Chapter 7Accounting Periods and Methods and Depreciation
Income Tax Fundamentals2013Student SlidesGerald E. WhittenburgMarthaAltus-BullerSteven Gill
2013 Cengage Learning
Accounting Periods
Most individuals file tax returns that utilize a calendar yearMost partnerships, S corporations, and personal service corporations owned by individuals have same calendar year as almost all individualsIn these entitiesAllowed a September, October, orNovembeyear-end if owners make tax depositBeyond scope of this textNote: Partnerships don’t pay tax as an entity
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must use same methodfor tax & books
Accounting Methods
There are three acceptable accounting methods for reporting taxable incomeCashHybridAccrualMust use one method consistentlyMake an election on your first return by filing using a particular methodMust obtain permission from IRS to change accounting methods
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Depreciation
Depreciation is a process of allocating and deducting the cost of assets over their useful livesDoesnot meandevaluation of assetLand is not depreciatedMaintenance vs. depreciationMaintenance expenses are incurred to keep asset in good operating orderDepreciation refers todeducting part of the original cost of the assetReport depreciation on Form 4562
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Depreciation Methods
Straight-line depreciation is easiest, for accounting purposes, and is calculated as(Cost of asset – salvage value)/Years in estimated lifeModified Accelerated Cost Recovery System (MACRS), for tax purposes, allows capital assets to be written off over a period identified in tax lawAccelerated method used for all assets except real estate
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Personal PropertyRecovery Periods
With MACRS,each asset is depreciated according to an IRS-specified recovery period3 yearADR* midpoint of 4 years or less5 yearComputers, cars and light trucks, R&D equipment, certain energy property and certain equipment7 yearMostly business furniture and equipment and property with no ADR life*See Table 7.1 on page 7-9 for Asset DepreciationRanges (ADR) for recovery periods for all classes of assets
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Calculating Depreciationfor Personal Property
Depreciation is determined using IRS tablesMACRS rates found in Table 7.2 on page 7-10Rates multiplied by cost (salvage value not used in MACRS)Tables based on half-year conventionMeans 1/2 year depreciation taken in year of acquisition and 1/2 year taken in final yearMay elect to use tables based on straight-line instead (percentages in Table 7.3 on page 7-11)Note: Must use either MACRS or straight-line for allproperty in a given class placed in service during that year
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Real Estate
Real assets depreciated based on a recovery period – 2 types of real property27.5 years Residential real estate39 years Nonresidential real estateReal assets are depreciated using the straight-line method with a mid-month conventionMid-month convention assumes all purchases made in middle of monthUsed for real estate acquired after 1986Rates found on Table 7.4 on page 7-13Note: Different rates apply for real property acquiredbefore 1981 and after 1980 but before 1987
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Election to Expense - §179
§179 allows immediate expensing of qualifying property(tangible personal property used in a business, new or used)For 2012, the annual amount allowed is $139,000 (this amount may increase in final weeks of 2012; seeWhittenburgcompanion web site for updated information)§179 election to expense is limited by 2 thingsIf cost of qualifying property placed in service in a year > $560,000, then reduce §179 expense dollar for dollarFor example, if assets purchased in current year = $662,000, taxpayer must reduce§179 by$102,000. Therefore, election to expense islimited to = $37,000 ($139,000 – 102,000). The remaining $625,000 of basis is depreciated over assets’ useful lives (including bonus depreciation) if applicable.Cannot take §179 expense in excess of taxable income
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Listed Property
Special rules exist to limit deductions on assets that lend themselves to personal use, called ‘listed property’Cars and trucks/vans under 6000 lbs. gross vehicle weight with specific exclusionsComputers (unless used exclusively at business)Equipment used for entertainment, recreation or amusementIf asset used <= 50% for business (or if business use falls below 50% in subsequent years)must use straight-line and election to expense not allowedIf asset used > 50% for business, must use MACRSSeparate section (Part V) on page 2 of Form 4562
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