Liberty Tax Service Online Basic Income Tax Course. Lesson 12 1
Chapter 11 Homework 1 HOMEWORK 1: William D. Williams (345 -77 -3443, born 10/14/1960) of 4545 West Ave. , Braden, TN 38010 is single. He received the following forms and he is a radio engineer. Prepare William’s return. 2
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Chapter 11 Homework 2 HOMEWORK 2: Matthew J. Morgan (SSN 083 -21 -6493, born 9/18/1958) lives at 4684 Mc. Kinley Parkway, New Orleans, LA 70130. He has Form 1099 -B from Broker One, who reported gross proceeds as follows: Stock Date Sold Sales Price 100 shares MNO 02/12/2008 $5, 050 500 shares ZYX 08/06/2008 $5, 250 Broker One reported sales commissions to Matthew separately. They were: MNO, $50 and ZYX, $200. 10
Chapter 11 Homework 2 Matthew also has a Form 1099 -B from Broker Two, who reported the net proceeds as follows: Stock Date Sold Sales Price 200 shares BCA 08/06/2008 $4, 000 300 shares JKL 08/06/2008 $5, 910 Matthew gave you the following information about the stocks he sold: ü He paid $6, 940, plus a $60 commission, to buy the MNO stock on February 12, 2006. ü He bought the ZYX on March 11, 2005, for $5, 200, plus a $100 commission. ü He paid $3, 900, plus a $50 commission, to buy the BCA stock on January 29, 2008. ü He bought the JKL on June 25, 2006, for $6, 300, plus a $30 commission. 11
Chapter 11 Homework 2 Matthew’s filing status is head of household. His son Joe (SSN 088 -99 -1234, born 03/25/1999) lived with him the whole year. His only other income was $65, 182 in wages. Line 41 of his Form 1040 shows $54, 182. Matthew’s Form 1040 and Capital Loss Carryover Worksheet from 2007 shows that he has a $450 short -term loss and a $325 long-term loss that he can carryover to his 2008 return. Complete Matthew’s Schedule D and his Form 1040 through line 13. Also complete the Capital Loss Carryover Worksheet to figure how much capital loss he can carry over to 2009. 12
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Chapter 12: Depreciation Chapter Content ü ü ü ü The Depreciation Deduction Modified Accelerated Cost Recovery System (MACRS) Listed Property Section 179 Deduction Disposition of Property Amortization Form 4562, Depreciation and Amortization Key Ideas Objectives ü ü ü Understand Property Depreciation and the Depreciation Deduction Know How to Use MACRS to Depreciate Property Understand the Limits on Depreciating Listed Property Determine What Property Qualifies for the Section 179 Deduction Know When to Use Form 4562 and How to Complete the Form 18
Depreciation A. Depreciation is the decrease in the value of property over the time it is used. B. You can recover the cost of certain business or income-producing property by taking yearly deductions for depreciation over the life of the property. C. The property must have a useful life lasting substantially beyond the tax year. D. Tax law sets the time periods that different types of property are expected to last. 19
Depreciation E. To depreciate property you need to know: 1. The basis of the property 2. The useful life of the property, and 3. The depreciation method. 4. Date placed in service 5. Convention F. There additional rules and requirements for depreciation of property that is listed property. 20
Depreciation G. Section 179 allows you to deduct all or part of the cost of certain property, up to a limit, in the first year you place the property in service (this is called expensing). H. The form or schedule used to report depreciation depends on the use of the property being depreciated. I. For many depreciation deductions, you must also complete Form 4562. 21
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THE DEPRECIATION DEDUCTION A. The depreciation deduction is a percentage of the basis of depreciable property taken over the useful life of the property. You purchase a copier in 2008 at a cost of $4, 000. If the useful life of the copier is 5 years, you deduct a percentage of the $4, 000 each year. B. IRS rules determine the useful life and the percentage to use. C. If the property is depreciable, you must take the deduction. 24
THE DEPRECIATION DEDUCTION D. To claim the deduction, you must own the property and use it in your business or for producing income. Sue took out a loan to buy a van. She is a carpenter and she uses the van 75% in her business and 25% for personal purposes. She owns the van and can depreciate 75% of the cost of the van. E. Depreciable property is either tangible or intangible. 1. Tangible property is property you can see or touch and includes both real and personal property (land, buildings, cars, furniture) John rents apartments in an apartment building he owns. The building, the furnace, the garage, and the trees and shrubs are all real property owned by John. His computer, the furniture in his office, and the truck he uses for his business are all examples of tangible personal property. 25
THE DEPRECIATION DEDUCTION 2. Intangible property is generally any property that has value but cannot be seen or touched (computer software, copyrights, patents). F. Real or personal property used for personal (nonbusiness) purposes is not depreciable. Chris owns a framing business. In 2007, she purchased a van that she uses to deliver frames to her customers. She also uses the van to shop and take her kids to school. Chris can depreciate the cost of the van based on its business use. If 60% of the miles she drives are for business, she can use 60% of the cost of the van as her cost basis for depreciation. 26
THE DEPRECIATION DEDUCTION What Can And Cannot Be Depreciated G. You can depreciate property only if it: 1. Is used for business or held to produce income 2. Is expected to last more than one year, and, 3. Has a limited useful life (for this reason, land is never depreciable). 27
THE DEPRECIATION DEDUCTION H. In addition to land, business-use property you cannot depreciate includes: 1. Inventory and stock in trade 2. Items placed in service and disposed of in the same year 3. Most leased property John completely replaces the roof on the apartment building he owns. The new roof increases the value of the property so he must depreciate the cost of the roof. If John merely repaired a leak around the chimney, he would deduct the cost of the repair in the year the repair is made. 28
THE DEPRECIATION DEDUCTION When Depreciation Begins And Ends I. Begin depreciating property when you place it in service for use in your trade or business. 1. Property is placed in service when it is ready and available for its specific use. J. Stop depreciating when you have fully recovered the cost or when you retire the property from service, whichever comes first. 1. The cost is recovered when your section 179 and depreciation deductions are equal to your cost or investment in the property 2. Property is retired from service when you permanently withdraw it from use in your trade or business or from use in the production of income. 29
THE DEPRECIATION DEDUCTION – Problem 1 John bought his apartment building in January 2008 and started advertising for tenants immediately. Because he did not rent the first apartment until April, depreciation will not begin until April. True or False? 30
THE DEPRECIATION DEDUCTION – Problem 1 John bought his apartment building in January 2008 and started advertising for tenants immediately. Because he did not rent the first apartment until April, depreciation will not begin until April. False The building was ready and available for rent in January so January 2008 is when it was placed in service and depreciation begins even though he did not rent the apartment until April. 31
THE DEPRECIATION DEDUCTION Depreciation Systems A. There are three different systems used to figure the depreciation deduction, each with its own set of rules. B. The rules of each system determine the useful life of the property and which depreciation method to use. 1. Straight line method of depreciation provides equal depreciation deductions each year of the useful life. 2. Accelerated methods allow larger deductions during the early years, resulting in a faster recovery of the cost of the property. 32
THE DEPRECIATION DEDUCTION C. Generally, the system you use depends on the type of property and when the property was placed in service. The three systems are: 1. Modified Accelerated Cost Recovery System (MACRS) for most tangible depreciable property placed in service after 1986. 2. Accelerated Cost Recovery System (ACRS) for most depreciable property placed in service after 1980 but before 1987. 3. Useful lives and either straight line or accelerated methods for property placed in service before 1981 or for which MACRS or ACRS is not used. D. IRS provides MACRS and ACRS tables that give the depreciation rate (the percentage of the cost you can deduct) for each year the property is in service. E. There are no tables for property placed in service before 1981. 33
MODIFIED ACCELERATED COST RECOVERY SYSTEM (MACRS) A. MACRS may be used for most tangible depreciable property placed in service after 1986 and must be used to depreciate real property acquired before 1987 that you changed from personal to business or income producing use after 1986. B. MACRS cannot be used to depreciate the following property: 1. Intangible property 2. Any films, video tape and recordings 3. Certain real and personal property placed in service before 1987. 34
MODIFIED ACCELERATED COST RECOVERY SYSTEM (MACRS) C. MACRS is actually two systems. 1. General Depreciation System (GDS) is used for most tangible property (accelerated methods and straight line method) 2. Alternative Depreciation System (ADS) is used when specifically required by law or if you elect it (straight line method) 3. Refer to Table 12 -1 for a summary of MACRS depreciation methods used in each system. D. The MACRS percentage tables are based on the different depreciation methods. 1. Refer to Table 12 -2 for the percentage tables to use to depreciate personal property and to Table 12 -3 for the tables for residential rental and nonresidential real property. 35
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MODIFIED ACCELERATED COST RECOVERY SYSTEM (MACRS) Table 12 -3. MACRS Percentage Table Guide for Residential Rental and Nonresidential Real Property 38
MODIFIED ACCELERATED COST RECOVERY SYSTEM (MACRS) E. To use the MACRS tables, you need to know the depreciation method and the following about your property: 1. The basis 2. The property class and recovery period 3. The date placed in service 4. The convention to use. 39
MODIFIED ACCELERATED COST RECOVERY SYSTEM (MACRS) Basis is usually the cost of purchased property. The cost includes sales tax (unless it was claimed on Schedule A), shipping, installation and testing fees. 1. If you change personal use property to business use, the basis is the lesser of the fair market value on the date you change it from personal use or your original cost basis adjusted for the cost of improvements and certain tax deductions 2. If you use property for both personal and business purposes, use only the percentage of the basis used for business to figure the depreciation deduction. 40
MODIFIED ACCELERATED COST RECOVERY SYSTEM (MACRS) – Problem 1 Rebecca bought a computer system for use in her business. The price of the system was $28, 000. She paid sales tax of $1, 400 and shipping charges of $130. What is her cost basis? a. $28, 000 b. $29, 400 c. $28, 130 d. $29, 530 41
MODIFIED ACCELERATED COST RECOVERY SYSTEM (MACRS) – Problem 1 Rebecca bought a computer system for use in her business. The price of the system was $28, 000. She paid sales tax of $1, 400 and shipping charges of $130. What is her cost basis? d. $29, 530 The cost basis is $29, 530 ($28, 000 +$1, 400 + $130). 42
MODIFIED ACCELERATED COST RECOVERY SYSTEM (MACRS) Property Classes And Recovery Periods Property classes establish the recovery period (number of years) over which you can take the deduction. 1. The class property it is assigned to is generally determined by its class life. 2. Under GDS, property is assigned to one of 9 classes. 3. The shorter the recovery period, the sooner you get back the cost of the property. 43
MODIFIED ACCELERATED COST RECOVERY SYSTEM (MACRS) The nine property classes: ü 3 -year property ü 5 -year property ü 7 -year property ü 10 -year property ü 15 -year property ü 20 -year property ü 25 -year property ü Residential rental property ü Nonresidential real property 44
MODIFIED ACCELERATED COST RECOVERY SYSTEM (MACRS) 4. Residential rental property and nonresidential real property have different recovery periods. 5. The recovery period for nonresidential real property depends on the year it was placed in service. 6. Additions and improvements are treated as separate property for depreciation purposes. In 2003, William and Mary bought a house to be used as rental property for $70, 000 not including the land value. They began depreciating the $70, 000 in 2003 over the recovery period of 27. 5 years. In 2008, they completely replaced the roof at a cost of $7, 000. In 2008, they will begin depreciating the $7, 000 cost of the roof over 27. 5 years. 45
MODIFIED ACCELERATED COST RECOVERY SYSTEM (MACRS) Conventions determine the number of months you can depreciate property in the year it is placed in service and the year it is disposed of. The half-year convention is generally used for personal property. 1. Under the half-year convention, all property is treated as having been placed in service or disposed of at the midpoint of the year no matter when in the year you begin or end the use of the property. 46
Convention Property Classes Years Property Has Been in Service Depreciation Percentage Rate 47
MODIFIED ACCELERATED COST RECOVERY SYSTEM (MACRS) Louise is furnishing her new office. In February 2008, she purchased filing cabinets for $600, office furniture for $2, 000, and computer equipment for $5, 000. All her purchases are used 100% for her business. This is all tangible personal property so she can use MACRS. First, she determines the class for each item. The filing cabinets and the office furniture are 7 -year property. The computer equipment is 5 -year property. Next she determines the convention. The property is all tangible personal property and none of it was bought in the last quarter of the year. She can use the half-year convention. She figures the depreciation deduction for each item using percentage Table A-1. 48
MODIFIED ACCELERATED COST RECOVERY SYSTEM (MACRS) The basis for the filing cabinets is $600. She looks in year 1 under 7 -year property and finds the percentage rate is 14. 29%. Her depreciation deduction for the cabinets is $86 [$600 basis (cost) x 14. 29%]. The furniture is also 7 -year property so the deduction is $286 ($2, 000 basis x 14. 29%). The computer equipment is 5 -year property so Louise uses the percentage under the 5 -year column which is 20%. The deduction for the computer equipment is $1, 000 ($5, 000 basis x 20%). Louise will enter these amounts on a depreciation worksheet. She will then add the 7 -year property together and enter the 5 -year property and the 7 year property on Form 4562. 49
MODIFIED ACCELERATED COST RECOVERY SYSTEM (MACRS) The mid-quarter convention must be used if the depreciable basis of personal property placed in service in the last 3 months of the year exceeds 40% of the total depreciable basis of all personal property placed in service that year. 1. Under this convention, all property is treated as having been placed in service or disposed of at the midpoint of the quarter of the year in which you begin or end the use of the property. 2. There is a separate MACRS percentage table for each quarter. 3. If you are required to use the mid-quarter convention, you must use it for all personal property placed in service during the entire year. 50
MODIFIED ACCELERATED COST RECOVERY SYSTEM (MACRS) – Problem 2 In 2008, Richard purchased and placed in service office furniture and computer equipment for his business. The total cost was $14, 000. $7, 000 worth of equipment was purchased in November 2008 ($7, 000 is 50% of $14, 000). He does not claim the section 179 deduction. What convention will Richard use to depreciate his office furniture and equipment? a. Mid-month b. Mid-quarter c. Half year 51
MODIFIED ACCELERATED COST RECOVERY SYSTEM (MACRS) – Problem 2 In 2008, Richard purchased and placed in service office furniture and computer equipment for his business. The total cost was $14, 000. $7, 000 worth of equipment was purchased in November 2008 ($7, 000 is 50% of $14, 000). He does not claim the section 179 deduction. What convention will Richard use to depreciate his office furniture and equipment? b. Mid-quarter Because the cost of Richard's purchases in the last three months of the tax year is more than 40% of the total cost of the property, he must use the mid-quarter convention for all the property placed in service in 2008. 52
MODIFIED ACCELERATED COST RECOVERY SYSTEM (MACRS) 4. Property that is depreciated under the mid-quarter convention in the first year it is placed in service must be depreciated under the mid-quarter convention for each later year. 53
MODIFIED ACCELERATED COST RECOVERY SYSTEM (MACRS) The mid-month convention is used for nonresidential real property and residential rental property. 1. Under this convention, all property is treated as having been placed in service or disposed of at the midpoint of the month in which you begin or end the use of the property. 54
MODIFIED ACCELERATED COST RECOVERY SYSTEM (MACRS) On June 1, 2008, Chuck Greene purchased an office building for $500, 000. The value of the land included in the price was $75, 000. Land is never depreciable so his depreciation basis is $425, 000 ($500, 000 $75, 000). Because this is nonresidential real property purchased after 5/12/1993, the recovery period is 39 years. Since the property is real property, the mid-month convention is used. 55
MODIFIED ACCELERATED COST RECOVERY SYSTEM (MACRS) Chuck figures his depreciation deduction by using Table A-7 a. Chuck placed the property in service in June so he looks under column 6 (June is the sixth month). The depreciation percentage rate for June is 1. 391%. His depreciation deduction for 2008 is $5, 911. 75 ($425, 000 basis x 1. 391%). To figure his deduction for tax year 2009, he will multiply the basis by the second year percentage under column 6 ($425, 000 x 2. 564% = $10, 897). 56
MODIFIED ACCELERATED COST RECOVERY SYSTEM (MACRS) For any convention, when determining the year of the recovery period to use count the year the property was placed in service as year 1. Mighty Maids bought filing cabinets in May 2005. In 2008, the filing cabinets are in year 4 of the recovery period, not year 3. The correct percentage in Table A-1 under 7 year property is 12. 49% not 17. 49%. 57
MODIFIED ACCELERATED COST RECOVERY SYSTEM (MACRS) Special Depreciation Allowance For property placed in service beginning January 1, 2008, only certain types of property are eligible for an additional 50% (or 30% if applicable) special depreciation allowance, primarily limited to: • Qualified Liberty Zone property • Qualified Gulf Opportunity Zone (GO Zone) property • Qualified Recovery Assistance property ( property in the Kansas disaster area) • Qualified disaster assistance property (property in federally declared disaster areas) • Certain qualified property placed in service after December 31, 2007, and before January 1, 2010. 58
MODIFIED ACCELERATED COST RECOVERY SYSTEM (MACRS) Special Depreciation Allowance This allowance is an additional deduction taken after any section 179 deduction and before figuring regular depreciation under MACRS for the year the property is placed in service. The allowance applies only for the first year the property is placed in service. You can elect, for any class of property, not to deduct any special allowances for all property in such class placed in service in the tax year. To make an election, attach a statement to your return indicating what election you are making and the class of property for which you are making the election. 59
MODIFIED ACCELERATED COST RECOVERY SYSTEM (MACRS) On November 24, 2008, Elisabeth Martin bought and placed in service qualified 7 -year property for $100, 000 for her business in the Gulf Opportunity Zone. Elisabeth can deduct $50, 000 ($100, 000 x 50%) as a special depreciation allowance for 2008. She will use the remaining $50, 000 ($100, 000 $50, 000) of the cost to figure her regular year one depreciation deduction and for each later year of the recovery period. Her regular year one depreciation deduction is $7, 145 ($50, 000 depreciation basis x 14. 29%). Her total 2008 depreciation deduction is $57, 145 ($7, 145 regular year one depreciation deduction plus $50, 000 special depreciation allowance). 60
MODIFIED ACCELERATED COST RECOVERY SYSTEM (MACRS) § The special depreciation allowance for property placed in service after September 10, 2001 and before January 1, 2005 and after December 31, 2007 and before January 1, 2010 applied to all areas of the country and is not limited to the “Qualified” zones. § For qualified property placed in service after September 10, 2001 and before May 6, 2003, the 30% additional depreciation automatically applied unless you elected not to use it. After May 5, 2003 and before January 1, 2005, the 50% additional depreciation automatically applied unless you elected out. If you did elect out, the 30% bonus depreciation applied. Or you could have elected out of both the 30% and 50% additional depreciation. 61
DEPRECIATION WORKSHEET Use a depreciation worksheet to assist you in maintaining depreciation records. On the worksheet you record the date placed-in-service, basis, recovery period and other information needed to figure the deduction for each item of property you are depreciating. Use the worksheet to figure your deductions each tax year and keep the worksheet with your records for that year. 62
LISTED PROPERTY A. Property the IRS considers likely to be used for personal as well as business purposes is listed property and it includes: 1. Any passenger automobile 2. Any other property used for transportation (trucks, buses, boats) 3. Any property used for entertainment, recreation or amusement (cameras, VCRs) 4. Computers and related equipment (unless used at a regular business establishment owned or leased by the person operating the establishment) 5. Any cellular telephone or similar telecommunication equipment. 63
LISTED PROPERTY Depreciating Listed Property B. There additional rules and record keeping requirements for depreciating listed property. C. Only the business-use part of the cost can be depreciated. D. To depreciate listed property using GDS, the qualified business use of the property must be more than 50% of its total use (Predominant Use Test). 1. A qualified business use is any use in your trade or business 2. Qualified business use does not include use of investment or rental property; use of a vehicle for commuting; or employee use of listed property unless the use is required as a condition of employment. 64
LISTED PROPERTY – Problem 1 April is self-employed and sells cosmetics. She uses a computer in a part of her home that does not qualify as a home office, so the computer is listed property. Her records show that in 2008 she used the computer a total of 1, 300 hours. She used it 900 hours for business and 400 hours for personal purposes. How much of the cost of the computer can April depreciate? a. 100% b. 32% c. 69% 65
LISTED PROPERTY – Problem 1 April is self-employed and sells cosmetics. She uses a computer in a part of her home that does not qualify as a home office, so the computer is listed property. Her records show that in 2008 she used the computer a total of 1, 300 hours. She used it 900 hours for business and 400 hours for personal purposes. How much of the cost of the computer can April depreciate? c. 69% Because her business use of the computer is more than 50% of the total use (900 of 1, 300 hours is 69%), she can depreciate 69% of the cost of the computer using the regular (GDS) MACRS rules. 66
LISTED PROPERTY E. If the qualified business use of the property is 50% or less of its total use: 1. Must depreciate using ADS 2. Cannot claim a section 179 deduction. F. To take a depreciation deduction for listed property, you must be able to prove business use with supporting records or evidence. 67
LISTED PROPERTY Sally Jones uses the computer in her home 50% of the time to manage her investments. She also uses the computer 40% of the time in her research business. The computer is listed property because it is not used at a regular business establishment or in a part of her home used regularly and exclusively for business. Because she does not use the computer more than 50% for business, it does not meet the predominant use test. Because it does not meet the predominant use test, she cannot claim a section 179 deduction and she must use ADS to depreciate the computer. Her depreciation basis under ADS is 90% of the cost of the computer (50% investment use on Form 4952 and 40% business use on her business return). 68
LISTED PROPERTY Special Rules For Passenger Automobiles G. There are special additional depreciation rules for passenger automobiles. 1. Total depreciation allowed (including the section 179 deduction) is limited to the lower of amounts set by tax law or yearly percentage of the cost basis 2. Each year of useful life, you must determine maximum depreciation allowed under these limits by the date the automobile is placed in service 3. Also figure the deduction using MACRS and use the lower amount as your deduction a. Must reduce the deduction further if business use is less than 100%. 4. Refer to Table 12 -4 for the maximum deduction, based on the year the automobile was placed in service. 69
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LISTED PROPERTY On September 26, 2008, Charles Smyth bought and placed in service a new car for $18, 000. He used the car 60% for business during 2008. He files his tax return based on the calendar year. Under GDS, his car is a 5 -year property. He uses Table A-1 to determine the depreciation rate. Using Part 1 of the Depreciation Worksheet for Passenger Automobiles and Table 12 -4, Donald determines his maximum possible depreciation deduction for a passenger automobile is $6, 576 ($10, 960 x 60%). Donald's depreciation deduction is limited to $2, 160 (the lesser of $6, 576 MACRS depreciation or the passenger auto limit of $2, 160) as shown in the worksheet on the following page. If Donald continues to use his car for business, he will be subject to the deduction limits in Table 12 -4 each year. 72
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LISTED PROPERTY Trucks and Vans 5. The maximum depreciation deduction limit for certain trucks and vans first placed in service in 2008 are higher than those for other passenger automobiles. Refer to Table 12 -5 75
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SECTION 179 DEDUCTION A. Under section 179 of the Internal Revenue Code (IRC) you can elect to deduct (expense) all or part of the cost of certain qualifying property in the year you place it in service instead of taking depreciation deductions over a recovery period. 1. Elect the section 179 deduction on Form 4562 2. You can expense part of the cost (the elected cost) and depreciate the rest of the cost over the applicable recovery period 3. You can revoke an election to take a section 179 deduction without IRS approval. Make revocation on an amended return. Applies to tax years beginning in 2003. 4. You must keep records identifying each piece of section 179 property. 77
SECTION 179 DEDUCTION Deductible Costs B. Generally, qualifying property must be tangible personal property: 1. Acquired by purchase 2. Used in your trade or business 3. Used for business more than 50% of the total use in the year you place it in service. a. Use only the business use cost of the property to figure the section 179 deduction. 78
SECTION 179 DEDUCTION – Problem 1 In 2008, Sam Smith bought and placed in service an item of tangible property. He paid $11, 000 for it and used it 80% for business and 20% for personal purposes. What is the business part of the cost of the property that Sam can claim as a section 179 deduction? a. $8, 800 b. $11, 000 c. $2, 200 79
SECTION 179 DEDUCTION – Problem 1 In 2008, Sam Smith bought and placed in service an item of tangible property. He paid $11, 000 for it and used it 80% for business and 20% for personal purposes. What is the business part of the cost of the property that Sam can claim as a section 179 deduction? a. $8, 800 The business part of the cost of the property is $8, 800 (80% x $11, 000). John cannot claim more than $8, 800 as his section 179 deduction. 80
SECTION 179 DEDUCTION Nondeductible Costs C. Property for which a section 179 deduction generally cannot be claimed includes: property held only for the production of income and rental property; property used predominately to furnish lodging, and property acquired from relatives. 81
SECTION 179 DEDUCTION Figuring The Deduction D. Your section 179 deduction cannot be more than the business cost of the qualifying property. There are three additional limits on the amount of the deduction. 1. For tax year 2008, the total amount you can elect to deduct under section 179 property cannot exceed $250, 000 2. The $250, 000 maximum must be reduced one dollar for each dollar the cost of the property is over $800, 000 3. The total cost of the property you can deduct is limited to the amount of your taxable income from the active conduct of any trade or business, including wages, salaries, and other employee compensation 4. Any cost that is not deductible because of the taxable income limit can be carried over to the next tax year 82
SECTION 179 DEDUCTION – Problem 2 In 2008, Carter James placed in service machinery costing $807, 000. Because this cost is $7, 000 more than the investment limit of $800, 000, he must reduce his maximum dollar limit of $250, 000 by $7, 000. If his taxable income is at least $243, 000, he can claim a $243, 000 section 179 deduction for 2008. He will depreciate the balance of the basis over the applicable recovery period. Assume that Carter’s net income from his business in 2008 was $240, 000. His wife’s wages were $19, 000 and they are filing jointly. For what amount can they take a section 179 deduction? a. $250, 000 b. $243, 000 c. $240, 000 83
SECTION 179 DEDUCTION – Problem 2 In 2008, Carter James placed in service machinery costing $807, 000. Because this cost is $7, 000 more than the investment limit of $800, 000, he must reduce his maximum dollar limit of $250, 000 by $7, 000. If his taxable income is at least $243, 000, he can claim a $243, 000 section 179 deduction for 2008. He will depreciate the balance of the basis over the applicable recovery period. Assume that Carter’s net income from his business in 2008 was $240, 000. His wife’s wages were $19, 000 and they are filing jointly. For what amount can they take a section 179 deduction? b. $243, 000 Taxable income for section 179 purposes is $259, 000. They can take a section 179 deduction for the entire $243, 000. 84
SECTION 179 DEDUCTION In 2008, Ray bought and put into service office furniture for his new business at a cost of $13, 500. He elected to expense the cost on his tax return. $13, 500 is less than the maximum dollar limit of $250, 000 and less than the investment limit of $800, 000. However, Ray’s net income in 2008 from his business was only $11, 000. His section 179 deduction is limited to $11, 000. He can carry the $2, 500 he could not deduct to 2009 and take the $2, 500 deduction then, if it is within all three limits. He must deduct the $2, 500 before he takes any section 179 deduction for property acquired in 2009. 85
SECTION 179 LIMIT FOR SUVs Sport utility vehicles (SUVs) and other vehicles weighing over 6, 000 pounds are normally not subject to the luxury auto limitations. However, the maximum section 179 expense for sport utility vehicles and certain other vehicles placed in service after October 22, 2004, is $25, 000. 86
DISPOSITION OF PROPERTY A. The permanent withdrawal of property from use. B. A withdrawal can be made by sale, exchange, abandonment, or destruction. C. Disposal before the end of the recovery period is called early disposition. D. For MACRS property, you are allowed a depreciation deduction for the year of the disposition. E. The deduction is a percentage of the MACRS deduction for that year of service 1. The percentage is different depending on which convention you are using. 87
DISPOSITION OF PROPERTY – Problem 1 In May 2006, Tot’s Toys bought desks for $3, 000 for 100% business use. Desks are 7 -year property. The desks were sold in 2008. Using the half-year convention, the 2008 regular depreciation deduction for year 3 is $525 ($3, 000 x 17. 49%) for a full year of business use. What is the actual deduction for the property when it was disposed of in 2008? a. $525 b. $263 c. $350 88
DISPOSITION OF PROPERTY- Problem 1 In May 2006, Tot’s Toys bought desks for $3, 000 for 100% business use. Desks are 7 -year property. The desks were sold in 2008. Using the half-year convention, the 2008 regular depreciation deduction for year 3 is $525 ($3, 000 x 17. 49%) for a full year of business use. What is the actual deduction for the property when it was disposed of in 2008? b. $263 Because the property was disposed of, the actual deduction is $263 (½ of $525). 89
AMORTIZATION A. Used for intangible property; business start up costs; and certain other expenses. B. Deduct an equal amount of the cost of property each year over a period of time set by tax law (first and last years will generally be less than a full year). 90
FORM 4562 A. You are not required to file Form 4562 to report depreciation or amortization of non-listed property for the years after the property was placed in service. B. You must complete Form 4562 and attach it to your tax return if you claim: 1. A section 179 deduction or carryover 2. A depreciation deduction on property placed in service in the current year 3. A depreciation deduction on any vehicle or other listed property regardless of the year placed in service 4. A deduction for any vehicle using the standard mileage rate unless the deduction is reported on Schedule C or C-EZ 5. A deduction for amortization of costs that begin in the current year. 91
FORM 4562 C. Table 12 -7 explains the purpose of each part of Form 4562. D. Complete and file a separate Form 4562 for each business or activity for which you are claiming a depreciation deduction. E. The amount on line 22 of Form 4562 is entered on the form or schedule on which you are claiming the deduction. F. If you are an employee claiming actual expenses or the standard mileage rate for the business use of your vehicle, you must use Form 2106 instead of Form 4562. 92
Table 12 -7. Purpose of Form 4562 Part Purpose I • Electing the section 179 deduction • Figuring the maximum section 179 deduction for the current year • Figuring any section 179 deduction carryover to the next year II • Reporting depreciation deduction on property being depreciated under any method other than Modified Accelerated Cost Recovery System (MACRS) • Reporting special depreciation allowance deductions III • Reporting MACRS depreciation deductions for property placed in service before this year • Reporting MACRS depreciation deductions for property (other than listed property) placed in service during the current year IV • Summarizing total depreciation listed in other parts V • Reporting depreciation on automobiles and other listed property • Reporting information on the use of automobiles and other transportation vehicles VI • Reporting amortization deductions 93
Depreciation KEY IDEAS ♦ The depreciation deduction is a yearly deduction that allows you to recover your cost of certain business or investment property over the life of the property. The yearly deduction is a percentage of the business/investment basis of the property. ♦ You can only depreciate property you own that is used in business or to produce income, is expected to last more than one year, and has a limited useful life in that it wears out, gets used up or becomes obsolete. Land can never be depreciated. ♦ The Modified Accelerated Cost Recovery System (MACRS) is the depreciation system used to depreciate most tangible property placed in service after 1986. To depreciate property under MACRS, you need to know its basis, property class and recovery period, the placed-in-service date, and which convention to use. 94
Depreciation KEY IDEAS ♦ Under MACRS, you use rates taken from IRS percentage tables to figure your depreciation deduction. The tables incorporate the class lives of different types of property, the depreciation method, and the appropriate convention. ♦ Listed property is property that is likely to be used for personal purposes. This includes property used for transportation and entertainment as well as certain computers and cellular phones. You can use the GDS declining balance MACRS tables or expense such property only if the qualified business use of the property is more than 50% of its total use. ♦ If the qualified business use of the property is 50% or less, you must use the MACRS Alternative Depreciation System (ADS) which uses the straight-line method of depreciation. 95
Depreciation KEY IDEAS ♦ Instead of depreciating tangible personal property, you can choose to deduct part or all of the business cost of certain qualifying property in the year you place it in service for business. This is called a section 179 deduction. ♦ Property used 50% or less for business or property you hold only for the production of income such as investment property and rental property (if renting property is not your trade or business) does not qualify for this deduction. ♦ The depreciation (including the section 179 deduction) that can be taken for passenger automobiles (and small trucks and vans) is subject to a dollar limit. ♦ If you are depreciating property placed in service in the current year, taking a section 179 deduction, depreciating a vehicle, claiming a deduction using the standard mileage rate, or beginning amortization of costs, you must complete Form 4562. ♦ The total depreciation reported on Form 4562 is transferred to the schedule on which you are claiming depreciation such as Schedule C, E or F. Amortization will be entered separately as other deductions or other expenses. 96
Depreciation CLASSWORK 1: True or False. (1) Sharon bought business equipment costing $12, 000 in 2007. She took delivery of and placed in service $5, 000 worth of that equipment in November. She had to use the mid-quarter convention to depreciate all the equipment she purchased in 2007 and must use the mid-quarter convention when she depreciates the equipment in 2008. (2) Under the half-year convention, real property is treated as having been placed in service or disposed of at the midpoint of the year, no matter when in the year you begin or end the use of the property. (3) Depreciable property is property that is used in business or held to produce income, is expected to last more than one year, and has a limited useful life. 97
Depreciation CLASSWORK 1: True or False. (4) In 2008, Virginia Dare bought a computer and related equipment for $4, 000 which she used 100% to manage her investment property. If her taxable income from trade or business is $4, 000 or more, she can take a section 179 deduction for the computer. (5) In 2008, Ricky used his cellular phone 48% for business. The rest of the time the phone was used for personal purposes. Woody cannot depreciate his phone. (6) Amortization is the deduction of equal amounts of the cost of certain property over time periods set by tax law. (7) To take a section 179 deduction for, or to depreciate, listed property you must be able to prove each element of your expenditure or use with account books, logs or similar records. 98
Depreciation CLASSWORK 1: True or False. (8) In addition to the $5, 000 she made as a part time receptionist in 2008, Rebecca earned income from selling crafts that she made. She used a room in her home exclusively for her business. She bought furniture and equipment costing $6, 000 for her home office. Her income from her craft business was $4, 500. The maximum section 179 deduction she can claim is $4, 500. (9) The MACRS conventions determine how many months you can depreciate your property in the year it is placed in service and in the year you dispose of the property. (10) Under MACRS, the class to which property is assigned determines the number of years over which it can be depreciated. (11) Charles owns a building that he rents to a real estate company. In 2008, Charles paid for a new furnace which added to the value of the property. Charles must depreciate the cost of the furnace. 99
Depreciation CLASSWORK 1: True or False. (12) A trademark is an example of intangible property. (13) If you are only claiming a section 179 deduction, you do not need to complete a Form 4562. (14) In 2007, Mike bought a computer which he used for personal purposes. In January 2008, he started his own business and began to use the computer for business only. His business use of the computer in 2008 was 100%. Mike can take a section 179 deduction for 2008. (15) A computer used at a regular business establishment and owned by the person operating the establishment is not listed property. 100
Depreciation CLASSWORK 1: True or False. (1) Sharon bought business equipment costing $12, 000 in 2007. She took delivery of and placed in service $5, 000 worth of that equipment in November. She had to use the mid-quarter convention to depreciate all the equipment she purchased in 2007 and must use the mid-quarter convention when she depreciates the equipment in 2008. T (2) Under the half-year convention, real property is treated as having been placed in service or disposed of at the midpoint of the year, no matter when in the year you begin or end the use of the property. F (3) Depreciable property is property that is used in business or held to produce income, is expected to last more than one year, and has a limited useful life. T 101
Depreciation CLASSWORK 1: True or False. (4) In 2008, Virginia Dare bought a computer and related equipment for $4, 000 which she used 100% to manage her investment property. If her taxable income from trade or business is $4, 000 or more, she can take a section 179 deduction for the computer. F (5) In 2008, Ricky used his cellular phone 48% for business. The rest of the time the phone was used for personal purposes. Woody cannot depreciate his phone. F (6) Amortization is the deduction of equal amounts of the cost of certain property over time periods set by tax law. T (7) To take a section 179 deduction for, or to depreciate, listed property you must be able to prove each element of your expenditure or use with account books, logs or similar records. T 102
Depreciation CLASSWORK 1: True or False. (8) In addition to the $5, 000 she made as a part time receptionist in 2008, Rebecca earned income from selling crafts that she made. She used a room in her home exclusively for her business. She bought furniture and equipment costing $6, 000 for her home office. Her income from her craft business was $4, 500. The maximum section 179 deduction she can claim is $4, 500. F (9) The MACRS conventions determine how many months you can depreciate your property in the year it is placed in service and in the year you dispose of the property. T (10) Under MACRS, the class to which property is assigned determines the number of years over which it can be depreciated. T (11) Charles owns a building that he rents to a real estate company. In 2008, Charles paid for a new furnace which added to the value of the property. Charles must depreciate the cost of the furnace. T 103
Depreciation CLASSWORK 1: True or False. (12) A trademark is an example of intangible property. T (13) If you are only claiming a section 179 deduction, you do not need to complete a Form 4562. F (14) In 2007, Mike bought a computer which he used for personal purposes. In January 2008, he started his own business and began to use the computer for business only. His business use of the computer in 2008 was 100%. Mike can take a section 179 deduction for 2008. F (15) A computer used at a regular business establishment and owned by the person operating the establishment is not listed property. T 104
Depreciation CLASSWORK 2: Multiple Choice. 1. In 2006, Randy bought furniture for his office for $10, 000. Of the $10, 000 total, $3, 000 was for purchases made after October 2005. His depreciation deduction in 2007 is: a. b. c. d. 2. $1, 749 $1, 429 different for the purchases made before and after October $1, 920 For which of the following property can you claim a section 179 deduction: a. b. c. d. office equipment you bought from your brother a car used 50% for business furniture used in a rental property none of the above 105
Depreciation CLASSWORK 2: Multiple Choice 3. Which property can you depreciate a. an undeveloped piece of land used as a parking lot b. an apartment building used as rental property c. a small tool expected to last 6 months that you use in your business d. your personal residence 4. Under MACRS, the mid-month convention is used for: a. b. c. d. only nonresidential real property placed in service after 5/12/1993 tangible personal property acquired during the last 3 months of the year only residential rental property nonresidential real property and residential rental property 106
Depreciation CLASSWORK 2: Multiple Choice. 5. Cassie uses the car she purchased for $18, 000 in March 2007 to deliver goods to her customers. She depreciated the car using the half-year convention and in 2007, she used the car 80% for business. In 2008, she used the car 70% for business and 30% for personal use. Her 2008 depreciation deduction for the car is: a. b. c. d. 6. $3, 920 $4, 800 $4, 900 $3, 430 Under MACRS, you compute a deduction for depreciation by multiplying the business basis of your property by a percentage taken from the applicable table. To find the right percentage you must know: a. b. c. d. the year the property was placed in service the class the property is assigned to whether to use the half-year, mid-quarter, or mid-month convention all of the above 107
Depreciation CLASSWORK 2: Multiple Choice. 7. William and Mary have owned an apartment building since 2002. They paid $120, 000 for the building. In 2008, they put on a new roof which cost $8, 000. They must: a. b. c. d. 8. add the $8, 000 to the $120, 000 cost and depreciate the total subtract the $8, 000 from their rental income as an expense start depreciating the roof in 2007 as a separate property item depreciate the roof as a separate item placed in service in 2001 On May 20, 2008, Judy paid $18, 750 for a new car which she placed in service and uses 80% in her business. She does not elect a section 179 deduction. What is her allowable depreciation for 2008? a. b. c. d. $2, 368 $2, 960 $3, 000 $3, 750 108
Depreciation CLASSWORK 2: Multiple Choice. 1. In 2006, Randy bought furniture for his office for $10, 000. Of the $10, 000 total, $3, 000 was for purchases made after October 2006. His depreciation deduction in 2008 is: a. $1, 749 2. For which of the following property can you claim a section 179 deduction: d. none of the above 3. Which property can you depreciate: b. an apartment building used as rental property 109
Depreciation CLASSWORK 2: Multiple Choice. 4. Under MACRS, the mid-month convention is used for: d. nonresidential real property and residential rental property 5. Cassie uses the car she purchased for $18, 000 in March 2007 to deliver goods to her customers. She depreciated the car using the half-year convention and in 2007, she used the car 80% for business. In 2008, she used the car 70% for business and 30% for personal use. Her 2008 depreciation deduction for the car is: d. $3, 430 6. Under MACRS, you compute a deduction for depreciation by multiplying the business basis of your property by a percentage taken from the applicable table. To find the right percentage you must know: d. all of the above 110
Depreciation CLASSWORK 2: Multiple Choice. 7. William and Mary have owned an apartment building since 2002. They paid $120, 000 for the building. In 2008, they put on a new roof which cost $8, 000. They must: c. start depreciating the roof in 2008 as a separate property item 8. On May 20, 2008, Judy paid $18, 750 for a new car which she placed in service and uses 80% in her business. She does not elect a section 179 deduction. What is her allowable depreciation for 2008? c. $3, 000 111
Depreciation CLASSWORK 3: The following are items of business property followed by the date each was placed in service. Each is used 100% for business and none are subject to the midquarter convention. Determine the property class and MACRS percentage rate for 2008 for each item: 1. taxi – 2007 2. computer – 2003 3. file cabinet – 2005 4. copier – 2006 5. race horse age 3 – 2008 6. factory building - August 2008 7. calculator – 2008 8. over-the-road tractor unit – 2007 9. office building - April 1993 10. office desk and chair – 2002 11. residential rental - February 1998 12. apartment building - December 2008 112
Depreciation CLASSWORK 3: The following are items of business property followed by the date each was placed in service. Each is used 100% for business and none are subject to the mid-quarter convention. Determine the property class and MACRS percentage rate for 2008 for each item: 1. taxi – 2007 5 years, 32% 2. computer – 2003 5 years, 5. 76% 3. file cabinet – 2005 7 years, 12. 49% 4. copier – 2006 5 years, 19. 20% 5. race horse age 3 – 2008 3 years, 33. 33% 6. factory building - August 2008 39 years, 0. 963% 7. calculator – 2008 5 years, 20% 8. over-the-road tractor unit – 2007 3 years, 44. 45% 9. office building - April 1993 31. 5 years, 3. 174% 10. office desk and chair – 2002 7 years, 8. 93% 11. residential rental - February 1998 27. 5 years, 3. 636% 12. apartment building - December 2008 27. 5 years, 0. 152% 113
Questions & Answers 114
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