Chapter 8 Depreciation and Amortization - · PDF fileChapter 8 Depreciation and Amortization ... 132 Essentials of Federal Income Taxation Solutions to Questions and Problems ... Textbook

131

Chapter 8

Depreciation and Amortization

Teaching Suggestions

1. Computing first-year depreciation for personal property placed in service during 2007 may involve twoseparate calculations. Students need to be aware of the rules for each calculation and, more importantly, the orderin which these calculations need to be made.

First, if Section 179 property is placed in service during the year, the taxpayer must first determine themaximum Section 179 that is available. The statutory dollar limit ($125,000 in 2007), placed in service limit($500,000), and taxable income limit all come into consideration in making the decision. Once the taxpayerdetermines the maximum Section 179 that is available, the decision must be made on how much to elect to expensein the first year. The maximum amount of Section 179 expense that can be elected is based on the dollar and placed-in-service limits. The maximum amount that can be deducted is based on the taxable income limitation.

Second, the remainder of the taxpayer’s basis in the property (after subtracting out the amount elected) isdepreciated over the appropriate recovery period under MACRS/ADS (whichever the taxpayer elects to use). Thesum of the deductible Section 179 expense and the amount of MACRS/ADS comprise the taxpayer’s total first-yeardepreciation for property placed in service in 2007.

2. Students who have used the double declining balance (DDB) method in a financial accounting course mayhave difficulty with multiplying the cost of the property by the percentages provided in the tax depreciation tables.Students will want to use the “adjusted basis� of the property (cost minus accumulated depreciation). Showingstudents how the percentages in the table were derived may help them understand (1) that the half-year/mid-quarter convention has been incorporated into the percentages for the first year (but not for the year of sale) and(2) that the property’s adjusted basis actually is used in computing the annual cost recovery percentages.

For example, students could be presented with 5-year property costing $1,000. Assuming the half-yearconvention applies, the first year of cost recovery would be $200 ($1,000 × 1/5 × 200% × 1/2 year). Therefore, thefirst year recovery percentage would be 20% ($200/$1,000), the percentage from the table for Year 1. Using theDDB method, cost recovery for the second year would begin with the adjusted basis of the property, or $800($1,000 − $200). Cost recovery for the second year would be $320 ($800 × 1/5 × 200%). This amount equals 32% ofthe property’s cost ($320/$1,000), which is the percentage shown in the table for Year 2. The cost recovery for thethird year would begin with the adjusted basis of $480 ($1,000 − $200 − $320). The cost recovery amount for Year 3would be $192 ($480 × 1/5 × 200%), which is 19.2% of the cost of the property (and the percentage shown in thetable for Year 3).

At the end of Year 3, the property has an adjusted basis of $288 ($1,000 − $200 − $320 − $192) and has beendepreciated for 2.5 years. This means that 2.5 years of cost recovery remain. Using the DDB method, Year 4 costrecovery would be $115.20 ($288 × 1/5 × 200%), which is the same cost recovery amount had the straight-linemethod been used ($288/2.5 years). This deduction is 11.52% of the cost of the property ($115.20/$1,000), thepercentage in the table for Year 4. Because the DDB and straight-line methods both produce the same deduction,this indicates that beginning in Year 5, the switch to straight-line will produce a greater deduction.

In addition to convincing students that the depreciation tables incorporate the averaging convention into thefirst year, it also shows that for each subsequent year the percentages in the table reflect a full year of costrecovery. Therefore, it is up to the student to use the appropriate averaging convention (half-year or mid-quarter) toreduce the percentage in the year the property is sold.

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132 Essentials of Federal Income Taxation

Solutions to Questions and Problems1. ¶802, ¶803.

Useful Life Depreciation AveragingType of Asset in Years Method Convention

Automobiles 5 200% DB HY or MQ

Light trucks 5 200% DB HY or MQ

Computers 5 200% DB HY or MQ

Furniture & fixtures 7 200% DB HY or MQ

Machinery & equipment 7 200% DB HY or MQ

Commercial buildings (before 5/13/93) 31.5 Straight-line MM

Commercial buildings (on or after 5/13/93) 39 Straight-line MM

Residential buildings 27.5 Straight-line MM

2. Since more than 40% of the cost of the machines were placed in service in the last quarter($70,000/$130,000 = 54%), the taxpayer must use the mid-quarter convention for all personalty propertyacquired in 2007.

a. Mid-quarter convention with all amounts rounded to the nearest dollar. ¶802.03.

February 1 machine . . . . . . . . . . . . . . . . . . . . . . . . . . . . ($25,000 × 25.00%) = $6,250

April 1 machine . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . ($35,000 × 17.85%) = 6,248

October 1 machine . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . ($30,000 × 3.57%) = 1,071

December 1 machine . . . . . . . . . . . . . . . . . . . . . . . . . . . . ($40,000 × 3.57%) = 1,428

Total depreciation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $14,997

b. Half-year convention: $130,000 × 14.29% = $18,577. ¶802.03.

The cost recovery using the mid-quarter convention is $3,580 ($18,577 − $14,997) less than the costrecovery using the half-year convention. The requirement to use the mid-quarter convention whenmore than 40% of the tangible personal property is purchased in the last quarter of the year eliminatesthe tax advantage of postponing purchases until late in the year.

3. a. During 2007, $24,000 of the $144,000 total personal property placed in service during the year is placedin service in the fourth quarter. Since this percentage (16.67%) does not exceed 40%, the half-yearconvention applies to all personal property placed in service during 2007. The mid-month conventionapplies to the building. ¶802.01.

b. ¶802.03, ¶803.01.

Property 2007 2008

Machine $65,000 × 14.29% = $9,289 $65,000 × 24.49% = $15,919

Equipment $55,000 × 14.29% = $7,860 $55,000 × 24.49% = $13,470

Office building $200,000/39 × 2.5/12 = $1,068 $200,000/39 = $5,128

Furniture $24,000 × 14.29% = $3,430 $24,000 × 24.49% = $5,878

4. Computer: $4,200 × 11.52% × 1/2 year = $242

Automobile: $12,000 × 19.2% × 1/2 year = $1,152

Furniture: $24,000 × 8.85% × 7.5/12 = $1,328

Under the half-year convention, property is depreciated for 1/2 year in the year of disposition. The computerand the automobile were depreciated for 1/2 year. Under the mid-quarter convention, property is depreci-ated until the middle of the quarter in which it is sold. The furniture was depreciated until August 15.¶802.03.

Chapter 8 ©2007 CCH. All Rights Reserved.

133Textbook Solutions

5. Machine: $44,000 × 8.87% × 10.5/12 = $3,415 (4th quarter table; year 5)

Furniture: $12,000 × 24.49% × 1/2 = $1,469 (half-year table; year 2)

Computer: $24,000 × 15.60% × 7.5/12 = $2,340 (1st quarter table; year 3)

Under the mid-quarter convention, property is depreciated until the middle of the quarter in which is itsold. Thus, the machine is depreciated until November 15 (101/2 months) and the computer until August 15(71/2 months). ¶802.03.

6. ¶802.03.

a. Equipment: $72,000 / 10 year life under ADS = $7,200

Furniture: $42,000 MACRS basis × 12.49% = $5,246 (HY table, 7-yr property, year 4)

Computer: $5,000 × 19.2% = $960 (HY table, 5-yr property, year 3)

b. 2007 Depreciation on the furniture: $42,000 × 10.93% = $4,591 (1st quarter table, 7-yr property, year 4)

c. Equipment: $10,289 ($72,000 × 14.29%)

Furniture: $12,004 ($84,000 × 14.29%)

Computer: $1,000 ($5,000 × 20%)

7. a. Computer: $16,000 × 32% = $5,120 (HY table, 5-yr property, year 2)

Machine: $60,000 × 19.68% = $11,808 (4th quarter table, 7-yr property, year 3)

Furniture: $25,000 × 8.75% = $2,188 (1st quarter table, 7-yr property, year 7)

¶802.03

b. Computer: $16,000 × 15% = $2,400 (3rd quarter table, 5-yr property, year 1)

Machine: $60,000 × 3.57% = $2,142 (4th quarter table, 7-yr property, year 1)

Furniture: $25,000 × 25% = $6,250 (1st quarter table, 7-yr property, year 1)

Because more than 40% of the total personal property was placed in service in the fourth quarter($60,000 ÷ $101,000 = 59.4%), the mid-quarter convention applies to all three properties. ¶802.03.

8. a. $75,000 ($125,000 maximum Section 179 for 2007 − $50,000 excess Section 179 property over $500,000).The $75,000 maximum Sands can elect − $67,000 taxable income from the business = $8,000 carryoverto 2008. ¶802.05.

b. $134,878 [$67,000 Section 179 + $67,878 MACRS (($550,000 − $75,000 elected) × 14.29% half-yearpercentage)]. The $8,000 carryover of Section 179 expense is not deducted in 2007. ¶802.05.

9. ¶802.03, ¶802.05.

a.

Section 179 expense on the 5-year property . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $125,000

MACRS, 5-year property (($137,000 − $125,000) × 20%) . . . . . . . . . . . . . . . . . . . . . . . . 2,400

MACRS, 7-year property ($137,000 × 14.29%) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 19,577

Total depreciation expense . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $146,977

b.

MACRS, 5-year property ($137,000 × 20%) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 27,400

Section 179 expense on the 7-year property . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 125,000

MACRS, 7-year property (($137,000 − $125,000) × 14.29%) . . . . . . . . . . . . . . . . . . . . . . 1,715

Total depreciation expense . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $154,115

c. Total depreciation expense is greater when Roddick elects to expense the 7-year property. Thishappens because the MACRS first year percentage is lower on 7-year property (14.29%) vs. 5-yearproperty (20%). Thus, by keeping the MACRS basis in the 5-year property at $137,000, greater totaldepreciation results.

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10. ¶802.03, ¶802.05.

a.

Automobile (1st year maximum allowed) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $3,060

Copier ($14,200 × 20%) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2,840

Furniture ($42,000 × 14.29%) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 6,002

Equipment ($145,000 × 14.29%) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 20,721

Warehouse ($110,250 × 1/39 × 5.5/12 months) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1,296

$33,919

b.

2007

First year expense deduction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $125,000

MACRS, Year 1 (($145,000 − $125,000) × 14.29%) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2,858

Total 2007 depreciation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $127,858

2008

Second year MACRS depreciation ($20,000 × 24.49%) . . . . . . . . . . . . . . . . . . . . . . . . . . $4,898

c. The maximum $125,000 of Section 179 expense would involve expensing $14,200 for the copier and$42,000 for the furniture. This leaves $68,800 to be expensed for the equipment.

2007

First year expense deduction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $68,800

MACRS, Year 1 ($145,000 − $68,800 = $76,200 × 14.29%) . . . . . . . . . . . . . . . . . . . . . . . 10,889

Total 2007 depreciation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $79,689

2008

Second year MACRS depreciation ($76,200 × 24.49%) . . . . . . . . . . . . . . . . . . . . . . . . . . $18,661

11. a. Terrell’s business/investment basis is $2,100 ($2,800 × 75%). Terrell is entitled to take MACRS on thebusiness/investment basis because his business use alone exceeds 50%. MACRS using the half-yearconvention equals $420 ($2,100 × 20%). ¶802.07.

b. Terrell can elect to expense the business-use basis for the computer ($2,800 × 60% = $1,680) underSection 179 since business use exceeds 50%. The investment-use basis ($2,800 × 15% = $420) cannot beexpensed under Section 179. However, MACRS can be taken on the investment-use basis ($420 × 20% =$84). Regular (accelerated) MACRS is allowed (as opposed to the straight-line method) becausebusiness use exceeds 50%. ¶802.07.

c. Depreciation expense on the business portion of the computer is deducted on Schedule C. Deprecia-tion on the investment portion is a miscellaneous itemized deduction (subject to the 2% AGI rule) onSchedule A. ¶802.07.

12. Since business use does not exceed 50%, the automobile is not eligible for Section 179 expensing andSimon must use ADS (straight-line method over 5 years) to depreciate the combined business/investmentuse. The half-year convention applies in this situation. Total depreciation for 2007 equals $1,015 ($14,500 ×70% = $10,150 × 1/5 × 1/2), since this amount is less than the $2,142 ($3,060 × 70%) luxury automobile limit.¶802.09.



13.

Year Potential Deduction Luxury Auto Limitations

2005 $4,800 $2,368

($30,000 × 20% × 80%) ($2,960 × 80%)

2006 7,680 3,760

($30,000 × 32% × 80%) ($4,700 × 80%)

2007 4,608 2,280

($30,000 × 19.2% × 80%) ($2,850 × 80%)

2008 2,765 1,340

($30,000 × 11.52% × 80%) ($1,675 × 80%)

2009 2,765 1,340

($30,000 × 11.52% × 80%) ($1,675 × 80%)

2010 1,382 1,340

($30,000 × 5.76% × 80%) ($1,675 × 80%)

Totals $24,000 $12,428

As these figures show, the luxury automobile depreciation limitation allows only $12,428 of cost recovery inthe first six years assuming 80% business use each year. Without the limitations, Milone would have beenallowed to depreciate $24,000 of the luxury automobile in the first six years. ¶802.09.

14. $2,754. This is the lesser of (i) $4,500 [($25,000 × 90%) = $22,500 × 20% = $4,500 MACRS] or (ii) $2,754($3,060 × 90%). ¶802.09.

15. The business portion of Stukel’s lease payments is $3,525 ($470 × 10 × 75%) in 2007 and $4,230 ($470 × 12× 75%) in 2008. Her inclusion amount is $91 ($145 × 75% × 306/365) in 2007 and $239 ($318 × 75%) in 2008.The inclusion amounts reduce Stukel’s lease vehicle deduction on Schedule C, line 20a. Thus, herdeduction in 2007 is $3,434 ($3,525 − $91), and $3,991 ($4,230 − $239) in 2008. ¶802.09.

16. ¶802.09.

Year Business Lease Expense Inclusion Amount Lease Deduction

2007 $800 × 85% × 3 = $2,040 $166 × 85% × 92/365 = $36 $2,040 − $36 = $2,004

2008 $800 × 85% × 12 = $8,160 $363 × 85% = $309 $8,160 − $309 = $7,851

2009 $800 × 85% × 9 = $6,120 $541 × 85% × 273/365 = $344 $6,120 − $344 = $5,776

17. The mid-quarter convention applies to the personal property since more than 40% of the personal propertywas placed in service in the last quarter ($42,000/$80,000 = 53%). The mid-month convention applies to theoffice building. ¶802.03, ¶803.01.

MACRS for 2007

Computer, 1st quarter acquisition ($3,000 × 35%) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 1,050

Machinery, 3rd quarter acquisition ($35,000 × 10.71%) . . . . . . . . . . . . . . . . . . . . . . . . . . . 3,749

Office building, nonresidential realty ($270,000/39 × 3.5/12) . . . . . . . . . . . . . . . . . . . . . . 2,019

Equipment, 4th quarter acquisition ($42,000 × 3.57%) . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1,499

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MACRS for 2008

Computer ($3,000 × 26%) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 780

Machinery ($35,000 × 25.51%) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 8,929

Office building ($270,000/39) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 6,923

Equipment ($42,000 × 27.55%) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 11,571

18. a. The half-year convention applies to the personal property. The automobile is 5-year property and issubject to the luxury automobile limits. The machine and desk are 7-year property. The garage isnonresidential realty. ¶802.03, ¶803.01.

MACRS MACRSItem Cost Period Rate Deduction

Automobile $18,000 5 yrs. 20% $ 3,0601

Garage 39,000 39 yrs. SL 7922

Machine 1,246 7 yrs. 14.29% 1783

Office desk 910 7 yrs. 14.29% 1304

Total depreciation $ 4,160

1 Maximum 1st year cost recovery for a luxury automobile placed in service in 2007.2 $39,000/39 years × 9.5/12 = $792 (rounded)3 $1,246 × 14.29%4 $910 × 14.29%

b. See filled-in Form 4562 for H.B. Fields Company. Basis for depreciation of 7-year property (line 19c (c))is $2,156 ($1,246 + $910). ¶804.



Filled-in Form 4562, page 1 for H.B. Fields Company.

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Filled-in Form 4562, page 2 for H.B. Fields Company.



19. The office building is nonresidential realty. The apartment building is residential realty. The mid-monthconvention applies in both cases. ¶803.01.

Office building: ($320,000/39 years) × 11.5/12 months = $7,863

Apartment building: ($400,000/27.5 years) × 11.5/12 months = $13,939

20. The office building is nonresidential realty placed in service before May 13, 1993, so it is depreciated over31.5 years. Under the mid-month convention the taxpayer can depreciate the office building in 2007through August 15. Depreciation expense for 2007 is $4,960 ($250,000/31.5 × 7.5/12). ¶803.01.

21. ¶803.01, ¶803.02.

a. Warehouse: $650,000/39 × 11.5/12 = $15,972

Apartment building: $990,000/40 × 1.5/12 = $3,094

b. Warehouse: $650,000/40 × 11.5/12 = $15,573

Apartment building: $990,000/27.5 × 1.5/12 = $4,500

c. Warehouse: $650,000/39 × 11.5/12 = $15,972

Apartment building: $990,000/27.5 × 1.5/12 = $4,500

d. Warehouse: $650,000/40 × 11.5/12 = $15,573

Apartment building: $990,000/40 × 1.5/12 = $3,094

22. ¶803.02.

Year Depreciation Expense

2000 $450,000/40 × 8.5/12 = $7,969

2001-2006 $450,000/40 = $11,250

2007 $450,000/40 × .5/12 = $469

23. Even though taxpayers live in other parts of the home, the home office itself is used exclusively to conductbusiness, and as such, it is commercial (nonresidential) realty. Accordingly, the home office portion of thehouse must be depreciated using the straight-line method over 39 years under MACRS. Alternatively,taxpayers can elect to depreciate the home office using the straight-line method over 40 years under ADS.The mid-month convention applies to realty, regardless of whether MACRS or ADS is used. ¶803.03.

24. ¶805.

a. Yes. Straight-line method over 15 years.

b. Yes. Straight-line method over the shorter of 15 years or the remaining useful life.

c. No.

d. Yes. Straight-line method over 15 years since it was acquired in the purchase of a business.

e. No.

25. a. From Appendix A-5 in Publication 463, the inclusion amount in the third tax year of a lease involving anautomobile costing between $40,000 and $41,000 is $384. Woodby’s inclusion amount is $250 ($384 ×65%) in 2007. See page 46 of IRS Publication 463 (reproduced on the next page of this Instructor’sGuide). ¶802.09.

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Page 46 of IRS Publication 463.



b. Woodby uses the car 65% for business, so she can deduct 65% of her lease payments ($590 × 12 × 65% =$4,602). ¶802.09.

c. Woodby reports the net amount ($4,602 − $250 = $4,352) as a vehicle lease deduction on Schedule C,line 20a. ¶802.09.

26. a. The company can claim $20,000 ($550,000/27.5 years) under MACRS. ¶803.01.

b. For purposes of computing earnings and profits, the law requires the use of ADS over a period of 40years. Thus, earnings and profits are reduced by only $13,750 ($550,000/40 years). ¶803.02.

27. See Forms 1040 and accompanying forms and schedules for the Beckmans.

On Form 1040, the Beckmans deduct $3,000 ($1,500 × 2) for their contributions to their respectiveIRAs, since their modified AGI does not exceed the AGI threshold for MFJ. Danielle contributed atotal of $3,500 to her retirement plans during the year. Since the Beckmans’ AGI falls between$34,000 and $52,000, the Beckmans can claim a $350 retirement savings contribution credit ($2,000maximum for Danielle + $1,500 for Patrick = $3,500 × 10%).

Patrick cannot deduct expenses related to the office in their home because the room is not usedexclusively for his business.

Schedule C, line 9: $1,042 (2,148 × $.485).

Form 4562, line 16: The equipment purchased in 2005 is subject to the mid-quarter convention since itwas Patrick’s only acquisition that year and 100% of that year’s personal property was purchased inthe fourth quarter. Patrick uses the column for year 3 under the fourth quarter for 7-year property inFigure 8-4 to compute his depreciation on the equipment ($12,000 × 19.68% = $2,362).

Form 4562, line 26: The computer and printer fall under the half-year convention since they were theonly acquisitions in 2006 and 0% of all acquisitions were purchased in the fourth quarter. Thecomputer and printer are listed property. Since Patrick uses the computer and printer more than 50%of the time for business, he uses accelerated MACRS to compute his depreciation on Form 4562. HisMACRS deduction on the computer is $154 ($800 × 60% × 32%); his MACRS deduction on the printeris $38 ($200 × 60% × 32%).

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Filled-in Form 1040, page 1 for the Beckmans.




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Filled-in Schedule C for the Beckmans.



Filled-in Schedule SE for the Beckmans.

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Chapter 8 Depreciation and Amortization - · PDF fileChapter 8 Depreciation and Amortization ... 132 Essentials of Federal Income Taxation Solutions to Questions and Problems ... Textbook