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1 De nition of depreciable property A Property used in a trade or business or held to produce income B Property must lose its value over time C Property must have a determinable life of greater than one year 2 What cannot be depreciated A Property placed in service and disposed of in the same year B Land C Inventory D Equipment used to build capital improvements 3 Modi ed accelerated cost recovery system (MACRS) A Depreciation rules that apply to assets placed in service between 1981 and 1986 are often referred to as the accelerated cost recovery system (ACRS) Assets that are placed in service after 1986 fall under a modi ed cost recovery system, which is called the modi ed accelerated cost recovery system (MACRS) B ACRS generally provided faster recovery than MACRS, but only certain property placed in service under ACRS is still in service for tax purposes C The term accelerated means any cost recovery method that provides a higher deduction in the earlier years of the asset s recovery period than would have been provided in a straightline recovery method D The estimated useful life of an asset is irrelevant in the computation of tax depreciation with MACRS This often results in different numbers relative to what a rm reports as taxable income and what it reports as tax expense on its nancial statements E MACRS is used for most tangible assets in a business or in the production of income after 1986 Eight cost recovery periods are used for property: 3, 5, 7, 10, 15, 20, 271 2, and 39 years The most important recovery periods to know are those for computer software, at 3 years; cars and computer hardware, at 5 years; of ce furniture and xtures, at 7 years; residential real estate, at 271 2 years; and nonresidential rental property, at 39 years F Assets with a 3-, 5-, 7-, or 10-year recovery period are depreciated using a 200 percent declining-balance method Assets with a 15-year or 20-year recovery period are depreciated using a 150 percent declining-balance method The depreciation method switches to straight-line when a straight-line computation over the remaining recovery period results in a greater reduction There is no salvage value below 200 percent and 150 percent decliningbalance For property with a life of 271 2 or 39 years, straight-line depreciation must be used MACRS is an accelerated cost recovery system in name only for these assets G Cost basis (1) Depreciation allows for the recovery of the cost of assets purchased for use in a trade or business (a) Reduces the cost basis of an asset, thus increasing future gains (b) Reduces current income by providing a deduction in calculating net income for a business.

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204 - Income Tax Planning (2) Example: Rental property cost $50,000, sold for $90,000, and had $15,000 in depreciation The amount of gain is Step 1 Step 2 Adjusted basis = Basis ($50,000) Depreciation ($15,000) Gain = Proceeds ($90,000) Adjusted basis ($35,000) = $55,000

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