Advanced Individual Income Tax

Accounting 811: Spring, 1998

Week 10: Tax Depreciation Accounting

 Outline (c) 1997-98 Robert H. Daniels

 Control Panel

1. Tax and Book Depreciation

Financial "book" depreciation

Purpose: match revenue and cost for multiperiod assets

Note artificiality: income won't equal cash flow

The Issues

  • How much? Cost less estimated salvage

  • How long? Predicting useful lives
  • How fast? S/l or accelerated pattern for matching
  • How precise? Midperiod conventions, mass assets, etc.

Tax depreciation: cost recovery for multiperiod income

deductions over period of use, rather than sale

 

2. Evolution of Tax Depreciation Rules

From "reasonable allowance" to "modified ACRS"

How much and how long?

Inherent problem: need for estimates and predictions
  Could mean unending disputes between Tp and IRS

How fast and how precise?

These are inherently arbitrary: one as good as another

Tax Shields and economic policy

Tax can affect capital budgeting, cost of capital
  Affects overall level of capital investment
Fast depreciation means up front tax savings"
  Tax shield" finance concept

The Roots of Hypercomplexity: 3 systems during 1980's

The ACRS Legacy of 1981

Wildly generous: Corporate tax collections collapsed:

Loopholes galore

  • NPV of tax shield bigger than down payment: shelter

  • Leasing to nonprofits
  • Equip in service last day of year
  • Depreciation strip, convert to personal use

"Layers" of rules, dep. on when asset "placed in service".

Anti-Churning

"Old Federal", CA Corporate

ACRS

MACRS

How much

(debt financing?)

Cost.

Eff. 1962 disregard salvage

Cost

Cost

How long

Useful life

Eff. 1971 ADR class lives

3-5-10-15

(then 18, 19 ...)

Recovery life mapping from ADR lives

How fast

From s/l to DDB

1.5 DB or DDB

s/l to DDB

How precise

unclear

midyear or midmonth

midyear, midquarter or midmonth

Alternative Calculations

Sec. 312 "Earnings and Profits"

E&P, foreign use, nonprofit leasing.

Eff. 1994 "listed property"

MACRS

ADS

MADS

ACE

California Corp?

California AMT?

 

3. MACRS technique and terms:

Technical implementing language and Code structure

 167 was gutted. Now overridden for most things by 168

"Tangible property": Sec. 168(a)

tangible in service after 1986
Placed in service: ready and available for use

 Applicable method: 168(b): usually 2xdbl

1.5 dbl for 15, 20 year prop and farming
s/l for real estate

Applicable recovery period

"Class Life": 168(e)(1), and 168(i)
"Recovery Life" mapped from class life: 168(c)(1) and (e)

  • 5 for cars and r&D

  • 7 for most equip: 5 for computers
  • 10, 15, 20 for long lived equipment
  • 27.5 for res and 31.5 for commercial
  • changed to 39 commercial 5/93

 "Applicable Convention" 168(d)

Normally mid-year for equipment
Mid month for Real Estate: 168(d)(2)
Mid 1/4 iff: 168(d)(3)

Special purpose alternative computations:

ADS is s/l over midpoint life: 40 yrs realty

used for foreign property, prop leased to nonprofits: 168(g)

ADS: 1.5 x db over midpoint life

ACE for corporate alternative minimum tax

Midquarter years (can be computational nightmare):

if 40% of equipment assets in service in last quarter
then all equipment in service that year shifted to midquarter

 California corporate / or "old Federal" system

4. Non-recovery property: land and intangibles

See also 168(f) film, sound, anti-churning

key is proving a useful life. none for land

  • 17/19 for (P)

  • life +50 /75 for (c)
  • goodwill: 15 years: Sec. 197
  • Software: 3 yrs s/l

5. Expensing 

Immediate write-off alternative to depreciation

elected on return: Form 4562

generally equipment, but not res. buildings

Maximum $18,000 per TP (in 1997: to 25K in next few years)

eg cost 20K, expense 18, deprec balance

limit to Tp under 200K investment

problems if prop becomes personal use"

 

6. Listed Property

"Issue is treatment of part biz, part personal

eg. auto, computer, VCR, etc

 Sharp case

    to be reviewed in class

Sec. 280F:

limits on auto depreciation

Max 2,560, 4,100; 2,450; 1,475

Raised  for inflation: now equals about $16 K purchase price

then multiply by personal use %

 If mixed use, treat as a biz % (deprec) and personal (no w/off)

if over 50%, MACRS dep.

If below, ADS, s/l, 1/2 yr conv

if start above 50% and falls below, recapture

recompute for 50%+ years using the longer lives

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  Build date 3/30/98