DEPRECIATION $350K $100K $425K - $25K $75K $450K - $50K $50K HIGH- STAKES TAX DEFENSE & COMPLEX CRIMINAL DEFENSE

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1 HIGH- STAKES TAX DEFENSE & COMPLEX CRIMINAL DEFENSE 1012 Broad Street, 2nd Fl Bloomfield, NJ Tel (973) Fax (973) DEPRECIATION I. Depreciation groups a. Tangible personal property i. SS 179 was put in to help small mom and pop operations. How do they know you are a mom and pop? (i.e. desks, trucks, tractors, ovens) ii. Hypo is a $300K truck w/ a life of 5 years where T elects SS 179 bonus. T purchases $50K of property during the year. T s income form business this year is $300K iii. Bonus Depreciation 1. Step 1: Did T elect SS 179 bonus (generally $100K)? (Here, yes.) If so, determine amount allowed a. Check limitation based on basis of the asset (can t exceed basis) i. Basis is $300K so can t exceed this, however, b/c the maximum allowable deduction is only $100K and $100K is less than $300K this is n/ relevant ii. What if the basis of the truck is $70K and n/ $300K, what is the? Depreciation is $70K and n/ $100K b/c the bonus can t exceed the basis of the asset (it s limited to the basis of the asset) b. Check limitation based on amt. of SS 179 property purchased during the year (reduced dollar for dollar for each dollar of SS 179 property purchased in excess of $400K) i. Amt. of property purchased is $350K ($300K + $50K) which is less than $400K so there is no dollar for dollar reduction 400K Threshold $100K possible $350K $100K $425K - $25K $75K $450K - $50K $50K Michael J. DeBlis Jr., Esq. Partner MJDeBlisJr@DeBlisLaw.com Michael J. DeBlis III, Esq. Partner MJDeBlis@DeBlisLaw.com 1

2 $500K - $100K $0 c. Check limitation based on income from business (can t exceed income from business) i. Income from business is $300K so we don t have to be worried about the exceeding the business s income since $100K is less than $300K ii. What if the companies income were $70K and n/ $300K? Then the bonus would be $70K and n/ $100K b/c the can t exceed income from business 2. Step 2: Reduce basis by SS 179 bonus a. Bonus = $100K b. $300K - $100K= $200K iv. MACRS Depreciation 1. Step 3: Recover remaining adjusted basis (amt. determined under Step 2) under MACRS a. Select the correct percentage from the chart based on the class life and year at issue i. 5 years so 20% b. Multiply by TOTAL amt. to be depreciated under MACRS (note: this # never changes and will be the # determined in Step 2) by the percentage from the sheet i. $200K x 20%= $40K c. If year of sale, apply the ½- year convention i. i.e. July 1 ii. This isn t the year of sale 2. Step 4: Reduce the basis determined under Step 2 by MACRS a. $200K $40K= $160K 3. Step 5: Determine total for year: a. 179 (Step 1) (first year only) +MACRS (Step 3)=Total Depreciation i. Total Depreciation for first year: $100K + $40K= $140K ii. Total Depreciation for second year: $200K x 32%=$64K b. Real property (i.e. buildings) 2

3 i. Convention: Depreciation is calculated on a monthly basis in the year that the property is purchased or constructed and in the year that it is disposed of. The property is deemed to have been acquired or disposed of in the middle of the month 1. Hypo a. What if buy property on April 1? How many months of do you get? 8 ½. Get 11 ½ months of if buy property in January 30 b. What if buy apartment building on October 5? Property is deemed to have been acquired on October 15 so get half a month of deduction in October and two months of deduction for November and December ii. Step 1: Select the correct chart: 1. Residential or nonresidential real property? Must determine what real property it is: a. Residential or i. Buy residential property in May for $100K. Look in top of residential rental property chart for May 1. Year 1: $100K x 2.27%=$2, Year 2: $100K x 3.64%=$3, Year 3: $100K x 3.64%=$3,640 b. Nonresidential i. Hypo: Buy an apartment building in May for $100K. Look in nonresidential real estate chart for May to determine yearly : 1. Year 1: $100K x 1.6%=$1, Year 2: $100K x 2.56%=$2, Year 3: $100K x 2.56%=$2, Elect out of MACRS? iii. Step 2: Using the month the asset was placed in service, select the percentage for the year in issue iv. Step 3: Depreciation=(cost of the property) x (the percentage) c. intangible property i. All physical property (except land) that is used in a trade or business or held for production of income, and that has a limited useful life, may be depreciated 1. goodwill, 2. customer lists, 3. client lists, 3

4 4. franchise, 5. covenants n/ to compete, 6. going concern value ii. Prior law is obsolete: There is now a 15- year amortization period so it doesn t matter that T can t establish a determinable useful life and what the length of that life is iii. Step 1: Allocate the cost of the asset ratably over 15 years by dividing by 180 months iv. Step 2: Determine how many months T had the asset during the year v. Step 3: Amortization for year=(amt. per month) x (number of months) vi. Ask: 1. Does it wear out? a. if it doesn t, then the asset cannot be depreciated i. Assets other than intangibles that do n/ wear out (works of art and land) can be depreciated b. But Note: Cts. have allowed musicians to depreciate rare musical instruments, even though such instruments generally increase in value and last for hundreds of years, b/c they do suffer wear and tear w/ use viol vii. Hypo 1. Bought client list. Cost you $27,000 on Nov. 1. a. Allocate the $27K cost of the list ratably over 15 years (divide by 180 months). i. $27K/180=$150/mo b. How many months did T have the list during the first year? Purchased list on Nov. 1 so he had it for two months in the first year. i. Determine the total number of months that T had the list 1. 2 months plus 180 months (15 years)=182 months c. Amortization for year = (amount per month) x (number of months) i. Amortization for first year: $150 x 2= $300 ii. Amortization for second year and each subsequent year: $150 x 12= $1,800 d. all other depreciable/amortizable assets i. The cost of the asset is recovered ratably over its useful life. ii. Depreciation=cost of the asset/its useful life 4

5 e. Note on adjusted basis: Basis must be reduced by the amt. of allowed or allowable. The basis must be reduced by the greater of the amt. of allowed under the code or the amt. claimed by T f. Worksheet 1. L buys a freezer for her business. She pays $10K for the freezer and it has a class life of 7 years. She does n/ elect to claim add l under 179 (Tangible personal property example) Depreciation Basis Gain Amt. Realized a. In the year she purchases the freezer, how much can she claim? b. What is her basis in the freezer at the beginning of the second year? $10K x 14.28%=$1,428 $10K Basis=basis from prior year from prior year. $10K- $1,428=$8,572 c. In the second year, how much can she take? $10K x 24.49%=$2,449 d. In the 3 rd year she sells the freezer for $9K $9K What is her basis in the freezer at the $8,572 - $2,449=$6,123 5

6 beginning of the 3 rd year? How much can she claim in the 3 rd year? ½ year convention b/c she is selling freezer: $10K x 17.49%=$1,749. Divide by 2 and that equals $ How much gain must she report due to the sale? Amt. realized adjusted basis=$9k - $6,123=$2,877. Add Year three s : $2,877 + $874.50=$3, Rory publishes a monthly financial newsletter. To reproduce the newsletter, she purchases a copying machine for $150K, which has a class life of 5 years (tangible personal property example). Rory elects SS 179 ($100K) Step 1: What is the SS 179 bonus? Step 2: Reduce basis by SS 179 bonus Step 3: Recover remaining adjusted basis under MACRS Step 4: Reduce basis determined under Step 2 by MACRS Step 5: Total fo year If she also bought a table and desk for $350K, how much bonus would she qualify for under SS 179? Total =$350K + $150K=$500K. B/c the total is $100K greater than $400K, there is a dollar for dollar reduction of the $100K bonus. $100K - $100K=$0 6

7 If Rory only buys the copy machine but earns only $50K from her business how much bonus would she qualify for under SS 179? $50K. Bonus can t exceed income from business If Rory buys only the copy machine and makes $200K from her business, how much total can she claim in the first year? $100K $150K - $100K=$50K Recover remaining adjusted basis under MACRS: 20% x $50K=$10K $50K - $10K=$40K $100K + $10K=$110K How much can she claim in second year? $50K x 32%=$16K g. Intangible property example: On Feb. 1 of the second year, for $15,120 she purchased a list of customers from BankCo and she will send a flyer to each person on the list i. Can she amortize the cost of the list? If so, how much can she claim in the year she purchased the list? 1. allocate cost of asset over 15 years so we have $15,120/180=$84 2. she had asset for 11 months in year 1 3. amt. per month x number of months= amortization for year a. $84 x 11= $924 for year 1 b. $84 x 12= $1008 for year 2 7