Chapter 5, ACCT 371

Capital gain property

Property contributed to a charitable organization that if sold rather than contributed, would have resulted in long-term capital gain to the donor.

Indicate the cost recovery periods (years) under MACRS: Computers and peripheral equipment.

5 years

The MACRS rules were designed to?

-Encourage investment -Improve productivity -Simplify the pertinent law and its administration

The millionaires' provision limits the amount the employer can deduct for the compensation of a covered executive to $___________ annually.

1,000,000

Indicate the cost recovery periods (years) under MACRS: Single-purpose agricultural or horticultural structures.

10 years

The TCJA of 2017 allows taxpayers to deduct _____ percent cost recovery in the year qualified property is placed in service

100

Indicate the cost recovery periods (years) under MACRS: Land improvements.

15 years

Leasehold improvements are recovered over a ____ year life using the ______ _____ convention .

15, half-year

Indicate the cost recovery periods (years) under MACRS: Water utilities.

20 years

Indicate the cost recovery periods (years) under MACRS: Any horse that is not a racehorse and is more than 12 years old at the time it is placed in service.

3 years

Nonresidential realty has a ____-year life

39

Indicate the cost recovery periods (years) under MACRS: Office furniture, fixtures, and equipment.

7 years

half-year convention

A cost recovery convention that assumes that property is placed in service at mid-year and thus provides for a half-year's cost recovery for that year.

mid-month convention

A cost recovery convention that assumes that property is placed in service in the middle of the month that it is actually placed in service.

mid-quarter convention

A cost recovery convention that assumes that property placed in service during the year is placed in service at the middle of the quarter in which it is actually placed in service. The mid-quarter convention applies if more than 40 percent of the value of property (other than eligible real estate) is placed in service during the last quarter of the year.

alternative depreciation system (ADS)

A cost recovery system in which the cost or other initial basis of an asset is recovered using the straight-line method over recovery periods similar to those used in MACRS. The alternative system must be used in certain instances and can be elected in other instances. § 168(g).

accelerated cost recovery system (ACRS)

A method in which the cost of tangible property is recovered (depreciated) over a prescribed period of time. This depreciation approach disregards salvage value, imposes a period of cost recovery that depends upon the classification of the asset into one of various recovery periods, and prescribes the applicable percentage of cost that can be deducted each year. A modified system is currently the default cost recovery method; it is referred to as MACRS. § 168.

modified accelerated cost recovery system (MACRS)

A method in which the cost of tangible property is recovered over a prescribed period of time. Enacted by the Economic Recovery Tax Act (ERTA) of 1981 and substantially modified by the Tax Reform Act (TRA) of 1986, the method disregards salvage value, imposes a period of cost recovery that depends upon the classification of the asset into one of various recovery periods, and prescribes the applicable percentage of cost that can be deducted each year. § 168.

qualified improvement property

Any improvement to an interior portion of nonresidential real property made after the property is placed in service, including leasehold improvements.

Qualified improvement property is?

Any improvement to an interior portion of nonresidential real property made after the property is placed in service, including leasehold improvements. However, it does not include the costs of an elevator or escalator or improvements that enlarge a building or modify its internal framework.

Residential rental real estate

Buildings for which at least 80 percent of the gross rents are from dwelling units (e.g., an apartment building). This type of building is distinguished from nonresidential (commercial or industrial) buildings in applying the recapture of depreciation provisions. The term also is relevant in distinguishing between buildings that are eligible for a 27.5-year life versus a 39-year life for MACRS purposes. Generally, residential buildings receive preferential treatment.

charitable contribution

Contributions made to qualified nonprofit organizations. Taxpayers, regardless of their accounting method, are generally allowed to deduct (subject to various restrictions and limitations) contributions in the year of payment. Accrual basis corporations may accrue contributions at year-end if payment is properly authorized before the end of the year and payment is made within three and one-half months after the end of the year. § 170.

research and experimental expenditures

Costs incurred to develop a product or process for which there exists uncertainty regarding its viability. The Code provides three alternatives for the tax treatment of research and experimentation expenditures. They may be expensed in the year paid or incurred, deferred subject to amortization, or capitalized. If the taxpayer does not elect to expense such costs or to defer them subject to amortization (over 60 months), the expenditures must be capitalized. § 174. In general, research and experimentation expenditures paid or incurred after 2021 must be capitalized and amortized over a five-year period. Some of these expenditures may also qualify the taxpayer for the credit for increasing research activities. § 41.

Percentage depletion

Depletion based on a statutory percentage applied to the gross income from the property. The taxpayer deducts the greater of cost depletion or percentage depletion. § 613.

Cost depletion

Depletion that is calculated based on the adjusted basis of the asset. The adjusted basis is divided by the expected recoverable units to determine the depletion per unit. The depletion per unit is multiplied by the units sold during the tax year to calculate cost depletion.

startup expenditures

Expenditures paid or incurred prior to the beginning of the business that would have been deductible as an ordinary and necessary business expense if business operations had begun. Examples of such expenditures include advertising; salaries and wages; travel and other expenses incurred in lining up prospective distributors, suppliers, or customers; and salaries and fees to executives, consultants, and professional service providers. A taxpayer will immediately expense the first $5,000 (subject to phaseout) of startup expenditures and amortize the balance over a period of 180 months, unless the taxpayer elects not to do so.

Indicate whether the following statements are "True" or "False": Related parties include a corporation owned more than 35 percent (directly or indirectly) by the taxpayer.

False

"True" or "False" regarding listed property special exceptions under MACRS: Listed property INCLUDES any computer or peripheral equipment, with the exception of equipment used exclusively at a regular business establishment, including a qualifying home office.

False. A computer or peripheral equipment placed in service after 2017 is not listed property.

"True" or "False" regarding listed property: If the business usage of the listed property drops below the more-than-50 percent level, NO DEPRECIATION DEDUCTION IS ALLOWED for the property.

False. After the business usage of the listed property drops below the more-than-50 percent level, the straight-line method is used for the remaining life of the property.

"True" or "False" regarding cost recovery for tax purposes: Personal use property IS only personalty property (personal property) that is held for personal use rather than for use in a trade or business or an income-producing activity.

False. Do not confuse personalty (or personal property) with personal use 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 an income-producing activity. Cost recovery deductions are not allowed for personal use assets.

"True" or "False" regarding listed property special exceptions under MACRS: For listed property to be considered as predominantly used in business, its business usage must exceed 80 percent.

False. For listed property to be considered as predominantly used in business, its business usage must exceed 50 percent.

"True" or "False" regarding listed property special exceptions under MACRS: The use of listed property for production of income DOES qualify as business use for purposes of the more-than-50 percent test.

False. For listed property to be considered as predominantly used in business, its business usage must exceed 50 percent. The use of listed property for production of income does not qualify as business use for purposes of the more-than-50 percent test. However, both production of income and business use percentages are used to compute the cost recovery deduction.

"True" or "False" regarding the deduction criteria for § 162 and § 212: The Code refers to reasonableness solely with respect to INTEREST and EMPLOYEE BENEFITS?

False. The Code refers to reasonableness solely with respect to salaries and other compensation for services. But the courts have held that for any business expense to be ordinary and necessary, it must also be reasonable in amount. What constitutes reasonableness is a question of fact. If an expense is unreasonable, the excess amount is not allowed as a deduction. The question of reasonableness generally arises with respect to closely held corporations where there is no separation of ownership and management.

"True" or "False" regarding cost recovery for tax purposes: The key date for the commencement of depreciation is the date an asset is PURCHASED.

False. The key date for the commencement of depreciation is the date an asset is placed in service. This date, and not the purchase date of an asset, is relevant. This distinction is particularly important for an asset that is purchased near the end of the tax year, but not placed in service until after the beginning of the following tax year.

additional first-year depreciation

In general, this provision provides for an additional cost recovery deduction of 100 percent for qualified property acquired and placed in service after September 27, 2017, and before January 1, 2027. (The bonus depreciation percentage is reduced by 20 percent for each tax year after 2022.) Qualified property includes most types of new and used property other than buildings. The taxpayer can elect to forgo this bonus depreciation. Different rules applied between 2008 and September 28, 2017.

Ordinary income property

Property contributed to a charitable organization that, if sold rather than contributed, would have resulted in other than long-term capital gain to the donor (i.e., ordinary income property and short-term capital gain property). Examples are inventory and capital assets held for less than the long-term holding period. A contribution of ordinary income property must generally be valued at its fair market value less the gain, if any, that would have been realized if sold.

listed property

Property that includes (1) any passenger automobile; (2) any other property used as a means of transportation; (3) any property of a type generally used for purposes of entertainment, recreation, or amusement; and (4) any other property of a type specified in the Regulations. If listed property is predominantly used for business, the taxpayer is allowed to use the statutory percentage method of cost recovery. Otherwise, the straight-line cost recovery method must be used. § 280F.

intangible drilling and development costs (IDCs)

Taxpayers may elect to expense or capitalize (subject to amortization) intangible drilling and development costs. However, ordinary income recapture provisions apply to oil and gas properties on a sale or other disposition if the expense method is elected. §§ 263(c) and 1254(a).

reasonableness requirement

The Code includes a reasonableness requirement with respect to the deduction of salaries and other compensation for services. The courts have expanded this requirement to all business expenses, ruling that an expense must be reasonable in order to be ordinary and necessary. What constitutes reasonableness is a question of fact. If an expense is unreasonable, the amount that is classified as unreasonable is not allowed as a deduction. The question of reasonableness generally arises with respect to closely held corporations where there is no separation of ownership and management. § 162(a)(1).

Section 179 expensing election

The ability to deduct the cost of qualified property in the year the property is placed in service rather than over the asset's useful life or cost recovery period. The annual ceiling on the deduction is $1,020,000 in 2019 ($1,000,000 in 2018). However, the deduction is reduced dollar for dollar when § 179 property placed in service during the taxable year exceeds $2,550,000 ($2,500,000 in 2018). In addition, the amount expensed under § 179 cannot exceed the aggregate amount of taxable income derived from the conduct of any trade or business by the taxpayer.

§ 179 expensing election

The ability to deduct the cost of qualified property in the year the property is placed in service rather than over the asset's useful life or cost recovery period. The annual ceiling on the deduction is $1,020,000 in 2019 ($1,000,000 in 2018). However, the deduction is reduced dollar for dollar when § 179 property placed in service during the taxable year exceeds $2,550,000 ($2,500,000 in 2018). In addition, the amount expensed under § 179 cannot exceed the aggregate amount of taxable income derived from the conduct of any trade or business by the taxpayer.

depletion

The process by which the cost or other basis of a natural resource (e.g., an oil or gas interest) is recovered upon extraction and sale of the resource. The two ways to determine the depletion allowance are the cost and percentage (or statutory) methods. Under cost depletion, each unit of production sold is assigned a portion of the cost or other basis of the interest. This is determined by dividing the cost or other basis by the total units expected to be recovered. Under percentage (or statutory) depletion, the tax law provides a special percentage factor for different types of minerals and other natural resources. This percentage is multiplied by the gross income from the interest to arrive at the depletion allowance. §§ 613 and 613A.

depreciation

The system by which a taxpayer allocates for financial reporting purposes the cost of an asset to periods benefited by the asset.

cost recovery

The system by which taxpayers are allowed to recover their investment in an asset by reducing their taxable income by the asset's cost or initial basis. Cost recovery methods include MACRS, § 179 expense, additional first-year deprecation, amortization, and depletion. §§ 168, 179, and 613.

amortization

The tax deduction for the cost or other basis of an intangible asset over the asset's estimated useful life. Examples of amortizable intangibles include patents, copyrights, and leasehold interests. Most purchased intangible assets (e.g., goodwill) can be amortized for income tax purposes over a 15-year period.

related-party transactions

The tax law places restrictions upon the recognition of gains and losses between related parties because of the potential for abuse. For example, restrictions are placed on the deduction of losses from the sale or exchange of property between related parties. In addition, under certain circumstances, related-party gains that would otherwise be classified as capital gain are classified as ordinary income. §§ 267, 707(b), and 1239.

Indicate whether the following statements are "True" or "False": Constructive ownership provisions are applied to determine whether the taxpayers are related.

True

Indicate whether the following statements are "True" or "False": Related parties include brothers and sisters, spouse, ancestors (parents and grandparents), and lineal descendants (children and grandchildren) of the taxpayer.

True

Indicate whether the following statements are "True" or "False": Related parties include two corporations that are members of a controlled group.

True

"True" or "False" regarding the deduction criteria for § 162 and § 212: An expense is ORDINARY if it is normal, usual, or customary in the type of business conducted by the taxpayer and is not capital in nature.

True. An expense need not be recurring to be deductible as ordinary. For example, a business may be in a situation that is a very rare occurrence and incur an expense. If other businesses in a similar situation are likely to incur a similar expense, then the expense can be ordinary, even though it it not recurring.

"True" or "False" regarding cost recovery for tax purposes: Assets used in a trade or business or for the production of income ARE eligible for cost recovery if they are subject to wear and tear, decay or decline from natural causes, or obsolescence.

True. Assets that do not decline in value on a predictable basis or that do not have a determinable useful life (e.g., land, stock, and antiques) are not eligible for cost recovery.

"True" or "False" regarding listed property special exceptions under MACRS: In determining the percentage of business usage for listed property, a MILEAGE-BASED percentage is used for automobiles.

True. For other listed property, one employs the most appropriate unit of time (e.g., hours) for which the property actually is used (rather than its availability for use).

"True" or "False" regarding listed property: If listed property is subject to COST RECOVERY CAPTURE, the amount required to be recaptured and included in the taxpayer's ordinary income is the excess cost recovery.

True. If the business use percentage of listed property falls to 50 percent or less after the year the property is placed in service, the property is subject to cost recovery recapture. The amount required to be recaptured and included in the taxpayer's ordinary income is the excess cost recovery. Excess cost recovery 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.

"True" or "False" regarding listed property special exceptions under MACRS: The luxury auto limits are imposed BEFORE any percentage reduction for personal use.

True. In addition, the limitation in the first year includes any amount the taxpayer elects to expense under § 179. If the passenger automobile is used partly for personal use, the personal use percentage is ignored for the purpose of determining the unrecovered cost available for deduction in later years.

"True" or "False" regarding cost recovery for tax purposes: Realty (real property) generally includes LAND AND BUILDINGS permanently affixed to the land.

True. Property includes both realty (real property) and personalty (personal property). Realty generally includes land and buildings permanently affixed to the land. Personalty is defined as any asset that is not realty.

"True" or "False" regarding cost recovery for tax purposes: The basis of cost recovery property is reduced by the COST RECOVERY ALLOWED, and by not less than the allowable amount.

True. The allowed cost recovery is the cost recovery actually deducted, whereas the allowable cost recovery is the amount that could have been taken under the applicable cost recovery method. If the taxpayer does not claim any cost recovery on property during a particular year, the basis of the property still is reduced by the amount of cost recovery that should have been deducted (the allowable cost recovery).

"True" or "False" regarding the deduction criteria for § 162 and § 212: NEITHER "ordinary" nor "necessary" is defined in the Code or Regulations.

True. The courts have held that an expense is necessary if a prudent business person would incur the same expense and the expense is expected to be appropriate and helpful in the taxpayer's business. But no deduction will be allowed unless the expense is also ordinary.

"True" or "False" regarding listed property: A taxpayer who leases a passenger automobile reports an INCLUSION amount in gross income.

True. The inclusion amount is computed from an IRS table for each taxable year for which the taxpayer leases the automobile. The purpose of this provision is to prevent taxpayers from circumventing the luxury auto and other limitations by leasing, instead of purchasing, an automobile. The inclusion amount is based on the fair market value of the automobile; it is prorated for the number of days the auto is used during the taxable year. The prorated dollar amount then is multiplied by the business and income-producing usage percentage. The taxpayer deducts the lease payments, multiplied by the business and income-producing usage percentage.

"True" or "False" regarding the deduction criteria for § 162 and § 212: To be deductible, any trade or business expense must be "ORDINARY AND NECESSARY." Such expenses are deducted for AGI.

True. These include reasonable salaries paid for services, expenses for the use of business property, and part of self-employment taxes paid. Such expenses are deducted for AGI.

"True" or "False" regarding listed property special exceptions under MACRS: The law places special limitations on cost recovery deductions for PASSENGER automobiles (any four-wheeled vehicle manufactured for use on public streets, roads, and highways with an unloaded gross vehicle weight rating of 6,000 pounds or less.)

True. This definition specifically excludes vehicles used directly in the business of transporting people or property for compensation, such as taxicabs, ambulances, hearses, and trucks and vans as prescribed by the Regulations.

"True" or "False" regarding listed property: Listed property IS subject to the substantiation requirements of § 274.

True. This means that the taxpayer must prove for any business usage the amount of expense or use, the time and place of use, the business purpose for the use, and the business relationship to the taxpayer of persons using the property. Substantiation requires adequate records or sufficient evidence corroborating the taxpayer's statement.

ordinary and necessary

Two tests for the deductibility of expenses incurred or paid in connection with a trade or business; for the production or collection of income; for the management, conservation, or maintenance of property held for the production of income; or in connection with the determination, collection, or refund of any tax. An expense is ordinary if it is common and accepted in the general industry or type of activity in which the taxpayer is engaged. An expense is necessary if it is appropriate and helpful in furthering the taxpayer's business or income-producing activity. §§ 162(a) and 212.

The expenses of cash basis taxpayers are deductible when ________ or __________ paid .Therefore, payment ____ be made with borrowed funds.

actually, constructively, can

The Regulations set forth the general rule that an expenditure that creates an asset having a useful life that extends substantially beyond the end of the tax year must be ___________.

capitalized

The millionaires' provision _____ ____ limit the amount of compensation that can be paid to an employee.

does not

Qualified improvement property includes or does not include leasehold improvements?

includes