($320,000  3) x 50% for the mid-year convention]. This amount
adds to the net operating loss and can be carried back as per normal
net operating loss rules. For the 2nd and 3rd years, Dikembe deducts
$106,667 [($320,000 x (100%  3)]. For year 4, Dikembe deducts the
remaining undepreciated basis of $53,333.
Year 1 depreciation
Year 2 depreciation
Year 3 depreciation
Year 4 depreciation
Total cost recovery deduction
$ 53,333
106,667
106,667
53,333
$320,000
Note: Dikembe cannot ignore depreciation in the year the hogs are
placed in service or the following year. Depreciation must be taken
(i.e., allowed or allowable).
12
44. Rograin Corporation purchases turning lathes costing $670,000 and a bus
costing $280,000 in June of the current year. The lathes are 7-year
MACRS property, and the bus is 5-year MACRS property.
a. What is Rograin's maximum Section 179 deduction?
The maximum Section 179 expense deduction is $250,000 for 2010.
However, the deduction is reduced dollar for dollar when purchases
exceed $800,000. In this case, Rograin has purchased $950,000
($670,000
+
$280,000) of qualifying property.
Therefore, the
maximum deduction is reduced by $150,000 ($950,000 - $800,000) to
$100,000 ($250,000 - $150,000).
b. Assuming that Rograin deducts the maximum Section 179 expense, what
are the depreciable basis of the lathes and the bus?
The basis of assets expensed under Section 179 are reduced to
prevent capital recovery in excess of cost. Rograin must determine
which of the two properties to expense. To get the maximum overall
depreciation deduction, the Section 179 expense deduction should be
allocated to the property with the longest recovery period. This
results in a depreciable basis for the lathes of $570,000 ($670,000 $100,000) and $280,000 for the bus.
c. If Rograin wants to maximize its cost recovery this year, how much firstyear depreciation may it deduct in addition to the Section 179 deduction?
The basis of the lathes and the bus are depreciated using Table A10-2.
The lathes have a recovery period of 7 years and the bus has a
recovery period of 5 years. The maximum total first-year depreciation
is $237,453.
Election to expense (from part a)
Lathes – First-year depreciation
$570,000 x 14.29%
Bus – First-year depreciation
$280,000 x 20%
Total cost recovery deduction
$ 100,000
81,453
56,000
$237,453
13
45. Baker, Inc., purchases office furniture (7-year MACRS property) costing
$280,000 and a computer system (5-year MACRS property) costing
$280,000 in 2010. What is Baker's maximum cost-recovery deduction in
2010? (Hint: Maximize the Section 179 election effect.)
To maximize the cost-recovery deduction, Baker should elect to
expense $250,000 of the cost of the purchases and use the regular
MACRS depreciation system. To maximize the election to expense
deduction, the $250,000 should be allocated to the property with the
longest useful life, in this case the office furniture. This will result in a
2010 cost-recovery deduction of $310,287:
Cost-Recovery on Office Furniture:
Election to expense
Depreciable basis ($280,000 - $250,000)
1st year depreciation (Table A10-2)
Cost-recovery on office furniture
Cost-Recovery on Computer System:
Depreciable Basis
1st year depreciation (Table A10-2)
Total 2009 Cost-recovery
$250,000
$ 30,000
x 14.29%
$280,000
x
20%
4,287
$254,287
56,000
$310,287
NOTE: If Baker elected to expense $250,000 of the computer system,
the cost-recovery deduction would be $296,012:
Cost-Recovery on Office Furniture:
Depreciable basis
1st year depreciation (Table A10-2)
Cost-Recovery on Computer System:
Election to expense
Depreciable basis ($280,000 - $250,000)
1st year depreciation (Table A10-2)
Total 2009 cost-recovery
$280,000
x 14.29%
40,012
250,000
$ 30,000
x
20%
6,000
$296,012
14
48. The Gladys Corporation buys office equipment costing $290,000 on May
12, 2010. In 2013, new and improved models of the equipment make it
obsolete, and Gladys sells the old equipment for $34,000 on December 27,
2013.
a.
What is Gladys Corporation's gain or loss on the sale assuming that Gladys
takes the maximum cost-recovery deduction allowable on the equipment?
The office equipment is considered 7-year property. To maximize the
cost-recovery deductions, Gladys should elect to expense $250,000 of
the cost of the equipment and use the regular MACRS method on the
$40,000 ($290,000 - $250,000) depreciable basis. Gladys’ costrecovery deduction on the equipment for 2010 through 2013 is
$275,006:
Depreciable
Depreciation Depreciation
Year
Basis
Percentage
Deduction
2010
Election to expense
$ 250,000
2010
$ 40,000
14.290%
5,716
2011
$ 40,000
24.490%
9,796
2012
$ 40,000
17.490%
6,996
2013
$ 40,000
6.245%*
2,498
Total depreciation
$ 275,006
*
Personal property under MACRS is subject to the mid-year
convention. This allows a half-year of depreciation in the year of
disposition. For 2013, a full year of depreciation would be 12.49%.
Therefore, 6.245% is one-half of the 2013 depreciation percentage.
Gladys’ adjusted basis at the date of sale is $14,994 ($290,000 $275,006). This results in a gain on the sale of $19,006 ($34,000 $14,994).
15
b. What is Gladys Corporation's gain or loss on the equipment assuming that
Gladys takes the minimum cost-recovery deduction allowable on the
equipment?
To minimize the cost-recovery deductions, Gladys will not elect to
expense any of the equipment under Section 179 and use the straightline method over the Alternate Depreciation System life. Using Table
A10-1, office equipment would have an ADS life of 10-years. This
results in total depreciation deductions for 2010 through 2013 of
$87,000:
Depreciable Depreciation* Depreciation
Year
Basis
Percentage Deduction
2010
$ 290,000
5.00%
$ 14,500
2011
$ 290,000
10.00%
29,000
2012
$ 290,000
10.00%
29,000
2013
$ 290,000
5.00%**
14,500
Total Depreciation
$ 87,000
* Depreciation percentages are from Table A10-11.
** Personal property under MACRS is subject to the mid-year
convention. This allows a half-year of depreciation in the year of
disposition. For 2013, a full year of depreciation would be 10.00%
(5.00% is a half-year of depreciation in 2013).
Gladys' adjusted basis at the date of sale is $203,000 ($290,000 $87,000). This results in a loss on the sale of $169,000 ($34,000 $203,000).
16
From Chapter 11
61. The Gladys Corporation buys equipment (7-year MACRS property) costing
$290,000 on May 12, 2010. In 2013, new and improved models of the
equipment make it obsolete, and Gladys sells the old equipment for
$34,000 on December 27, 2013.
a. What is the character of Gladys corporation’s gain or loss on the sale
assuming that it takes the maximum cost-recovery deductions allowable on
the equipment?
NOTE: The depreciation calculations for this problem were done for
problem 48, Chapter 10.
From problem 48 in Chapter 10, the depreciation taken on the asset to
the date of sale is $275,006, resulting in an adjusted basis in the
equipment of $14,994 ($290,000 - $275,006). This results in a gain of
$19,006 on the sale. The equipment is Section 1245 property.
Because the depreciation is greater than the realized gain, all of the
gain is recaptured as ordinary income.
Amount realized
Adjusted basis ($290,000 - $275,006)
Gain realized on sale
Section 1245 recapture
Section 1231 gain
$ 34,000
(14,994)
$ 19,006
(19,006)
$ -0-
b. What is the character of Gladys Corporation’s gain or loss on the equipment
assuming that it takes the minimum cost-recovery deduction allowable on
the equipment?
Straight-line depreciation is $87,000, resulting in an adjusted basis of
$203,000 ($290,000 - $87,000). This results in a loss on the sale of
$169,000. Although the equipment is Section 1245 property, the
recapture rules apply only to gains caused by ordinary depreciation
deductions. Losses on Section 1245 assets are Section 1231 losses.
Amount realized
Adjusted basis ($290,000 - $87,000)
Loss realized on sale
$
34,000
(203,000)
$ (169,000)
Section 1231 loss
$ (169,000)
17
49. In June 2010, Copper Kettle, Inc., purchases duplicating equipment for
$350,000.
a. Compare cost recovery deductions using maximum, minimum, and
intermediate methods over the recovery period of the equipment.
Maximizing the cost recovery includes using the Section 179 election
($250,000) and using the regular MACRS method on the remaining
depreciable basis of $100,000 ($350,000 - $250,000) using Table A10-2.
Computer equipment has a MACRS recovery period of 5 years.
Depreciable
Year
2010
2010
2011
2012
2013
2014
2015
Total
Depreciation
Basis
Election to Expense
$100,000
$100,000
$100,000
$100,000
$100,000
$100,000
Depreciation
Percentage
20.00%
32.00%
19.20%
11.52%
11.52%
5.76%
Depreciation
Deduction
$250,000
20,000
32,000
19,200
11,520
11,520
5,760
$350,000
Minimizing the cost recovery deduction suggests using the ADS
straight-line method, and electing not to claim additional first-year
depreciation. The ADS recovery period is 6 years. Therefore, the
annual deduction rate is 16.67% (1/6).
Depreciable
Year
2010
2011
2012
2013
2014
2015
2016
Total
Depreciation
Basis
$350,000
$350,000
$350,000
$350,000
$350,000
$350,000
$350,000
Depreciation
Percentage
8.33%
16.67%
16.67%
16.67%
16.67%
16.66%*
8.33%
Depreciation
Deduction
$ 29,155
58,345
58,345
58,345
58,345
58,310
29,155
$350,000
18
An intermediate cost recovery method is to use the MACRS recovery
period (5 years) with the straight-line method (Table A10-11). The
Section 179 election to expense is not made.
Depreciable
Year
2010
2011
2012
2013
2014
2015
Total
Depreciation
Basis
$350,000
$350,000
$350,000
$350,000
$350,000
$350,000
Depreciation
Percentage
10%
20%
20%
20%
20%
10%
Depreciation
Deduction
$ 35,000
70,000
70,000
70,000
70,000
35,000
$350,000
b. Explain why Copper Kettle, Inc., would elect to use each of these methods.
Maximizing the cost recovery provides the largest deductions in the
early years to offset income. The larger deductions are more valuable
if taken in the early years due to the time value of money. A minimum
cost recovery method is desirable if an enterprise is experiencing
losses or relatively low income and does not have the income to offset
the deductions for cost recovery.
While the intermediate method
provides a slightly faster cost recovery than when minimizing because
the straight-line is 1 year faster than the ADS recovery period.
19
Test Questions
MULTIPLE CHOICE
1.
a.
b.
c.
d.
e.
Sawback Corporation purchases a new machine in July 2010 for $400,000. No other
fixed assets are placed in service in 2010. Sawback has substantial taxable income and
desires to minimize this amount to the fullest extent possible. How much can Sawback
deduct under Section 179?
$100,000
$125,000
$150,000
$200,000
$250,000
ANS: E
2.
I.
II.
III.
a.
b.
c.
d.
e.
Southerland, Inc., a motorcycle wheel manufacturer, purchased a new spoke machine in
2010 for $80,000. What are the tax effects of this purchase?
If taxable income is $100,000, then all $80,000 can be expensed in 2010.
No Section 179 election is allowed if Southerland decides to use a $80,000
depreciable basis.
If Southerland had purchased a total of $820,000 of equipment in 2010, the
corporation can deduct only $230,000 of the purchases in 2010 through use
of the Section 179 election.
Only statement I is correct.
Statements I and II are correct.
Statements II and III are correct.
Statements I and III are correct.
Statements I, II, and III are correct.
ANS: E
3.
During 2010, Witt Processing Corporation places $840,000 of Section 179 property in
service for use in its business. What is the amount of Witt Processing's maximum Section
179 deduction for 2010?
a.
b.
c.
d.
e.
$40,000
$210,000
$250,000
$420,000
$840,000
ANS: B
20
4.
In May 2010, Keith purchases 5-year MACRS property costing $140,000 and 7-year
MACRS property costing $150,000. If Keith wishes to maximize his total 2010 cost recovery
deduction, what will his total cost recovery deduction be on the properties purchased in
2010?
a.
b.
c.
d.
e.
$ 50,935
$266,000
$255,716
$258,000
$290.000
ANS: D
5.
The Cox Accounting Firm places the following property in service during the 2010 tax year:
Property
Description
Computers
Office furniture
Fax machine
Phone system
Placed in
Service
Feb 6
June 24
Aug 3
Dec 11
MACRS Life
5 years
7 years
5 years
5 years
Cost Basis
$ 60,000
$ 80,000
$100,000
$ 40,000
Cox wants to obtain the maximum possible first year depreciation deduction for these property
acquisitions including full utilization of the election to expense property under Section 179. Cox
will report 2010 taxable income in the amount of $500,000 before consideration of depreciation
on their 2010 property acquisitions. What is the maximum combined amount of cost recovery
that may be obtained under this set of fact circumstances?
a.
b.
c.
d.
e.
$280,000
$256,000
$254,287
$250,000
$ 47,432
ANS: B
6.
On July 17, 2010,Elise purchases office furniture (7-year property) costing $850,000 for use
in her business. What is the maximum total cost recovery deduction Elise can take for the
current year?
a.
b.
c.
d.
e.
$850,000
$800,000
$335,740
$292,885
$121,465
ANS: D
21
7.
South Lake Inc., a real estate appraisal firm, places the following assets in service during
the 2010 tax year:
Property Description
Computers
Office furniture
MACRS Life
5 years
7 years
Cost Basis
$170,000
$140,000
The office furniture was placed in service during July and the computers were placed in service
during September. South Lake Inc. wants to maximize the tax benefit of their capital recovery
allowances and has asked you to determine the maximum expense available on these assets
for the 2010 tax year.
a.
b.
c.
d.
e.
$ 54,006
$258,574
$262,000
$284,287
$286,000
ANS: C
8.
Baltimore Freight Company purchases 10 delivery vans on April 4, 2010, at a total cost of
$380,000. Baltimore uses the regular MACRS system on all of its delivery vans (the
delivery vans are 5-year MACRS property and are not limited by listed property rules). What
is Baltimore's maximum cost recovery deduction on the vans in 2010?
a.
b.
c.
d.
e.
$ 76,000
$275,000
$276,000
$328,000
$380,000
ANS: C
9.
a.
b.
c.
d.
e.
International Electronics Company purchases new equipment (5-year MACRS property) for
$820,000 on July 8, 2010. What is International Electronics' maximum allowable cost
recovery deduction for 2010 on the new equipment if this is the only purchase of equipment
for 2010?
$ -0$164,000
$180,000
$348,000
$364,000
ANS: D
22
11.
a.
b.
c.
d.
e.
During 2010, Witt Processing Corporation places $835,000 of Section 179 property in
service for use in its business. What is the amount of Witt Processing's maximum Section
179 deduction for 2010?
$ 35,000
$215,000
$250,000
$530,000
$835,000
ANS: B
23
PROBLEMS
2.
Arapaho Corporation purchased 5-year MACRS property with a 6-year ADS life costing $450,000
in 2010. What is Arapaho’s 2010 cost recovery deduction on the property if they want to deduct
a.
The maximum cost recovery on the property for 2010.
b.
The minimum cost recovery on the property for 2010.
a.
The maximum cost recovery is obtained by electing to expense $250,000 of the cost of the
property and using regular MACRS to depreciate the remaining basis of the property. The
maximum 2010 cost recovery is $290,000:
ANS:
Election to Expense
Depreciable Basis ($450,000 - $250,000)
1st year MACRS
Maximum 2010 Cost Recovery
b.
$250,000
$200,000
× 20%
40,000
$290,000
The minimum cost recovery is obtained by not electing to expense any of the property
under Section 179 depreciating the $450,000 basis straight-line over the 6-year ADS life.
The minimum 2010 cost recovery is $37,500:
Full year straight-line over ADS life
Mid-year convention
Minimum 2010 Cost Recovery
$450,000 ÷ 6 = $75,000
× 50%
$37,500