Chapter
7
Property Acquisitions and
Cost Recovery Deductions
Expense vs. Capitalize
Deduction permitted for all “ORDINARY
AND NECESSARY” business expenses
Deduction prohibited for “PERMANENT
improvements to increase the value of
property”
Some types of capitalized costs can be
recovered through amortization or
depreciation
Expense vs. Capitalize
Repairs and maintenance? Source of IRS dispute
due to facts.
Capitalize expenditures that increase the value or useful life
of an asset.
Environment cleanup and prevention costs: TRA1997 has a
provision allowing firms to elect to deduct rather than
capitalize expenditures to abate or control hazardous
substances at contaminated areas.
Tax Basis
Tax basis = unrecovered cost (cost - depreciation).
Starting basis generally equals COST basis:
original purchase price regardless of whether acquired by
debt, or
FMV of asset if cost more difficult to measure.
Cost recovery of
Inventory = cost of goods sold
Tangible assets = depreciation
Intangible assets = amortization
Natural resources = depletion
Cost of Goods Sold
Inventory Methods (must use accrual to
account for COGS
1) FIFO
2) specific ID
3) LIFO - If use LIFO for tax, must also use LIFO
for books.
In times of inflation, LIFO decreases book and
taxable income.
Depreciation
Depreciation applies to tangible assets (things you
can touch versus intangibles like patents, goodwill)
that:
Lose value over time due to wear and tear, obsolescence
Buildings depreciate even though real estate often increases
in value.
Have a reasonably ascertainable useful life
Artwork is not generally depreciable.
Depreciation
MACRS - Modified Accelerated Cost
Recovery System
Personalty:
DDB: 3, 5, 7, 10
150% DB:15, 20
General rule is half year convention
Realty: SL method: 27.5 years residential, 39
years non-residential (specialty realty 20, 25, 50)
Mid Month convention
Depreciation Conventions - Personalty
Table 7-2 incorporates a half-year
convention - provides only 1/2 of the regular
rate in the year the property is put in service.
Anti-Abuse provision Mid-quarter convention
: IF > 40% personalty is acquired during the last quarter
of the year, THEN
Compute depreciation separately for EACH quarter’s
acquisition using mid-quarter tables in appendix of
chapter 7
Automobiles
Maximum annual depreciation limit per
vehicle, indexed for inflation.
Year 1 $3,160 (1st yr) with bonus $11,060
Year 2 $5,100 (2nd yr)
Year 3 $3,050 (3rd yr)
Year 4 + $1,875 (4th +++ yrs).
Compute depreciation per MACRS, then
limit above.
Expensing Election – Section 179
Applies to tangible personalty. May expense
$500,000 of assets purchased before
12/31/2014 - $25,000 in 2015+
Expense cannot create a business loss.
Expense reduced $ for $ by purchases >
$2,000,000 in 2014, $200K for 2015+
50% Bonus depreciation on personalty for tax
years 2012-2014 none after
Planning - if buy a 3-year, 5-year and 7-year asset,
which one should you expense?
Amortization of Intangibles
Generally requires a determinable useful life.
Organizational costs & Start up costs
Immediately deduct up to $5,000
Amount over $5K amortized over 180 months.
Start-up costs & Organization costs are
defined on pg. 177.
Expansion costs may be currently
deductible.
Leasehold Costs and Improvements
Cost of acquiring lease is amortized
over the period of lease.
Improvements to leased property are
capitalized and depreciated according to
type of property.
Purchased Intangibles
Allocate lump-sum price to assets by
relative FMVs.
Residual = goodwill.
Tax = 15 years SL
GAAP = 40 years pre-2002. No GAAP
amortization post-2001 - evaluate for
impairment annually. Book-tax difference
is permanent post-2001.