South western federal taxation 2018 comprehensive 41st edition maloney solutions manual

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SWFT 2018 Comprehensive Volume Chapter 8: Depreciation, Cost Recovery, Amortization, and Depletion End-of-Chapter Question, Exercise, and Problem Correlations

Comp.

Vol. 40e (2017)

Comp.

Vol. 41e (2018)

Comp. Vol. 41e (2018) Learning Objectives

Exact Same

Revised

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© 2018 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

South-Western Federal Taxation 2018 Edition Series End-of-Chapter Question, Exercise, and Problem Correlations: Comprehensive Volume (Volume 3)

Comp.

Vol. 40e (2017)

Comp.

Vol. 41e (2018)

Comp. Vol. 41e (2018) Learning Objectives

Exact Same

Revised

Brand New

Source Volume: Ind. Income Taxes 41e (2018) OR Corporations 41e (2018)

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EOC 8-2

© 2018 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

South-Western Federal Taxation 2018 Edition Series End-of-Chapter Question, Exercise, and Problem Correlations: Comprehensive Volume (Volume 3)

Comp.

Vol. 40e (2017)

Comp.

Vol. 41e (2018)

Comp. Vol. 41e (2018) Learning Objectives

Exact Same

Revised

Brand New

Source Volume: Ind. Income Taxes 41e (2018) OR Corporations 41e (2018)

Source Volume Chapter

V1

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CHAPTER 8 DEPRECIATION, COST RECOVERY, AMORTIZATION, AND DEPLETION SOLUTIONS TO PROBLEM MATERIALS

DISCUSSION QUESTIONS 1.

(LO 1) Property that is classified as personal use property is not used in a trade or business or a transaction entered into for profit and, hence, is not subject to cost recovery.

2.

(LO 1) Personal property is any asset that is not real property. Personal use property is any property (realty or personalty) that is held for personal use rather than for use in a trade or business or incomeproducing activity.

3.

(LO 1) Land improvements have a MACRS class life of 15 years. Certain types of real property (e.g., land improvements) are cost recovered as MACRS personalty.

4.

(LO 2) The relevant issues for Henry: •

Can a portion of the purchase costs of a ski resort, which are allocated to the construction costs of the resort’s mountain roads, trails, and slopes, be depreciated?

•

If such costs can be depreciated, what is the correct recovery period?

•

Can costs incurred subsequent to the purchase, attributable to maintenance of such mountain roads, trails, and slopes, be depreciated?

5.

(LO 2) The three factors the MACRS tables take into account are (1) recovery period, (2) method, and (3) convention.

6.

(LO 2) The asset is treated as if it were placed in service in the middle of the quarter. The factors in the table take this into account; hence, the cost of the asset is multiplied by the factor to determine the first year’s cost recovery.

7.

(LO 2) The asset is treated as if it were sold in the middle of the quarter; hence, one-half quarter of cost recovery is allowed in the quarter of the sale. If the sale is in the first quarter, the ratio is .5/4; in the second quarter, 1.5/4; in the third quarter, 2.5/4; and in the fourth quarter, 3.5/4.

8.

(LO 2) Even if MACRS straight-line is elected for the 7-year class assets, the cost recovery on the 5-year class assets is computed using regular MACRS with a mid-quarter convention unless a separate election is made to use MACRS straight-line for the 5-year class assets (the mid-quarter convention also applies to the 7-year class assets). With respect to the mid-quarter convention, the assumption is made that Robert is a calendar year taxpayer.

9.

(LO 2) The following issues are relevant for Jim. •

What is the cost of a self-produced animal for purposes of computing its cost recovery?

•

What is the proper placed-in-service date relating to self-produced breeding animals?

8-1

© 2018 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

8-2

2018 Comprehensive Volume/Solutions Manual

10.

(LO 3) Ordinary income recapture is required anytime property on which an expense has been taken under § 179 is no longer used predominantly in a trade or business.

11.

(LO 3) The basis of the property for cost recovery purposes is reduced by the § 179 amount [after it is adjusted for property placed in service in excess of the appropriate acquisition limit ($2,030,000 in 2017 and $2,010,000 in 2016)]. The business income limitation does not affect basis.

12.

(LO 3) The § 179 amount eligible for expensing in a carryforward year is limited to the lesser of (1) the statutory dollar amount ($510,000 in 2017 and $500,000 in 2016) reduced by the cost of § 179 property placed in service in excess of the appropriate acquisition limit in the carryforward year ($2,030,000 for 2017 and $2,010,000 for 2016) or (2) the business income limitation in the carryforward year.

13.

(LO 3) For § 179 purposes, taxable income is defined as the aggregate amount of taxable income of any trade or business of the taxpayer without regard to the amount expensed under § 179. Therefore, the taxable income computation for purposes of the § 179 limit includes the deduction for additional first-year depreciation and MACRS.

14.

(LO 2, 3) The following issues are relevant to John.

•

Is John entitled to a § 179 deduction?

•

How much, if any, can John deduct under § 179 on his own tax return?

•

What are the tax consequences of the reimbursements that John receives?

15.

(LO 4) The cost of listed property that does not pass the more-than-50% business usage test must be recovered using the straight-line method. If the listed property is an automobile, the cost recovery is further limited by the cost recovery limitations.

16.

(LO 4) The property is subject to cost recovery recapture, which is included in the taxpayer’s income tax return as ordinary income. The amount of the inclusion is the excess cost recovery, which is the excess of the cost recovery deduction taken in prior years using the statutory percentage method over the amount that would have been allowed if the straight-line method had been used since the property was placed in service.

17.

(LO 7) The amortization period for a § 197 intangible is 15 years regardless of the actual useful life.

18.

(LO 7) The following issues are relevant for Orange Motors.

19.

20.

•

Does the noncompete agreement come under § 197 for intangibles?

•

Was the noncompete agreement in connection with the acquisition of a trade or business?

•

Can the cost of the noncompete agreement be amortized over a period other than the normal statutory period if the noncompete agreement is legally enforceable for a shorter period of time?

•

What is the normal statutory period for amortizing intangibles?

(LO 7) The following issues are relevant for George.

•

Are all of the expenditures qualifying expenditures?

•

Which of the expenditures must be capitalized?

•

Which of the expenditures will qualify for amortization under § 195?

•

What amount may be deducted under § 195 for 2017?

(LO 8) The cost basis is divided by the estimated recoverable units of the asset to arrive at the depletion per unit. The depletion per unit then is multiplied by the number of units sold during the year to arrive at the cost depletion allowed. © 2018 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

Depreciation, Cost Recovery, Amortization, and Depletion

8-3

COMPUTATIONAL EXERCISES 21.

22.

23.

24.

25.

(LO 2) The IRS provides tables that specify cost recovery allowances for personalty and for realty. To determine the amount of the cost recovery allowances, simply identify the asset by class and go to the appropriate table for the percentage (or factor).

2017

$80,000 × .1429 = $11,432.

2018

$80,000 × .2449 = $19,592.

(LO 2) The mid-quarter convention applies if more than 40% of the value of property other than eligible real estate is placed in service during the last quarter of the year. Hamlet acquired 100% of assets in the last quarter of the year. Therefore mid-quarter convention applies.

2017

$100,000 × .0357 = $3,570.

2018

$100,000 × .2755 = $27,550.

(LO 2) The IRS provides tables that specify cost recovery allowances for personalty and for realty.

Under MACRS, the cost recovery period for residential rental real estate is 27.5 years, and the straightline method is used for computing the cost recovery allowance. Nonresidential real estate uses a recovery period of 39 years; it also is depreciated using the straight-line method. Cost recovery is computed by multiplying the applicable rate by the cost recovery basis. a.

Residential rental real estate: $1,000,000 × .03636 = $36,360.

b.

Nonresidential rental real estate: $1,000,000 × .02564 = $25,640.

(LO 2) The IRS provides tables that specify cost recovery allowances for personalty and for realty.

The taxpayer may elect to use the straight-line method for depreciable personal property. The property is depreciated using the class life (recovery period) of the asset with a half-year convention or a mid-quarter convention, whichever applies. The election is available on a class-by-class and year-by-year basis (see Concept Summary 8.4). The percentages for the straight-line election with a half-year convention appear in Exhibit 8.5.

2017

$2,800 × .10 = $280.

2018

$2,800 × .20 = $560.

(LO 2) Additional first-year depreciation is taken in the year in which the qualifying property is placed in service; it may be claimed in addition to the otherwise available depreciation deduction.

After the additional first-year depreciation is calculated, the standard MACRS cost recovery allowance is calculated by multiplying the cost recovery basis (original cost recovery basis less additional first-year depreciation) by the percentage that reflects the applicable cost recovery method and convention. Because the asset was purchased during the last quarter of the year and is the only asset purchased during the year, the mid-quarter convention applies.

Diana’s $34,125 ($32,500 + $1,625) deduction is computed as follows.

50% additional first-year depreciation: ($65,000 × 50%) = $32,500.

MACRS cost recovery: ($65,000 − $32,500) × .05 = $1,625.

© 2018 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

8-4 26.

2018 Comprehensive Volume/Solutions Manual (LO 3) In 2017, § 179 permits the taxpayer to elect to deduct up to $510,000 of the acquisition cost of tangible personal property used in a trade or business.

Two additional limitations apply to the amount deductible under § 179. First, the ceiling amount on the deduction is reduced dollar for dollar when § 179 property placed in service during the taxable year exceeds a maximum amount ($2,030,000 in 2017). Second, the § 179 deduction cannot exceed the taxpayer’s trade or business taxable income, computed without regard to the § 179 amount. § 179 deduction before adjustment Less: Dollar limitation reduction ($212,000 < $2,030,000) Remaining § 179 deduction § 179 deduction allowed due to business income limitation § 179 deduction carryforward ($212,000 − $5,600)

27.

28.

$212,000 (–0–) $212,000 $ 5,600 $206,400

(LO 4) The law places special limitations on cost recovery deductions for passenger automobiles. The luxury auto limits are imposed before any percentage reduction for personal use. The cost recovery limitations are maximum amounts. If the regular MACRS calculation produces a lesser amount of cost recovery, the lesser amount is used.

Year

MACRS Amount

Recovery Limitation

Deduction Allowed

2017

$5,040 ($36,000 × .20 × 70%)

$2,212 ($3,160 × 70%)

$2,212

2018

$8,064 ($36,000 × .32 × 70%)

$3,570 ($5,100 × 70%)

$3,570

(LO 7) Taxpayers can claim an amortization deduction on intangible assets called “amortizable § 197 intangibles.” The amount of the deduction is determined by amortizing the adjusted basis of such intangibles ratably over a 15-year period beginning in the month in which the intangible is acquired.

The 2017 § 197 amortization deduction of $ $7,250 ($1,000 + $6,250) is computed as follows.

Patent: $60,000/15 years = $4,000 × 3/12 = $1,000.

Goodwill: $375,000/15 years × 3/12 = $6,250.

29.

(LO 8) Cost depletion is determined using the adjusted basis of the asset. The basis is divided by the estimated recoverable units of the asset (e.g., barrels and tons) to arrive at the depletion per unit. This amount is then multiplied by the number of units sold (not the units produced) during the year to arrive at the cost depletion allowed.

Parscale’s depletion per ton is $16 ($8,000,000 adjusted basis/500,000 estimated recoverable tons). If 75,000 tons are sold this year, the cost depletion is $1,200,000 ($16 depletion per ton × 75,000 tons sold).

30.

(LO 8) Percentage depletion (also referred to as statutory depletion) uses a specified percentage provided by the Code. The percentage varies according to the type of mineral interest involved. The rate is applied to the gross income from the property, but in no event may percentage depletion exceed 50% of the taxable income from the property before the allowance for depletion.

Gross income Less: Other expenses Taxable income before depletion Depletion allowance 1

$340,000 (229,000) $111,000 $ 47,6001

[The lesser of $47,600 (14% × $340,000) or $55,500 (50% × $111,000)].

© 2018 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

Depreciation, Cost Recovery, Amortization, and Depletion

8-5

PROBLEMS 31.

(LO 1, 2) Cost of asset Less: Greater of allowed and allowable cost recovery: 2015 2016 Basis at the end of 2016 Less: Cost recovery for 2017 ($200,000 × .03636 × .5/12) Basis on date of sale

$200,000 $ 910 7,272

Loss on sale of asset ($180,000 − $191,515)

(8,182) $191,818 (303) $ 191,515 ($ 11,515)

32.

(LO 1, 2) José’s basis for cost recovery is $300,000 because the basis of the house at the date of the conversion from personal use to rental property ($300,000) is less than the $400,000 fair market value. The cost recovery is $8,637 [$300,000 × .02879 (Exhibit 8.8)].

33.

(LO 2) The office furniture qualifies for additional first-year depreciation. So part of the $130,000 cost can be deducted as additional first-year depreciation. The property is 7-year class property. Cost recovery would be calculated as follows.

Additional first-year depreciation: ($130,000 × 50%) MACRS cost recovery: [($130,000 − $65,000) × .1429 (Exhibit 8.3)] Total cost recovery

34.

(LO 2) a.

The mid-quarter convention must be used. The office machine is 7-year class property.

b.

35.

2016 Additional first-year depreciation ($75,000 × 50%) MACRS cost recovery [($75,000 − $37,500) × .0357 (Exhibit 8.4)] Total cost recovery

$37,500 1,339 $38,839

2017 MACRS cost recovery [$37,500 × (.2755 × 2.5/4)]

$6,457

(LO 2) a.

2017 MACRS cost recovery ($200,000 × .20) (Exhibit 8.3) b.

36.

$65,000 9,289 $74,289

2018 MACRS cost recovery [$200,000 × .32 (Exhibit 8.3) × 1/2]

$40,000 $32,000

(LO 2) The mid-quarter convention must be used because the cost of the computers acquired in the fourth quarter exceeds 40% of the cost of all the personal property acquired during the year ($70,000/$150,000 = 47%).

Furniture (7-year class property) MACRS cost recovery [$40,000 × .1785 (Exhibit 8.4)]

$ 7,140

Trucks (5-year class property) MACRS cost recovery [$40,000 × .15 (Exhibit 8.4)]

6,000

Computers (5-year class property) MACRS cost recovery [$70,000 × .05 (Exhibit 8.4)] Total cost recovery

3,500 $16,640

© 2018 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

8-6 37.

2018 Comprehensive Volume/Solutions Manual (LO 2) a.

The building was placed in service in October.

b.

38.

2017

$3,800,000 × .00535 (Exhibit 8.8) = $20,330

2021

$3,800,000 × .02564 (Exhibit 8.8) × 6.5/12 = $52,776

(LO 2) The building meets the 80% gross receipts from dwelling units test. Therefore, it is classified as residential real property. The building’s depreciable basis is $1,500,000 [$2,000,000 (cost) − $500,000 (land)]. $1,500,000 × .02576 (Exhibit 8.8) = $38,640

39.

40.

41.

(LO 2) 2017

$10,800,000 × .01605 (Exhibit 8.8) = $173,340

2027

$10,800,000 × .02564 (Exhibit 8.8) = $276,912

(LO 2) The building’s depreciable basis is $1,300,000 [$1,600,000 (cost) − $300,000 (land)]. a.

2017

$1,300,000 × .0197 (Exhibit 8.8) = $25,610

b.

2023

$1,300,000 × .03636 (Exhibit 8.8) × 10.5/12 = $41,360

(LO 2, 3, 9) a.

5-year class property Immediate expense deduction under § 179 7-year class property Immediate expense deduction under § 179 ($510,000 − $200,000) MACRS cost recovery [($410,000 − $310,000) × .1429] Total deduction b.

c.

7-year class property Immediate expense deduction under § 179 5-year class property Immediate expense deduction under § 179 MACRS cost recovery [($200,000 − $100,000) × .20] Total deduction

$200,000 310,000 14,290 $524,290 $410,000 100,000 20,000 $530,000

The deduction for the year would be $5,710 larger ($530,000 − $524,290) if § 179 expense was first allocated to the 7-year class property (i.e., the longer lived asset). Therefore, she should elect to expense the 7-year property (the furniture) first.

© 2018 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

Depreciation, Cost Recovery, Amortization, and Depletion d.

The present value of the tax savings is $150,094.

Year 1 2 3 4 5 6 7 8 Total

e.

5-Year Asset $120,000 32,000 19,200 11,520 11,520 5,760 $200,000

7-Year Asset $410,000 0 0 0 0 0 0 0 $410,000

Total $530,000 32,000 19,200 11,520 11,520 5,760 0 0 $610,000

Tax Savings (@ 25%) $132,500 8,000 4,800 2,880 2,880 1,440 0 0 $152,500

PV PV of Tax Factor Savings 1.0000 $132,500 0.9434 7,547 0.8900 4,272 0.8396 2,418 0.7921 2,281 0.7473 1,076 0.7050 0 0.6651 0 $150,094

If Lori chooses not to use the § 179 expense election, the present value of the tax savings generated from using MACRS deductions is $133,798. As a result, the present value of the tax savings from using the § 179 deduction on the 7-year asset is $16,296 ($150,094 less $133,798).

Year 1 2 3 4 5 6 7 8 Total

42.

8-7

5-Year Asset $ 40,000 64,000 38,400 23,040 23,040 11,520 $200,000

7-Year Asset $ 58,589 100,409 71,709 51,209 36,613 36,572 36,613 18,286 $410,000

Total $ 98,589 164,409 110,109 74,249 59,653 48,092 36,613 18,286 $610,000

Tax Savings (@ 25%) $ 24,647 41,102 27,527 18,562 14,913 12,023 9,153 4,572 $152,500

PV Factor 1.0000 0.9434 0.8900 0.8396 0.7921 0.7473 0.7050 0.6651

PV of Tax Savings $ 24,647 38,776 24,499 15,585 11,813 8,985 6,453 3,040 $133,798

(LO 2, 3) Section 179 limit

$510,000

Cost recovery for 7-year class assets [($610,000 − $510,000) × .1429]

$ 14,290

Income limitation Income before § 179 and cost recovery Cost recovery ($95,000 + $14,290) Income before § 179 amount

$250,000 (109,290) $140,710

Section 179 amount of $510,000 (limited to $140,710)

140,710

Total deduction with respect to the 7-year assets in 2017

$155,000

Section 179 carryforward ($510,000 − $140,710)

$369,290

© 2018 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

8-8 43.

2018 Comprehensive Volume/Solutions Manual (LO 2, 3, 9) a. 2016 Section 179 expense Additional first-year depreciation [($550,000 − $500,000) × 50%] MACRS cost recovery [($550,000 − $500,000 − $25,000) × .1429] Total deduction 2017 MACRS cost recovery [($550,000 − $500,000 − $25,000) × .2449] Total deduction

$500,000 25,000 3,573 $528,573 $ $

6,123 6,123

b. Form 4562 (2016) would be completed as follows.

© 2018 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

Depreciation, Cost Recovery, Amortization, and Depletion

© 2018 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

8-9

8-10 44.

2018 Comprehensive Volume/Solutions Manual (LO 3, 4)

Maloney, Hoffman, Raabe, & Young, CPAs 5191 Natorp Boulevard Mason, OH 45040

December 20, 2017 Mr. Jabari Johnson 100 Morningside Clinton, MS 39058 Dear Mr. Johnson: I am responding to your inquiry concerning the amount of cost recovery you may deduct in the first year of operation of a new taxi. If the automobile is purchased at the beginning of 2017 for $35,000, the total cost recovery deductions in the first year will be $35,000 (via an expense election under § 179).

Because the car will be used as a taxi, it is not subject to the cost recovery limitations imposed on passenger automobiles. This $35,000 cost recovery assumes that your income from your taxi business before consideration of this cost recovery will be at least $35,000 and an election is made under § 179 to expense the maximum allowable amount.

If you need additional information or need clarification of our calculations, please contact me.

Sincerely yours, John J. Jones, CPA Partner TAX FILE MEMORANDUM DATE:

December 20, 2017

FROM:

John J. Jones

SUBJECT:

Jabari Johnson: Calculations for cost recovery in year of acquisition

Facts Jabari Johnson is considering purchasing an automobile at the beginning of 2017 to be used 100% as a taxi. The cost of the automobile is $35,000. Jabari wants to know the total recovery for the year of acquisition of the car.

Calculations Because the automobile will be used as a taxi, it is not subject to the cost recovery limitations for passenger automobiles. Therefore, Jabari can elect § 179 expensing and expense the entire cost of the automobile (which is less than the $510,000 maximum § 179 election amount). In deducting the full § 179 amount of $35,000, the assumption is made that Jabari’s income from the taxi business before consideration of the § 179 expense will equal or exceed $35,000.

45.

(LO 2, 4) Because the car is a used car, it is not eligible for additional first-year depreciation, if available.

Cost Statutory percentage (mid-quarter convention) Cost recovery but subject to the limitation

$25,000 × 5% $ 1,250

Recovery limit (limited to $3,160*) Less: Personal usage (20% × $1,250) MACRS cost recovery

$ 1,250 (250) $ 1,000

*These cost recovery limits are indexed annually. The 2016 amounts are used.

© 2018 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

Depreciation, Cost Recovery, Amortization, and Depletion 46.

(LO 4) 2016

Additional first-year depreciation ($20,000 × 50%) MACRS cost recovery [($20,000 − $10,000) × .20] Total cost recovery

8-11

$10,000 2,000 $12,000

Limited to $11,160* ($3,160 + $8,000) 2017

($10,000 × .32) = $3,200 (limited to $5,100*)

$3,200

So the deduction for 2016 is $11,160; for 2017, it is $3,200. *These cost recovery limits are indexed annually. The 2016 amounts are used.

47.

(LO 2, 3, 4) Because the Escalade has a GVW rating in excess of 6,000 pounds, it is not a passenger automobile and hence is not subject to the cost recovery limitations. However, because the vehicle is an SUV with a GVW between 6,000 and 14,000 pounds, the § 179 expense amount is limited to $25,000.

The total MACRS deductions would be computed, including the first-year amount, as follows. § 179 expense Additional first-year depreciation [($62,000 – $25,000) × 50%] MACRS cost recovery [($62,000 − $25,000 – 18,500) × .20] Total deduction

48.

$25,000 18,500 3,700 $47,200

(LO 2, 4) Recall that only business use percentages are used in determining whether the more-than-50% business use test applies (production of income and personal use percentages are ignored). However, both business and production of income use percentages are used for cost recovery purposes.

Deduction for 2017 MACRS cost recovery ($20,000 × .20) = $4,000 (limited to $3,160*) × 80%

$2,528

Deduction for 2018 Straight-line ($20,000 × .20) = $4,000 (limited to $5,100*) × 70%

$2,800

Cost recovery recapture in 2018 (Related to 2017) 2017 MACRS deduction 2017 Straight-line ($20,000 × .10) = $2,000 (limited to $3,160*) × 80% Excess

$2,528 (1,600) $ 928

*These cost recovery limits are indexed annually. The 2016 amounts are used.

49.

(LO 2, 4, 9) 100% business use [$4,000 × .20 (Exhibit 8.3)] × 100% 45% business use [$4,000 × .10 (Exhibit 8.7)] × 45% Reduced cost recovery if personal use occurs

$800 (180) $620

Tax cost ($620 × 28%)

$174

© 2018 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

8-12 50.

2018 Comprehensive Volume/Solutions Manual (LO 2, 4, 9)

Maloney, Hoffman, Raabe, & Young, CPAs 5191 Natorp Boulevard Mason, OH 45040

December 20, 2016 Mr. Dennis Harding 150 Avenue I Memphis, TN 38112 Dear Mr. Harding: I am writing in response to your request concerning the tax consequences of purchasing versus leasing an automobile. Our calculations are based on the data you provided in our telephone conversation.

If the automobile is purchased, the total cost recovery deductions for the five years will be $15,060. If the automobile is leased, lease payment deductions will total $22,500. In addition, you also must include $870 in your gross income.

If you need additional information or clarification of our calculations, please contact us.

Sincerely yours, John J. Jones, CPA Partner TAX FILE MEMORANDUM DATE:

December 20, 2016

FROM:

John J. Jones

SUBJECT: Dennis Harding: Calculation of lease versus purchase Facts Dennis Harding is considering purchasing or leasing an automobile on January 1, 2017. The purchase price of the automobile is $48,500. The lease payments for five years would be $375 per month. The inclusion dollar amounts for the next five years would be $59, $128, $191, $228, and $264.

Dennis wants to know the effect on his adjusted gross income for purchasing versus leasing the automobile for five years.

Calculations Purchase: Cost recovery deductions 2017 ($48,500 × .20) = $9,700 (limited to $3,160*) 2018 [$48,500 × .32 (limited to $5,100*)] 2019 [$48,500 × .192 (limited to $3,050*)] 2020 [$48,500 × .1152 (limited to $1,875*)] 2021 [$48,500 × .1152 (limited to $1,875*)] Total cost recovery deductions

$ 3,160 5,100 3,050 1,875 1,875 $15,060

*These cost recovery limits are indexed annually. The 2016 amounts are used.

Lease:

Lease payments ($375 × 60)

$22,500

Inclusion dollar amounts ($59 + $128 + $191 + $228 + $264)

$

870

© 2018 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

Depreciation, Cost Recovery, Amortization, and Depletion 51.

52.

(LO 2, 5) For regular income tax liability MACRS cost recovery ($16,000 × .20; Exhibit 8.3)

$3,200

For AMT liability ($16,000 × .15; Exhibit 8.6)

$2,400

(LO 2, 5, 9) a.

Using ADS over the first three years generates $44,870 of depreciation (versus $56,270 using MACRS). The total tax cost of this difference is $3,192, and the PV of this tax cost is $3,031.

Year 1 2 3 Total b.

ADS $10,710 19,130 15,030 $44,870

MACRS $14,290 24,490 17,490 $56,270

Difference ($3,580) (5,360) (2,460) ($11,400)

Tax Cost (@ 28%) ($1,002) (1,501) (689) ($3,192)

PV Factor 1.0000 0.9434 0.8900

PV of Tax Cost ($1,002) (1,416) (613) ($3,031)

Over the life of the asset, total depreciation is the same (and the overall tax cost or savings is zero). However, the present value of tax savings generated via ADS in the later years of the asset’s life is not sufficient to overcome the present value of the tax cost of this choice in the asset’s early years. Overall, the present value of the tax cost of using ADS (versus MACRS) is $688.

Year 1 2 3 4 5 6 7 8 Total 53.

8-13

ADS $ 10,710 19,130 15,030 12,250 12,250 12,250 12,250 6,130 $100,000

(LO 2, 7, 9)

MACRS $ 14,290 24,490 17,490 12,490 8,930 8,920 8,930 4,460 $100,000

Difference ($3,580) (5,360) (2,460) (240) 3,320 3,330 3,320 1,670 ($ 0)

Tax (Cost) or Savings (@ 28%) ($1,002) (1,501) (689) (67) 930 932 930 467 $ 0

PV Factor 1.0000 0.9434 0.8900 0.8396 0.7921 0.7473 0.7050 0.6651

PV of Tax (Cost) or Savings ($1,002) (1,416) (613) (56) 736 697 655 311 ($ 688)

Maloney, Hoffman, Raabe, & Young, CPAs 5191 Natorp Boulevard Mason, OH 45040

October 15, 2017 Mr. Mike Saxon 200 Rolling Hills Drive Shavertown, PA 18708 Dear Mr. Saxon: This letter is in response to your request concerning the tax consequences of allocating the purchase price of a business between the two assets purchased: a warehouse and goodwill.

If the purchase price of $2,000,000 is allocated $1,200,000 to the warehouse and $800,000 to goodwill, the total recovery in the first year of operations will be $82,865. Cost recovery on the warehouse will be $29,532, and amortization of the goodwill will be $53,333. If the purchase price is allocated $1,500,000 to the warehouse and $500,000 to goodwill, the total recovery in the first year of

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8-14

2018 Comprehensive Volume/Solutions Manual operations will be $70,248. Cost recovery on the warehouse will be $36,915, and amortization of the goodwill will be $33,333.

Therefore, under the first option, your deductions in the first year will be $12,617 greater ($82,865 − $70,248). The building is written off over 39 years, whereas the goodwill is written off over 15 years.

Thus, the higher the allocation to goodwill, the faster the write-off. Should you need more information or clarification of calculations, please contact us.

Sincerely yours, Janelle J. Jones, CPA Partner TAX FILE MEMORANDUM DATE:

October 15, 2017

FROM:

Janelle J. Jones

SUBJECT:

Mike Saxon: Calculations of amount of recovery depending on the allocation of purchase price between a warehouse and goodwill

Facts Mike is negotiating the purchase of a business. The final purchase price ($2 million) has been determined, but the allocation of the purchase price between a warehouse and goodwill is still subject to discussion. Two alternatives are being considered. The first alternative allocates $1,200,000 to the warehouse and $800,000 to goodwill. The second alternative allocates $1,500,000 to the warehouse and $500,000 to goodwill. Mike wants to know the total recovery during the first year of operation from each alternative.

Calculations Alternative 1 Warehouse [$1,200,000 × .02461 (Exhibit 8.8)] Goodwill ($800,000/15 years) Total recovery

$29,532 53,333 $82,865

Alternative 2 Warehouse [$1,500,000 × .02461 (Exhibit 8.8)] Goodwill ($500,000/15 years) Total recovery

$36,915 33,333 $70,248

Additional deductions in first year under Alternative 1 ($82,865 − $70,248)

$12,617

54.

(LO 7) Deductible amount [$5,000 − ($64,000 −$50,000)] Amortizable amount [($64,000/180) × 10 months] Total deduction for startup expenditures

$ –0– 3,556 $3,556

55.

(LO 7) Deductible amount [$5,000 − ($53,000 − $50,000)] Amortizable amount {[($53,000* − $2,000)/180] × 6 months} Total deduction for startup expenditures

$2,000 1,700 $3,700

*Startup expenses do not include interest expense. © 2018 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

Depreciation, Cost Recovery, Amortization, and Depletion 56.

(LO 8) Gross income Less: Expenses Taxable income before depletion Cost depletion ($10,000,000/250,000 × 45,000) = $1,800,000 Percentage depletion (22% × $12,000,000 = $2,640,000, limited to 50% × $7,000,000 = $3,500,000) Taxable income

8-15

$12,000,000 (5,000,000) $ 7,000,000 (2,640,000) $ 4,360,000

CUMULATIVE PROBLEMS 57.

Net income from Writers Anonymous (Note 1) Interest income Self-employment tax deduction (Note 4) Adjusted gross income Less: Itemized deductions Personal exemption Taxable income

$ 17,500 4,000 (1,237) $ 20,263 (11,650) (4,050) $ 4,563

Tax on $4,563 from 2016 Tax Table Self-employment tax (Note 4) Less: Estimated tax payments Net tax payable (or refund due) for 2016

$

458 2,473 (3,000) ($ 69)

See the tax return solution below.

Notes (1)

The net income of Writers Anonymous is calculated as follows.

Income from sales Less: Rent Utilities Supplies Insurance Travel excluding meals ($3,500 − $1,200) Meals [$1,200 − $600 ($1,200 × 50%)] Depreciation and § 179 deduction (Note 3) Income from business

$16,500 7,900 1,800 5,000 2,300 600 33,400

$85,000

(67,500) $17,500

(2) The itemized deductions include: State income tax Home mortgage interest Property taxes on home Charitable contributions Total itemized deductions (3) Furniture and fixtures § 179 expense deduction Cost recovery ($21,000 − $21,000) × .1429 Computer equipment §179 expense deduction Cost recovery ($12,400 − $12,400) × .2000 Total deduction

$ 2,950 6,000 1,500 1,200 $11,650 $21,000 –0– $12,400 –0–

$21,000 12,400 $33,400

© 2018 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

8-16

2018 Comprehensive Volume/Solutions Manual All the assets acquired by Ms. Morgan can be expensed in 2016. If all assets cannot be expensed, the § 179 limited expensing election would be allocated to the longest-lived assets first. In this case, it would be first associated with the furniture and fixtures ($21,000) and then with the computer equipment ($12,400). The furniture and fixtures have a 7-year recovery period, whereas the computer equipment uses a 5-year recovery period.

(4) The self-employment tax is calculated as follows (see Chapter 12).

1. Net earnings from self-employment.

2. Multiply line 1 by 92.35%.

3. If the amount on line 2 is $127,200 or less, multiply the line 2 amount by 15.3%. This is the self-employment tax.

$17,500 16,161 $ 2,473

One-half of the self-employment tax, or $1,237, is a deduction for AGI. 58.

Maloney, Hoffman, Raabe, & Young, CPAs 5191 Natorp Boulevard Mason, OH 45040 December 21, 2017 Mr. John Smith 1045 Center Street Lindon, UT 84042 Dear Mr. Smith: I am writing in response to your request concerning the effects on your 2017 adjusted gross income of selling IBM stock and using some of the proceeds to purchase an automobile to be used in your business.

If the stock was not sold and the car was not purchased, your adjusted gross income would be $188,000. If the stock was sold and the car was purchased, your adjusted gross income would be $191,840. The supporting calculations follow.

No sale of stock and no purchase of car Fees for services Less: Business expenses Building rental Office furniture and equipment rental Office supplies Utilities Salaries ($34,000 + $42,000) Payroll taxes Fuel and oil Cost recovery (Note 3) Front-end loaders Dump truck Total business expenses Business income before § 179 deduction Less: § 179 deduction (Note 1) Business income Interest income Dividend income Adjusted gross income

$912,000 $36,000 9,000 2,500 4,000 76,000 7,000 21,000 30,000 48,000

(233,500) $678,500 (510,000) $168,500 10,000 9,500 $188,000

© 2018 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

Depreciation, Cost Recovery, Amortization, and Depletion

8-17

Notes (1)

Section 179 deduction of $510,000 (total acquisitions less than $2,030,000).

(2)

The inheritance of IBM stock worth $110,000 from Aunt Mildred is excludible under § 101.

(3)

Cost recovery Front-end loaders Additional first-year depreciation [($560,000 − $510,000) × 50%] MACRS cost recovery [($560,000 − $510,000 − $25,000) × .20] Total deduction

$25,000 5,000 $30,000

Dump truck Additional first-year depreciation ($80,000 × 50%) MACRS cost recovery [($80,000 − $40,000) × .20] Total deduction

$40,000 8,000 $48,000

Sale of stock and purchase of car Fees for services Less: Business expenses Building rental Office furniture and equipment rental Office supplies Utilities Salaries ($34,000 + $42,000) Payroll taxes Fuel and oil Cost recovery (Note 3) Front-end loaders Dump truck Car Total business expenses Business income before § 179 deduction Less: § 179 deduction (Note 1) Business income Interest income Dividend income Gain on stock sale (Note 2) Adjusted gross income

$912,000 $ 36,000 9,000 2,500 4,000 76,000 7,000 21,000 30,000 48,000 11,160

(244,660) $667,340 (510,000) $157,340 10,000 9,500 15,000 $191,840

Notes (1)

Section 179 deduction of $510,000 (total acquisitions less than $2,030,000).

(2)

The inheritance of IBM stock worth $110,000 from Aunt Mildred is excludible under § 101.

John’s recognized gain on the sale of the IBM stock is $15,000 ($125,000 amount realized − $110,000 adjusted basis) and is automatically classified as a long-term capital gain.

(3)

Cost recovery Front-end loaders Additional first-year depreciation [($560,000 − $510,000) × 50%] MACRS cost recovery [($560,000 − $510,000 − $25,000) × .20] Total deduction

$25,000 5,000 $30,000

© 2018 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

8-18

2018 Comprehensive Volume/Solutions Manual Dump truck Additional first-year depreciation ($80,000 × 50%) MACRS cost recovery [($80,000 − $40,000) × .20] Total

$40,000 8,000 $48,000

Car Additional first-year depreciation ($75,000 × 50%) MACRS cost recovery [($75,000 − $37,500) × .20] Total potential deduction

$37,500 7,500 $45,000

Limited to ($3,160* + $8,000)

$11,160

*The cost recovery limits are indexed annually. The 2016 amounts are used.

Should you want more information or need us to clarify our calculations, please contact us.

Sincerely, Josita J. Jones, CPA Partner TAX FILE MEMORANDUM DATE:

December 20, 2017

FROM:

Josita J. Jones

SUBJECT:

John Smith: Calculation of adjusted gross income for (1) no sale of stock or purchase of car versus (2) sale of stock and purchase of car

Facts John is considering selling inherited IBM stock with an adjusted basis to him of $110,000 for $125,000 on December 29, 2017. He would use $75,000 of the proceeds to purchase a car that would be used 100% for business. John wants to know the effect these transactions would have on his adjusted gross income.

No sale of stock and no purchase of car Fees for services Less: Business expenses Building rental Office furniture and equipment rental Office supplies Utilities Salaries ($34,000 + $42,000) Payroll taxes Fuel and oil Cost recovery (Note 3) Front-end loaders Dump truck Total business expenses Business income before § 179 deduction Less: § 179 deduction (Note 1) Business income Interest income Dividend income Adjusted gross income

$912,000 $36,000 9,000 2,500 4,000 76,000 7,000 21,000 30,000 48,000

(233,500) $678,500 (510,000) $168,500 10,000 9,500 $188,000

© 2018 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

Depreciation, Cost Recovery, Amortization, and Depletion

8-19

Notes (1)

Section 179 deduction of $510,000 (total acquisitions less than $2,030,000).

(2)

The inheritance of IBM stock worth $110,000 from Aunt Mildred is excludible under § 101.

(3)

Cost recovery Front-end loaders Additional first-year depreciation [($560,000 – $510,000) × 50%] MACRS cost recovery [($560,000 − $510,000 − $25,000) × .20] Total deduction

$25,000 5,000 $30,000

Dump truck Additional first-year depreciation ($80,000 × 50%) MACRS cost recovery [($80,000 − $40,000) × .20] Total deduction

$40,000 8,000 $48,000

Sale of stock and purchase of car Fees for services Less: Business expenses Building rental Office furniture and equipment rental Office supplies Utilities Salaries ($34,000 + $42,000) Payroll taxes Fuel and oil Cost recovery (Note 3) Front-end loaders Dump truck Car Total business expenses Business income before § 179 deduction Less: § 179 deduction (Note 1) Business income Interest income Dividend income Gain on stock sale (Note 2) Adjusted gross income

$912,000 $36,000 9,000 2,500 4,000 76,000 7,000 21,000 30,000 48,000 11,160

(244,660) $667,340 (510,000) $157,340 10,000 9,500 15,000 $191,840

Notes (1)

Section 179 deduction of $510,000 (total acquisitions less than $2,030,000).

(2)

The inheritance of IBM stock worth $110,000 from Aunt Mildred is excludible under § 101.

John’s recognized gain on the sale of the IBM stock is $15,000 ($125,000 amount realized − $110,000 adjusted basis) and is automatically classified as a long-term capital gain.

(3)

Cost recovery Front-end loaders Additional first-year depreciation [($560,000 − $510,000) × 50%] MACRS cost recovery [($560,000 − $510,000 − $25,000) × .20] Total deduction

$25,000 5,000 $30,000

© 2018 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

8-20

2018 Comprehensive Volume/Solutions Manual Dump truck Additional first-year depreciation ($80,000 × 50%) MACRS cost recovery [($80,000 − $40,000) × .20] Total

$40,000 8,000 $48,000

Car Additional first-year depreciation ($75,000 × 50%) MACRS cost recovery [($75,000 − $37,500) × .20] Total potential deduction

$37,500 7,500 $45,000

Limited to ($3,160* + $8,000)

$11,160

*The cost recovery limits are indexed annually. The 2016 amounts are used.

RESEARCH PROBLEMS 1.

CLIENT LETTER Maloney, Hoffman, Raabe, & Young, CPAs 5191 Natorp Boulevard Mason, OH 45040 April 1, 2018 Ms. Cassandra Martin, CFO Dave’s Sport Shop 867 Broadway New York, NY 10003 Dear Ms. Martin: This letter is in response to your request to provide Dave’s Sport Shop with tax advice regarding the tax treatment of the inventory management software purchased in 2017.

Generally, tax law provides that the cost of off-the-shelf software is recovered over 36 months, which would mean that the full cost of the software could not be deducted in the year of purchase. However, software is eligible for IRC § 179 expensing. In 2017, this provision allows for up to $510,000 of the cost of property other than real estate placed in service in the year to be immediately expensed. As long as Dave’s Sport Shop has not exceeded this limit with other property acquired in 2017 and expensed under § 179, the full cost of the software can be deducted under the provisions of § 179.

If we can be of assistance in helping you to maximize your cost recovery deductions, please let me know.

Sincerely, Gayle B. Anders, CPA Partner

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Depreciation, Cost Recovery, Amortization, and Depletion

8-21

TAX FILE MEMORANDUM DATE:

March 30, 2017

FROM:

Gayle B. Anders

SUBJECT:

Amortization of software costs

Cassandra Martin, CFO of Dave’s Sport Shop, has requested that we provide tax advice regarding the immediate deduction of the cost of inventory management software purchased in the 2017 tax year.

Per IRC § 167(a), off-the-shelf software that has not been substantially modified is amortized over 36 months. (Note that software acquired as part of the purchase of a trade or business is an IRC § 197 intangible, subject to 15-year amortization. The client has not indicated that the software was acquired as a part of the acquisition of a business.)

However, software is eligible for IRC § 179 expensing as well as additional first-year depreciation. As long as Dave’s has not exceeded the maximum § 179 limit in 2017 ($510,000) with other property acquired, the full cost of the software can be deducted in 2017. I did not mention the additional firstyear depreciation provisions to the client. If acquisitions qualifying for § 179 exceed $510,000 for the year, we should contact the client to make her aware of this additional benefit.

I have notified Cassandra Martin of the amortization and § 179 provisions.

2.

The facts of the case are similar to Chief Counsel Advice Memorandum 201234024, May 9, 2012. In the memorandum, it was determined that a vineyard constituted § 179 property. Hence, taxpayers were entitled to elect to expense the costs incurred when the vineyard was planted on the current year’s income tax return. Therefore, Jed should be able to deduct the costs incurred in planting the vineyard in 2013 on his 2017 income tax return. This is assuming that all of the other requirements under § 179 have been satisfied.

3.

The facts of the case are similar to Bruce Selig, 70 TCM 1125, T.C. Memo. 1995–519. In this case, the court ruled that a deduction was allowable. The Court found that over time, the exotic automobiles would, because of those exotic features, become obsolete in the petitioner’s business.

The fact that petitioner failed to show the useful lives of the automobiles was irrelevant to the decision.

Research Problems 4 and 5 These research problems require that students utilize online resources to research and answer the questions.

As a result, solutions may vary among students and courses. You should determine the skill and experience levels of the students before assigning these problems, coaching where necessary. Encourage students to use reliable websites and blogs of the IRS and other government agencies, media outlets, businesses, tax professionals, academics, think tanks, and political outlets to research their answers.

4.

MarketWatch provides such a calculator: www.marketwatch.com/tools/carleaseorbuy. Edmunds.com also provides a helpful discussion of the costs and benefits of leasing versus buying: www.edmunds.com/car-buying/should-you-lease-or-buy-your-car.html.

© 2018 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

8-22 5.

2018 Comprehensive Volume/Solutions Manual In a November 2013 tax reform proposal released by Max Baucus (formerly a senator from Montana and the Chair of the Senate Finance Committee), a change to the current system of depreciation was proposed. In theory, this change would generate additional tax revenue that would allow the corporate tax rate to be lowered. Search on www.finance.senate.gov to find this proposal.

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Depreciation, Cost Recovery, Amortization, and Depletion

8-23

CHECK FIGURES 21.

22.

23.a.

23.b.

24.

25.

26.

27.

28.

29.

30.

31.

32.

33.

34.a.

34.b.

35.a.

35.b.

36.

37.a.

37.b.

38.

39.

40.a.

40.b.

41.a.

$11,432; $19,592. $3,570; $27,550. $36,360. $25,640. $280; $560. $34,125. $5,600; $206,400. $2,212; $3,570. $7,250. $1,200,000. $47,600.

Loss $11,515. $300,000 basis; $8,637 cost recovery. $74,289. $38,839. $6,457. $40,000. $32,000. $16,640. $20,330. $52,776. $38,640.

2017: $173,340; 2027: $276,912. $25,610. $41,360. $524,290.

41.b.

41.d.

41.e.

42.

43.

44.

45.

46.

47.

48.

49.

51.

52.a.

52.b.

53.

54.

55.

56.

57.

58.

$530,000. $150,094. $16,296.

Cost recovery $155,000; § 179 carryforward $369,290.

2016: $528,573; 2017: $6,123. $35,000. $1,000. $11,160 in 2016; $3,200 in 2017. $47,200.

Deduction in 2017 $2,528; deduction in 2018 $2,800; recapture in 2019 $928. $174.

Regular tax deduction $3,200; AMT deduction $2,400.

PV of tax cost is ($3,031).

PV of tax cost is ($688).

The first option produces a $12,617 greater deduction. $3,556. $3,700. $4,360,000 taxable income.

Refund for 2016 $69.

AGI without purchase $188,000; AGI with stock sale and car purchase $191,840.

© 2018 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

8-24

2018 Comprehensive Volume/Solutions Manual

SOLUTION TO ETHICS & EQUITY FEATURE Section 179 Limitation (p. 8-14). Joe can expense $25,000 of the cost of the truck under § 179. The income limitation is the aggregate amount of taxable income derived from the conduct of any trade or business.

Although Joe reported a net operating loss from one business, the sale of his other business had a profit of $300,000. Therefore, taxable income is not a limitation.

SOLUTIONS TO ROGER CPA REVIEW QUESTIONS Detailed answer feedback for Roger CPA Review questions is available on the instructor companion site (www.cengage.com/login).

1.

a

4.

b

2.

c

5.

d

3.

b

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Depreciation, Cost Recovery, Amortization, and Depletion 57.

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8-25

8-26

2018 Comprehensive Volume/Solutions Manual

57. continued

© 2018 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

Depreciation, Cost Recovery, Amortization, and Depletion 57. continued

© 2018 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

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57. continued

© 2018 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

Depreciation, Cost Recovery, Amortization, and Depletion 57. continued

© 2018 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

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57. continued

© 2018 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

Depreciation, Cost Recovery, Amortization, and Depletion 57. continued

© 2018 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

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© 2018 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.