Depreciation i for tax purposes is not the same as depreciation for management decisions or accounting. Non cash event but still reduces taxable income Flexibility in calculating it Can be used to level lincome
Establishes Etblih an asset s value at a given time: Beginning Tax Basis This is not the asset s value for purposes p on a balance sheet; it is a value for tax purposes only Basis adjusts over the asset s s useful life: Adjusted Tax Basis The asset s useful life for tax purposes is not the same as useful life for accounting or management decisions All assets are assumed to have a salvage value of $0 (under most common depreciation system). Adjustment rate depends on class of asset
If asset is purchased outright ti new or used: beginning tax basis = purchase price If asset is acquired by trading in another asset: beginning tax basis = cash boot + remaining adjusted tax basis of trade in Cash boot = cash paid to complete the trade Adjusted tax basis almost never equals the value of an asset because tax depreciation is considered fast.
So how do you calculate the depreciation to arrive at an adjusted tax basis? MACRS ~ Modified d Accelerated Cost Recovery System ** There are alternatives but this is most frequently used (likely because it is the faster depreciation schedule). Can you formulate arguments for and against a faster Can you formulate arguments for and against a faster depreciation? What might it depend upon?
3 year: breeding hogs 5 year: cars, pickups, breeding cattle and sheep, dairy cattle, computers, trucks 7 year: most machinery and equipment, fences, grain bins, silos, furniture 10 year: single purpose agricultural and horticultural structures, fruit or nut trees 15 year: paved lots, wells, drainage tile 20 year: general purpose buildings
All assets have a salvage value of $0 ½ Year Rule: automatic ½ year of depreciation in the first year regardless of date of purchase Exception: If > 40% of assets purchased that year are placed in service in the last 3 months of the year, then depreciation of each asset begins in the middle of the quarter in which it was purchased
Recovery Percentages Recovery 3-year 5-year 7-year Year class class class 1 25.00 15.00 10.71 2 37.50 25.50 19.13 3 25.00 17.85 15.03 4 12.50 16.66 12.25 5 16.66 12.25 6 8.33 12.25 7 12.25 8 6.13 Be sure to always check current tax code
Section 179 of the tax regulations provides for expensing Optional, can only be taken in purchase year Not a depreciation in language but has the same effect Puts a large chunk of depreciation in the first year; reduces the remaining depreciable amount (reduces the tax basis). Most 3, 5, 7, and 10 year class property is eligible Only eligible on cash boot amount of trade in.
The maximum section 179 expense deduction you can elect for qualified section 179 property you placed in service in tax years that begin in 2009 remains at $250,000 5, ($285,000 for qualified enterprise zone property and qualified renewal community property). This limit is reduced by the amount by which h the cost of section 179 property placed in service in the tax year exceeds $800,000. (www.irs.gov)
You knew it was too good to be tue true. MACRS creates an incentive to quickly depreciate an asset for tax purposes and then sell or trade it again. But For depreciated assets whose selling price is greater than its adjusted tax basis, you have to claim as income the amount of depreciation recapture. Depreciation Recapture = (selling price adjusted tax basis) The income from depreciation recapture is not subject to SE tax. Only used on sales, not trade in s of like assets.
This is a tax on income Results from the sale or exchange of certain qualified assets (called Section 1231 assets for farmers/ranchers). It is the gain or profit on the sale of an asset above its original purchase price. If asset is depreciable, depreciation recapture applies first, then capital gains. To qualify, the asset has to have been held for a specified minimum amount of time (currently 1 year).
1. Capital gains income is not subject to the self employment tax. 2. Capital gains income is generally taxed at a lower rate than ordinary income.
Cash basis farmers have a basis of zero on raised breeding or working livestock; hence the entire sales value can often be treated as capital gains. Purchased livestock may be eligible if sales price is above original purchase price. Remember though, purchased livestock are depreciable.
Understand the difference between depreciation for tax purposes and depreciation for balance sheet / farm statements Calculate beginning tax basis for assets purchased outright and those purchased on trade in Calculate adjusted tax basis if given asset class and depreciation schedule. Know what expensing is (for tax purposes) and how it differs from depreciation; if an asset is expensed and then used for a trade in, how does that affect the beginning tax basis of the asset purchased with the trade in? Calculate adjusted tax basis, expense deductions and depreciation amounts if given expensing and depreciation schedule (see example). Define and calculate depreciation recapture; how is it taxed? Define and calculate capital gains; how is it taxed? In what way is capital gains tax different from ordinary income tax? How is a capital loss determined? d? Understand how/if capital gains tax may be used in each of the following situations: a) raised breeding stock using cash basis; b) raised breeding stock using accrual basis; c) purchased breeding stock using cash basis; d) purchased breeding stock using accrual basis. Understand the calculations in the example provided.
Example from Lecture on April 19 th Concepts: beginning tax basis, adjusted tax basis, expensing, depreciation recapture, and capital gains In Farmsim you begin with Machinery Set #1 (MS1) and are given the option to trade-up for different machinery sets. Let s look at an example of some of the tax implications of trading in MS1 for Machinery Set #2 (MS2) and then also selling MS1 outright under different scenarios. Suppose you are given the following information: Trade-in of Machinery Set #1 for Machinery Set #2 Mach Set #1 Price: $225,000 Mach Set #2 Price: $280,000 Cash Boot if Trade-in Year #3: $105,000 Cash Boot if Trade-in Year #7 $205,000 The cash boot assumes a useful life of 7 years and salvage value = $50,000 Depreciation Schedule for Machinery Set #1 Year Recovery Depreciation Taken Cumulative Depreciation Adjusted Tax Basis 1 10.7% $24,098 $24,098 $200,903 2 19.1% $43,043 $67,140 $157,860 3 15.0% $33,818 $100,958 $124,043 4 12.3% $27,563 $128,520 $96,480 5 12.3% $27,563 $156,083 $68,918 6 12.3% $27,563 $183,645 $41,355 7 12.3% $27,563 $211,208 $13,793 8 6.1% $13,793 $225,000 $0 Total 100.0% $225,000 Note: the cash boot is calculated by the farm equipment dealer and he has calculated that the market value of MS1 in year #3 is $225,000 less $25,000 depreciation for each full year. The $25,000 market value depreciation has been calculated assuming that MS1 has a useful life of 7 years and salvage value of $50,000. Recall that the useful life and salvage value for market value purposes is NOT the same as for tax purposes. The cash boot is based off market value. 1. Calculate the adjusted tax basis for MS2 if MS1 is traded-in at the beginning of tax year #3 (MS1 has only been depreciated on taxes for 2 years). Beg. tax basis on MS2 = cash boot + adjusted tax basis on MS1 = $105,000 + $157,860 = $262,860 2. Calculate the adjusted tax basis for MS2 if MS1 is traded-in at the beginning of tax year #7 (MS1 has only been depreciated on taxes for 6 years). = $205,000 + $41,355 = $ 246,355
Suppose instead of using the MACRS depreciation schedule for tax purposes, you had elected to expense the purchase of MS1 in the first year you bought it. The tax laws at that time (2006) allowed you to expense up to $108,000 in the first year, and so you did. This is what the new expensing and depreciation table would look like given that MS1 is in the 7- year class of assets. Depreciation Schedule for Machinery Set #1 assuming EXPENSING was taken in Year #1 Year Recovery Depreciation / Expense Taken Cumulative Depreciation Adjusted Tax Basis 1 - $108,000 $108,000 1 10.7% $12,531 $120,531 $104,469 2 19.1% $22,382 $142,913 $82,087 3 15.0% $17,585 $160,498 $64,502 4 12.3% $14,333 $174,830 $50,170 5 12.3% $14,333 $189,163 $35,837 6 12.3% $14,333 $203,495 $21,505 7 12.3% $14,333 $217,828 $7,172 8 6.1% $7,172 $225,000 $0 Total 100.0% $225,000 In Year #1, MS1 is expensed for $108,000 and then depreciated (both are allowed in the first year) by $12,531 (10.7% of the adjusted tax basis AFTER expensing). Expensing reduces the tax basis. 3. Calculate the adjusted tax basis for MS2 if MS1 is traded-in at the beginning of tax year #3 (MS1 has been expensed and depreciated for 2 years). Beg. tax basis on MS2 = cash boot + adjusted tax basis on MS1 = $105,000 + $82,087 = $187,087 4. Calculate the adjusted tax basis for MS2 if MS1 is traded-in at the beginning of tax year #7 (MS1 has been expensed and depreciated for 6 years). = $205,000 + $21,505 = $226,505?? Can you see the difference in the beginning tax basis of MS2 if MS1 is expensed vs not expensed? How might this matter in future years??
5. Now if you wanted to expense MS2, how much can be expensed and depreciated in the first year? Since MS2 was not purchased outright, only the amount of the cash boot can be expensed up to $109,000. If this happened at the beginning of year #3 of MS1, then MS2 can only expensed in the first year for $105,000 and the depreciation to be taken would be 10.7% of ($187,087 - $105,000) = $8783. If instead the trade-in took place at the beginning of year #7, MS2 can be expensed in the first year for $109,000 and then depreciation in that first year would be 10.7% of ($226,505 - $109,000) = $12,573. 6. Instead of trading in MS1, you decide to sell it outright. Calculate the depreciation recapture (if any) and capital gains (if any) in each of the three situations (assume MS1 had NOT been expensed but make sure you know how to calculate these even if it had been expensed). Remember, depreciation recapture is taxed as ordinary income (but not subject to self-employment tax) and capital gains are taxed at the capital gains tax rate, often lower than the ordinary income tax rate. a) Sold MS1 outright for $230,000 at the beginning of year #3 Depreciation recapture = selling price adjusted tax basis (up to the original purchase price) = $225,000 - $157,860 = $67,140 Capital gains = selling price original purchase price (beginning tax basis) = $230,000 - $225,000 = $5,000 b) Sold MS1 outright for $175,000 at the beginning of year #3 Depreciation recapture = $175,000 - $157,850 = $17,140 No capital gains. c) Sold MS1 outright for $110,000 at the beginning of year #3 No depreciation recapture since the selling price is less than the adjusted tax basis Capital gain = $110,000 - $157,860 = -$47,860 ** CAPITAL LOSS because the selling price is less than adjusted tax basis.