Answer to Question 3
1. First you have to find out the class of this property. It’s easy; it’s given. This is a 7-yr property.
2. Next, you have to find out the depreciation convention. Should it be mid-month, mid-quarter or
half-year. This determines the period for which you can claim depreciation in the year of
purchase or sale. The mid-month convention is used for nonresidential real property, residential
rental property, and any railroad grading or tunnel bore. Since, we are depreciating equipment,
these don’t apply to us. In fact, since this is the only MACRS depreciable property we can use the
mid-quarter convention. Under this convention, the depreciation period is 1.5 months for the
quarter the property is purchased or sold in.
3. Third, we need to figure out if the depreciation rate should be 100%, 150% or 200%. Since, we
want maximum cost recovery deduction, we can use 200% for a 7-yr property.
Answer to Question 3a
Depreciation in year 2013 is given by,
Cost * (1/Useful Life) * Depreciation Rate * Depreciation Period
= $2,150,000 * (1/7) * 200% * (1.5/12) = $76,786.
Answer to Question 3b
For 2014 and 2015 we will use declining balance method of depreciation as it gives higher depreciation
for the first 4 years in a 7-year property. Depreciation in year 2014 and 2015 is given by,
(Cost – prior years depreciation) * (1/Recovery Period) * Depreciation Rate * 1
Recovery period is obviously 7 years.
Thus, depreciation for 2014:
($2,150,000 - $76,786) * (1/7) * 200% * 1 = $592,347
And for 2015:
($2,150,000 - $76,786 - $592,347) * (1/7) * 200% * 1 = $423,105
Answer to Question 3c
Now, it sells the equipment on June 30, 2016. Therefore in 2016, it can claim depreciation for entire
quarter 1 and only 1.5 months in quarter 2 under the mid-quarter convention. Thus, the period for
depreciation will be ((3 + 1.5)/12) years = 4.5/12 years.
Thus, depreciation in 2016:
($2,150,000 - $76,786 - $592,347 - $423,105) * (1/7) * 200% * (4.5/12) = $113,332
Just as a check, let us see what we get by using straight line depreciation,
($2,150,000 - $76,786 - $592,347 - $423,105) * (1/(7 – 2.125)) * (4.5/12) = $113,332
So in 2016, it doesn’t really matter which method you use. The cost recovery deduction is the same.
Answer to Question 4
1. Once again, first find out the property class. The storage facility is a non-residential real property
and hence, has a recovery period of 39 years. However, it needs to be noted that land cannot be
depreciated. Hence, only the building will qualify for depreciation.
2. We will use mid-month convention for a non-residential real property. Thus, the depreciation
period for the year of purchase will be 11.5 months (half of January + 11 months).
3. For real property we can use straight line method of depreciation.
Answer to Question 4a
Adjusted basis of the facility = $2,500,000 (excluding the land)
Straight line depreciation rate = 1/39
Depreciation period (mid-month) = 11.5
Depreciation for 2013:
Adj. basis * SL rate * period = $2,500,000 * (1/39) * 11.5 = $737,179.
Answer to Question 4b
Refer the following table for years 2014 through 2016:
Adjusted basis
Remaining Life
SL rate
Depr period
Depreciation
Amount
2013
2014
2015
2016
2017
2018
$2,500,000 $2,438,568 $2,374,466 $2,310,363 $2,246,261 $2,182,158
39.00
38.04
37.04
36.04
35.04
34.04
0.02564
0.96
$ 61,432
0.02629
1.00
$ 64,103
0.02700
1.00
$ 64,103
0.02775
1.00
$ 64,103
0.02854
1.00
$ 64,103
0.02938
0.88
$ 56,090
The adjusted basis is (the cost of the building – depreciation claimed so far). Therefore, for 2014,
adjusted basis = $2,500,000 - $61,432.
For, 2015 through 2016,
Adjusted basis 2015 = Cost of building – depreciation of 2014 & 2013
Adjusted basis 2016 = Cost of building – depreciation of 2015 & 2014 & 2013
Adjusted basis 2017 = Cost of building – depreciation of 2016 & 2015 & 2014 & 2013
Similarly, the remaining life is the life of the building (39 yrs) – period depreciated so far.
Therefore,
Remaining life 2014 = 39 – (11.5/12) = 38.04
Remaining life 2015 = 39 – (11.5/12) – 1 = 37.04
Remaining life 2016 = 39 – (11.5/12) – 1 – 1 = 36.04
… and so on …
The straight line rate = (1/remaining life)
So, SL rate 2014 = 1/38.04 = 0.02629
… and so on …
And for 2014 to 2017, the facility is dedicated to business for the full year and hence, full year
depreciation is applicable.
Therefore, depreciation amount for each year is $64,103.
Answer to Question 4c
For 2018,
Adjusted basis = Cost – depreciation claimed in previous years
= $2,500,000 - $61,432 - $64,103 - $64,103 - $64,103 - $64,103 = $2,182,158
Remaining life = 39 – (11.5/12) – 4 (one each for 2014 to 2017) = 34.04
SL rate = 1/34.04 = 0.02938
The facility is disposed of in November 2018. Therefore, using mid-month method, only 10.5 months of
depreciation is allowed (Jan to Oct + half of Nov).
Therefore, depreciation period = 10.5/12
Thus, depreciation amount for 2018 = $2,182,158 * 0.02938 * 10.5/12 = $56,090.