Depreciation, Part I Session 19

Transcription

1 Basic Income Tax Depreciation, Part I 19-1 Depreciation, Part I Session 19 A A A AI OMB No Form Department of the Treasury Attachment Internal Revenue Service (99) Sequence No Cost (business use only) Elected cost Description of property Month and Basis for depreciation Classification of property Recovery Convention Method Depreciation (business/investment use year placed in period deduction only - see instructions) service Form (2011) F 11/18/11 Business or activity to which this form relates Name(s) shown on return Identifying number If you have any listed property, complete Part V before you complete Part I Tentative deduction Enter the Do not use Part II or Part III below for listed property Instead, use Part V include listed property) (See instructions) Special depreciation allowance for qualified property (other than listed property) placed in service include listed property) (See instructions) If you are electing to group any assets placed in service during the tax year into one or more general 25-year property 25 yrs S/L 275 yrs MM S/L property 275 yrs MM S/L 39 yrs MM S/L property MM S/L S/L 12 yrs S/L 40 yrs MM S/L (See instructions) Add amounts from line 12, lines 14 through 17, lines 19 and 20 in column (g), and line 21 Enter here Maximum amount (see instructions) Total cost of section 179 property placed in service (see instructions) Threshold cost of section 179 property before reduction in limitation (see instructions) Reduction in limitation Subtract line 3 from line 2 If zero or less, enter -0- Dollar limitation for tax year Subtract line 4 from line 1 If zero or less, enter -0- If married filing separately, see instrs Listed property Enter the amount from line 29 Total elected cost of section 179 property Add amounts in column (c), lines 6 and 7 of line 5 or line 8 Carryover of disallowed deduction from line 13 of your 2010 Form 4562 Business income limitation Enter the smaller of business income (not less than zero) or line 5 (see instructions) Section 179 expense deduction Add lines 9 and 10, but do not enter more than line 11 Carryover of disallowed deduction to 2012 Add lines 9 and 10, less line 12 during the tax year (see instructions) Property subject to section 168(f)(1) election Other depreciation (including ACRS) MACRS deductions for assets placed in service in tax years beginning before 2011 asset accounts, check here 3-year property 5-year property 7-year property 10-year property 15-year property 20-year property Residential rental Nonresidential real Class life 12-year 40-year Listed property Enter amount from line 28 and on the appropriate lines of your return Partnerships and S corporations - see instructions For assets shown above and placed in service during the current year, enter the portion of the basis attributable to section 263A costs See separate instructions Attach to your tax return Note: smaller Note: (Do not (Do not Section A (b) (c) (a) (d) (e) (f) (g) 19 a i 20 a For Paperwork Reduction Act Notice, see separate instructions (b) (c) (a) Section B - Assets Placed in Service During 2011 Tax Year Using the General Depreciation System b c d e f g h Section C - Assets Placed in Service During 2011 Tax Year Using the Alternative Depreciation System b c Total 23 (Including Information on Listed Property) 179 Election To Expense Certain Property Under Section 179 Special Depreciation Allowance and Other Depreciation MACRS Depreciation Part I Part II Part III Part IV Summary Depreciation and Amortization

2 19-2 Depreciation, Part I Basic Income Tax

3 Contents Lesson I: Depreciation 19-6 Eligible Property 19-6 Basis 19-7 When Depreciation Begins and Ends 19-8 Lesson II: MACRS Depreciation Systems19-10 Class Life Property Classes Half-Year Convention Mid-Quarter Convention Mid-Month Convention Depreciation Methods19-15 Lesson III: Depreciation Calculations Special Depreciation Allowance Depreciation Tables Depreciation Worksheet Lesson IV: Depreciation Reporting Session 19 Summary Session 19 Homework Session 19 Knowledge Check Answers Basic Income Tax Depreciation, Part I 19-3

4 19-4 Depreciation, Part I Basic Income Tax

5 Introduction In accounting, when we talk about depreciation, we are talking about the loss in value that an object incurs over a period of time due to wear and obsolescence For example, when you buy a lawn mower at a garage sale or fl ea market, you don t expect to pay the same price as when you buy the same item new from a store The lawn mower you use at home to maintain your personal residence is a capital asset, as we discussed in an earlier session Your personal lawn mower is not a depreciable item even though it wears out and loses value over time However, if you have a business where you mow lawns for other people, the lawn mower you use in that business can be depreciated because its cost is an expense of the business operation Depreciation is an annual income tax deduction that allows you to recover the cost of property used for a taxpayer s business or investment purposes, that does not qualify to be expensed in the year it was acquired By depreciating property over a predetermined number of years, taxpayers may recover a portion of their cost for each year the property is used The Modifi ed Accelerated Cost Recovery System (MACRS) is used to depreciate most property placed in service after 1986 In this session, we focus on the components of basic depreciation, including how to calculate, report, and track it The majority of information in this session can be found in IRS Publication 946, How to Depreciate Property, and in the instructions for Form 4562, Depreciation and Amortization Objectives After completing this session, you will be able to Identify property that can be depreciated Determine when depreciation begins and ends Determine the recovery period for property Determine the convention for depreciating property Identify the appropriate method for depreciating property Identify factors that affect depreciation Calculate depreciation on property Identify where depreciation is reported Basic Income Tax Depreciation, Part I 19-5

6 Lesson I: Depreciation The cost of property used in a business may not be fully deductible in the year it is purchased If the property is expected to last longer than a year but will eventually wear out or become useless, the cost must be spread over the expected life of the property, with only part of the cost deducted each year Real Property - Land and generally anything built on, growing on, or attached to land, such as buildings and their structural components (real estate) Personal Property - Things moveable, as distinguished from real property This includes equipment, vehicles, livestock, off-the-shelf computer software, and stocks and bonds The cost of most real and personal property used for business or for the production of income can be recovered through depreciation Depreciation is an amount that can be deducted annually It allows the taxpayer to recover the cost or other basis of certain property over the time the property is used in trade or business Eligible Property To be depreciable, property must be owned by the taxpayer and must lose its value over time from any of the following: Wear and tear Deterioration Obsolescence Natural causes Property that does not wear out (such as land) cannot be depreciated Placed in Service - Ready and available for a specifi c use whether in a trade or business, the production of income, a taxexempt activity, or a personal activity Depreciation is a business expense deduction Property used exclusively for personal activities, or to generate nontaxable income, is not depreciable Property that is placed in service and disposed of in the same year is also not depreciable Any addition or improvement made to depreciable property is treated as a separate depreciable property Example: Tanya completely replaced the roof of a rental property she owns The new roof is an improvement and, for tax purposes, is a different asset from the building Tanya must depreciate the cost of the new roof separately from the building Repairs and maintenance costs are not depreciated Replacement of small items, such as a faucet or switch, are considered maintenance 19-6 Depreciation, Part I Basic Income Tax

7 Basis The original basis of an asset purchased for use in a business is generally the property s cost, including the following: Tax Delivery Set-up or installation charges When an asset s basis is altered by some event, such as an improvement, the updated basis is known as adjusted basis The basis of an asset converted from personal use to business use is usually the lower of one of the following: Cost Fair market value (FMV) at the time of conversion Adjusted Basis - The basis in property (usually its cost) increased or decreased by various events, such as improvements, depreciation, and casualty losses Example: Bobbie bought a townhome four years ago The purchase price of the townhome was $75,000, which includes a land value of $10,000 This year, Bobbie moved and decided she would use her townhome as rental property When she began renting the townhome, it had an FMV of $120,000, which includes a land value of $15,000 Bobbie s adjusted basis for depreciation on the rental townhome is $65,000, which is the lower of the home s original cost or the FMV at the time she converted its use Because land does not wear out, it is not considered in the basis for purposes of depreciation The taxpayer s basis in an asset is reduced annually by the greater of the amount of allowed or allowable depreciation, as follows: Allowed depreciation - The amount the taxpayer actually took Allowable depreciation - The amount the taxpayer could have taken under the depreciation rules Example: Alice paid $2,000 for a machine to use in her business The total allowable depreciation was $776, but she did not actually claim the depreciation The adjusted basis for calculating her gain or loss if she sells the machine is $1,224 Generally, the taxpayer has fully recovered their basis when the total of their depreciation deductions equals their basis in the property When this happens, the taxpayer cannot take any further depreciation for the property Due Diligence: Generally, the taxpayer can choose whether or not to claim allowable depreciation When the taxpayer disposes of the depreciable property, they are required to recapture the allowable depreciation, even if they did not claim it during the life of the asset But they must depreciate property when it falls into a category where depreciation is expected The topic of recapture is discussed later in this session Basic Income Tax Depreciation, Part I 19-7

8 When Depreciation Begins and Ends Depreciation begins when the taxpayer fi rst places the property in service for a business or for the production of income Property is placed in service when it is ready and available for a specifi c use It does not matter that the property is not yet being used for the intended purpose Example: Callie bought a key-making machine for her hardware store She ordered it on May 1 It was delivered on June 16 and installed on July 7 Callie made her fi rst key on September 4 The date the key machine was placed in service is July 7, which is the date it was ready and available for its intended purpose The fact that Callie did not use it until September does not affect the date the machine was placed in service Once the taxpayer has begun depreciating property, they continue to claim depreciation on the property even if it is temporarily idle Example: If Frank stops using a machine because there is a temporary lack of market for a product made with that machine, he continues to deduct depreciation on it Generally, depreciation ends when the asset is no longer used in business or is fully depreciated Even if the taxpayer has not fully recovered their cost or other basis, they must stop depreciating property when they retire it from service The taxpayer retires property from service when they permanently withdraw it from use in a trade or business or from use in the production of income, because the property has been any of the following: Sold, exchanged, or destroyed Changed to personal use Abandoned Transferred to a supply or scrap account 19-8 Depreciation, Part I Basic Income Tax

9 Knowledge Check One 1 For property to be depreciated, which of the following statements must be true? (Select all that apply) The property must have an expected useful life longer than one year The property must be something that does not wear out The property must be land The property must be used for business or to produce income 2 Tom owns the offi ce building where his law practice is located Which of the following assets are depreciable? (Select all that apply) Extra shoes and clothing he keeps in the offi ce Offi ce furniture Offi ce building Land under the offi ce building 3 Joseph bought a pickup truck on July 1, 2008, for $20,000 On April 22, 2011, he started using the truck full time in his new landscaping business At that time, he looked in newspaper ads and determined that the FMV of the truck was $13,000 He owes $14,000 on his truck loan What is Joseph s basis for the truck for determining his depreciation deduction? $0 $13,000 $14,000 $20,000 4 When does depreciation for an asset begin? When the asset is purchased When the asset is fi rst used for business purposes When the asset is fi rst made available for use in business When the taxpayer decides they want the depreciation deduction for tax purposes Basic Income Tax Depreciation, Part I 19-9

10 5 When does depreciation for an asset end? (Select all that apply) When the asset is removed from service When the asset is sold When the asset is not available for use because it is being repaired When the taxpayer no longer makes a profi t in their business 6 Carmen bought a copier for $1,020 to use exclusively in her business She paid $50 for shipping and $100 to have the copier set up What is Carmen s basis in the copier? $1,000 $1,020 $1,070 $1,170 Lesson II: MACRS Recovery Period - A predetermined number of years over which the cost or other basis of a property is recovered General Depreciation System (GDS) - The faster of the two depreciation systems under MACRS Under GDS, 200% declining balance, 150% declining balance, or straightline methods are used for calculating depreciation Alternative Depreciation System (ADS) - The slower of the two depreciation systems under MACRS Under ADS, straight-line methods are used for calculating depreciation Modifi ed Accelerated Cost Recovery System (MACRS) is the cost recovery system used to depreciate most property Under MACRS, an asset is classifi ed according to its property type and the period of time over which the cost can be recovered The recovery period depends on the depreciation system the taxpayer chooses Depreciation Systems MACRS consists of two depreciation systems: General Depreciation System (GDS) Alternative Depreciation System (ADS) Depreciation, Part I Basic Income Tax

11 GDS is the default system used under MACRS, and is sometimes referred to as regular MACRS GDS accelerates the recovery of an asset s cost by taking greater deductions in early years, and uses the shortest recovery period allowable ADS applies straight-line depreciation, in which an equal amount of an asset s cost is deducted each full year over its useful life ADS recovery periods can be longer than regular MACRS recovery periods Using the ADS method is an election for most properties, but is mandatory in some situations Class Life To help standardize depreciation deductions, the IRS groups similar assets into classes according to the type of property Each of these general classes is assigned a class life, which is roughly the average time the property is expected to remain useful Taxpayers must use the IRS estimates of an asset s class life The IRS defi nes class life as the number of years that establishes a property class and recovery period for most types of property for GDS and ADS Property Classes Under regular MACRS, assets are assigned to one of nine property classes The property class generally determines the following: Depreciation method Recovery period Convention Table A lists some of the most common property classes under regular MACRS, and shows examples of the types of property included in each class Property Class - A category for property under MACRS that generally determines the depreciation method, recovery period, and convention Convention - A method established under MACRS to determine when the recovery period begins and ends The convention affects a taxpayer s depreciation deduction for the year they place their property in service and for the year they dispose of it Basic Income Tax Depreciation, Part I 19-11

12 Table A - Regular MACRS (GDS) Property Classes for Various Types of Property Property Class 3-year property 5-year property 7-year property 15-year property Residential rental property Nonresidential real property Recovery Period Allowable Conventions 3 years Half-year (HY) Mid-quarter (MQ) 5 years Half-year Mid-quarter 7 years Half-year Mid-quarter 15 years Half-year Mid-quarter 275 years Mid-month (MM) Types of Property Tractor units for over-the-road use Any race horse over two years old when placed in service Any other horse over 12 years old when placed in service Qualifi ed rent-to-own property Automobiles, taxis, buses, and trucks Computers and peripheral equipment Offi ce machinery (such as typewriters, calculators, or copiers) Any property used in research and experimentation Breeding cattle and dairy cattle Items used in residential rental real estate activity (such as appliances, carpets, or furniture) Offi ce furniture and fi xtures (such as desks, fi les, or safes) Agricultural machinery and equipment Any property that does not have a class life and has not been designated by law as being in any other class Certain improvements made to land (such as certain fences, paving and shrubbery) Qualifi ed Leasehold Improvements placed in service before January 1, 2012 Any building or structure, such as a rental home (including a mobile home), for which 80% or more of its gross rental income for the tax year is from dwelling units 39 years Mid-month Real property that is not residential rental property (such as offi ce buildings, stores, or warehouses) Certain special-use real property has a separate property class and is neither residential rental property nor nonresidential real property For more information, refer to IRS Publication 946, How To Depreciate Property Depreciation, Part I Basic Income Tax

13 Half-Year Convention The half-year (HY) convention is the most common Under this convention, all property placed in service or disposed of during a tax year is treated as placed in service or disposed of at the midpoint of the year This means that one half-year of depreciation is allowed for the year the property is placed in service or disposed of, no matter how long during the year it was actually in service Use the half-year convention when no other convention is required Example: Latisha purchased a new over-the-road tractor for her independent trucking business on March 10 of this year This asset has a property class of three years and a recovery period of three years under GDS Since Latisha is using the half-year convention for this asset, she depreciates it for 6 months in the fi rst year of ownership, even though she placed it in service for more than 8 months She does not lose the extra 2 months of depreciation because in the final year of depreciation, the tractor will again be depreciated for 6 months Mid-Quarter Convention The mid-quarter (MQ) convention is required when the total depreciable basis of property placed in service during the last three months of the tax year exceeds 40% of the total depreciable basis of all property placed in service during the tax year This excludes any residential rental property or nonresidential real property (which must use the mid-month convention) A calendar year is divided into quarters, as shown in Table B Table B - Quarters of the Calendar Quarter First Quarter Second Quarter Third Quarter Fourth Quarter Months January, February, March April, May, June July, August, September October, November, December Basic Income Tax Depreciation, Part I 19-13

14 Refer to Appendix L for the Mid-Quarter Convention Depreciation Charts, Tables A-2 through A-5 When the mid-quarter convention is required, it must be used for all property placed in service during the year There are separate depreciation percentage tables for each quarter Under the mid-quarter convention, all property placed in service or disposed of during any quarter of a tax year is treated as placed in service or disposed of at the midpoint of the quarter This means that 15 months of depreciation are allowed for the quarter in the tax year the property is placed in service or disposed of, no matter how many days or months during the quarter it was actually in service From Table A, we see that certain property classes allow only one specifi c convention to be used The two property classes shown in the table that require a specifi c convention are Residential rental property and Nonresidential real property Mid-Month Convention Residential rental property and nonresidential real property require the use of the mid-month (MM) convention Under this convention, all property placed in service or disposed of during a month is treated as placed in service or disposed of at the midpoint of the month This results in a half-month of depreciation for the month in which the property is placed in service and for the month in which it is disposed of, no matter how many days that month it was actually in service Example: Annorah bought a residential rental apartment property for $200,000 on June 19 The mid-month convention is required for residential rental property On July 1, she purchased a refrigerator for $700 for one of the apartments On November 9, Annorah purchased three stoves for the property for $1,500 She placed 68% of her qualifi ed assets in service during the last quarter ($1,500 [$1,500 + $700]) Annorah must use the mid-quarter convention for both the refrigerator and the stoves The cost of residential rental property is not taken into consideration when determining what percentage of assets was placed in service during the last quarter Depreciation, Part I Basic Income Tax

15 Depreciation Methods Depreciation is calculated using either a straight-line method or an accelerated method Under regular MACRS (GDS), the methods are Straight-line (S/L) 200% declining balance (200 DB) 150% declining balance (150 DB) Under the straight-line method, an equal amount of depreciation is taken each full year during the asset s useful life Under the declining balance methods, the cost recovery rate of an asset is accelerated Under the 200% declining balance (double declining balance) method, 200% of the straight-line rate is applied to the remaining depreciable balance of an asset, until the straightline method results in a larger deduction Under the 150% declining balance method, 150% of the straight-line rate is applied to the remaining depreciable balance of an asset The ADS system uses only the straight-line method Straight-Line Method - A method of calculating the depreciation for property that uses a percentage rate to deduct the same amount for each year in the recovery period The percentage rate is determined by dividing one by the number of years in the recovery period Accelerated methods result in a higher amount of depreciation in the fi rst few years of use Knowledge Check Two 1 MACRS consists of which of the following depreciation systems? (Select all that apply) ACRS ADS DEPR GDS 2 Property class determines which of the following? (Select all that apply) Allowable conventions Asset basis Placed-in-service date Recovery period Basic Income Tax Depreciation, Part I 19-15

16 3 Which of the following is not a MACRS convention? Half-year Full-year Mid-quarter Mid-month 4 Clarence has a ditch-digging business, and owns a residential duplex that he rents to tenants Match his business and income-producing assets with their recovery periods Asset Answer Recovery Period Storage building Duplex Ditch digger Computer 7 years 5 years 39 years 275 years Lesson III: Depreciation Calculations Refer to Appendix L for the complete set of MACRS tables The IRS has created depreciation charts (also called percentage tables) that incorporate depreciation methods, and the applicable recovery periods, into a percentage that is applied to the beginning basis of a depreciable asset Applying the percentages from these tables to a property s basis simplifi es the depreciation calculation The MACRS tables automatically provide for the change to straight-line when it benefi ts the taxpayer To calculate the depreciation deduction, the taxpayer must fi rst determine their basis in an asset Increase the basis in the property (usually its cost) by the value of improvements the taxpayer made to the property before they placed it in service, and decrease the value by any uninsured casualty losses they sustained Depreciation, Part I Basic Income Tax

17 Certain property may be eligible to have part or all of its cost recovered in the year the taxpayer purchased it This is known as a section 179 deduction, which is discussed in another session At times, Congress increases certain benefi ts to taxpayers to help boost the economy To accomplish this, they may increase limitations (such as the section 179 deduction) or make additional deductions available that allow taxpayers to take advantage of the temporary changes One such additional deduction is known as a special depreciation allowance (also known as bonus depreciation or fi rst-year additional depreciation allowance) This is an additional deduction taxpayers can take before calculating regular depreciation on a new (not used) asset under MACRS, for the fi rst year the property is placed in service When determining the basis for depreciation, reduce the original basis by any special depreciation previously claimed Only the portion of the taxpayer s basis that represents business use is depreciable Multiply the basis of the asset by the percentage of business use to determine the depreciable basis Example: Luis purchased a new lawn mower for $800 He uses it 80% of the time in his lawn care business His depreciable basis for business use is $640 ($ ) The taxpayer must maintain records such as a calendar or log book to substantiate the determination of business-use percentage The method used must be reasonable and consistent For qualifi ed property acquired before May 6, 2003, the special depreciation allowance is 30% For qualifi ed property acquired after May 5, 2003, and before January 1, 2008, the special depreciation allowance is 50%, unless the taxpayer elects to use the 30% allowance In 2008, the Economic Stimulus Act eliminated the 30% allowance and made 50% the allowance percentage For qualifi ed property acquired after September 8, 2010, the allowance is 100% For more information on these special allowances, refer to IRS Publication 946 Special Depreciation Allowance For qualifi ed property acquired after September 8, 2010, and placed in service before January 1, 2012, the special depreciation allowance is 100% of the business-use percentage This special allowance is based on the depreciable basis of the property after any section 179 deduction is claimed and before any regular depreciation is taken for the tax year The 50% special depreciation allowance cannot alternatively be selected for assets placed in service in 2011 If the taxpayer elects out of the 100% special depreciation allowance for property acquired after September 8, 2010, and placed in service before January 1, 2012, then the property does not qualify for the 50% special depreciation allowance Basic Income Tax Depreciation, Part I 19-17

18 Property that qualifi es for the special depreciation allowance includes the following: Tangible property depreciated under MACRS with a recovery period of 20 years or less Water utility property Off-the-shelf computer software Qualifi ed leasehold improvement property (LHI) The original use of the property must begin with the taxpayer The allowance does not apply to the purchase of used assets Property that does not qualify includes Property placed in service and disposed of in the same tax year Property converted from business use to personal use in the same tax year it is acquired Property required to be depreciated under ADS Property included in a class of property for which the taxpayer elected not to claim the special depreciation allowance Example: On May 1, Tom bought a business desk that cost $7,000, and placed it in service as qualifi ed property He does not elect to claim a section 179 deduction The special depreciation allowance is $7,000 (100%), if all other requirements are met Depreciation, Part I Basic Income Tax

19 Depreciation Tables To determine the depreciation for the year, apply the exact rates (as they appear in the tables) to the property s basis Use the percentage tables that correspond to the appropriate recovery years Once the percentage tables are used for any item of property, generally, they must continue to be used for the entire recovery period of the property Computerized methods of calculating depreciation use rounding techniques that sometimes result in slightly different amounts from those calculated using the tables Example: Willis placed a new mechanic s toolbox in service for his business on May 3 It was the only asset placed in service during the year and he uses it 100% for business His basis in the toolbox is $1,100 Under regular MACRS, a toolbox is 7-year property and the half-year convention applies With a recovery period of seven years, Willis uses the IRS MACRS Percentage Table A-1 According to this table, the depreciation rate for the year he places the toolbox in service is 1429% The total depreciation for this year is $157 ($1, ) Refer to the MACRS Percentage Tables in Appendix L If Willis had chosen to claim the special depreciation allowance, his total depreciation for the fi rst year would be $1,100 Depreciation Worksheet Although the taxpayer is not required to submit detailed information about the depreciation of assets with their return, the information needed to calculate this depreciation must be part of their permanent records Use a depreciation worksheet or similar record to track depreciation deductions Each business or investment activity of the taxpayer should maintain a worksheet that lists the assets associated with the activity Due Diligence: Paid preparers are required to provide taxpayers with documentation that shows how depreciation is calculated The depreciation worksheet shown in this session meets this requirement When an asset is disposed of prior to the end of its depreciable life (recovery period), some of the previously deducted depreciation may need to be recaptured as taxable income The taxpayer needs information from the depreciation worksheet to calculate the amount that must be recaptured, and to adjust their basis to determine whether they have a gain or a loss on the disposition Basic Income Tax Depreciation, Part I 19-19

20 Illustration One Mabel Johnson bought offi ce furniture for $10,000 and placed it in service on August 11 She uses the furniture only for business The furniture is the only property she placed in service this year, so the halfyear convention applies Mabel does not use the special depreciation allowance Under regular MACRS (GDS), the furniture is 7-year property She uses IRS MACRS Percentage Table A-1 Mabel s basis in the furniture is its cost For each year, the basis is multiplied by the percentage for 7-year property provided in Table A-1 Mabel multiplies her depreciable basis by the fi rst-year percentage to determine her deduction for the year Mabel s depreciation deduction for each year of the recovery period is shown Year Basis Percentage Deduction 1 $10, % $1,429 2 $10, % $2,449 3 $10, % $1,749 4 $10, % $1,249 5 $10, % $893 6 $10, % $892 7 $10, % $893 8 $10, % $446 Due Diligence: Preparers should be sure taxpayers understand the requirement to maintain accurate records, and the importance of providing their records from previous years to their preparer Mabel s depreciation deduction for years one and eight of the property s recovery period are based on a half-year Mabel records the current year s deduction on a depreciation worksheet, as shown Depreciation, Part I Basic Income Tax

21 DEPRECIATION WORKSHEET Name: Mabel Johnson SSN: Description Date Placed In Service Cost Bus % 179 Exp Special Depr Depr Basis Recov Period Mthd Conv Recovered Prior Yrs % 2011 Amt % Office Furniture 08/11/11 $10, $0 $0 $10,000 7 yr 200DB HY $ $1,429 Amt % Amt Basic Income Tax Depreciation, Part I 19-21

22 For some assets, the percentage of business use may change from year to year The taxpayer must maintain, as a part of their permanent records, the business-use percentage for each year A separate line of the depreciation worksheet can be used when the business percentage changes Illustration Two Briggs Watkins has a laptop computer that he bought two years ago to use in his management consulting business He has used it each year, as follows: First year - Did not use it for any personal purpose Last year - Used it to take three online courses in photography, his new hobby This year - Took one online photography course He determined his business-use percentage according to the number of hours he spent working on his courses Each year his business-use percentage changes, a new line is used to track the depreciation on his depreciation worksheet, as shown Depreciation, Part I Basic Income Tax

23 DEPRECIATION WORKSHEET Name: Briggs Watkins SSN: Description Date Placed In Service Cost Bus % 179 Exp Special Depr Depr Basis Recov Period Mthd Conv Recovered Prior Yrs % 2009 Amount % 2010 Amount % 2011 Amount Laptop (Yr 1) 08/25/09 $4, $4, DB HY $0 200 $866 Laptop (Yr 2) 840 $3,630 $ $1,162 Laptop (Yr 3) 930 $4,019 $2, $772 Basic Income Tax Depreciation, Part I 19-23

24 Knowledge Check Three 1 What information is needed to calculate depreciation? The date the taxpayer paid for property The property class The property location How long the taxpayer intends to keep the property 2 Caroline bought a refrigerator for soft drinks for her employees last year Her depreciable basis is $535 It is being depreciated under the half-year convention How much is Caroline s depreciation deduction for the refrigerator this year, which is the second year of service? $ 3 Cassidy bought a store building seven years ago, from which he operates a candy business His basis is $175,000 How much is Cassidy s depreciation deduction for this year for the building? $ 4 Which of the following property types are eligible for the 2011 special depreciation allowance? (Select all that apply) Tangible property depreciated under MACRS with a recovery period of 20 years or less An apartment building Off-the-shelf computer software A warehouse Depreciation, Part I Basic Income Tax

25 Lesson IV: Depreciation Reporting After entering asset information into the depreciation worksheet, report the taxpayer s depreciation deduction on the appropriate line of the form or schedule for the business activity Enter depreciation for an employee s assets on Form 2106, Employee Business Expenses If the taxpayer is self-employed, enter depreciation related to their business assets on Schedule C, Profi t or Loss From Business If any assets were placed in service in the current year, Form 4562, Depreciation and Amortization, is also required Complete a separate Form 4562 for each activity and indicate the activity in the box next to the taxpayer s name Table 1-1, Purpose of Form 4562, from IRS Publication 946, Chapter 1, Overview of Depreciation, provides an overview of the purpose of the various parts of Form 4562 Basic Income Tax Depreciation, Part I 19-25

26 Most regular and ADS MACRS depreciation is summarized and reported in Form 4562, Part III When Form 4562 is required, enter the total depreciation deduction for items placed in service in prior years on Section A, Line 17, A as shown in Figure A Figure A - Form 4562, Part III, MACRS Depreciation section Part III MACRS Depreciation (Do not include listed property) (See instructions) Section A A 17 MACRS deductions for assets placed in service in tax years beginning before If you are electing to group any assets placed in service during the tax year into one or more general AI asset accounts, check here Section B - Assets Placed in Service During 2011 Tax Year Using the General Depreciation System Month and Basis for depreciation (a) (b) (c) Classification of property (d) Recovery (e) Convention (f) Method (g) Depreciation year placed in (business/investment use only - see instructions) period deduction service 19 a 3-year property b 5-year property C c 7-year property d 10-year property D e 15-year property f 20-year property g 25-year property 25 yrs S/L h Residential rental 275 yrs MM S/L property B 275 yrs MM S/L i Nonresidential real 39 yrs MM S/L property MM S/L E Section C - Assets s Placed in Service During 2011 Tax Year Using the Alternative Depreciation System 20 a Class life S/L b 12-year 12 yrs S/L c 40-year 40 yrs MM S/L Complete Form 4562, Part III, Section B, for assets placed in service during the current year for which the regular MACRS (GDS) system is being used For residential rental property and nonresidential real property, enter the month and year the property p was placed in service on Section B, Column (b), Line 19h or 19i Report the convention used in Section B, Column (e), for assets in the property classes listed on Lines 19a through 19g C All assets on these lines must use the same convention Enter HY for the half-year convention or MQ for the mid-quarter convention Report the method in Section B, Column (f) D Enter 200 DB for the 200% declining balance method, 150 DB for the 150% declining balance method, and S/L for the straight-line method B Use Section C E when using the ADS depreciation system Depreciation, Part I Basic Income Tax

27 Illustration Three Seth Stuart is self-employed as a carpenter He has several tools that he bought in prior years, and a new circular saw he bought this year Because he put assets in service in the current year, Seth must complete Form 4562 to take his depreciation deduction Seth s depreciation for prior-year assets is entered on Form 4562, Part III, Section A, Line 17 a His depreciable basis for the saw is entered on the 7-year property line (Line 19c b ), and the depreciation deduction namount is entered in Column (g) c Seth deducts the depreciation on Schedule C, as indicated in the box for the business or activity to which this form relates His total depreciation deduction is entered on Line 22 d Seth s depreciation worksheet and Form 4562, Page 1, are completed as shown Basic Income Tax Depreciation, Part I 19-27

28 DEPRECIATION WORKSHEET Name: Seth Stuart SSN: Amt % 2010 Amt % 2009 Amt % Recovered Prior Yrs Mthd Conv Recov Period Depr Basis Special Depr 179 Exp Bus % Cost Date Placed In Service Description Tool Box 03/03/07 $1, $0 $0 $1,689 7 yr HY 200DB $ $ $ $151 Nail Gun 09/18/09 $ $0 $0 $258 7 yr HY 200DB 1429 $ $ $45 Table Saw 07/10/09 $1, $0 $0 $1,893 7 yr HY 200DB 1429 $ $ $331 Compressor 05/22/10 $1, $0 $0 $1,459 7 yr HY 200DB 1429 $ $357 Circular Saw 07/08/11 $ $0 $0 $319 7 yr HY 200DB 1429 $46 a Depreciation, Part I Basic Income Tax

29 Form 4562 A Depreciation and Amortization (Including Information on Listed Property) A OMB No Department of the Treasury Attachment Internal Revenue Service (99) See separate instructions Attach to your tax return Sequence No Name(s) shown on return Business or activity to which this form relates Identifying number 179 SETH STUART SCHC-1: SETH STUART Part I Election To Expense Certain Property Under Section 179 Note: If you have any listed property, complete Part V before you complete Part I 1 Maximum amount (see instructions) 1 2 Total cost of section 179 property placed in service (see instructions) 2 3 Threshold cost of section 179 property before reduction in limitation (see instructions) 3 4 Reduction in limitation Subtract line 3 from line 2 If zero or less, enter Dollar limitation for tax year Subtract line 4 from line 1 If zero or less, enter -0- If married filing separately, see instrs (a) Description of property (b) Cost (business use only) (c) Elected cost 2,000, Listed property Enter the amount from line Total elected cost of section 179 property Add amounts in column (c), lines 6 and Tentative deduction Enter the smaller of line 5 or line Carryover of disallowed deduction from line 13 of your 2010 Form Business income limitation Enter the smaller of business income (not less than zero) or line 5 (see instructions) Section 179 expense deduction Add lines 9 and 10, but do not enter more than line Carryover of disallowed deduction to 2012 Add lines 9 and 10, less line 12 A 13 NONE Note: Do not use Part II or Part III below for listed property Instead, use Part V Part II Special Depreciation Allowance and Other Depreciation (Do not include listed property) (See instructions) 14 Special depreciation allowance for qualified property (other than listed property) placed in service during the tax year (see instructions) Property subject to section 168(f)(1) election Other depreciation (including ACRS) 16 Part III MACRS Depreciation (Do not include listed property) (See instructions) Section A a 17 MACRS deductions for assets placed in service in tax years beginning before If you are electing to group any assets placed in service during the tax year into one or more general asset accounts, check here AI Section B - Assets Placed in Service During 2011 Tax Year Using the General Depreciation System (a) Classification of property (b) Month and (c) Basis for depreciation (d) Recovery (e) Convention (f) Method (g) Depreciation year placed in (business/investment use only - see instructions) period deduction service 19 a 3-year property b 5-year property p b c c 7-year property YR HY 200 DB d 10-year property e 15-year property f 20-year property g 25-year property 25 yrs S/L h Residential rental 275 yrs MM S/L property 275 yrs MM S/L i Nonresidential real 39 yrs MM S/L property MM S/L Section C - Assets Placed in Service During 2011 Tax Year Using the Alternative Depreciation System 20 a Class life S/L b 12-year 12 yrs S/L c 40-year 40 yrs MM S/L Part IV Summary (See instructions) 21 Listed property Enter amount from line Total Add amounts from line 12, lines 14 through 17, lines 19 and 20 in column (g), and line 21 Enter here d and on the appropriate lines of your return Partnerships and S corporations - see instructions For assets shown above and placed in service during the current year, enter the portion of the basis attributable to section 263A costs 23 For Paperwork Reduction Act Notice, see separate instructions Form 4562 (2011) F 11/18/11 MXA NONE NONE Basic Income Tax Depreciation, Part I 19-29

30 Illustration Four Continuing from Illustration Three, Seth s depreciation deduction for his carpentry business is entered on his Schedule C, Line 13, as shown SCHEDULE C (Form 1040) J J J J A A A NONE IX I IOther (specify) A P A I OMB No For information on Schedule C and its instructions, go to Department of the Treasury wwwirsgov/schedulec Attachment Internal Revenue Service (99) Attach to Form 1040, 1040NR, or 1041; partnerships generally must file Form 1065 Sequence No Name of proprietor Social security number (SSN) A C E Principal business or profession, including product or service (see the instructions) Business name If no separate business name, leave blank Business address (including suite or room no) City, town or post office, state, and ZIP code (Sole Proprietorship) c Income reported to you on Form W-2 if the "Statutory Employee" box on that form was checked Caution See instr before completing this line 1c d Total gross receipts Add lines 1a through 1c 1d 2 Returns and allowances plus any other adjustments (see instructions) 2 3 Subtract line 2 from line 1d 3 4 Cost of goods sold (from line 42) 4 5 Gross profit Subtract line 4 from line Other income, including federal and state gasoline or fuel tax credit or refund (see instructions) 6 7 Gross income Add lines 5 and 6 A 7 Part II Expenses Enter expenses for business use of your home only on line 30 8 Advertising 8 18 Office expense (see instructions) 18 9 Car and truck expenses 19 Pension and profit-sharing plans 19 (see instructions) Rent or lease (see instructions): 10 Commissions and fees 10 a Vehicles, machinery, and equipment 20a 11 Contract labor (see instructions) 11 b Other business property 20b 12 Depletion Repairs and maintenance Depreciation and section Supplies (not included in Part III) 22 expense deduction (not included 23 Taxes and licenses 23 in Part III) (see instructions) 13 d 24 Travel, meals, and entertainment: 14 Employee benefit programs a Travel 24a (other than on line 19) 14 b Deductible meals and 15 Insurance (other than health) entertainment (see instructions) 24b 16 Interest: 25 Utilities 25 a Mortgage (paid to banks, etc) 16a 26 Wages (less employment credits) 26 b Other 16b 27 a Other expenses (from line 48) 27a 17 Legal and professional services b Reserved for future use 27b 28 Total expenses before expenses for business use of home Add lines 8 through 27a A Tentative profit or (loss) Subtract line 28 from line Expenses for business use of your home Attach Form 8829 Do not report such expenses elsewhere Net profit or (loss) Subtract line 30 from line 29 If a profit, enter on both Form 1040, line 12 (or Form 1040NR, line 13 ) and on Schedule SE, line 2 If you entered an amount on line 1c, see instructions Estates and trusts, enter on Form 1041, line 3 31 If a loss, you must go to line 32 Enter code from instructions Employer ID number (EIN), if any AI IX I F Accounting method: (1) Cash (2) Accrual (3) G H I J Did you "materially participate" in the operation of this business during 2011? If "No," see instructions for limit on losses If you started or acquired this business during 2011, check here Did you make any payments in 2011 that would require you to file Form(s) 1099? (see instructions) If "Yes," did you or will you file all required Forms 1099? Yes Yes Yes No No No Part I Income 32 1 a b Profit or Loss From Business Merchant card and third party payments For 2011, enter -0- Gross receipts or sales not entered on line 1a (see instructions) If you have a loss, check the box that describes your investment in this activity (see instructions) If you checked 32a, enter the loss on both Form 1040, line 12, (or Form 1040NR, line 13) and on Schedule SE, line 2 If you entered an amount on line 1c, see the instructions for line 31 Estates and 32a All investment is at risk trusts, enter on Form 1041, line 3 32b Some investment is not If you checked 32b, you must attach Form 6198 Your loss may be limited N at risk For Paperwork Reduction Act Notice, see your tax return instructions Schedule C (Form 1040) a 1b B D SCHC-1 SETH STUART CARPENTRY CONTRACTOR , I I X 52,495 52,495 52,495 52, , ,526 1,200 NONE 11,310 41,185 41, Depreciation, Part I Basic Income Tax

31 Knowledge Check Four Use the information provided to answer the questions that follow Lorraine purchased an apartment building fi ve years ago This year, she purchased new carpeting for the entire building Last year, she purchased a set of tools that she uses in her job as a mechanic for a car repair shop On weekends, Lorraine has a small business repairing torn awnings She bought a sewing machine for the business two years ago Lorraine can take depreciation for all of these assets 1 Which of Lorraine s depreciation deductions will be shown on a Form 4562? Apartment building Carpeting Tools Sewing machine 2 How many Forms 4562 must Lorraine fi le for the current year? One Two Three Four 3 Where will Lorraine report the depreciation for the sewing machine? Form 4562 Schedule C Schedule E Form 2106 Basic Income Tax Depreciation, Part I 19-31

32 19-32 Depreciation, Part I Basic Income Tax

33 Session 19 Summary Depreciation allows taxpayers to recover the cost or other basis of tangible business-use property over the time the property is used It is a business expense deduction for age, wear, deterioration, or obsolescence of the property To claim depreciation, taxpayers must own the property and use it in a trade or business or for producing income Property must have a useful life that can be determined, and must be expected to last more than one year The cost of land is not depreciated because land does not wear out or become obsolete Taxpayers do not have to claim the depreciation deduction However, when they dispose of the property, the basis is determined by subtracting the allowable or claimed depreciation The basis of the property must be determined in order to calculate the depreciation deduction Depreciation begins when the property is placed in service for use in a trade or business or for the production of income Depreciation stops when the cost has been fully recovered, or when the property has been removed from service MACRS property is assigned to one of several property classes These property classes establish the number of years (recovery period) over which the basis of the property is recovered, ie 3, 5, 7, 275, or 39 years The recovery period is a predetermined number of years over which the cost or other basis of property is recovered Additions and improvements to depreciable property must be treated as separate depreciable property If the taxpayer sells or otherwise disposes of property before the end of its recovery period, the depreciation deduction for the year of the disposition is only part of the depreciation amount for the full year Under MACRS, the allowed conventions are half-year, mid-quarter, or mid-month Depreciation is calculated using either a straight-line method or an accelerated method A special depreciation allowance of 100% may be claimed on certain assets placed in service after September 8, 2010 This is also known as bonus depreciation or fi rst-year additional depreciation Basic Income Tax Depreciation, Part I 19-33