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ACC351CH10.pptxTaxation of Individuals and Business Entities
Property Acquisition and Cost Recovery
2021 Edition
Chapter 10
Copyright ©2021 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.
Copyright ©2021 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.
Describe the cost recovery methods for recovering the cost of personal property, real property, intangible assets, and natural resources.
Determine the applicable cost recovery (depreciation) life, method, and convention for tangible personal and real property and the deduction allowable under basic MACRS.
Learning Objectives (1 of 2)
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Calculate the deduction allowable under the additional special cost recovery rules (§179, bonus, and listed property).
Calculate the deduction for amortization.
Explain cost recovery of natural resources and the allowable depletion methods.
Learning Objectives (2 of 2)
10-3
Businesses must capitalize the cost of assets with a useful life of more than one year on the balance sheet rather than expense the cost immediately.
Also known as depreciation, amortization, or depletion—depending upon the underlying nature of asset.
Businesses use these methods to recover cost of assets due to wear, tear, and obsolescence of assets.
Cost Recovery (1 of 4)
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Different methods to recover the costs of assets
Depreciation: Deducting the cost of tangible personal and real property (other than land) over a specific period of time
Amortization: Deducting the cost of intangible property over a specific period of time
Depletion: Deducting the cost of natural resources over time
Cost Recovery (2 of 4)
10-5
Basis for Cost Recovery
Once the use of purchased assets is started, recouping the cost of assets also starts.
Initial basis reduces when cost is recovered through cost recovery deductions, which is called asset’s adjusted basis or tax basis.
Asset’s adjusted tax basis = asset’s initial basis minus accumulated depreciation (amortization or depletion).
Cost Recovery (3 of 4)
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EXHIBIT 10-1 Assets and Cost Recovery
Cost Recovery (4 of 4)
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| Asset Type | Cost Recovery Method |
| Personal property is comprised of tangible assets such as automobiles, equipment, and machinery. | Depreciation |
| Real property comprises buildings and land (although land is nondepreciable). | Depreciation |
| Intangible assets are nonphysical assets such as goodwill and patents. | Amortization |
| Natural resources are commodities that are considered valuable in their natural form, such as oil, coal, timber, and gold. | Depletion |
Scrap-Happy Inc., a scrapbooking retail chain, purchased an old office building for $175,000 for use in expanding its current operations. An additional $15,000 was spent painting and remodeling the building in preparation for its opening.
Two years later, a Scrap-Happy employee discovered that several leaks in the roof were causing serious water damage to the store’s inventory; the company spent $50,000 to reroof the building.
Every six months, Scrap-Happy pays $500 to have the carpet professionally cleaned.
Basis Example (1 of 2)
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What is the initial basis of the building?
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Basis Example (2 of 2)
What effects do the other two transactions have on the initial basis?
$50,000 reroofing expense: Added to basis (Results in a restoration of a major component of the building)
$500 biannual carpet cleaning: No effect on basis (Deducted immediately routine maintenance)
| $175,000 | initial cost |
| +15,000 | painting and remodeling |
| $190,000 | original basis |
The TCJA made many changes to the way taxpayers will recover the cost of their assets for the next several years.
The changes primarily affect the special rules for depreciating personal property (§179 expensing and bonus depreciation).
The special rules (and changes) are covered after the basis depreciation rules.
Depreciation (1 of 22)
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Since 1986, businesses calculate their tax depreciation using the Modified Accelerated Cost Recovery System (MACRS, which is pronounced “makers” by tax accountants).
Depreciation (2 of 22)
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To compute MACRS depreciation for an asset, the following need to be known:
Asset’s initial basis
Date it was placed in service
Applicable depreciation method
Asset’s recovery period (or depreciable “life”)
Applicable depreciation convention (depreciation deductible in the year of acquisition and the year of disposition)
Depreciation (3 of 22)
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Personal Property Depreciation
Includes all tangible property such as computers, automobiles, furniture, machinery, and equipment, other than real property
Personal property (not real property) and personal-use property (used for personal purposes) are not the same.
Depreciation (4 of 22)
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Depreciation Method
Three acceptable methods for depreciating personal property
200 percent (double) declining balance
150 percent declining balance
Straight-line
Depreciation (5 of 22)
10-14
Depreciation Recovery Period
For financial accounting purposes, an asset’s recovery period (depreciable life) is based on its taxpayer-determined estimated useful life.
For tax purposes, an asset’s recovery period is predetermined by the IRS in Rev. Proc. 87-56, which helps taxpayers categorize each of their assets based upon the property’s description.
Depreciation (6 of 22)
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Once the business has determined the appropriate categories for its assets, it can use the revenue procedure to identify the recovery period for all assets in a particular category.
Depreciation (7 of 22)
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EXHIBIT 10-3 Excerpt Revenue Procedure 87-56
Depreciation (8 of 22)
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| Description of Assets Included | Years | Years | Years |
| Specific depreciable assets used in all business activities, except as noted: | Class Life | General Recovery Period | Alternative Recovery Period |
| 00.11 Office Furniture, Fixtures, and Equipment: Includes furniture and fixtures that are not a structural component of a building. Includes such assets as desks, files, safes, and communications equipment. Does not include communications equipment that is included in other classes. | 10 | 7 | 10 |
| 00.12 Information Systems: Includes computers and their peripheral equipment used in administering normal business transactions and the maintenance of business records. | 6 | 5 | 5 |
| 00.241 Light General Purpose Trucks: Includes trucks for use over the road (actual unloaded weight less than 13,000 pounds). . . | 4 | 5 | 5 |
| 34.0 Manufacture of Fabricated Metal Products Special Tools: Includes assets used in the production of metal cans, tinware. . . | 12 | 7 | 12 |
EXHIBIT 10-4 Recovery Period for Most Common Business Assets
Depreciation (9 of 22)
10-18
| Asset Description (Summary of Rev. Proc. 87-56) | Recovery Period |
| Cars, light general-purpose trucks, and computers and peripheral equipment | 5 years |
| Office furniture, fixtures, and equipment | 7 years |
Depreciation Conventions
Half-year convention
One-half of a full year’s depreciation is allowed in first and last year of an asset’s life.
IRS depreciation tables automatically account for the half-year convention in year of purchase and disposition.
If an asset is disposed of before it is fully depreciated, only one-half of the table’s applicable depreciation percentage is allowed in the year of disposition.
Depreciation (10 of 22)
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Mid-Quarter Convention
Becomes largely irrelevant post-TCJA
Applicable when > 40 percent of qualified property is placed in service in the last quarter of the business’s tax year
Separate tables include rates
Depreciation (11 of 22)
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Calculating depreciation for personal property
Determine the appropriate convention (half-year or mid-quarter).
Locate the applicable table provided in Rev. Proc. 87-57.
Select the column that corresponds with the asset’s recovery period.
Find the row identifying the year of the asset’s recovery period.
Applying the half-year convention
Half-year convention for year of disposition
Applying the mid-quarter convention
Mid-quarter convention for year of disposition
Depreciation (12 of 22)
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TABLE 1 MACRS Half-Year Convention
Depreciation Rate for Recovery Period
Depreciation (13 of 22)
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| Year | 3-Year | 5-Year | 7-Year | 10-Year | 15-Year | 20-Year |
| 1 | 33.33% | 20.00% | 14.29% | 10.00% | 5.00% | 3.750% |
| 2 | 44.45 | 32.00 | 24.49 | 18.00 | 9.50 | 7.219 |
| 3 | 14.81 | 19.20 | 17.49 | 14.40 | 8.55 | 6.677 |
| 4 | 7.41 | 11.52 | 12.49 | 11.52 | 7.70 | 6.177 |
| 5 | 11.52 | 8.93 | 9.22 | 6.93 | 5.713 | |
| 6 | 5.76 | 8.92 | 7.37 | 6.23 | 5.285 | |
| 7 | 8.93 | 6.55 | 5.90 | 4.888 | ||
| 8 | 4.46 | 6.55 | 5.90 | 4.522 | ||
| 9 | 6.56 | 5.91 | 4.462 | |||
| 10 | 6.55 | 5.90 | 4.461 |
Depreciation (14 of 22)
10-23
| Year | 3-Year | 5-Year | 7-Year | 10-Year | 15-Year | 20-Year |
| 11 | 3.28 | 5.91 | 4.462 | |||
| 12 | 5.90 | 4.461 | ||||
| 13 | 5.91 | 4.462 | ||||
| 14 | 5.90 | 4.461 | ||||
| 15 | 5.91 | 4.462 | ||||
| 16 | 2.95 | 4.461 | ||||
| 17 | 4.462 | |||||
| 18 | 4.461 | |||||
| 19 | 4.462 | |||||
| 20 | 4.461 | |||||
| 21 | 2.231 |
TABLE 2a–d MACRS Mid-Quarter Convention
Depreciation Rate for Recovery Period
Depreciation (15 of 22)
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Depreciation (16 of 22)
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In 2020, Scrap-Happy purchased and placed in service the following assets:
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Depreciation Example (1 of 2)
What is the recovery period for each of the assets?
Computer = 5 years
Di-Cut Machine = 7 years
Which convention should Scrap-Happy use to determine depreciation for 2020?
Answer: Half-year
$1,200 4th qtr. assets/$4,700 total assets = 25.53% < 40%
| Asset | Cost | Date placed in service |
| Di-Cut Machine | $3,500 | February 2 (1st Qtr.) |
| Computer | $1,200 | October 25 (4th Qtr.) |
Now assume all the same facts, except that the computer was purchased in February and the machine in October, as shown:
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Depreciation Example (2 of 2)
What convention should be used in computing depreciation for the year?
Answer: Mid-quarter
$3,500 4th qtr. assets/$4,700 total assets = 74.46% > 40%
How much depreciation can they take for each of the assets in 2020?
Computer: $1,200 × 35%* = $420
Di-Cut Machine: 3,500 × 3.57%* = $125
*See respective mid-quarter MACRS tables for rates
| Asset | Cost | Date placed in service | Recovery Period |
| Computer | $1,200 | February 2 (1st Qtr.) | 5 Years |
| Di-Cut Machine | $3,500 | October 25 (4th Qtr.) | 7 Years |
Real Property
Uses mid-month convention and depreciated using straight-line method
EXHIBIT 10-7 Recovery Period for Real Property
Depreciation (17 of 22)
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| Asset Description (Summary from Rev. Proc. 87-57) | Recovery Period |
| Residential | 27.5 years |
| Nonresidential property placed in service on or after May 13, 1993 | 39 years |
| Nonresidential property placed in service before May 13, 1993 | 31.5 years |
On July 12, Scrap-Happy purchases and places in service a warehouse and the land it resides on for $170,000 ($120,000 is allocated to the building and $50,000 to the land).
What is the amount of depreciation on the property for the first year?
Answer: $120,000 × 1.177% = $1,412
1.177 percent is the rate given in the nonresidential real property MACRS table under the column for the seventh month.
Land is not included in the calculation because it is not depreciable.
REAL PROPERTY: Depreciation Example
10-29
Immediate Expensing
This incentive is commonly referred to as §179 expense or immediate expensing election.
Limits on immediate expensing
Property limitation
Taxable income limitation
Choosing the assets to immediately expense
Depreciation (18 of 22)
10-30
Bonus Depreciation
To stimulate the economy, policy makers occasionally implement bonus depreciation.
Percentage is 100 percent for assets placed in service between September 27, 2017, and December 31, 2022.
Bonus depreciation will be the primary way to depreciate qualified assets for most businesses.
Businesses may elect out of bonus depreciation.
Depreciation (19 of 22)
10-31
Listed Property
Defined: Assets that tend to be used for both business and personal purposes.
Depreciation is limited to business use.
If business use is > 50 percent, use normal depreciation methods.
If business use is ≤ 50 percent, use straight-line depreciation.
Depreciation (20 of 22)
10-32
If business use drops to ≤ 50 percent, use the following steps to calculate depreciation:
Compute depreciation for the year it drops to 50 percent or below using the straight-line method.
Compute amount to be deducted if straight-line method is used over ADS recovery period for all prior years (limited to business-use percentage).
Compute the amount of depreciation taxpayer actually deducted on the assets for all prior years.
Subtract amount in Step 2 from amount in Step 3. Difference is prior-year accelerated depreciation in excess of straight-line depreciation.
Subtract amount in Step 4 from Step 1. This is business’s allowable depreciation expense on the asset for that year.
Depreciation (21 of 22)
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Luxury Automobiles
EXHIBIT 10-10 Automobile Depreciation Limits
Depreciation (22 of 22)
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| Recovery Year | Year Placed in Service | |||
| 2020 | 2019 | 2018 | 2017 | |
| 1 | 10,100* | 10,100* | 10,000* | 3,160* |
| 2 | 16,100 | 16,100 | 16,000 | 5,100 |
| 3 | 9,700 | 9,700 | 9,600 | 3,050 |
| 4 and after | 5,760 | 5,760 | 5,760 | 1,875 |
*$8,000 additional depreciation is allowed when bonus is claimed.
Businesses recover cost of intangible assets through amortization.
Intangible assets in the form of capitalized expenditures, such as capitalized research and experimentation (R&E) costs or covenants, do not have physical characteristics.
An intangible asset can be placed in one of four general categories:
§197 intangibles
Start-up expenditures and organizational costs
Research and experimentation costs
Patents and copyrights
Amortization (1 of 7)
10-35
§197 Intangibles
According to §197, these assets have a recovery period of 180 months (15 years), regardless of their actual life.
Full-month convention allows taxpayers to deduct an entire month’s worth of amortization for the month of purchase and all subsequent months in the year.
Amortization (2 of 7)
10-36
Organizational Expenditures and Start-up Costs
Organizational expenditures include expenditures to form and organize a business in the form of a corporation or a partnership and are incurred prior to the starting of business.
Start-up costs are costs businesses incur to start up a business.
Amortization (3 of 7)
10-37
Research and Experimentation Expenditures
To stay competitive, businesses often invest in activities that will generate innovative products or significantly improve their current products or processes.
Businesses may immediately expense these costs or they may elect to capitalize and amortize these costs using the straight-line method over a period of not less than 60 months, beginning in the month benefits are first derived from the research.
Amortization (4 of 7)
10-38
Patents and Copyrights
Manner of amortization depends on whether the business directly purchases the patent or copyright or whether it self-creates the intangibles.
Businesses directly purchasing patents or copyrights amortize the cost over the remaining life of the patents or copyrights.
Businesses receiving “self-created” patents or copyrights amortize the cost or basis of the self-created intangible assets over the shorter of the legal life or remaining useful life.
Amortization (5 of 7)
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EXHIBIT 10-14 Summary of Amortizable Assets
Amortization (6 of 7)
10-40
| Asset Description | Recovery Period (months) | Applicable Method | Applicable Convention | Financial Accounting Treatment |
| §197 purchased intangibles, including goodwill, trademarks, patents, and covenants not to compete | 180 | Straight-line | Full-month beginning with month of purchase | ASC 350 tests for annual impairment |
| Organizational expenditures and start-up costs that are required to be capitalized | 180 | Straight-line | Full-month in month business begins | AICPA SOP 98-5 |
Amortization (7 of 7)
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| Asset Description | Recovery Period (months) | Applicable Method | Applicable Convention | Financial Accounting Treatment |
| Research and experimentation costs that are capitalized | Determinable useful life, or (not less than) 60; ceases when patent is issued. | Straight-line | Full-month in first month that benefits from research are obtained | Expensed |
| Self-created patents and copyrights | Actual life | Straight-line | Full-month in month intangible is obtained | Expensed |
| Purchased patents and copyrights | Remaining life | Straight-line | Full-month in month intangible is obtained | Expensed |
A method taxpayers use to recover their capital investment in natural resources
Businesses compute annual depletion expense under both the cost and percentage depletion methods and they deduct the larger of the two.
Taxpayers must estimate or determine the number of units or reserves that remain at the beginning of the year and allocate a pro rata share of that basis to each unit that is extracted during the year.
Depletion (1 of 3)
10-42
Once entire cost is recovered, businesses are not allowed to use cost depletion to determine depletion deduction.
The amount of percentage depletion for a natural resource business activity is determined by multiplying the gross income from the resource extraction activity by a fixed percentage based on the type of natural resource as indicated in Exhibit 10-16.
Depletion (2 of 3)
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EXHIBIT 10-16 Applicable Percentage Depletion Rates
Depletion (3 of 3)
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| Statutory Percentage | Natural Resources (partial list) |
| 5 percent [§613(b)(6)] | Gravel, pumice, and stone |
| 14 percent [§613(b)(3)] | Asphalt rock, clay, and other metals |
| 15 percent [§613(b)(2)] | Gold, copper, oil shale, and silver |
| 15 percent [§613A(c)(1)] | Domestic oil and gas |
| 22 percent [§613(b)(1)] | Platinum, sulfur, uranium, and titanium |
Scrap-Happy purchases a tract of forest land that it plans to use to harvest trees for the production of scrapbook paper. It is estimated that the tract contains 30,000 board feet of timber. The original cost of the property is $75,000, of which $60,000 is allocated to the timber and $15,000 to the land.
Cost Depletion Example (1 of 2)
10-45
What is the cost depletion per board foot?
Answer: $60,000 basis/30,000 ft = $2/ft
If the company uses 10,000 board feet during the first year, how much will they expense under the cost depletion method?
Answer: 10,000 ft. × $2/ft = $20,000
OR $60,000 basis × 33.33% resource used = $20,000
Cost Depletion Example (2 of 2)
10-46
End of Presentation
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