Federal Taxation 2013 Pratt 7th Edition Solutions

Manual

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Federal Taxation 2013 Pratt 7th Edition Solutions Manual

Capital Recovery: Depreciation Amortization, and Depletion

Solutions to Problem Materials

DISCUSSION QUESTIONS

9-1 Section 167 sets forth the basic requirements, stating that a depreciation deduction
is allowed for the exhaustion, wear and tear, and obsolescence of property that is
either used in a trade or business or held for the production of income. The
regulations further state that only property that has a determinable life can be
depreciated. Property must be used for business or income-producing purposes, at
least in part, to be eligible for depreciation. [See p. 9-3, § 167(a), and Reg. §
1.167(a)-2.]

9-2

a. Land is not depreciable because it does not have a determinable life. [See p. 9-
3, § 167, and Reg. § 1.167(a)-2.]

b. If a single asset is used for both personal activities and profit-seeking

activities, the taxpayer may deduct depreciation on the portion of the asset
used for business or production of income. Here, the taxpayer cannot deduct
depreciation for the half of the duplex he lives in because this is personal use
of the asset. He can deduct depreciation for the half he rents out, as this
property is used for the production of income. (See Example 1 and p. 9-3.)

c. As in part (b), the taxpayer can deduct depreciation on the portion of the asset
used for business or for the production of income. Here, the taxpayer can
deduct depreciation on the portion of the residence she uses as a home office.
(See Example 1 and p. 9-3.)

d. Taxpayer can deduct depreciation on property that was formerly used for
personal purposes (e.g., a residence) and has been converted to use in business
or production of income activities. A depreciation deduction can be taken on a
former residence held out for rental use (i.e., production of income), even if
the property has not yet been rented. [See p. 9-3 and Reg. § 1.167(a)-10.]

e. As in part (d), where property used for personal use is converted to use in
business or production of income activities, depreciation can be deducted on
that property. (See Example 2 and p. 9-3.)

f. For many years, covenants not to compete could be amortized over their
useful life. In contrast, goodwill could not be amortized since it did not have a
determinable life. However, since 1993 § 197 has permitted amortization of
both intangibles over 15 years regardless of their actual life. [See p. 9-38 and

Visit TestBankBell.com to get complete for all chapters

 § 197.]

g. If the standard mileage rate is used to compute the deduction for business or
income-producing usage of an automobile, no depreciation deduction can be
taken. The decline in value (i.e., depreciation) is already included in the
standard mileage rate. (See p. 9-5.)

9-3 There are various cost allocation methods allowed by the Code, including
depreciation, amortization, and depletion. Depreciation denotes the process by
which expenditures for tangible property with a determinable life are
systematically and rationally allocated to the periods that the property benefits.
Amortization is the same process applied to intangible assets with determinable
lives, such as patents or copyrights. Depletion is the method of recovering the cost
of investments in natural resources, such as oil, gas, and certain metals and
minerals, as these assets are extracted and sold. (See p. 9-2; and §§ 167, 168, 611,
and 613.)

9-4 In practice, one might encounter the following depreciation systems:

1. Under the facts-and-circumstances system, the taxpayer elects to depreciate

tangible property under the straight-line, declining-balance, or sum-of-the-
years'-digits methods. In this system, the taxpayer ascertains a useful life and
a salvage value for the property according to all the facts and circumstances.
Intangible assets are depreciated using the straight-line method over their
useful lives, as is the case in all depreciation systems.

2. Under the Class Life System, the taxpayer depreciates assets by electing a
useful life for the assets from prescribed depreciable life ranges promulgated
by the IRS.

3. In 1981, the facts and circumstances system and Class Life System were all
but eliminated for assets placed in service after 1980. In the Economic
Recovery Tax Act of 1981 (ERTA), Congress substantially revised the
method for computing depreciation by adding the Accelerated Cost Recovery
System (ACRS) under § 168. Altered several times since 1981, the current
version of this system is known as the Modified Accelerated Cost Recovery
System (MACRS). An alternative to MACRS, called the Alternative
Depreciation System (ADS), is also available. A major benefit of MACRS
and ADS is the elimination of previous areas of dispute between taxpayers
and the IRS. Under these systems, the taxpayer is required to choose from a
small set of predetermined options regarding depreciable life and depreciation
method. Salvage value is ignored in all cases. Thus, depreciation calculations
are more uniform for all taxpayers.

(See pp. 9-4 and 9-5.)

9-5 Property not subject to MACRS includes

 1. Property owned or placed in service before 1987.

2. Intangible property.

3. Property depreciated under a method that is not expressed in terms of years.

For example, if the taxpayer initially elects to use the standard mileage rate to
account for automobile expenses, this is considered a method of depreciation
expressed in terms other than years. Thus, MACRS cannot be used for
vehicles if the standard mileage rate has been previously used.

4. Certain motion picture films, video tapes, and public utility property.

5. Property ineligible due to the anti-churning rules. [See p. 9-5 and § 168(e).]

The taxpayer may avoid using MACRS on limited amounts of property by

electing to expense the property under § 179. This provision allows the taxpayer
to expense up to a given amount of tangible personal property used in a trade or
business, and not acquired from a related party. (See Examples 17, pp. 9-21
through 9-23, and § 179.)

9-6

a. Office furniture is considered seven-year recovery property; the first-year

recovery percentage is 14.29 percent. This percentage was computed by
taking the straight-line rate for seven years (i.e., 1/7 = 14.29%) and
multiplying it by 200 percent to accelerate depreciation. The result (i.e.,
28.57%) was then divided by two to allow only a half-year of depreciation in
the first year. (See Example 7, Exhibit 9-3 and Exhibit 9-4, and p. 9-11.)

b. Residential real property is considered to be 27.5-year property; the first-year

recovery percentage for property placed in service in the first month of the
year is 3.485 percent. This percentage was computed by taking the straight-
line rate for 27.5 years (i.e., 1/27.5 = 3.64%). This is then divided by 12 in
order to compute the monthly percentage (3.64% × 1/12 = 0.303%). In order
to give effect to the mid-month convention, this percentage is multiplied by
11.5 to obtain the depreciation percentage for the year, 3.485 (11.5 × 0.303%).
(See Example 10, Exhibit 9-5, and pp. 9-12 and 9-14.)

9-7 Taxpayers who wish to use the slower straight-line method have two options after
1986. They may elect the straight-line method under either MACRS or the
alternative depreciation system (ADS). The only difference between straight-line
under MACRS and the normal MACRS method is that the straight-line method is
used rather than an accelerated method. Under MACRS, depreciation is computed
using an accelerated method for all property except residential and nonresidential
real estate. When using the straight-line alternative under MACRS, property is
depreciated using the same recovery period and accounting convention as is
normally used. Under ADS, depreciation is computed in the same manner as
MACRS straight-line except the recovery periods to be used are different. Exhibit
 9-9 For ADS, the property's class life serves as the recovery period except when
there is no class life prescribed or a special life has been prescribed by statute.
ADS must be used to compute depreciation for property not used more than 50
percent for business, alternative minimum tax (using 150% balance), and earnings
and profits of a corporation. (See pp. 9-17 and 9-18.)

9-8 Taxpayers should select the depreciation method that maximizes the present value
of tax savings from depreciation deductions. For most taxpayers, the method that
achieves this goal is the one that provides the most rapid write-offs over the
shortest time period (i.e., MACRS accelerated depreciation). Taxpayers who
expect their future marginal tax rate to remain constant or decline should select
MACRS accelerated depreciation. However, for taxpayers anticipating their
future marginal tax rate to rise or fluctuate (perhaps due to business conditions,
expected future tax legislation, or loss carryovers from NOLs, charitable
contributions, or capital losses), a slower rate of depreciation over a longer
recovery period may actually yield a higher present value of tax savings from
depreciation deductions. For these taxpayers, either the ADS straight-line or
accelerated method may be optimal. Present value analysis should be used to
make the proper depreciation method choice. ADS is generally elective but must
be used in computing depreciation in the following situations: (1) for listed
property that is not used predominately for business (i.e., more than 50%), (2) in
the computation of a corporation's earnings and profits [see § 312(k)(3)(A)], and
(3) for purposes of the alternative minimum tax. (See pp. 9-18 through 9-19.)

9-9

a. No. MACRS assigns a useful life to be used in computing depreciation for

each asset. (See p. 9-5.)

b. No. Salvage value is ignored under MACRS. (See p. 9-5.)

c. Yes. The accounting convention is determined by the type of property. In

computing the depreciation for real property, the taxpayer must use the mid-
month convention. This allows the taxpayer a half-month of depreciation for
the month the asset is placed in service and one additional month for each
month the asset is in service. In addition, for personal property, the taxpayer is
required to use the mid-quarter convention if more than 40 percent of the cost
of personal property is placed in service during the last three months of the
taxable year. (See pp. 9-9 through 9-14.)

d. Yes. Because different useful lives are used to depreciate residential (27.5
years) and nonresidential buildings (39 years), the taxpayer must characterize
the building as one or the other. If 80 percent or more of the gross rents from
the building are from rental of the dwelling units, the building is considered
residential. (See p. 9-9.)

e. No. Depreciation is computed in the same manner for all entities.

 f. No. Property is depreciable if used in a trade or business or for investment
purposes. The depreciation methods that are used for the different properties
are the same. However, the limited expensing provisions of § 179 can be
applied only to expense property that is used in a trade or business. (See pp. 9-
3 and 9-23.)

g. Yes. A portion of the cost must be allocated to the land, which is not
depreciable. (See p. 9-3.)

h. Yes. If the building is leased to a tax-exempt entity only ADS may be used.
(See p. 9-37.)

9-10

a. False. For the year that the asset is placed in service, the various conventions
preclude the taxpayer from obtaining a full year of depreciation. If the
property is personal property, the asset is treated as having been in service for
one-half the number of months in the year regardless of when it is placed in
service. If the property is real property, the taxpayer is allowed only a half-
month of depreciation for the month the asset is placed in service. (See pp. 9-9
and 9-14.)

b. False. This statement is true only for personal property that is depreciated
using the half-year convention. Personal property must be depreciated using
the mid-quarter convention when more than 40 percent of the personal
property placed in service during the year is placed in service during the last
three months of the taxable year. Real property is depreciated using the mid-
month convention, which can yield up to 11.5 months of depreciation. (See
pp. 9-9 and 9-14.)

c. True only for personal property when the half-year convention applies. (See
pp. 9-9 and 9-14.)

d. False. Section 179 may be applied to expense the cost of qualifying property
regardless of the time when it was acquired. Time of acquisition is irrelevant.
(See p. 9-21.)

9-11 This problem demonstrates the significance of the tax treatment of goodwill,
which normally arises in the course of acquiring a business. Technically, under
the residual method of allocation required by § 1060, the amount allocated to an
asset cannot exceed the value of that asset. Any portion of the purchase price that
is not allocated to specific assets must be allocated to goodwill. Thus, the $2
million purchase price is allocated as follows: $1,400,000 to the tangible assets
(e.g., equipment) and the remaining $600,000 to goodwill. L will recover the
$1,400,000 investment in the tangible assets as they are sold or through their
depreciation. The $600,000 cost allocated to goodwill will be amortized over 15
years using the straight line method.
 L may be able to reduce the amount allocated to goodwill by breaking it into
component parts that have a limited life and thus may be amortized over a period
shorter than 15 years. For example, a portion of the "goodwill" may be allocated
to favorable leases or contractual relationships that may have a determinable life.
(See p. 9-38.)

9-12

a. False. Absent § 280F, in the year of acquisition, the taxpayer could elect to
expense the entire cost of the car. Section 280F limits depreciation of
passenger automobiles in 2012 to $3,160 in the first year. (See Example 21
and pp. 9-25 through 9-27.)

b. True. Absent § 280F, the taxpayer could recover the cost of a passenger
automobile over five years (plus one additional year to recover the half-year
of depreciation not allowed in the year the asset was placed in service). Under
current restrictions, however, the taxpayer must add additional years to the
normal recovery period for autos costing more than $15,800 ($3,160 in
2012/20%) (assuming accelerated depreciation is elected). (See p. 9-26.)

9-13 As with the acquisition of any business asset, D's objective is to minimize the
present value of the after-tax cost of the vehicle (while not compromising on
vehicle quality).

The lease vs. buy decision can be quite complex. Indeed, a search of the
Internet yields thousands of websites, offering explanations, considerations and
calculators.

In determining the after-tax cost, there is a conglomeration of special tax

rules, a virtual cornucopia of provisions, a patchwork of tax limitations, that must
be considered. There is one set of considerations if an automobile is purchased
and another set if the automobile is leased. The primary determinants of the
present value of the after-tax cost are the timing and amount of the deductions
related to the acquisition. Under the general rules, the cost of a vehicle would be
recovered through depreciation over its estimated useful life. The amount of
depreciation for tax purposes is generally governed by MACRS which enables the
cost of a car to be depreciated over five years using double declining balance. The
taxpayer does have other options that slow the speed of recovery, including the
straight-line methods of MACRS and ADS. However, there are a number of
provisions can alter this basic approach. For example, absent any limitations, the
cost of most vehicles could be expensed immediately under § 179. In 2012, § 179
permits taxpayers to deduct up to $125,000 (2012) in the year of acquisition.
However, the luxury automobile rules of § 280F limit the amount deducted in the
year of acquisition to $3,160 (2012) and impose additional limitations in
subsequent years. Below is a comparison of the recovery periods for an $18,000
automobile used 100 percent for business (See Example 21 and pp. 9-25 through
9-27.)
 Year

One Two Three Four Five Six Seven Eight

MACRS without limitation $3,600 5,760 3,456 2,074 2,074

1,037

MACRS with § 280F in 2012 $3,160 5,100 3,050 1,875 1,875 1,875
1,065 0

Note that § 280F effectively extends the recovery period an additional two years,
thereby increasing the present value of the after tax cost.

The basic operation of § 280F shown above is also altered in several situations
that must be considered in the analysis. The listed property rules of § 280F
prohibit the use of § 179 as well as MACRS depreciation by requiring the
taxpayer to use the straight-line method of ADS if the automobile is not used
more than 50 percent for business (and in the case of an employee that use must
be "qualified" business use). In addition, the limitations of § 280F are less
restrictive for trucks, vans or electric automobiles. The § 280F limitations are also
relaxed for SUVs (e.g., 6,000 – 14,000 pounds gross vehicle weight), allowing a
first-year write-off under § 179 of $25,000. Finally, the alternative minimum tax
may have an impact since AMT deductions for depreciation are normally made
using ADS. Note, however, that § 179 expensing is allowed for AMT purposes.

In contrast, if the vehicle is leased, the taxpayer eliminates all of the complex
rules relating to depreciation above—a nontax benefit that cannot be dismissed—
in exchange for yet another set of considerations. If the taxpayer leases, the lease
expense is generally a substitute for the depreciation expense. The lease is
expense is deductible when paid. But to ensure that the § 280F limitations are not
sidestepped the taxpayer must consider the income inclusion requirement. Under
this rule, the taxpayer must include in income annually an amount based on the
value of the vehicle. Note that the amount of income does not vary based on the
type of vehicle. There is no AMT concerns with leasing, which can be a huge
benefit.

There are still other tax considerations that cannot be overlooked. For
example, in the case of a purchase, if the taxpayer sells the vehicle at some point,
it often results in a deductible loss (an ordinary loss under § 1231 as discussed in
Chapter 17). However, if the vehicle is traded in for another vehicle, the potential
loss (or gain, if any) is postponed. Leasing does not produce gains and losses on
the disposition of the vehicle.

Finally, it must always be remembered that leasing is simply a method of

financing. For this reason, if the taxpayer finances a purchase of the vehicle, the
tax treatment of the interest expense must also be considered.

(See pp. 9-25 through 9-30.)

9-14

a. False. Under § 280F, the camera is considered listed property because it is

entertainment-related equipment. Because it is not used predominantly for
business (i.e., greater than 50%), the alternative depreciation system (ADS),
using the straight-line method and the asset's ADR life, must be used in
computing depreciation. Note also that the limited expensing benefits of § 179
are not available. (See pp. 9-30 and 9-31.)

b. True. Because the computer is listed property and is not used predominantly
for business, the limitations of § 280F apply. Thus, the taxpayer is not entitled
to use the limited expensing provisions of § 179. Moreover, depreciation must
be computed using the straight-line method under ADS. The statutory
recovery period for a computer under ADS is five years [see Exhibit 9-8 and
§§ 168(g)(3)(C) and 168(i)(2)]. Consequently, depreciation for the first year
would be $500 ($10,000 × 50% × 10% rate per Exhibit 9-8, five-year
property). Note, this problem assumes that the property is not exclusively used
at a regular business establishment. When the property is used in such a
manner, the rules of § 280F do not apply. (See pp. 9-30 and 9-31.)

c. True. Because the computer is listed property, the special provision of § 280F
must be considered. In this case, the computer is not used predominantly for
business (Investment use is not business use.). In making this determination,
only qualified business use is counted—which in this case is 35 percent.
Consequently, the limitations apply, and ADS must be used. In determining
the asset's depreciable basis, the time used for investment purposes is
combined with qualified business use. Thus, 95 percent (60% + 35%) of the
cost is subject to depreciation. (See Examples 27 and 28, and pp. 9-30 through
9-33.)

d. False. An employee's use is considered "qualified business use" only if it is for

the convenience of the employer and it is required as a condition of
employment. Although it is not completely clear what these standards
demand, the proposed regulations suggest that use such as C's is not for her
employer's convenience nor is it required. This is particularly true in light of
the Service's rulings (e.g., Letter Ruling 8615024), which require the taxpayer
to demonstrate that the work could not be properly performed without the
computer. (See Example 26 and pp. 9-32 through 9-33.)

e. True. Because the computer is used exclusively at a regular business

establishment—in this case a home office that satisfies the requirements of §
280A—it is not considered listed property.

(See p. 9-32.)

9-15

a. False. The statement incorrectly combines two of the four alternatives. The
 employer can include the entire value of the car as if it were compensation
income for the employee and the employee can then claim a mileage
deduction for business use. Alternatively, the employer can include only the
value of the personal use as if it were employee compensation, in which case
the employee would get no deduction.

b. False. The employer can treat the auto as used entirely for business as long as
one of the four qualified employer-provided auto methods is used to
determine the employee's taxable portion.

c. True. This is one of the four qualified employer-provided auto methods.

d. True. This is one of the four qualified employer-provided auto methods.

e. False. Section 280F applies in this situation. When an employee owns 5

percent or more of the employer, the employer can not disregard the personal
use of the employee. The employer can claim deductions for depreciation and
other related expanses only for the percentage based on actual business use.
Because the car was not used more than 50 percent for business (i.e., only
40%), ADS must be used rather than accelerated depreciation in depreciating
40 percent of the cost of the car.

(See Example 29 and pp. 9-33 and 9-34.)

9-16 Goodwill, going-concern value, covenants not to compete, and other so-called §
197 intangibles may or may not have indeterminate useful lives, but § 197
requires the cost of such items to be amortized using the straight-line method over
15 years. Because other intangible assets such as patents or copyrights have
ascertainable useful lives, they are generally amortized over their estimated useful
life using the straight-line method. [See pp. 9-38 through 9-39, § 197, and Reg. §
1.167(a)-3.]

9-17

a. Assume a state government wished to construct a new medical clinic for a

cost of $100,000. Instead of constructing the building, it might lease the
structure from a taxable entity. For example, a corporation in the 35 percent
tax bracket could construct the building and lease it to the state. Ignoring the
time value of money, the effective cost of the building to the corporation is
$65,000 ($100,000 cost – tax savings of $35,000), since it will ultimately
claim depreciation deductions for $100,000 that will save the corporation
$35,000 in taxes (35% × $100,000 depreciation). If the state builds the clinic
itself, none of the cost savings attributable to depreciation can be obtained
because it pays no taxes. In addition, it receives no tax benefits from other
expenses associated with the property such as interest, taxes, insurance, and
maintenance. However, if the state is willing to lease the property from the
corporation, the tax savings could be passed on to the state through the rental
terms. Moreover, the state would be willing to pay higher rent than a taxable
 entity, since a taxable entity would be entitled to the tax benefits just like the
corporation. Note, however, that property leased to a tax-exempt entity must
be depreciated using ADS. [See p. 9-37 and § 168(h).]

b. The cost of leasehold improvements are recovered in the normal manner

without regard to the term of the lease. (See p. 9-39.)

9-18 Section 1016 requires that the basis of property be adjusted to reflect allowed or
allowable depreciation. Although R has not claimed any depreciation on the
property, she must reduce the basis by the amount allowable, $80,000 [($100,000
/ 30 years) × 24 years]. A gain of $150,000 results [$170,000 – ($100,000 –
$80,000)]. R would receive no benefit from the reduction.

However, recently, the IRS has provided some relief to the taxpayer where the
taxpayer has failed to deduct the correct amount of deprecation. When the
taxpayer is entitled to additional depreciation, the IRS permits a change in
accounting method and the taxpayer may deduct all of the unclaimed depreciation
for years that are closed by the statute of limitations as well as open years. This is
normally done through a § 481 (a) adjustment that reduces income in the year of
the change (a single year adjustment). [See p. 9-19 and Reg. § 1.167(a)-10.]

9-19 Salvage value is completely ignored under MACRS. The entire cost of the
property may be recovered; that is, the asset may be depreciated below salvage
value to zero. [See p. 9-5 and § 168(g)(9).]

9-20 If the taxpayer elects to deduct under the limited expensing provisions all or a part
of the basis of an asset in the first year it is placed in service, the depreciable basis
is reduced by the amount so expensed. There is a fixed dollar ceiling which limits
the amount that the taxpayer may treat in this manner for each year. [See Example
17, pp. 9-21 and 9-22, and §§ 168(d)(1)(A) and 179.]

9-21 The anti-churning rules generally prohibit post-1986 MACRS treatment for pre-
1987 assets. The purpose of the rules is to prevent the use of MACRS advantages
for assets when the owner changes but not the user. The rules apply typically in
leasing or nontaxable transactions, such as (1) a sale followed by immediate
leaseback, (2) a like-kind exchange, or (3) the formation and liquidation of a
corporation or partnership including transfers of property to and distributions
from these entities. (See Example 31 and p. 9-36.)

9-22

a. Component depreciation is the process by which the various parts of a realty

asset are depreciated separately. Each part is assigned a useful life and salvage
value, and is depreciated as an individual component. By contrast, composite
depreciation is the process of depreciating an entire realty structure, assigning
a single useful life and a salvage value to the asset, and depreciating it all
accordingly.
 Component depreciation was used to maximize depreciation deductions by
assigning shorter useful lives to various components and depreciating them
faster than the shell of the structure. MACRS generally does not permit
component depreciation. However, more recently, taxpayers have been able to
achieve a similar result by segregating certain costs based on engineering or
cost segregation studies. [Seep. 9-46 and § 168(f)(1).]

b. Taxpayers are permitted to use either component or composite depreciation

for property not subject to MACRS (i.e., nonrecovery property). However,
component depreciation is not generally allowed under MACRS. (See p. 9-
46.)

9-23

a. The mid-quarter convention applies if the taxpayer acquired less than

$750,000 of personal property during the year ($300,000 divided by 40%).
The mid-quarter convention requires the taxpayer to compute depreciation as
though the property had been placed in service in the middle of the quarter in
which it was actually placed in service. The effect of this provision is to allow
the taxpayer _, or 12.5 percent, of the normal depreciation for the quarter Qli
of the quarter's depreciation). This rule operates whenever more than 40
percent of the assets placed in service during the year are placed in service in
the last quarter of the year. (See Examples 13, 14 and 15 and pp. 9-15 through
9-16.)

b. The taxpayer should recognize that if the mid-quarter convention applies,

depreciation for the assets placed in service in the first quarter will be 87.5
percent of the annual depreciation otherwise allowable, or 37.5 percentage
points greater than the 50 percent normally allowed under the half-year
convention. In contrast, depreciation for assets in the fourth quarter is 12.5
percent of the annual depreciation or 37.5 percentage points less than the 50
percent normally allowed. If slightly less than 60 percent of these assets are
placed in service during the first quarter and slightly more than 40 percent are
placed in service during the last quarter, the mid-quarter convention will apply
and depreciation expense for the year will be maximized. This happens
because the depreciation decrease on the fourth quarter assets (compared to
half-year depreciation) is more than offset by the depreciation increase from
the first quarter assets. (See pp. 9-15 through 9-16.)

9-24

a. The Code provides special rules governing the depreciation of retail motor
fuel outlets in § 168(e)(3)(E)(iii). The legislative history provides a 50%
revenue and 50% sq. ft. tests for qualifying the property as a retail motor fuel
outlet with a 15-year recovery period. The taxpayer tried to meet the 50
percent revenue test by aggregating the revenues from main building, separate
fuel center, truck wash and service center. However, the IRS asserted that
 aggregation was not permissible and that the test was to be applied on a
building by building approach. The taxpayer lost in the District Court.
However, the taxpayer never attempted to qualify under the square footage
test.

b. On appeal (Iowa 80 Group, Inc. & Subs. v. IRS, 95 AFTR 2d 2005-2190, 406
F.3d 950 (CA-8, 2005)., the taxpayer raised the square footage test and argued
that all of the buildings were "devoted to petroleum marketing" and, in effect,
anything related to attracting truckers could be considered marketing.
Therefore it believed that it should meet the test. However, the IRS
disregarded floor space for movie theater, game arcade, restaurant, showers,
laundromat, TV lounge that arguably attracted truck drivers to facilities and
the Eighth Circuit agreed.

c. The moral of the Iowa 80 case is that there may be special rules in the law that
alter what may be the result suggested in the discussion in Chapter 9.

9-25

a. Cost depletion is computed by multiplying the taxpayer's basis per unit of

recoverable natural resource by the number of units sold in the period. The
taxpayer's basis per unit is found by dividing the unrecovered adjusted basis
of the investment by the estimated recoverable units of natural resource. Cost
depletion attempts to match the cost of the investment against the revenues
produced.

Percentage depletion is computed by multiplying the gross income from

the property for the period by the percentage specified by statute in the
Internal Revenue Code. However, for oil and gas properties percentage
depletion may not exceed the taxpayer's taxable income from the property
before depletion. For mineral properties, percentage depletion may not exceed
50 percent of the taxpayer's taxable income from the property before
depletion. Because this method of depletion does not take the taxpayer's basis
into account, total depletion allowable may exceed the taxpayer's investment
in the property.

The taxpayer must compute depletion under both methods in each year
and must take a deduction for the higher amount. Due to the many variables
involved in a given year, it is not possible to state any general rule regarding
which method will yield the highest depletion allowance (so as to be the
deductible method) in any given year. (See Examples 33, 34, and 35, pp. 9-39
through 9-41, and §§ 611 and 613.)

b. Once the basis of the property is reduced to zero, only percentage depletion
may be claimed, and no adjustment is made to create a negative basis. (See p.
9-41.)

9-26 Certain expenses incurred in farming and ranching, which would normally be
 considered capital expenditures, may be deducted. In this case, it may be to N's
advantage to incur and deduct such expenses currently while he is in a high tax
bracket instead of waiting until retirement when his tax bracket will probably be
lower. N could benefit because many of the costs may be used to shelter non-farm
income. For example, costs associated with establishing his dairy herd, such as
depreciation and feed, could be deducted even though no income is produced
from farming. Similarly, the costs of the farmhouse, equipment, and other related
property could be depreciated even though the activity may provide a substantial
amount of pleasure. Other costs such as those for fertilizer, lime, and other
materials used to enrich farmland can be deducted without limitation in the year
incurred. Note, however, that deduction for other soil and water conservation
expenses, such as the costs of brush eradication, ponds, and the like, is limited to
25 percent of the taxpayer's gross income from farming. Thus, assuming that N's
efforts initially produce losses, such expenses could produce limited benefits. (See
pp. 9-44 through 9-45 and §§ 178 and 180.)

PROBLEMS

9-27

a. $15,000. F must use the lesser of the fair market value or the adjusted basis at
the time of the conversion. [See Example 2, p. 9-4, and Reg. § 1.167(g)-1.]

b. Yes. Because the property is held for the production of rents (an income
producing activity), the traveling expenses incurred to check on his property
are deductible for A.G.I. It is irrelevant that the property is near his alma
mater. [See p. 9-3 and Reg. §§ 1.167(a)-2 and 1.167(a)-3.]

9-28

a. The furniture is seven-year property while the building is nonresidential real

estate. Depreciation (ignoring § 179 expensing) for 2012 is $4,281, calculated
as follows:

Building—$700,000 × 2.033% $14,231

(See Exhibit 9-6.)

Furniture—$200,000 × 14.29% $28,580

(See Exhibit 9-4.)

Total depreciation $42,811

(See Example 8 and Example 11 and pp. 9-9 through 9-14.)

b. Depreciation for 2013 is $6,693, determined as follows:

 Building—$700,000 × 2.564% $17,948

(See Exhibit 9-6.)

Furniture—$200,000 × 24.49% 48,980

(See Exhibit 9-4.)

Total depreciation $66,928

(See Examples 8 and 11 and pp. 9-9 through 9-14.)

c. The office building and the furniture were sold on July 20, 2014. In this case,
the mid-month convention applies in computing the depreciation for the
building, while the half-year convention applies in computing the depreciation
for the furniture. (See pp. 9-9 through 9-14.)

Building—$700,000 × 2.564% × 6.5/12 $ 9,728

Furniture—$200,000 × 17.49% × ½ 17,490

Total depreciation $27,218

d. Due to the purchase of the furniture in October, more than 40 percent of T's
personal property was placed in service during the last quarter of the year. As
a result, the mid-quarter convention must be used in computing depreciation
for the furniture. This convention assumes that the assets were placed in
service in the middle of the quarter in which they were actually placed in
service. Thus, assuming the furniture is placed in service in October the fourth
quarter only 12.5 percent (½ × ¼) of the annual depreciation may be claimed
for the furniture in the year of the acquisition. Exhibit 9-7 The answers above
do not change with respect to the building because the mid-month convention
must be used for realty in all cases.

1. Depreciation for the furniture in 2012 is $7,140:

$200,000 × 3.57% = $7,140

Note that 3.57 percent is derived as follows (1/7 straight-line rate × 200%
declining balance × 12.5% mid-quarter convention). (See Appendix C-9,
Example 14, and pp. 9-15 through 9-16.)

2. Depreciation for the furniture in 2013 is $55,100:

$200,000 × 27.55% second-year rate = $55,100

(See Appendix C-9, Example 14, and pp. 9-15 through 9-16.)

3. Because the furniture was sold in July, the taxpayer is allowed 2½ quarters
 of depreciation (½for the quarter in which the property was disposed of) or
62.5 percent of the normal annual depreciation for 2014. Depreciation is
computed as follows:

$200,000 × 19.68% third-year × 62.5% = $24,600

(See Appendix C-9, Example 15, and pp. 9-15 through 9-16.)

9-29

a. If all the property is purchased on February 2, the half-year convention

applies. Total depreciation for the first two years is $116,340 ($42,870 +
$73,470), computed as follows:

Year one: $300,000 × 14.29% = $42,870

Year two: $300,000 × 24.49% = $73,470

b. If all the property is purchased on December 6, the mid-quarter convention

applies. Total depreciation for the first two years is $93,360 ($10,710 +
$82,650), computed as follows:

Year one: $300,000 × 3.57% = $10,710

Year two: $300,000 × 27.55% = $82,650

c. If the purchase of the property is split during the year, 59 percent on February
2 and 41 percent on December 6, the mid-quarter convention applies (because
more than 40% placed in service during the fourth quarter). Total depreciation
for the first two years is $120,459 ($48,641 + $71,818), computed as follows:

Year one: $177,000 × 25% = $44,250

$123,000 × 3.57% = 4,391

Total $48,641

Year two: $177,000 × 21.43% = $37,931

$123,000 × 27.55% = 33,887

Total $71,818

d. If the purchase of the property is split during the year as in part (c), 59 percent
on February 2 and 41 percent on December 6, depreciation during the first two
years will be maximized. Therefore, Q Corporation should purchase the
furniture and fixtures in this manner. (See pp. 9-15 through 9-16.)

9-30
a. If G is in a lower tax bracket now than it expects to be in the future, deferring
the depreciation deductions by electing the straight-line method might be
more beneficial. Similarly, if G has a net operating loss this year, it might be
advantageous to defer the deduction. It also should be noted that the new
alternative minimum tax for corporations may provide an incentive for the
corporation to use straight-line rather than accelerated depreciation. Under the
new alternative minimum tax for corporations, one-half of the difference
between book and tax income is a preference item. Consequently, if G uses
straight-line, this difference is reduced, and concomitantly, its exposure to the
alternative minimum tax.

b. G may elect the MACRS recovery percentages (straight-line for realty) only
for the building. An election to use the straight-line method for seven-year
property applies to all property in that class placed in service during the year.
Thus, an election to use the straight-line method for the stove requires G to
use the same method for the refrigerator because they are in the same class.
(See p. 9-17.)

c. 2012:

Property Unadjusted Basis Straight-line Recovery

Percentage Depreciation

Stove $ 5,000 × 7.14% (Exhibit 9-8)

$ 357

Nonresidential building 100,000 × 2.247%

(Exhibit 9-6) 2,247

$2,604

(See Example 16 and pp. 9-17 through 9-18.)

d. 2013:

Property Unadjusted Basis Straight-line

Recovery Percentage Depreciation

Stove $ 5,000 × 14.29%

(Exhibit 9-8) $ 715

Nonresidential building 100,000 ×

2.564% (Exhibit 9-6) $2,564

$3,279

(See Example 16 and pp. 9-17 through 9-18.)

 e.

Property Unadjusted Basis Straight-line

Recovery Percentage Depreciation

Stove $ 5,000 × 7.14% (Exhibit

9-8) $ 357 in 2019

Nonresidential building 100,000 × .321%

(Exhibit 9-6) $ 321 in 2052

(See Example 16 and pp. 9-17 through 9-18.)

f. If the corporation disposes of the assets in October 2012 (the second year of
service), the mid-month convention must be used in computing the
depreciation for the building and the half-year convention must be used in
computing the depreciation for the stove (as follows):

Stove $5,000 × 14.29% × ½ = $357

(See Exhibit 9-8 and p. 9-17.)

Nonresidential $100,000 × 2.564% × 9.5 / 12 = $2,030

(See Exhibit 9-6 and p. 9-17.)

9-31 The truck is considered listed property and is subject to the restrictions of § 280F.
Under this provision, if the vehicle is not used more than 50 percent for business,
depreciation must be computed using the alternative depreciation system (ADS).
(See pp. 9-17 through 9-19.) Depreciation under ADS for the truck, which is
treated as five-year property, is computed as follows:

Adjusted basis $ 9,000

× Business use × 20%

= Depreciable basis $ 1,800

× ADS rate Exhibit 9-8 × 10%

= Depreciation $ 180

(See Example 25 and pp. 9-30 through 9-31.)

9-32 Section 179 limits the amount that the taxpayer could deduct to the amount of the
taxable income (prior to consideration of the deduction) derived from all of the
taxpayer's trades and businesses (including wage and salary income). Thus,
although K may have no income from her novel this year, her salary income
would enable her to deduct the $3,000 computer cost. (See p. 9-22.)
 Even if K desired to claim depreciation on the computer, her deductions may
be limited under the uniform cost capitalization rules of §§ 263A(a)(1)(B) and
263A(b)(1). These rules require K to capitalize all of the direct and indirect costs
incurred in producing property. Apparently such costs could be amortized against
future book sales.

9-33

a. Yes. The benefits of the limited expensing provision are available to all
taxpayers except estates and trusts. However, if the corporation places more
than $625,000 ($500,000 + $125,000) (2012) of qualifying property in service
during the year, the $125,000 allowable is eliminated. (See pp. 9-21 and 9-
22.)
b. Yes. The $125,000 (2012) allowable is reduced to $1 for each $1 of qualifying
property placed in service during the year exceeding $500,000 in 2012. For this purpose,
qualifying property under § 179 does not include real property (the building). Ignoring
the cost of the building, the amount of qualifying property placed in service during the
year is well below the $500,000 threshold so then the entire $125,000 (2012) could be
used, and therefore, all of the cost of the equipment could be expensed. (See pp. 9-21 and
9-22.)
c. No. Section 179 limits the taxpayer's deduction to the amount of the taxable
income (prior to consideration of the deduction) derived from all of the
taxpayer's trades and businesses (including wage and salary income). Since
T's business activities this year resulted in a net operating loss before the §
179 deduction is considered, T could not deduct the cost of the property this
year. But T may carry over the deduction to be used against future income.
Note, however, that the amount that can be expensed in future years is not
increased by the carryover but is limited to $125,000 (2012) annually. (See
pp. 9-21 and 9-22.)

d. Yes. Section 179 may be applied to expense the costs of qualifying property
regardless of the time when it was acquired. Time of acquisition is irrelevant.
(See pp. 9-21 and 9-22.)

9-34

a. The depreciable basis of the car is $30,000 (75% the asset's $40,000 cost). If
this asset were a computer instead of a car, the entire $30,000 basis could be
expensed. However, because this asset is a car, § 280F limits the total write-
off in the first year (depreciation plus limited expensing) to $2,370 (75% ×
$3,160 in 2012). The unused portion of the limited expensing amount cannot
be carried over to future years, even though the depreciable basis of the car
would be reduced. Thus, the taxpayer should not elect to use limited
expensing for the auto because of the adverse effects of the § 280F limitation.
(See pp. 9-25 through 9-27.)
 b. An election is not allowed, since the computer is not used in a trade or
business. (See p. 9-23 and § 179.)

c. No election is allowed because buildings are not eligible for investment credit.
(See p. 9-22.)

d. No election is allowed because the taxpayer received the desk as a gift from
his father, who is a related party. (See p. 9-23.)

9-35

a. N may expense $125,000 (2012) of the equipment's cost, which is the

maximum amount allowable.

(See Example 17, pp. 9-21 through 9-23, and § 179.)

b. The duplicating equipment is five-year property (i.e., copying equipment per

Exhibit 9-3). N's depreciation deduction is $10,000 for a total deduction of
$135,000 (2012) computed as follows (See Example 17 and p. 9-22.):

Original cost $ 175,000

Less: Portion elected to expense (2012) (125,000) $125,000

Unadjusted basis for recovery $ 50,000

Recovery percentage for five-year property × 20%

Depreciation deduction $ 10,000 10,000

Total Sec. 179 depreciation deduction $135,000

c. The total § 179 and depreciation deduction is $176,000 (2012) computed as

follows.

Original cost $540,000

Maximum amount that can be expensed under § 179 $125,000

Reduction in maximum § 179 expense

Applies if qualified property exceeds $500,000

($540,000 – $500,000) (40,000)

Amount expensed under § 179 (85,000) $85,000

Remaining basis subject to MACRS $455,000

 MACRS depreciation rate for five-year property

(1/5 × 200% × 1/2 = 20%) × 20%

Depreciation deduction for the year $91,000 91,000

Total § 179 and depreciation deduction for year $176,000

(See Example 17 and p. 9-21 through 9-22.)

9-36 When an automobile is leased, the taxpayer is entitled to deduct all of the lease
payment attributable to business use. However, to ensure that the taxpayer does
not sidestep the luxury automobile limitations on depreciation by leasing, § 280F
requires the taxpayer to include annually a certain amount of income based on the
value of the car at the time of the lease. Here the car has a value of $30,000. The
amount of income can be found in a Revenue Procedure produced annually.
Exhibit 9-14 contains these values for 2012 and can be obtained from Rev. Proc.
2012-21 and are given below. As computed below, using the value of the car at
the time of the lease, $30,000, J's gross income will increase $5 for 2012 and $19
for 2013.

Tax Year Exhibit 9-14 Dollar Amount Proportion Percentage of

Business Use Inclusion Amount

2012 $9 219 / 365 (60%) 100% $5

2013 20 366 / 366 (100%) 100% 19

(See Example 22 and pp. 9-28 through 9-29.)

9-37

a. Depreciation must be computed in light of the special limits applying to cars

contained in § 280F. As a result, for a vehicle placed in service in 2012 it
takes 14 years to fully depreciate the car as shown below.

Year One Two Three Four Five Six Seven Eight Nine 10 11
12 13 14

Depreciable basis $30,000 $30,000 $30,000 $30,000

$30,000 $30,000 $30,000 $30,000 $30,000
$30,000 $30,000 $30,000 $30,000 $30,000

MACRS Percentage 20.00% 32.00% 19.20% 11.52%

11.52% 5.76%

MACRS
Depreciation $ 6,000 $ 9,600 $ 5,760 $ 3,456 $ 3,456
$ 1,728

Limit (2012) 3,160 5,100 3,050 1,875 1,875 1,875 1,875 1,875 1,875 1,875
1,875 1,875 1,875 1,875

Deduction $ 3,160 $ 5,100 $ 3,050 $ 1,875 $ 1,875

$ 1,728 $ 1,875 $ 1,875 $ 1,875 $ 1,875 $ 1,875
$ 1,875 1,875 1,875

Remaining basis $30,000 $26,840 $21,740 $18,690

$16,815 $14,940 $13,212 $11,337 $9,462 $ 7,587
$ 5,712 $ 3,837 1,962 87

Deduction (3,160) (5,100) (3,050) (1,875) (1,875)

(1,875) (1,875) (1,875) (1,875) (1,875) (1,875)
(1,875) (1,875) (87)

Total $56,840 $21,740 $18,690 $16,815 $14,940

$13,212 $11,337 $9,462 $ 7,587 $ 5,712 $ 3,837
$ 1,962 $ 87 $ 0

Depreciation for year 14 is $87 (the remaining adjusted basis). (See Example 21 and pp.
9-25 through 9-27.)

b. Because the car is used only 80 percent for business, only 80 percent of the
car is eligible for depreciation. Moreover, the limitations imposed by § 280F
must be adjusted to reflect the personal use. The maximum first-year
depreciation is limited to $2,528 (80% of $3,160 (2012). Depreciation would
be calculated as shown below.

Year Year One

Adjusted basis for business $24,000 ($30,000 × 80%)

MACRS recovery percentage ×20%

MACRS depreciation $ 4,800 $4,800

Limit ($3,160 (2012) × 80%) $2,528

Deduction $2,528

(See Example 20 and pp. 9-26 and 9-27.)

c. Although production of income use is not considered in determining whether

the predominant use test is met, it is included in making the calculation of
depreciation. Thus, the answer is the same as (b) above, since production of
 income use is combined with business use in making the actual calculations.
(See Example 20 and pp. 9-26 and 9-27.)

d. In this case, the car is not used predominantly for business (i.e., more than
50%). Consequently, limited expensing is not allowed. Moreover,
depreciation can be claimed using only the straight-line rates and recovery
periods prescribed by ADS. In addition, the maximums for depreciation must
be adjusted for personal use.

Year Year One Year Two Year Three Year Four and
Thereafter

Depreciation limits $3,160 $5,100 $3,050 $1,875

Personal Use × 40% × 40% × 40% × 40%

Limit after personal use adjustment $1,264 $2,040 $1,220 $ 750

Depreciation is calculated below. (Adjusted basis for depreciation: 40% ×

$30,000 = $12,000.)

Year One Year Two Year Three Year Four Year Five
Year Six Year Seven Year Eight Year Nine Year 10
Year 11 Year 12 Year 13 Year 14

Depreciable basis $12,000 $12,000 $12,000 $12,000

$12,000 $12,000 $12,000 $12,000 $12,000
$12,000 $12,000 $12,000 $12,000 $12,000

ADS

percentage ADS × 10.00% × 20.00% ×20.00% × 20.00%

×20.00% × 10.00%

Depreciation $ 1,200 $ 2,400 $ 2,400 $ 2,400 $ 2,400

$ 1,200

Limit (2011) 1,264 2,040 1,220 750 750 750 750 750 750
750 750 750 750 750

Deduction 1,200 2,040 1,220 750 750 750 750 750 750
750 750 750 750 40

Cumulative
 Depreciation 1,200 3,240 4,460 5,210 5,960 6,710 7,460 8,210 8,960
9,710 10,460 11,120 11,960 12,000

Remaining basis $12,000 $10,800 $ 8,760 $ 7,540

$ 6,790 $ 6,040 $ 5,290 $ 4,540 $ 3,790 $ 3,040
$ 2,290 $ 1,540 $ 790 $ 40

Deduction (1,200) (2,040) (1,220) (750) (750) (750) (750) (750) (750)
(750) (750) (750) (750) (40)

Basis 10,800 8,760 7,540 6,790 6,040 5,290 4,540 3,790 3,040 2,290
1,540 790 40 0

Depreciation for Year 14 is $40 (the remaining adjusted basis) . (See Exhibit
9-8, Example 20 and Example 21, and pp. 9-25 through 9-27.)

9-38.

a. Since the Suburban weighs more than 6,000 pounds it is not subject to the
depreciation limitations for passenger automobiles. Instead, C is permitted to
deduct up to $25,000 in the first year. The $25,000 allowance is not adjusted
for personal use since it is provided in § 179 and is not subject to § 280F.
Thus C could deduct $26,400 computed as shown below. (See Example 23
and pp. 9-29 and 9-30.)

Cost of Suburban $40,000

Business use ×80%

Depreciable cost $32,000

SUV allowance (no adjustment) (25,000) $25,000

Depreciable basis $ 7,000

Depreciation percentage ×20%

Depreciation $ 1,400 1,400

Total deduction $26,400

b. In this case, the business portion of the vehicle would be $24,000 (80% ×
$30,000) and C could use the $25,000 to deduct all $24,000. This computation
is shown below. (See Example 24 and pp. 9-29 and 9-30.)

Cost of Suburban $30,000

Business use × 80 %
 Depreciable cost $24,000

SUV allowance (no adjustment) (24,000) $24,000

Total deduction $24,000

c. C should select the model that has a truck bed of six feet or longer to avoid
any limitations on the amount that can be expensed under § 179. In such case,
C could expense the portion used for business up to $125,000 (2012). Here C
could deduct the entire business use portion of $32,000 (80% × $40,000).
Since the truck has a gross vehicle weight exceeding 6,000 pounds it is not
subject to the limitations of § 280F. Similarly, under § 179, the $25,000
limitation does not apply to standard pickup trucks that have a truck bed of six
feet or longer. (Technically, the § 179 $25,000 limitation does not apply to
vehicles that are equipped with a cargo area of at least six feet in interior
length which is an open area or is designed for use as an open area but is
enclosed by a cap and is not readily accessible directly from the passenger
compartment as well as vehicles weighing 14,000 or more and certain other
vehicles. See § 179(b)(6)(B)(ii)). (See p. 9-29.)

d. C could deduct the portion used for business up to $125,000 (2012) or

$32,000 in this case. Neither the § 280F nor the § 179 limitations apply for
vehicles weighing more than 14,000 pounds or the vehicles identified below.
(See § 179(b)(6)(B)(ii)) and pp. 9-29 and 9-30.)

1. A vehicle designed to have a seating capacity of more than nine persons

behind the driver's seat.

2. A vehicle equipped with a cargo area of at least six feet in interior length
which is an open area or is designed for use as an open area but is
enclosed by a cap and is not readily accessible directly from the passenger
compartment.

3. A vehicle having an integral enclosure, fully enclosing the driver

compartment and load carrying device, and does not have seating rearward
of the driver's seat.

4. A vehicle having no body section protruding more than 30 inches ahead of

the leading edge of the windshield.

9-39

a. The computations below ignores first year expensing election under pp. 9-29
and 9-30.)

Year Year One Year Two Year Three Year Four Year Five
Year Six
Depreciable basis $30,000 $30,000 $30,000 $30,000
$30,000 $30,000

Depreciation percentage ×20% ×32% ×19.2% ×11.52%

×11.52% ×5.76% $ 1,728

MACRS depreciation $ 6,000 $ 9,600 $ 5,780 $ 3,456

$ 3,456

Present value factor ×0.91 ×0.83 ×0.75 ×0.68 ×0.62 ×0.56

PV of MACRS depreciation $ 5,460 $ 7,968 $ 4,320 $ 2,350

$ 2,143 $ 968

Limit in 2012 $ 3,160 $ 5,100 $ 3,050 $ 1,875 $ 1,875

$ 1,875

Actual deduction: Lesser of MACRS depreciation or limit or adjusted basis

$ 3,160 $ 5,100 $ 3,050 $ 1,875 $ 1,875
$ 1,728

Present value factor ×0.91 ×0.83 ×0.75 ×0.68 ×0.62 ×0.56

PV of actual deduction $ 2,876 $ 4,233 $ 2,288 $ 1,275

$ 1,163 $ 968

Adjusted basis $26,840 $21,740 $18,690 $16,815

$14,940 $13,212

Year Seven Year Eight Year Nine Year 10 Year 11

Year 12

Limit $ 1,875 $ 1,875 $ 1,875 $ 1,875 $ 1,875

$ 1,875

Actual deduction: Lesser of MACRS depreciation or limit or adjusted basis

$ 1,875 $ 1,875 $ 1,875 $ 1,875 $ 1,875
$ 1,875

Present value factor ×0.51 ×0.47 ×0.42 ×0.39 ×0.35 ×0.32

PV of actual deduction $ 956 $ 881 $ 788 $ 731 $ 656 $ 600

Adjusted basis $11,337 $9,462 $ 7,587 $ 5,712

$ 3,837 $ 1,692

Year 13 Year 14

Limit $ 1,875 $ 1,875

 Actual deduction: Lesser of MACRS depreciation or limit or adjusted basis
$ 1,875 $ 87

Present value factor ×0.29 ×0.26

PV of actual deduction $ 544 $ 23

Adjusted basis $ 87 $0

b. M will receive $10,000 of tax savings from depreciation, calculated as

follows:

$30,000 × 25% = $7,500

c. See the solution for part a., above. The sum of the present values from the
"PV of actual deduction" as limited by Section 280F is $17,980. Using a 25
percent marginal tax rate, the present value of the taxpayer's tax savings from
this depreciation is $4,495 ($17,980 × 25%).

d. See the solution for part a., above. The sum of the present values from the
"PV of MACRS deduction" is $23,208. This present value assumes § 280F
was repealed, thereby allowing the automobile to be depreciated over six
years (using MACRS) rather than 16 years. With a 25 percent marginal tax
rate, the present value of the taxpayer's tax savings from MACRS depreciation
is $5,802 ($23,208 × 25%).

e. Discounting shows that the true value of tax savings from depreciation is
dramatically less than it may appear at first. In part c, the present value of tax
savings from depreciation is $4,495, which is roughly 43 percent of the
$10,000 undiscounted tax savings from depreciation (from part b).

f. The § 280F limitations decrease the present value of depreciation tax savings
for this taxpayer by $1,307 rounded ($5,802 – $4,495).

9-40 The three alternative methods for treating R&D expenditures are as follows:

Method 1: The taxpayer may elect to deduct all research and experimental
expenditures currently as follows:

MACRS depreciation on lab equipment:

(20% of $30,000) $ 6,000*

Salaries 60,000

Materials and supplies10,000

Total deduction $76,000

 *Note: Only depreciation of the equipment was included, not the entire
$30,000 cost.

Method 2: The taxpayer may defer the expenses and amortize them over 60
months:

Method 3: If neither of the previously mentioned methods is used, taxpayer must

capitalize the expenditures. If the expenses are capitalized, no deduction is allowed until
the asset is disposed of or abandoned. (See Example 36, Exhibit 9-4, pp. 9-42 through 9-
43, and § 174.)

9-41

Year Cost Depletion* 15% of Gross * Income 50% Limit Depletion

Allowed Undepleted Basis

One $30,000 $45,000 $62,000 $45,000

$55,000 ($100,000 – $45,000)

Two 31,429 60,000 25,000 31,429 23,571

($55,000 – $31,429)

Three 15,714 37,500 45,000 37,500 —

*Cost depletion calculations:

(See Examples 33 through 35 and pp. 9-39 through 9-41.)

9-42

Year Cost Depletion* 15% of Gross Income 100% Limit

Depletion Allowed Undepleted Basis

One $30,000 $45,000 $124,000 $45,000

$55,000 ($100,000 – $45,000)
Federal Taxation 2013 Pratt 7th Edition Solutions Manual

Two 31,429 60,000 50,000 50,000 5,000 ($55,000 – $50,000)

Three 3,333 37,500 90,000 37,500 —

*Cost depletion calculations:

(See Examples 33 through 35 and pp. 9-39 through 9-41.)

CUMULATIVE PROBLEMS

Solutions to the Cumulative Problems (9-43–9-44) are contained in the Instructor's

Resource Guide and Test Bank for 2013.

TAX RESEARCH PROBLEMS

Solutions to the Tax Research Problems (9-45–9-46) are contained in the Instructor's
Resource Guide and Test Bank for 2013.

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