Tax Depreciation and Amortization Best
Practices
Presented By:
This manual was created for online viewing. State specific information in this manual is used for illustration and is an example only.
mail: P.O. Box 509 Eau Claire, WI 54702-0509 • telephone: 866-352-9539 • fax: 715-833-3953email: [email protected] • website: www.lorman.com • seminar id: 399974
William F. BeckerJr., CPA*, M.B.A.Cherry Bekaert LLP
Take advantage of this special offer for $50 off of a Lorman
live webinar!
C O N V E N I E N T:Lorman offers a wide variety of live webinars covering current issues affecting numerous industries. Learn the latest on legal compliance, cost savings and strategies, and business trends.
E X P E R I E N C E D :Learn about today’s hot topics presented by our expert speakers who represent prominent firms and have years of industry experience and knowledge.
C U R R E N T :In today’s business world, staying current of the ever-changing regulations is absolutely necessary in order to advance in your field. Earn continuing education credits, educate your entire team and ask questions of the speakers. For a complete listing of upcoming live webinars visit www.lorman.com.
SPECIAL OFFER
$50 OFFYOUR NEXT Discount Code Y1719669This offer can not be used in combination with other discounts.
LIVE WEBINAR
Tax Depreciation and Amortization Best
Practices
©2016 Lorman Education Services. All Rights Reserved.
All Rights Reserved. Lorman programs are copyrighted and may not be recorded or transcribed in whole or part without its express prior written permission. Your attendance at a Lorman seminar constitutes your agreement not to record or transcribe all or any part of it.
Full terms and conditions available at www.lorman.com/terms.php.
This publication is designed to provide general information on the topic presented. It is sold with the understanding that the publisher is not engaged in rendering any legal or professional services. The opinions or viewpoints expressed by faculty members do not necessarily reflect those of Lorman Education Services. These materials were
prepared by the faculty who are solely responsible for the correctness and appropriateness of the content. Although this manual is prepared by professionals, the content and information provided should not be used as a substitute for professional services, and such content and information does not constitute legal or other professional
advice. If legal or other professional advice is required, the services of a professional should be sought. Lorman Education Services is in no way responsible or liable for any advice or information provided by the faculty.
This disclosure may be required by the Circular 230 regulations of the U.S. Treasury and the Internal Revenue Service. We inform you that any federal tax advice contained in this written communication (including any attachments) is not intended to be used, and cannot be used, for the purpose of (i) avoiding federal tax penalties imposed by
the federal government or (ii) promoting, marketing or recommending to another party any tax related matters addressed herein.
mail: P.O. Box 509 Eau Claire, WI 54702-0509 • telephone: 866-352-9539 • fax: 715-833-3953email: [email protected] • website: www.lorman.com • seminar id: 399974
Prepared By:William F. BeckerJr., CPA*, M.B.A.
Cherry Bekaert LLP
Learn What You Want, When You Want From Our Entire
Course Library
UNLIMITED ACCESS
ON-THE-GO LEARNING
We Offer Accredited Training Including CLE, CPE, HRCI, ENG and Many More
A L L - A C C E S S P A S SLORMAN EDUCATION SERVICES
Learn at Your Own Pace From Your Computer,
Tablet or Mobile Device
lorman.com/pass
GET CERTIFIED
Want to learn more? Contact a Lorman
All-Access Pass Specialist:
[email protected] or call 1-877-296-2169
Tax Depreciation and Amortization Best Practices
William F. Becker Jr., CPA, MBA Cherry Bekaert LLP
1
2
Depreciation and Amortization Update
• Depreciation methods, lives, and conventions
• Section 179 expense
• Listed property, luxury autos, and leased autos
• Bonus depreciation
• Alternative minimum tax
• Amortization and intangibles
Depreciation Methods, Lives, and Conventions
3
ACRS
• The Accelerated Cost Recovery System (ACRS) generally applied to tangible depreciable property placed in service after December 31, 1980 and before January 1, 1987.
• Currently, property would only be depreciated using ACRS if:– A taxpayer elected an especially long, optional straight‐line recovery period
under ACRS
– A taxpayer or related party previously owned the property in 1986, and the current ACRS deduction would be smaller than the MACRS deduction
• The main differences from MACRS:
– ACRS had shorter recovery periods for almost all types of property
– Real property could be depreciated using the declining balance method
MACRS
• The Modified Accelerated Cost Recovery System (MACRS) is mandatory for most tangible depreciable property generally placed in service after 1986
• There are two depreciation systems under MACRS
– General Depreciation System (GDS)
• 200/150 double declining balance and straight line methods
– Alternative Depreciation System (ADS)
• Straight line method
• Property is considered depreciable if:
– It wears out
– Has a determinable life that exceeds one year
– Used in a trade of business
4
GDS vs. ADS
• ADS is mandatory for certain property:– Tangible property used predominantly outside the US
– Tax‐exempt use or bond‐financed property
– Property imported from a foreign country, for which an Executive Order is in effect
• ADS recovery periods are longer than GDS– Personal property with no class life: 12 years
– Nonresidential real property and residential rental property: 40 years
– Railroad grading or tunnel bores: 50 years
• GDS is used to compute depreciation under MACRS unless ADS is specifically required
• ADS can be elected under IRC section 168(g)– ADS election is made on a property class basis
– ADS election is irrevocable
Half‐Year Convention
• Applies to any property other than residential and nonresidential real estate (27.5 and 39 year property)
• All property placed in service, or disposed of, during any tax year treated as placed in service at the midpoint of that tax year
• Half‐year convention has effect of giving depreciation deduction over 1 more tax year than there are initial recovery periods
• Amount of allowable depreciation for year placed in service is 1/2 the amount that would be allowed for full tax year
5
Mid‐Quarter Convention• The 40% test
– More than 40% of the aggregate bases of all recovery property other than residential rental and nonresidential real property placed in service during the last quarter of the year – mid‐quarter convention
– If depreciable property is placed in service during a tax year consisting of three months or less – mid‐quarter convention
• Mid‐quarter treats all property placed in service during any quarter of a tax year as having been placed in service at the midpoint of that quarter
• The determination of whether or not the mid‐quarter convention applies is made without regard to any amounts claimed as bonus depreciation
Quarter of the Year Percentage
First 87.5 percent
Second 62.5 percent
Third 37.5 percent
Fourth 12.5 percent
Mid‐Month Convention
• Applies to residential and nonresidential real property (27.5 and 39 years)
• The deduction is based on the numbers of months the property was in service
– 1/2 month’s depreciation is allowed for the month the property is placed in service
– 1/2 month’s depreciation is allowed for the month the property is disposed
6
GDS Depreciable Lives
Class Life Description Example
3 year property In general, 3 year property includes property with an ADR class life of 4 years or less
Tractor units for use over the road, breeding hogs, certain horses
5 year property Property with a class life of more than 4 but less than 10 years is generally classified as 5 year property
Cars, trucks, trailers, equipment, computers
7 year property Property with an ADR class life of 10 years or more but less than 16 years
Office furniture and fixtures that are not structural components
10 year property Property with an ADR class life of 16 years or more and less than 20 years
Vessels, barges, tugs, similar water transportation equipment
15 year property Property with an ADR class life of 20 years or more but less than 25 years
Land improvements, landscaping, fencing
20 year property Property with an ADR class life of 25 years or more, other than Section 1250 real property
Municipal sewers placed in service on of before June 12, 1996, farm buildings
27.5 property Section 1250 real property placed in service after 1986, that is not (1) residential rental property or (2) class life less than 27.5 years
Nonresidential real property, structural components of buildings or affixed/attached to interior or exterior of building
39 year property Buildings or structures with 80% or more of gross rental income as rental income from dwelling units
Residential real property, structural components of buildings or affixed/attached to interior or exterior of building
Section 179 Expense
7
Section 179 ‐ General
• Form 4562 is used to make the election in IRC Section 179 to expense certain property
– Estates and trusts cannot make this election
• Can elect to expense all or part of the cost of Section 179 property placed in service during the year used more than 50% in an active trade or business
• If only part of the cost is elected to be expensed, the rest can be depreciated
Section 179 ‐ Election
• Section 179 is an elective, not mandatory, code section
• Why would you not want to make this election?
– A company must look at the tax implications to the shareholders, it may be that the shareholders cannot use the deduction in the current year and it would be more advantageous for them to take depreciation deductions over the life of the asset
8
Section 179 – Limitations and Thresholds
• Higher expensing and other provisions made permanent by the PATH Act:– Maximum expense deduction is $500,000
– Maximum deduction is reduced by the cost of Section 179 property that exceeds $2 million
– Indexed for inflation
Section 179 – Limitations and Thresholds, continued
Other §179 provisions made permanent by the PATH Act:
– “Off the shelf” software is eligible
– Qualified real property leasehold improvements and retail/restaurant improvements are eligible
– Beginning in tax years after 12/31/2015, air conditioning & heating units qualify
– Taxpayer can now revoke expensing election without IRS consent
9
Section 179 – Limitations and Thresholds, continued
• The total cost of Section 179 expense that can actually be deducted is limited to the taxable income from the active conduct of a trade or business during the tax year
• Any disallowed deduction resulting from the business income limitation can be carried over to the following year
• This limitation is applied based on taxpayer, not each separate business if an individual has multiple business activities
Section 179 – Qualifying Property
• Property acquired by purchase for use in the active conduct of a trade or business and is one of the following:– Tangible personal property
– Qualified Section 179 real property (special rules)
– Other tangible property used in a trade or business that is not a building or their structural component
– Single purpose agricultural (livestock) or horticultural structures
– Storage facilities used in connection with petroleum distribution
– Off the shelf computer software
10
Section 179 – Qualifying Property, continued
• Special rules for Qualified Section 179 real property
– Mainly Section 1245 property
– If the election is made, this includes real property which is:
• Qualified leasehold improvement property under Section 168(e)(6)
• Qualified restaurant property under Section 168(e)(7)
• Qualified retail improvement property under Section 168(e)(8)
– This property is limited to $500,000 of the total cost of all Section 179 property placed in service in the tax year
Section 179 – Qualifying Property, continued
• Section 179 property specifically does NOT include:– Property held for investment under Section 212
– Property used mainly outside the United States
– Property used mainly to furnish lodging or in connection with the furnishing of lodging
– Property used by a tax‐exempt organization, unless the property is used mainly in a taxable unrelated trade or business
– Property used by a governmental unit or foreign person or entity
– Air conditioning or heating units
11
Section 179 – IRC §179 and De MinimisExpensing
In accordance with IRC §179(d)(1)(A)(i)(c):
Section 179 property is generally any tangible property to which
IRC §168 applies
– Tangible property expensed under de minimis election safe harbor of Reg. §1.263(a)‐1(f) is not property to which IRC §168 applies
– When items are expensed under de minimis election, items are not included in $ 2 million phase‐out threshold, and not included in $500,000 annual limit for §179 election
Listed Property, Luxury Autos, and Leased Autos
12
Listed Property• Defined as the following:
1) Passenger automobiles
2) Transportation equipment (eg., trucks, buses, boats, airplanes, motorcycles)
2) Property generally used for entertainment, recreation, or amusement‐Exception for items used exclusively in the trade or business
2) Computer equipment (and associated peripheral computer equipment)‐Exception of items used exclusively at the taxpayer’s business establishment
• Generally, Listed Property is property that potentially could be used for personal use.
Listed Property (cont’d)• Passenger Automobiles are defined as the following:
1) Manufactured for use on public streets, roads, and highways, and
1) Weigh 6,000 pounds or less using the vehicle’s Gross Vehicle Weight
• Exceptions for:
a) Ambulancesb) Hearsesc) Vehicles used in a transportation trade or business (eg., couriers’
vehicles, buses)d) Qualified nonpersonal‐use vehicles (eg., bucket trucks, dump
trucks, tractors, delivery trucks)
13
Listed Property ‐ Depreciation• For listed property that does not have a business use greater than 50%,
accelerated depreciation methods cannot be used
• Business use is determined by the business mileage vs. total mileage
• Accelerated depreciation methods include the following:a) Bonus Depreciationb) §179 Depreciationc) 200% Declining Balanced) 150% Declining Balance
• Straight line depreciation must be used instead
• Investment use does not count toward the 50% business use requirement
Listed Property ‐ Depreciation• If a taxpayer’s business use begins in one year at >50% but
falls in subsequent years, several rules apply:
a) The taxpayer must switch to the straight‐line methodb) The taxpayer cannot use accelerated methods in subsequent years,
even if business use increases to >50%c) The taxpayer must recompute prior years’ depreciation using the
straight‐line method and include the difference between depreciation claimed and the recomputed depreciation as income
14
Listed Property – Luxury Vehicles• Depreciation is limited per year on luxury automobiles. The limitation
is different based on whether the vehicle is a car or a truck/van.
• The yearly limitations are reduced by any personal use of the vehicle
• Disallowed depreciation is deducted in years after the recovery period. The years following the recovery period also have limitations as to how much depreciation you can take.
• Unrecovered Cost Basis is the original cost of the car reduced by all depreciation that would have been taken had the vehicle been used 100% for business purposes.
• The Unrecovered Cost Basis is what is used to calculate depreciation in subsequent years
Listed Property – Yearly Limitations
Vehicles ‐ LuxuryWith Bonus Dep. Without Bonus Dep.
First Year $11,160 $3,160
Second Year $5,100 $5,100
Third Year $3,050 $3,050
Subsequent Years $1,875 $1,875
Note: These amounts assume 100% business/investment use.These amounts are reduced pro‐rata by any personal use.
15
Listed Property – Yearly Limitations
Trucks and VansWith Bonus Dep. Without Bonus Dep.
First Year $11,460 $3,460
Second Year $5,600 $5,600
Third Year $3,350 $3,350
Subsequent Years $1,975 $1,975
Note: These amounts assume 100% business/investment use. These amounts are reduced pro‐rata by any personal use.
Listed Property ‐ ExampleJohn purchased a car weighing less than 6,000 lbs. for $28,000 on 6/1/2015. 80% of his mileage is used toward her trade or business while the remaining 20% is used for personal purposes. The following shows the allowable depreciation that John can take on the car.
$28,000 x 50% bonus = $14,000 bonus depreciation
$28,000 ‐ $14,000 = $14,000 subject to MACRS depreciation$14,000 x 20% MACRS table percentage = $2,800($2,800 + $14,000) x 80% = $13,440 maximum depreciation John can take before luxury auto rules are applied
$11,160 maximum depreciation from luxury auto table x 80% personal use = $8,928 maximum depreciation John can take under luxury auto rules
16
Listed Property – Leased Passenger Automobiles
• A taxpayer who leases a vehicle cannot claim depreciation deductions on that vehicle, and is thus not subject to the listed property limitations
• The taxpayer is required to include a calculated amount in income for each year the vehicle is leased • Income amount is based on the fair market value of the vehicle• Income inclusions is not required if lease term of the vehicle is
less than 30 days• Inclusion excludes any personal use of the vehicle• Revenue Procedure issued each year with amounts of income
inclusion (Rev. Proc. 2015‐19 is most up to date)
Bonus Depreciation
17
MACRS Bonus Depreciation
• IRC Sec. 168(k) allows additional bonus depreciation deduction for qualifying MACRS property place in service after December 31, 2007 and before January 1, 2020.
• Bonus depreciation rates for the following date ranges:– 12/31/07 thru 9/9/10 ‐ 50%
– 9/8/10 thru 1/1/12 ‐ 100%
– 12/31/11 thru 1/1/17 ‐ 50%
– 12/31/18 – 40%
– 12/31/19 – 30%
• The basis of the qualifying property, after Sec. 179 depreciation has been taken into account, is reduced by the amount of the bonus deduction allowed. The remaining adjusted basis is then used to calculate other allowable depreciation.
MACRS Bonus Depreciation
• Other bonus depreciation provisions contained in the PATH Act:
– Certain longer‐lived assets and transportation asset may receive one more year to each of above
– After 2015, bonus depreciation enhanced for qualified real property and certain plants
– Enhanced first year depreciation cap for autos and trucks continues
18
Qualified Property
• New property with a recovery period of 20 years or less
• Qualified improvement property
• Qualified leasehold improvement property
• Computer software that is depreciable over a three‐year period
• Property that is purchased in a sale‐leaseback transaction within three months after the original purchase
• MACRS water utility property
Qualified Leasehold Improvement Property
• An improvement to an interior portion of nonresidential real property by a lessor or lessee, under or pursuant to a lease (even if the improvement is structural)
• The lease is not between related parties
• The improvement must be placed in service more than three years after the building was first placed in service
• Mandatory 15 year recovery period
19
Qualified Leasehold Improvement Property
• Expenditures not considered qualified leasehold improvement property:
• The enlargement of a building
• Any elevator or escalator
• Any structural component that benefits a common area
• The internal structural framework of the building
Qualified Improvement Property
• Added by the PATH Act for property placed in service after
2015:
• Similar to Qualified Leasehold Improvement Property, except:
– Property does not need to be placed in service pursuant to terms of a lease
– Eligible for property placed in service after the date the building was first placed into service
– Property is depreciable over 39 years
– Enlargements, elevators and escalators or the internal structural framework of the building are still ineligible
20
Additional Considerations
• Bonus depreciation is subject to recapture rules upon the sale of the property.
• Unlike the Sec. 179 deduction, there is no limitation on income or investment amount.
• Bonus depreciation is calculated after any Sec. 179 deduction is claimed
• Many states do not allow bonus depreciation requiring a separate depreciation calculation for that individual state.
• Bonus depreciation is allowed in full for AMT purposes.
Election Out of Bonus Depreciation
• Taxpayers are allowed to elect out of bonus depreciation for specific asset classes, not individual assets.
• Potential reasons to elect out of bonus depreciation:– The taxpayer already has significant losses in the year the qualifying
asset was placed in service.
– The taxpayer expects future profitability ‐ it could be more advantageous to have higher MACRS deductions to offset income in the future.
21
Alternative Minimum Tax
• For MACRS property placed in service after 1986, it may be necessary to recalculate depreciation for AMT purposes
– Pre‐1999 property has different lives and methods
– Post 1998 property has a different method only
• Can elect to expense all or part of the cost of Section 179 property placed in service during the year, subject to other limitations
• No difference between regular tax and AMT when bonus depreciation is claimed
• May election to forego bonus depreciation and claim AMT credits
Amortization and Intangibles
22
Section 197 Intangibles
• Section 197 intangibles include:
– Goodwill
– Going concern value
– Workforce in place
– Business books and records, operating systems, or any other information base
– License, permit, or other right granted by a governmental unit or agency
– Customer based intangible
– Supplier based intangible
– Covenants not to compete
– Franchise, trademark, or trade name
• In general, taxpayers must amortize the adjusted basis of section 197 intangibles on a straight‐line basis for 15 years, beginning in month of acquisition
Section 197 Intangibles
• If a Section 197 intangible is disposed of, and other 197 intangibles are acquired in the same transaction, no loss is allowed and the basis of the remaining intangibles are increased to reflect the loss
• Business start up costs are amortizable if:
– It is a cost you could deduct if you paid or incurred it to operate an existing business (same field as one you entered)
– It is a cost you pay or incur before the day your active business begins
• Loan commissions and expenses should be amortized over the life of the loan
– The same rules apply to commissions paid to secure renewal of a loan
• If you obtain a lease for business property, you may recover the cost of acquiring the lease by amortizing it over the term of the lease
23
24
Notes