Agenda 3-15 BA 128A-1
•
•
•
•
•
Questions from lecture
Form groups
Review Chapter 10&11
Assignment - I10-27,29,42 I11-44,46
Additional - I10-24,34, I11-37,51
Depreciation, Depletion and
Amortization
• For assets/property used in trade or business or held for
production of income
• Disallowed depreciation - personal use assets , indefinite
life assets - e.g. land/securities
• Rules – before 1981 - same as financial accounting standards
– 1981-1986 - ACRS - provide stimulus for investment
– After 1986 - MACRS - follow economic useful life of
assets
• Deduction allowed in year asset place into service
• Capitalization vs. Expenses
Types of property
• Tangibles - land, building, equipment natural
resources (depletion)
• Intangibles - goodwill (amortization), patents,
stocks, bonds
• Personal use property
• Personal property - equipment, vehicles, furniture
• Real Property - land and structure permanently
attached to the land
Rules
• Conversion of personal use asset to business valued at lesser of adjusted basis or FMV as of
conversion date
• Pre 1981 - Financial accounting methods of
depreciation - Straight line, Declining Balance,
Sum of the years digit
• Useful life determined by experience and business
practice
• Can elect ADR system (asset depreciation range
system) for useful life references
ACRS
• Stimulate private investment, accelerated cost recovery system
• Improve business productivity, simplify taxpayer compliance and
facilitate IRS administration
• Provide great tax benefits
• Personal property - ACRS table or straight line, half year convention
for 3,5,10,15 recovery period, all assets treated as if acquired in the
mid point of the year, no cost recovery in the year of sale/disposition
• Real property - residential/nonresidential real property used in trade or
business or held for the production of income
• recovery periods 15.18.19 years for different property acquired at
different dates P I10-6
• After 6/22/84, mid month convention is used
• Can elect to use st. line 3- year ACRS can have recovery periods of
e.g. 3,5,12 years (See page I10-6), similar to ACRS, half year
convention for personal property, mid month for real estate and no cost
recovery for personal property in year of disposition
MACRS
• Class lives generally lengthened
• No salvage value for both ACRS and MACRS
• Personal property - half year convention, conversion to st.
line if yields larger amount, amount reduced by half in year
of disposition, recovery period is 3,5,7,10,15 years
• Requires the use of mid-quarter if aggregate basis of all
personal property in service in the last 3 months > 40% of
the cost of all personal property placed in service during
the tax year (exclude section 179 property and property
place and disposed in the same year) - however this does
not mean half year convention always yields more.
• Disposal calculation needs to be consistent, half year or
quarter
• May elect straight line, same recovery period or use the
ADS
MACRS- real property
• Residential - 27.5 years recovery period,
80% of income has to derive from dwelling
purpose
• Non-residential, 39 years
• mid-month
• Straight line
• Capital improvements depreciated over its
econ. life, not the life of the building
Alternative depreciation System
(ADS)
• Certain property is required or taxpayers
can elect - property outside the US is
required, recovery period is much longer
• Use of straight over lengthened period and
same convention - midyear, month or
quarter
• Annual election
Section 179
• Apply only to tangible personal business property
• $18500 in 1998 in year of acquisition and has to
be placed in service the same year
• Not applied to real estate
• Election made on annual basis
• Limitations
– cannot be related party transaction
– Phase out >$200,000 property acquired $ for $
– Cannot exceed taxpayer’s income, excess
carryforward to unlimited # of years, cost basis
is reduced immediately
MACRS restrictions
• >50% business use, if not, ADS system is
used
• MACRS recapture if business use fall
below 50%, excess depreciation included in
ordinary income
• Use ADS subsequently even if business
>50% later
• Luxurious automobile restriction, leasing
restriction
Depletion
• Intangible drilling and development costs
applies to oil, gas and geothermal wells
• Deducted or capitalized
• Amount of depletion claimed each year =
greater of % of depletion and cost depletion
amounts.
• Methods - cost depletion(units sold) and %
of depletion (15% of gross income)
Amortization
• Straight line
• Apply to goodwill & other purchased
intangibles
• Research and experimental expenditures
• Start-up expenditures and others
• Section 197 - acquisition of substantial part
of business - 15 year amortization period definition of 197 assets PI10-19 (including
goodwill, licenses, workforce/customer lists
Amortization
• Partial disposal of Section 197 assets - no recognition of
loss allowed - other assets’ basis is increased
• R&E expenditures - election - expense in the year
occurred, defer/amortized the costs. If no election capitalized
• Expense not qualify as R&E (table I10-5)
• Capital expenditures in connection with R&E cannot be
expensed
• Amortization commences the month in which benefits
from the expenditures are realized
Chapter 11 - Accounting period
•
•
•
•
Period to recognize income and expense
Tax year = fiscal year
If no fiscal year - tax year = calendar year
Tax year determined when first tax return is filed, need IRS
approval for change
• Partnerships - follow the tax year of majority partners, if
partners do not have the same tax years, use the period that
results in the smaller deferral of income
• S-corp, PSC - generally use calendar year unless there is a
business purpose
• Allow tax year to fall on same last day of the month or day
closest to the end of the month
Change in accounting period
• Generally required IRS approval, need a
substantial business purpose (e.g. natural business
year)
• Exceptions - newly married spouse, change to 5253 weeks with same calendar month, partnership
changes, corporation (with no accounting change
in the last 10 years, no NOL, no change in
corporate status, taxable income from short year is
>= 90% of preceding full tax year
• Taxpayers changing accounting period have to
annualize their income - prevent income to be
taxed at lower rate
Accounting methods
• Cash method (no inventory)
• Accrual method (all events and economic
tests)
– all events - rights to receive, amount
determined at reasonable accuracy or liability is
established for expenses
– economic performance - services/property
provided
• Hybrid
Inventories
• Accounted for using best accounting practice
(GAAP) or clearly reflect income
• At cost or lower of cost or market
• If use LIFO, cannot use lower of cost or market
• COGM - uniform capitalization method full
absorption method
• if use LIFO, financial accounting needs to use
LIFO, other inventory methods allowed to use,
FIFO, specific identification, avg costs methods
• LIFO - $ value LIFO, LIFO pools, use
government price indices for different pools conversion from FIFO to LIFO
Long Term contracts
• Construction of property/good that cannot be
completed within the tax year period after it has begun
• Methods to account for income
– % of completion - (according to % of work completed)
– completed contract method - (income reported in year
contract is completed)
– modified % of completion - (if cost is hard to estimate,
recognized income until 10% of costs incurred)
– Look back interest adjustments (compare to actual costs)
• Costs include DL, DM and OH, indirect costs such as
selling, marketing, advertising R&D can be deducted
currently, G&A expenses and interest costs need to be
allocated
Installment sale
• Installment sale - at least 1 payment is
received after close of the taxable year in
which the disposition occurs.
• Not applicable to inventory by dealers and
publicly traded property
• Computations PI1-17, compute Gross
profit, contract price and compute gross
profit %. Subject to depreciation recapture
and excess mortgage
Installment sale
• Installments as gifts - taxable event - recognize
gain/loss between face value and adjusted basis
• Repossession of property sold on installment basis
is a taxable event - recog gain/loss between value
of repossessed property and adjusted basis of
installment obligation
• Borrowed funds from installment obligation
• Related party installment sales
Imputed interest
• Installment basis contract with no interest or low
rate of interest
• IRS apply rate according to fed government rate
on borrowed funds
• If principal < $2.8 million, interest rate limited to
9%, related party rate limited to 6%
• Exemption - personal use property, original issue
discount (bond), < 6months due payments
• e.g. compensation related loans, gift loans or
corporate shareholder loans
Change in accounting methods
• Requires IRS approval except changing to
LIFO
• negative or positive adjustment (e.g. from
cash to accrual or vice versa)
• involuntary change
• voluntary change
• may spread amount over a period (table I115)