10-1©2007 Prentice Hall, Inc.

©2007 Prentice Hall, Inc. 10-2

DEPR., COST RECOVERY, DEPR., COST RECOVERY, AMORTIZATION, & AMORTIZATION, &

DEPLETIONDEPLETION

Depreciation and cost recoveryAmortizationDepletion, intangible drilling an

development costsTax planning considerationsCompliance and procedural

considerations

©2007 Prentice Hall, Inc. 10-3

Depreciation and Cost Depreciation and Cost RecoveryRecovery

General considerationsDepreciation methodsCalculation of depreciationMACRS restrictions

©2007 Prentice Hall, Inc. 10-4

General Considerations(1 of 3)

Taxpayers must use specific depreciation methods depending on when an asset is placed into servicePrior to 1981After 12/30/80 and before 1/1/87

(ACRS)After 12/31/96 (MACRS)

©2007 Prentice Hall, Inc. 10-5

General Considerations(2 of 3)

Common rules to all systemsNo depreciation may claimed on land

or other assets with an indefinite lifeDepreciation permitted in year asset

placed into serviceApply method consistentlyBasis of property being depreciated

reduced by amount of allowable depreciation each taxable year

©2007 Prentice Hall, Inc. 10-6

General Considerations(3 of 3)

Types of PropertyTangible Property (physical)Intangible Property (non-physical)Real Property Personal Property vs. Personal-Use

Property

©2007 Prentice Hall, Inc. 10-7

Depreciation Methods(1 of 2)

MACRSPersonal property

Use 3, 5, 7, 10, 15, 20 year useful lifeDDB with conversion to straight-lineHalf-year convention

½ year depr in 1st year and year of dispositionMid-Quarter convention when aggregate basis

of all personal property placed into service during last three months of year exceed 40%

No salvage value

©2007 Prentice Hall, Inc. 10-8

Depreciation Methods(2 of 2)

MACRSReal property

Residential rental property 27.5 yearsNonresidential rental property 39 yearsStraight-line depreciation methodMid-month convention in year of

acquisition and year of disposition Straight-line or Alternate Depreciation

System (ADS)

©2007 Prentice Hall, Inc. 10-9

Calculation of Depreciation§179 Expense

May elect to expense up to $108K in 2006 for certain tangible personal property placed into service during the year

$ for $ phaseout if qualified property placed into service during year >$430K

Limited to taxable ToB income

©2007 Prentice Hall, Inc. 10-10

Calculation of DepreciationYear of Disposition

MACRS allows depreciation to be taken in year of disposition based on conventionE.g., ½ year, mid-quarter, mid-

month

©2007 Prentice Hall, Inc. 10-11

MACRS Restrictions(1 of 2)

Portion of asset used for personal use is not depreciable

Listed property rulesMust use straight-line of business

use < 50%Recapture of excess cost-recovery if

MACRS claimed and business use falls below 50%

©2007 Prentice Hall, Inc. 10-12

MACRS Restrictions(2 of 2)

Luxury automobile limitationDepreciation cannot exceed ceiling

limitations (see page P10-14)Trucks, vans and SUVs (>6,000 lb)

More generous rulesLeased vehicles

Income inclusion based on IRS tables to eliminate avoiding luxury auto rules

©2007 Prentice Hall, Inc. 10-13

AmortizationAmortization

§197 intangiblesResearch and experimental

expendituresComputer software

©2007 Prentice Hall, Inc. 10-14

§197 Intangibles

Goodwill and going concern value, covenants not to compete, franchise fees, trademarks, trade names, etc.

Classification and disposition of intangibles§197 asset treated as depreciable prop

so that § 1231 treatment accorded disposition if held > 1 year

©2007 Prentice Hall, Inc. 10-15

Research and Experimental Expenditures

Include experimental and laboratory costs incidental to the development of a product (see table I10-4)

Tax treatment optionsExpense in year paidDefer and amortize costs over 60 mo.Capitalize and write-off when project

abandoned or is worthless

©2007 Prentice Hall, Inc. 10-16

Computer Software

Developed computer softwareCost of developing software is

qualified R&E under §174Expense immediately orAmortize over 60 months

Separately purchased softwareStraight-line depreciation over 36

months

©2007 Prentice Hall, Inc. 10-17

Depletion, Intangible Depletion, Intangible Drilling and Development Drilling and Development

CostsCosts (1 of 2) (1 of 2)

Depletion methodsCost depletion

Similar to units of activity depreciationPercentage depletion

Depletion rates based on statutory percentages

Can claim depletion deductions in excess of cost over the life of the asset

©2007 Prentice Hall, Inc. 10-18

Depletion, Intangible Depletion, Intangible Drilling and Development Drilling and Development

CostsCosts (2 of 2) (2 of 2)

Treatment of intangible drilling and development costsCapitalized or deducted currentlyDecision to expense or capitalize

depends on taxpayer’s current positionExpected marginal tax rates

©2007 Prentice Hall, Inc. 10-19

Tax Planning Tax Planning ConsiderationsConsiderations

Alternative depreciation under MACRS

Units of production depreciationMay use instead of MACRS

Structuring a business combinationMust consider amortization of goodwill

©2007 Prentice Hall, Inc. 10-20

Compliance and Compliance and Procedural Procedural

ConsiderationsConsiderations

Form 4562 is used to report depreciation, §179 expense, depletion, and amortization deductions

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10-21©2007 Prentice Hall, Inc.