Depreciation, Cost Recovery, Amortization, and Depletion

1
Chapter 10

• Depreciation, Cost Recovery, Amortization, and
  Depletion

2
Learning Objectives

• Understand the general concepts of tax
  depreciation
• Classify property and calculate depreciation
  under the MACRS rules
• Calculate amortization for intangible assets and
  understand the difference between amortizable and
  non-amortizable assets
• Apply cost and percentage depletion methods and
  understand the treatment for intangible drilling
  costs

3
Introduction

• Allows taxpayers to deduct a reasonable allowance
  for the exhaustion, wear and tear, and
  obsolescence.
• Taxpayers must use specific depreciation methods
  depending on when an asset is placed into
  service.

4
Depreciation and Cost Recovery

• Property placed into service prior to 1981
• Property placed into after December 30, 1980 and
  before January 1, 1987
• Property placed into service after December 31,
  1986

5
Common Rules of All Systems

• No depreciation may be claimed on land or other
  assets that have an indefinite life (works of
  art).
• Depreciation is permitted in the year the asset
  is placed into service
• Consistency is required, no matter which system
  is used

6
Types of Property

• Tangible Property
• Intangible Property
• Real Property
• Personal Property vs. Personal-Use Property

7
Depreciation Methods

• 1986 and later years
• MACRS
• Personal property
• Use 3, 5, 7, 10, 15, 20 year useful life
• 200 declining balance with a conversion to
  straight-line
• Half-year convention(no matter when asset is
  placed into service, the first year can only take
  a half years depreciation)
• Mid-Quarter convention is used when the aggregate
  basis of all personal property placed into
  service during the last three months of the year
  exceed 40
• No salvage value

8
Depreciation Methods

• Real Property
• Residential rental property 27.5 years
• Nonresidential rental property 39 years
• Depreciation is calculated using the
  straight-line method
• Mid-month convention year of acquisition and
  year of disposition
• Straight-line or Alternate Depreciation
  System(ADS)

9
Section 179 Expensing Election

• May elect to expense up to 24,000 in 2001 Placed
  into service during the year
• Not applicable to real estate, only applicable
  personal property.

10
Section 179 Expense
11
MACRS Restrictions

• Portion of asset used for personal use is not
  depreciable
• Listed property rules
• Recapture of excess cost-recovery
• Luxury automobile limitation (see textbook for
  limits)

12
Amortization

• Intangible Assets
• Definition of Section 197 Goodwill and going
  concern value, covenants not to compete,
  franchise fees, trademarks, and trade names etc.
• Classification and disposition of intangibles
• A Sec. 197 asset is treated as depreciable
  property so that Sec. 1231 treatment is accorded.
• Research and experimental expenditures
• Include experimental and laboratory costs
  incidental to the development of a product.

13
Depletion and Intangible Drilling and Development
Costs

• Treatment of intangible drilling and development
  costs (IDCs)
• Capitalized or deducted currently
• Decision to expense or capitalize depends on
  taxpayers current position (profit or loss)

14
Depletion and Intangible Drilling and Development
Costs

• Depletion methods
• Cost depletion method is calculated by dividing
  the adjusted basis of natural resource by
  expected quantity to be extracted
• Percentage depletion method is calculated by
  multiplying the statutory depletion percentage
  times the gross income generated

15
Tax Planning Considerations

• Alternative depreciation under MACRS
• IDCs CAPITALIZATION VS. EXPENSING
• Structuring a business combination

16
Compliance And Procedural Considerations

• IDCs Election
• Form 4562 is used to report depreciation,
  depletion, and amortization deductions.