South Western Federal Taxation 2015 Individual Income Taxes 38th Edition Hoffman Solutions Manual

South-Western Federal Taxation 2015
Individual Income Taxes 38th Edition

Hoffman Solutions Manual
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CHAPTER 8
DEPRECIATION, COST RECOVERY, AMORTIZATION, AND DEPLETION
SOLUTIONS TO PROBLEM MATERIALS
Status: Q/P
Question/ Learning Present in Prior
Problem Objective Topic Edition Edition
1 LO 1 Cost recovery Unchanged 1

2 LO 1 Personal property versus personal use Unchanged 2
property
3 LO 1 Cost recovery of land improvements Unchanged 3
4 LO 2 Eligibility for cost recovery Unchanged 4
5 LO 2 Mid-quarter convention: placed in service Unchanged 5
6 LO 2 MACRS tables Unchanged 6
7 LO 2 Mid-quarter convention: year placed in Unchanged 7
service
8 LO 2 Property eligible for additional first-year Unchanged 8
depreciation
9 LO 2 Mid-quarter convention: year of sale Unchanged 9
10 LO 2 Residential rental real estate deduction Unchanged 10
11 LO 2 Straight-line method: applicable convention Unchanged 11
12 LO 2 Farm property Unchanged 12
15 LO 2 Leasehold property owned by lessor Unchanged 15
16 LO 2 Qualified leasehold property owned by lessee Unchanged 16
17 LO 3 Section 179 expensing Unchanged 17
18 LO 3 Depreciation recapture and § 179 expense Unchanged 18
19 LO 3 Section 179 expensing: effect on MACRS Updated 19
cost recovery
20 LO 3 Section 179 expensing: carryforward Updated 20
21 LO 3 Section 179 expensing: taxable income Unchanged 21
limitation
22 LO 2, 3 Section 179 expensing: eligibility Unchanged 22
23 LO 3, 4 Listed property: passenger auto Unchanged 23
24 LO 4 Listed property: passenger auto and cost Unchanged 24
recovery limit
25 LO 4 Listed property and change in percentage Unchanged 25
26 LO 7 Amortization: § 197 intangibles Unchanged 26
27 LO 7 Covenant not to compete Unchanged 27
28 LO 7 Startup expenditures Unchanged 28
8-1
© 2015 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
8-2 2015 Individual Income Taxes/Solutions Manual
Status: Q/P
Question/ Learning Present in Prior
Problem Objective Topic Edition Edition

30 LO 8 Cost depletion Unchanged 30
31 LO 1, 2 Cost recovery allowed and allowable Unchanged 31
32 LO 1, 2 Personal residence converted to rental Unchanged 32
property
33 LO 2 MACRS for personalty Updated 33
34 LO 2 MACRS for personalty Updated 34
35 LO 2 MACRS for personalty: half-year convention Unchanged 35
36 LO 2 MACRS for personalty: mid-quarter Updated 36
convention
37 LO 2 MACRS for realty Unchanged 37
42 LO 2 Farm property Updated 42
43 LO 2 Leasehold improvement property Updated 43
44 LO 2 Leasehold improvement property Unchanged 44
45 LO 2, 3, 10 MACRS and § 179 expensing Updated 45
46 LO 2, 3 MACRS and § 179 expensing Updated 46
47 LO 2, 3, 10 MACRS and § 179 expensing Updated 47
48 LO 3, 4 Listed property and § 179 deduction: not Unchanged 48
passenger automobile
49 LO 2, 4 Listed property: luxury auto Unchanged 49
50 LO 4 Listed property: luxury auto Updated 50
51 LO 2, 3, 4 Listed property: not passenger automobile Updated 51
52 LO 2, 4 Listed property: recapture and luxury auto Unchanged 52
53 LO 2, 4, 10 Listed property Unchanged 53
54 LO 2, 4, 10 Listed property: lease versus purchase for Unchanged 54
luxury auto
55 LO 2, 5 Alternative minimum tax cost recovery Unchanged 55
56 LO 2, 5, 10 Alternative depreciation system versus Unchanged 56
MACRS
57 LO 2, 7, 10 Amortization of goodwill versus MACRS Unchanged 57
on building
60 LO 8 Depletion: cost versus percentage Unchanged 60
61 LO 8, 10 Intangible drilling costs: capitalized versus Unchanged 61
expensed
62 Cumulative Updated 62
63 Cumulative Updated 63
Depreciation, Cost Recovery, Amortization, and Depletion 8-3
Status: Q/P
Research Present in Prior
Problem Topic Edition Edition
1 Cost recovery of software New

2 Leasing and luxury auto limits Unchanged 2
3 Cost recovery: § 179 Unchanged 3
4 Cost recovery availability Unchanged 4
5 Amortization of intangibles Unchanged 5
6 Internet activity Unchanged 6
7 Internet activity Unchanged 7
Proposed solutions to the Research Problems are found in the Instructor’s Guide.
CHECK FIGURES
31. Loss $11,515. 47. 2013: $528,573; 2014: $6,123.

32. $300,000 basis; $8,637 cost 48. $27,000.
recovery. 49. $1,000.
33. $42,866. 50. $11,160 in 2014; $5,100 in 2015.
34.a. $38,839. 51. $32,400.
34.b. $6,457. 52. Deduction in 2014 $2,528; deduction in
35.a. $40,000. 2015 $2,800; recapture in 2015 $928.
35.b. $32,000. 53. $174.
36. $16,640. 54. Leasing provides a greater tax benefit.
37.a. $20,330. 55. Regular tax deduction $3,200; AMT
37.b. $52,776. deduction $2,400.
38. $38,640. 56. $3,192.
39. 2014: $173,340; 2024: $276,912. 57. The first option produces a $12,617
40.a. $25,610. greater deduction.
40.b. $41,360. 58. $3,556.
41. $16,065. 59. $3,700.
42. $4,000. 60. $4,360,000 taxable income.
43. $1,605. 61. Capitalized $1,880,000; expensed
44. $65,980 loss. $1,024,000.
45.a. $32,202. 62. Refund for 2013 $59.
45.b. $33,629. 63. AGI without purchase $198,000; AGI
45.c. Allocate to 7-year class property. with stock sale and car purchase $209,840.
46. Cost recovery $18,000; § 179
carryforward $9,144.
DISCUSSION QUESTIONS
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. 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 income-
producing activity.
3. Land improvements have a MACRS class life of 15 years.
4. 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. The placed-in-service date, not the purchase date, is the critical date in determining whether the mid-
quarter or half-year convention applies.
6. The three factors the MACRS tables take into account are (1) recovery period, (2) method, and (3)
convention.
7. 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.
8. Qualified property for additional first-year depreciation includes most types of new property other
than depreciable realty.
9. 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.
10. Residential rental real estate is property where 80% or more of the gross rental revenues are from
nontransient dwelling units.
11. 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. With respect to the mid-
quarter convention, the assumption is made that Robert is a calendar year taxpayer.
12. The general cost recovery method for farming assets is the 150% declining-balance method.
However, the straight-line method is required for any tree or vine bearing fruits or nuts. The recovery
period is seven years.
13. Even though ADS is used, it does not prevent the taxpayer from electing to expense personalty under
§ 179.
14. 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?
15. The recovery methods and periods for lessor-owned leasehold improvement property generally are
the same as those used for non-leasehold property.
16. The costs are recovered in accordance with the general cost recovery rules without regard to the lease
term. Any unrecovered basis in property not retained by the lessee is deducted in the year the lease is
terminated.
17. Section 179 can only be taken on property used in a trade or business.
18. 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.
19. 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 ($200,000 in
2014 and $2 million in 2013)]. The business income limitation does not affect basis.
20. The § 179 amount eligible for expensing in a carryforward year is limited to the lesser of (1) the
statutory dollar amount ($25,000 in 2014; $500,000 in 2013) reduced by the cost of § 179 property
placed in service in excess of $200,000 in 2014 ($2,000,000 in 2013) in the carryforward year or
(2) the business income limitation in the carryforward year.
21. 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.
22. 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?
23. An automobile is listed property and consequently must pass the predominantly business use test to
be eligible for MACRS statutory percentage cost recovery. However, by weighing more than 6,000
pounds, the automobile is not subject to the statutory dollar limits on cost recovery. However,
legislation enacted in 2004 provides that SUVs with a GVW between 6,000 pounds and 14,000
pounds are subject to a $25,000 ceiling in calculating the § 179 expense rather than the normal ceiling
for 2013 of $500,000. In 2014, the § 179 limit is $25,000 (so the ceiling is the same as the normal
limit).
24. 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.
25. 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.
26. The amortization period for a § 197 intangible is 15 years regardless of the actual useful life.
27. The following issues are relevant for Orange Motors:

• 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?
28. The elective treatment for startup expenditures allows the taxpayer to deduct the lesser of (1) the
amount of startup expenditures with respect to the trade or business or (2) $5,000 reduced, but not
below zero, by the amount by which the startup expenditures exceed $50,000. Any startup
expenditures not deducted may be amortized ratably over a 180-month period beginning in the month
in which the trade or business begins.
29. 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 2014?
30. 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.
PROBLEMS
31. Cost of asset $200,000

Less: Greater of allowed and allowable cost recovery:
2012 $ 910
2013 7,272 (8,182)
Basis at the end of 2013 $191,818
Less: Cost recovery for 2014 ($200,000 × 3.636% × .5/12) (303)
Basis on date of sale $191,515
Loss on sale of asset ($180,000 − $191,515) ($ 11,515)
32. 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 × 2.879% (Table 8.6)].
33. As Orange Corporation’s acquisitions exceed $200,000, the amount of the § 179 immediate expense
election is reduced dollar-for-dollar by the costs in excess of $200,000. As a result, the maximum
expense election is reduced from $25,000 to $15,000. Office furniture is a MACRS 7-year class asset.
Cost recovery would be $42,866.
§ 179 expense $15,000
Office furniture [($210,000 − $15,000) × .1429] 27,866
$42,866
34. a. The mid-quarter convention must be used. The office machine is 7-year class property.
2013
Additional first-year depreciation
($75,000 × .50) $37,500
MACRS cost recovery
[($75,000 − $37,500) × .0357 (Table 8.2)] 1,339
Total cost recovery $38,839
b. 2014
MACRS cost recovery [$37,500 × (.2755 × 2.5/4)] $6,457
35. a. 2014
MACRS cost recovery ($200,000 × 20%) (Table 8.1) $40,000
b. 2015
MACRS cost recovery [$200,000 × 32% (Table 8.1) × 1/2] $32,000
36. 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 (Table 8.2)] $ 7,140
Trucks (5-year class property)

MACRS cost recovery
[$40,000 × .15 (Table 8.2)] 6,000
Computers (5-year class property)
MACRS cost recovery

[$70,000 × .05 (Table 8.2)] 3,500
37. a. The building was placed in service in October.
2014: $3,800,000 × .00535 (Table 8.6) = $20,330
b. 2018: $3,800,000 × .02564 (Table 8.6) × 6.5/12 = $52,776
38. 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 × 2.576% (Table 8.6) = $38,640
39. 2014: $10,800,000 × .01605 (Table 8.6) = $173,340
2024: $10,800,000 × .02564 (Table 8.6) = $276,912
40. The building’s depreciable basis is $1,300,000 [$1,600,000 (cost) − $300,000 (land)].
a. 2014: $1,300,000 × .0197 (Table 8.6) = $25,610
b. 2020: $1,300,000 × .03636 (Table 8.6) × 10.5/12 = $41,360
41. The 150% declining-balance method must be used under these circumstances with a 7-year cost
recovery period.
MACRS cost recovery ($150,000 × .1071) (Table 8.4) $16,065
42. MACRS cost recovery (straight-line method)

[$80,000 × .05 (Table 8.5)] $4,000
43. This is a leasehold improvement that will be recovered over 39 years.

MACRS cost recovery
[$300,000 × .00535 (Table 8.6; Month 10)] $1,605
44. Cost of leasehold improvement $80,000

Less: Cost recovery
2008 (.02247 × $80,000) (1,798)
2009–2013 (.02564 × $80,000 × 5) (10,256)
2014 [.02564 × (11.5/12) × $80,000] (1,966)
Loss (unrecovered cost) $65,980
45. a. Immediate expense deduction under § 179 $25,000

Copier
Regular MACRS [($31,000 – $25,000) × 20%] 1,200
Furniture
Regular MACRS ($42,000 × 14.29%) 6,002
Total deduction $32,202
b. Immediate expense deduction under § 179 $25,000

Copier
Regular MACRS ($31,000 × 20%) 6,200
Furniture
Regular MACRS [($42,000 – $25,000) × 14.29%] 2,429
c. The deduction for the year would be $1,427 ($33,629 – $32,202) larger if the § 179 expense
election amount is allocated to the furniture (i.e., the longer-lived asset). Therefore, she
should elect to expense the 7-year property (the furniture) first.
46. Section 179 limit $25,000
Cost recovery for 7-year class assets
[($40,000 − $25,000) × .1429] $ 2,144
Income limitation
Income before § 179 and cost recovery $104,000
Cost recovery ($86,000 + $2,144) (88,144)
Income before § 179 amount $ 15,856
Section 179 amount of $25,000 (limited to $15,856) 15,856
Total deduction with respect to the 7-year assets in 2014 $18,000
Section 179 carryforward ($25,000 − $15,856) $ 9,144
47. 2013:
Section 179 expense $500,000
Additional first-year depreciation
[($550,000 – $500,000) × .50] 25,000
MACRS cost recovery
[($550,000 – $500,000 – $25,000) × .1429] 3,573
2014:
MACRS cost recovery
[($550,000 – $500,000 – $25,000) × .2449] $ 6,123
Total deduction $ 6,123
48. Hoffman and Smith, CPAs

5191 Natorp Boulevard
Mason, OH 45040
December 20, 2014
Mr. John 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 2014 for $35,000,
the total cost recovery deductions in the first year would be $27,000.
Because the car will be used as a taxi, it is not subject to the cost recovery limitations imposed on
passenger automobiles. This $27,000 cost recovery assumes that your income from your taxi business
before considering this cost recovery would be at least $25,000 and an election is made under § 179
to expense the maximum allowable amount. The $27,000 is calculated as follows:
§ 179 amount $25,000
Regular MACRS [($35,000 – $25,000) × 20%] 2,000
If you need additional information or need clarification of our calculations, please contact me.
Sincerely yours,
John J. Jones, CPA
Partner
TAX FILE MEMORANDUM
December 20, 2014
FROM: John J. Jones
SUBJECT: John Johnson: Calculations for cost recovery in year of acquisition
Facts. John Johnson is considering purchasing an automobile at the beginning of 2014 to be used
100% as a taxi. The cost of the automobile is $35,000. John 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, John can elect § 179 expensing. In deducting the
full § 179 amount of $25,000, the assumption is made that John’s income from the taxi business
before considering the § 179 expense will equal or exceed $25,000. The total amount of cost recovery
in the acquisition year would be $27,000, computed as follows:
§ 179 amount $25,000

Regular MACRS [($35,000 – $25,000) × 20%] 2,000
49. Because the car is a used car, it is not eligible for additional first-year depreciation, if available.
MACRS cost recovery:

Cost $25,000
Statutory percentage (mid-quarter convention) × 5%
Cost recovery but subject to the limitation $ 1,250
Recovery limit (limited to $3,160*) $ 1,250

Less: Personal usage (20% × $1,250) (250)
Cost recovery $ 1,000
*These cost recovery limits are indexed annually. The 2013 amounts are used.
50. Deduction for 2013
Additional first-year depreciation ($20,000 × 50%) $10,000
MACRS cost recovery [($20,000 − $10,000) × 20%] 2,000
Limited to $11,160* ($3,160 + $8,000) $12,000
Deduction for 2014

($20,000 × 32%) = $6,400 (limited to $5,100*) $6,400
So the deduction for 2013 is $11,160; for 2014, it is $5,100.
51. The total MACRS deductions would be as follows:
§ 179 expense $25,000

MACRS cost recovery [($62,000 − $25,000) × 20%] 7,400
52. Deduction for 2014

MACRS cost recovery ($20,000 × 20%) = $4,000
(limited to $3,160*) × 80% $2,528
Deduction for 2015

Straight-line ($20,000 × 20%) = $4,000 (limited to $5,100*) × 70% $2,800
Cost recovery recapture in 2015

2014 deduction $2,528
Straight-line ($20,000 × 10%) = $2,000
(limited to $3,160*) × 80% (1,600)
Excess $ 928
53. 100% business use

[$4,000 × 20% (Table 8.1)] × 100% $800
45% business use
[($4,000 × 10%) (Table 8.5)] × 45% (180)
Reduced cost recovery if personal use occurs $620
Tax cost ($620 × 28%) $174

Mason, OH 45040
December 20, 2014
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 $286 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
December 20, 2014
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, 2014. 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 $19, $42, $63, $75, and $87.
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
2014 ($48,500 × 20%) = $9,700 (limited to $3,160*) $ 3,160
2015 [$48,500 × 32% (limited to $5,100*)] 5,100
2016 [$48,500 × 19.2% (limited to $3,050*)] 3,050
2017 [$48,500 × 11.52% (limited to $1,875*)] 1,875
2018 [$48,500 × 11.52% (limited to $1,875*)] 1,875
Total cost recovery deductions $15,060
Lease:
Lease payments ($375 × 60) $22,500
Inclusion dollar amounts ($19 + $42 + $63 + $75 + $87) $ 286
55. For regular income tax liability

MACRS cost recovery ($16,000 × .20) $3,200
For AMT liability
($16,000 × .15) $2,400
56. MACRS:
Year 1 [$100,000 × 14.29% (Table 8.1)] $14,290
Year 2 ($100,000 × 24.49%) 24,490
Year 3 ($100,000 × 17.49%) 17,490
ADS:
Year 1 [$100,000 × 10.71% (Table 8.4)] $10,710
Year 2 ($100,000 × 19.13%) 19,130
Year 3 ($100,000 × 15.03%) 15,030
Total cost recovery (44,870)
Cost recovery lost by electing ADS $11,400
Tax cost of election ($11,400 × 28%) $ 3,192

Mason, OH 45040
October 15, 2014
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
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 will be. Should you need more
information or clarification of calculations, please contact us.
Sincerely yours,
John J. Jones, CPA
Partner
TAX FILE MEMORANDUM
October 15, 2014
FROM: John 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 × 2.461% (Table 8.6)] $29,532
Goodwill ($800,000/15 years) 53,333
Total recovery $82,865
Alternative 2
Warehouse [$1,500,000 × 2.461% (Table 8.6)] $36,915
Goodwill ($500,000/15 years) 33,333
Total recovery $70,248
Additional deductions in first year under alternative 1

($82,865 − $70,248) $12,617
58. Deductible amount [$5,000 – ($64,000 – $50,000)] $ –0–

Amortizable amount [($64,000/180) × 10 months] 3,556
Total deduction for startup expenditures $3,556
59. Deductible amount [$5,000 − ($53,000 – $50,000)] $2,000

Amortizable amount {[($53,000* − $2,000)/180] × 6 months} 1,700
Total deduction for startup expenditures $3,700
*Startup expenses do not include interest expense.
60. Gross income $12,000,000

Less: Expenses (5,000,000)
Taxable income before depletion $ 7,000,000
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) (2,640,000)
Taxable income $ 4,360,000
61. Not expensed
Gross income $3,840,000

Less: Expenses (1,240,000)
Taxable income before depletion $2,600,000
Cost depletion ($6* × 120,000) $720,000
Percentage depletion (15% × $3,840,000) $576,000
Greater of cost or percentage depletion (720,000)
Taxable income $1,880,000
Expensed
Gross income $3,840,000

Less: Expenses, including IDC (2,240,000)
Taxable income before depletion $1,600,000
Cost depletion ($4** × 120,000) $480,000
Percentage depletion (15% × $3,840,000) $576,000
Greater of cost or percentage depletion (576,000)
Taxable income $1,024,000
*Oil interest cost plus IDC ($2,000,000 + $1,000,000) ÷ 500,000 = $6.

**Oil interest cost of $2,000,000 ÷ 500,000 = $4.
CUMULATIVE PROBLEMS
62. Net income from Writers Anonymous (Note 1) $ 17,500

Interest income 4,000
Self-employment tax deduction (Note 4) (1,237)
Adjusted gross income $ 20,263
Less: Itemized deductions (11,700)
Personal exemption (3,900)
Taxable income $ 4,663
Tax on $4,663 from 2013 Tax Table $ 468

Self-employment tax (Note 4) 2,473
Less: Estimated tax payments (3,000)
Net tax payable (or refund due) for 2013 ($ 59)
See the tax return solution beginning on page 8-21 of this Solutions Manual.
Notes
(1) The net income of Writers Anonymous is calculated as follows.

Income from sales $85,000
Less: Rent $16,500
Utilities 7,900
Supplies 1,800
Insurance 5,000
Travel excluding meals ($3,500 – $1,200) 2,300
Meals ($1,200 – $600) 600
MACRS deduction (Note 3) 33,400 (67,500)
Income from business $17,500
(2) The itemized deductions include:

State income tax $ 3,000
Home mortgage interest 6,000
Property taxes on home 1,500
Charitable contributions 1,200
Total itemized deductions $11,700
(3) Furniture and fixtures:

§ 179 limited expensing $21,000
Cost recovery ($21,000 – $21,000) × .1429 –0– $21,000
Computer equipment:
§179 limited expensing $12,400
Cost recovery ($12,400 – $12,400) × .2000 –0– 12,400
All the assets acquired by Ms. Morgan can be expensed in 2013. 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
for 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 13).
1. Net earnings from self-employment. $17,500

2. Multiply line 1 by 92.35%. 16,161
3. If the amount on line 2 is $113,700 or less,
multiply the line 2 amount by 15.3%. This is
the self-employment tax. $ 2,473
One-half of the self-employment tax, or $1,237, is a deduction for AGI.

Mason, OH 45040
December 21, 2014
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 2014 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 is not sold and the car is not purchased, your adjusted gross income would be $198,000. If
the stock is sold and the car purchased, your adjusted gross income would be $209,840. The
supporting calculations follow:
No sale of stock and no purchase of car

Fees for services $460,000
Less: Business expenses
Building rental $ 36,000
Office furniture and equipment rental 9,000
Office supplies 2,500
Utilities 4,000
Salaries ($34,000 + $42,000) 76,000
Payroll taxes 7,000
Fuel and oil 21,000
Cost recovery (Note 3):
Front-end loaders 110,000
Dump truck 16,000
Total business expenses (281,500)
Business income before § 179 deduction $178,500
Less: § 179 deduction (Notes 1 and 3) (–0–)
Business income $178,500
Dividend income 9,500
Adjusted gross income $198,000
Notes
(1) No Section 179 deduction is allowed as acquisitions exceed $225,000.
(2) The inheritance of IBM stock worth $110,000 from Aunt Mildred is excludible under § 101.
(3) Cost recovery:
Front-end loaders
Dump truck
MACRS cost recovery ($80,000 × .20) $ 16,000
Sale of stock and purchase of car

Utilities 4,000
Salaries ($34,000 + $42,000) 76,000
Payroll taxes 7,000
Fuel and oil 21,000
Dump truck 16,000
Car 3,160
Gain on stock sale (Note 2) 15,000
Notes
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
Dump truck
Car
Limited to $3,160* $ 3,160
*The cost recovery limits are indexed annually. The 2013 amounts are used.
Should you want more information or need us to clarify our calculations, please contact us.
Sincerely,
John J. Jones, CPA
Partner
TAX FILE MEMORANDUM
December 20, 2014
FROM: John 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
$115,000 on December 29, 2014. 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
Utilities 4,000
Salaries ($34,000 + $42,000) 76,000
Payroll taxes 7,000
Fuel and oil 21,000
Dump truck 16,000
Notes
(3) Cost recovery:
Front-end loaders
Dump truck
Sale of stock and purchase of car
Utilities 4,000
Salaries ($34,000 + $42,000) 76,000
Payroll taxes 7,000
Fuel and oil 21,000
Dump truck 16,000
Car 3,160
Gain on stock sale (Note 2) 15,000
Notes
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
Dump truck
Car
Limited to $3,160* $ 3,160
*The cost recovery limits are indexed annually. The 2013 amounts are used.
SOLUTIONS TO ETHICS & EQUITY FEATURES
Section 179 Limitation (p. 8-14). Joe is entitled to 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 had 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.
Allocation of Purchase Price to Covenant Not to Compete (p. 8-26). At the time the purchase documents
were executed, there was no indication of an intent to allocate any portion of the purchase to the covenant not
to compete. The written purchase agreement explicitly and unambiguously allocated the entire $400,000
purchase price to the stock. Therefore, Red Corporation should not unilaterally after the fact allocate any of
the purchase price to the covenant not to compete for purposes of future amortization under § 197.
Business Expense or Startup Expense? (p. 8-27). Section 162 allows a deduction for ordinary and
necessary expenses paid in connection with carrying on a trade or business. However, these expenses must be
associated with a trade or business that is functioning at the time the expenses are incurred. Until that time,
the expenses are not currently deductible under §162, but rather as startup expenses under §195. Startup
expenses must be capitalized and amortized beginning in the year the business begins. Jim did not begin the
business until next year, when the property was rented. Therefore, Jim cannot deduct the renovation expenses
in the current year.
62.
62. continued
62. continued
62. continued
62. continued
62. continued
62. continued
NOTES

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DEPRECIATION, COST RECOVERY, AMORTIZATION, AND DEPLETION

SOLUTIONS TO PROBLEM MATERIALS

1 LO 1 Cost recovery Unchanged 1

29 LO 7 Startup expenditures Unchanged 29

1 Cost recovery of software New

31. Loss $11,515. 47. 2013: $528,573; 2014: $6,123.

3. Land improvements have a MACRS class life of 15 years.

4. The relevant issues for Henry:

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

14. The following issues are relevant for Jim:

27. The following issues are relevant for Orange Motors:

29. The following issues are relevant for George:

31. Cost of asset $200,000

Trucks (5-year class property)

Computers (5-year class property)

MACRS cost recovery

37. a. The building was placed in service in October.

2014: $3,800,000 × .00535 (Table 8.6) = $20,330

b. 2018: $3,800,000 × .02564 (Table 8.6) × 6.5/12 = $52,776

$1,500,000 × 2.576% (Table 8.6) = $38,640

39. 2014: $10,800,000 × .01605 (Table 8.6) = $173,340

2024: $10,800,000 × .02564 (Table 8.6) = $276,912

b. 2020: $1,300,000 × .03636 (Table 8.6) × 10.5/12 = $41,360

42. MACRS cost recovery (straight-line method)

43. This is a leasehold improvement that will be recovered over 39 years.

44. Cost of leasehold improvement $80,000

45. a. Immediate expense deduction under § 179 $25,000

b. Immediate expense deduction under § 179 $25,000

48. Hoffman and Smith, CPAs

§ 179 amount $25,000

MACRS cost recovery:

Recovery limit (limited to $3,160*) $ 1,250

Deduction for 2014

So the deduction for 2013 is $11,160; for 2014, it is $5,100.

51. The total MACRS deductions would be as follows:

§ 179 expense $25,000

52. Deduction for 2014

Deduction for 2015

Cost recovery recapture in 2015

53. 100% business use

54. Hoffman and Smith, CPAs

55. For regular income tax liability

57. Hoffman and Smith, CPAs

TAX FILE MEMORANDUM

October 15, 2014

FROM: John J. Jones

SUBJECT: Mike Saxon: Calculations of amount of recovery depending on the allocation of

Additional deductions in first year under alternative 1

58. Deductible amount [$5,000 – ($64,000 – $50,000)] $ –0–

59. Deductible amount [$5,000 − ($53,000 – $50,000)] $2,000

*Startup expenses do not include interest expense.

60. Gross income $12,000,000

61. Not expensed

Gross income $3,840,000

Gross income $3,840,000

*Oil interest cost plus IDC ($2,000,000 + $1,000,000) ÷ 500,000 = $6.