Depreciation, Cost Recovery, Amortization, and Depletion

1
Chapter 10

• Depreciation, Cost Recovery, Amortization, and
  Depletion

2
Overview

• Cost Recovery
• ACRS
• MACRS
• Section 179
• Listed Property
• Passenger Auto Limits
• Amortization
• Depletion
• Research Development

3
Cost Recovery

• The recovery of the costs of business or
  income-producing assets is through
• Cost recovery or depreciation tangible assets
• Depletion natural assets
• Amortization intangible assets

4
General Considerations

• The basis in an asset is reduced by the amount of
  recovery that is allowed or allowable
• ACRS MACRS apply to
• Assets placed in service after 1980
• Assets subject to wear and tear, obsolescence,
  etc.
• Assets must have a determinable useful life
• Assets that are tangible personalty or realty

5
Accelerated Cost Recovery System

• ACRS (1981-1986) characteristics
• Statutory lives of 3, 5, 10, 15, 18, 19
• Assets have no salvage value
• Mid-year convention
• Reduced depreciable basis by 1/2 investment tax
  credit taken

6
MACRS (slide 1 of 10)

• MACRS (after 1986) characteristics
• 
  MACRS Personalty
• Statutory lives 3, 5, 7, 10 yrs ?
  15, 20 yrs ?
• Method 200 DB
  ? 150 DB
• Convention Half Yr or
  Mid-Quarter
• DB declining balance with switch to st. line
• St. line depreciation may be elected

7
MACRS (slide 2 of 10)

• MACRS (after 1986) characteristics
• MACRS
  Realty
• Residential Rental
  Nonresid. Realty
• Statutory lives 27.5 yrs 31.5
  yrs or 39 yrs
• Method Straight
  line
• Convention Mid-month
• Placed in service after December 31, 1986 and
  before May 13, 1993
• Placed in service on or after May 13, 1993

8
MACRS (slide 3 of 10)

• Half-year convention
• General rule for personalty
• Half-Year assets treated as if placed in
  service (or disposed of) in the middle of
  taxable year regardless of when actually placed
  in service (or disposed of)
• Example (see Table 1, page C-2)
• 3 year asset 11/32001/233.33
• 5 year asset 11/52001/220
• 7 year asset 11/72001/214.29

9
MACRS (slide 4 of 10)

• Example of half-year convention
• Bought and placed in service an asset on March 15
• Tax year end is December 31
• Treated as placed in service June 30
• Six months cost recovery in year 1 (and year
  disposed of, if within recovery period)

10
MACRS (slide 5 of 10)

• Mid-quarter convention
• Applies to personalty when more than 40 of
  personalty placed in service during the year was
  placed in service in last quarter
• Assets treated as if placed into service (or
  disposed of) in the middle of the quarter in
  which they were actually placed in service (or
  disposed of)

11
MACRS (slide 6 of 10)

• Example of mid-quarter convention
• Business with 12/31 year end purchased and
  placed in service the following 5-year class
  assets
• Asset 1 on 3/28 for 50,000, and
• Asset 2 on 12/28 for 100,000

12
MACRS (slide 7 of 10)

• Example of mid-quarter convention (contd)
• More than 40 placed in service in last
  quarter therefore, mid-quarter convention used
• Asset 1 50,000 X .20 X 200 X 10.5/12 17,500
• Asset 2 100,000 X .20 X 200 X 1.5/12 5,000

13
MACRS (slide 8 of 10)

• Realty cost recovery
• Statutory lives
• 27.5 years for residential rental property
• 31.5 years for nonresidential property placed
  into service before May 13, 1993
• 39 years for nonresidential property placed into
  service after May 12, 1993

14
MACRS (slide 9 of 10)

• Realty cost recovery
• Depreciation method straight-line
• Convention mid-month
• Example Business building placed in service
  April 25 is treated as placed in service April 15

15
MACRS (slide 10 of 10)

• Optional straight-line election
• May elect straight-line rather than accelerated
  depreciation on personalty placed in service
  during year
• Use the same class life for the asset
• Election is made annually by class (e.g. 3-year
  property class, 5-year property class, etc)

16
Election to Expense Assets (Sec. 179)(slide 1 of
4)

• Sec. 179 general rules
• Can immediately expense up to 24,000 (for 2001)
  of business tangible personalty costs in year
  assets placed into service during the year
• Expense limitation increases annually to
• 19,000 for 1999
• 20,000 for 2000
• 24,000 for 2001 and 2002
• 25,000 for year 2003 and after

17
Election to Expense Assets (Sec. 179)(slide 2 of
4)

• Sec. 179 general rules
• Amount expensed reduces depreciable basis
• Cost recovery available on remaining basis
• Cannot use Sec. 179 for realty or production of
  income property, i.e., investment property, non
  trade or business rental property, property
  producing royalties

18
Election to Expense Assets (Sec. 179)(slide 3 of
4)

• Annual limitations
• Expense limitation (20,000 for 2000) is reduced
  by amount of Sec. 179 property placed in service
  during year that exceeds 200,000
• Example If taxpayer placed in service during the
  year 207,000 of Sec. 179 property, the
  limitation is reduced to 12,000 19,000 -
  (207,000 - 200,000).

19
Election to Expense Assets (Sec. 179)(slide 4 of
4)

• Annual limitations
• Election to expense cannot exceed taxable income
  (before Sec. 179) of taxpayers trades or
  businesses
• Excess of limitation over taxable income
  limitation may be carried over to subsequent
  year(s)
• Amount carried over stills reduces basis currently

20
Listed Property (Sec. 280F)(slide 1 of 3)

• There can be substantial limits on cost recovery
  of assets considered listed property
• Listed property are assets which may be used
  personally and for business such as
• Passenger automobile
• Computer
• Cellular telephone
• Amusement property

21
Listed Property (Sec. 280F)(slide 2 of 3)

• Listed property use
• Not predominantly used for business
• Business use does not exceed 50
• Must use straight-line method under ADS -
  alternative depreciation system (may result in
  longer recovery period) for that and all future
  recovery years, e.g.
• Office Equipment MACRS 7-year, ADS 10-year
• Information Systems MACRS 5-year, ADS 5-year
• See Publication 946, Appendix B

22
Listed Property (Sec. 280F)(slide 3 of 3)

• Listed property use
• Predominantly used for business
• Business use exceeds 50
• Allowed to use statutory percentage method of
  recovery with some limitations
• Failure to use property greater than 50 for
  business in any future recovery year results in
• Cost recovery recapture (gross income) in that
  recovery year, and
• Straight-line under ADS for that and future
  recovery years

23
Passenger Auto Cost Recovery Limits (slide 1 of 4)

• For autos placed in service in 2001, limits are
• Year Recovery Limitation
• 1 3,060
• 2 4,900
• 3 2,950
• Succeeding years until
• the cost is recovered 1,775

24
Passenger Auto Cost Recovery Limits (slide 2 of 4)

• Limits are for 100 depreciable use
• Must reduce limits by percentage of personal use
• Example For an auto placed in service in 2001
  and used 80 business use and 20 personal use,
  the limitation is 2,448 (80 X 3,060)

25
Passenger Auto Cost Recovery Limits (slide 3 of 4)

• First year limit includes any Sec. 179 expense
  elected
• Limits apply to passenger autos but not other
  listed property
• Cost recovery of passenger auto under
  straight-line listed property rule still subject
  to annual limits

26
Passenger Auto Cost Recovery Limits (slide 4 of 4)

• Leased autos subject to inclusion amount rule
• Using IRS tables, taxpayer has gross income equal
  to each lease years inclusion amount
• Purpose is to subject leased autos to cost
  recovery limits applicable to purchased autos

27
Amortization (slide 1 of 2)

• Intangible asset amortization
• Use straight-line recovery over remaining useful
  life for
• Assets created by taxpayer with limited useful
  lives
• Assets acquired before August 11, 1993 with
  limited useful lives, and
• Assets not under Section 197

28
Amortization (slide 2 of 2)

• Section 197 intangible assets
• Use straight-line recovery over 15 years (180
  months)
• Acquired goodwill is a Section 197 intangible and
  is amortizable

29
Depletion (slide 1 of 4)

• Two methods of natural resource depletion
• Cost determined by using the adjusted basis of
  the resource and allocating over the recoverable
  units
• Percentage determined using percentage provided
  in Code and multiplying against gross income from
  resource sales

30
Depletion (slide 2 of 4)

• Cost depletion
• Depletion is computed on a per unit basis
• Per unit amount is determined by dividing the
  basis of the resource by the estimated
  recoverable units of resource
• Number of units sold in year x per unit
  depletion depletion for year
• Total depletion can not exceed total cost of the
  property

31
Depletion (slide 3 of 4)

• Percentage depletion
• Depletion is computed by using the statutory
  percentage rate for the type of resource
• Rate is applied to the gross income from the
  property
• Oil gas 15
• Coal, asbestos 10
• Gold,silver,copper,iron ore 15
• Sulphur and uranium 22
• Gravel, stone 5

32
Depletion (slide 4 of 4)

• Percentage depletion
• Percentage depletion cannot exceed 50 of the
  taxable income (before depletion) from the
  property 100 for oil and gas properties
• Percentage depletion reduces basis in property
• However, total percentage depletion may exceed
  the total cost of the property
• Example Property with zero basis but still
  generating income

33
Research and Experimental Expenditures

• Alternatives available
• May elect to expense in the year paid or incurred
• May elect to capitalize and amortize costs over
  60 months or more
• If no election is made, must capitalize and write
  off the costs only when research project is
  abandoned or worthless