Depreciation cost recovery

1
Depreciation
Steven M. Foulks, CPA, CFP
2
Introduction

• Depreciation, depletion, amortization is the
  mechanism used to recover the cost of long lived
  assets for tax purposes
• We will discuss how depreciation has changed for
  tax purposes over time

3
Agenda

• Allowed vs.allowable
• Different time periods
• Differences between time periods
• Listed property
• Sale of depreciable property

4
Overview

• Cost recovery has been a mechanism used by
  Congress to
• stimulate/retard business investment activity
• stimulate/retard economic investment activity
• raise/lower taxes
• Consequently it is subject to tinkering

5
Vocabulary

• Realty - land and anything permanently affixed to
  it such that its removal would adversely effect
  the utility of the structure
• Personalty - every other asset, excluding cash
  A/R, etc.

6
Vocabulary

• Residential business realty - realty that is
  rented more than 80 of the time on a non
  transient, non business basis (test must be
  passed annualy)
• Non residential business realty- 162, 212
  property which is not residential as defined above

7
Allowed vs. Allowable

• The reduction in the tax basis of an asset in any
  given year is the greater of the depreciation
• allowed - amount actually deducted
• allowable - using one of the acceptable methods

8
Different Depreciation periods

• WWII (needed to raise money for war)
• Class Life ADR ( simplified your life as a
  depreciator) vs. non class life ADR
• ACRS (Regans plan to stimulate business)
• MACRS (Regans plan to undo above to some extent)

9
Things have differed between different
depreciation periods

• Convention for acquisition dates
• Methods of depreciation
• useful lives
• Salvage value
• Repairs/replacement

10
Calculating depreciation

• Assume that you are calculating DDB for a 3 year
  asset using the half year convention, switching
  over to straight line in the year when the DDB
  rate would be less than the straight line rate
  (33)
• Note Depreciation years and tax years do not
  match up because of ½ year convention
• - 1st tax year only includes 1/3 of first depr
  year.

11
Calculating depreciation

• DDB 2/UL BV
• BV of asset Cost -accum.depr
• 1st tax year 2/3 ½ year
• 33.33

12
Calculating depreciation

• 2nd tax year 2nd half of first depreciation
  year (33.33 )
• the 1st half of 2nd depreciation year 2/3 33
  1/2 11.11 for a total of 44.44

13
Calculating depreciation (cont)

• In the 3rd year the DDB rate would be less than
  the SL rate and thus we switchover and depreciate
  the remaining book value (100 -44.44-33.33) of
  22.23 over the remaining life
• 3rd year 22.23 2/3 14.83
• 4th year 22.23 1/3 7.41
• Look at table 8-1 on page 8-31

14
Listed Property

• What is listed property?
• If used more than 50 of the time in a business,
  then you can use accelerated depreciation
• e.g., 51 business, 40 investment management, 9
  personal

15
Listed Property

• If the previous test is failed in a subsequent
  year, must switch to straight line and recapture
  excess depr. taken in earlier years
• Autos subject to special amount limit (which
  is subject to reduction by business use )
• must include a fixed amount in income for leased
  cars

16
Section 179

• Up to 125,000 (2007)(250,000 for 2008) of
  tangible personalty can be immediately expensed
  subject to certain limits
• Limit reduced on a for basis if total
  personalty placed in service exceeds 500,000
  (800,000 for 2008)
• Limited by taxable income from business,
  excluding 179 expense
• Basis in property is reduced by 179 expense

17
Sale of depreciable property

• When property is sold that is not fully
  depreciated, you take
• A half years depreciation where you use the half
  years convention,
• and a half quarter, or half months depreciation
  in the quarter or month of disposition where
  those methods are used.

18
Section 197

• Intangible property can be amortized using SLD,
  full month convention if acquired after 8/10/93
• Intangibles acquired prior to 8/10/93
• If indeterminate life, no amortization
• If determinate life, SLD, full month convention
  over life

19
ADS

• Alternate depreciation system - a less
  accelerated depreciation system which must be
  used
• For calculating corporate E P
• For calculating tax preferences
• and may be used for calculating regular taxable
  income

20
Depletion, IDC

• Choice of method
• Statutory depletion limited to the lesser of
• 50 Gross profit excluding depletion, or
• the statutory rate times revenues from depletable
  assets
• Cost deletion - remaining cost of depletable
  asset /amount of resource rate to be applied to
  sales

21
Depletion, IDC

• Can switch between Statutory and cost each year,
  but what happens when basis goes to 0?
• IDC costs can be capitalized and amortized, or
  immediately expenses. Which is better?