Depreciation Taxes

What is delta (triangle) in the tax computation in the tax schedule?

The actual taxable income minus the low end of the taxable income bracket (i.e., if you're in the bracket 0-$50,000, you would do taxable income - $0)

When a depreciable asset is sold for a different amount than its book value, how do you calculate book value at the time of disposal?

Sum the Dn up to and including the year it was disposed of, then subtract that from its cost basis.

What is a depreciable asset, and what three criteria must an asset meet to be called as such?

A depreciable asset is something that can be taken as a depreciation deduction against income for tax purposes. The three criteria are: Be used/held for the production of income Have a definite service life greater than 1 year. Be something that deteriorates/loses value naturally.

What is book value (Bn)?

A depreciable asset's cost minus accumulated depreciation.

What is book depreciation intended for, and what is tax depreciation intended for?

Book depreciation is intended for financial reports, while tax depreciation is intended for the IRS to calculate taxes.

When a depreciable asset is sold for a different amount than its book value, what is case 1 and case 2?

Case 1 is when the salvage value is less than the cost basis and case 2 is the opposite.

How does the MACRS method work? What is important to note about the salvage value?

For the MACRS method, the asset falls within a given class with a certain recovery period. You can find Dn using the percentages given in the MACRS depreciation schedules. The salvage value in the MACRS method is always zero.

What are gross revenues and expenses?

Gross revenues are incomes earned by a business selling goods or services. Expenses are the business' costs to generate revenue.

Explain switching policy.

In switching policy, you start with the DB method, then switch to the SL method once the Dn of the SL method is greater than the Dn of the DB method.

What is profit/income, loss, and net income

Income is when revenues exceed costs, loss is when costs exceed revenues, and net income is the income after tax.

What does it mean that capital expenditures must be capitalized?

It means that you cannot just subtract an asset's total capital expenditure (I) from the income the year it was bought. Instead, you take the Dn and deduct it from each year's income until you reach the end of the asset's life. So the depreciation of the asset is a deductible, meaning it will reduce the taxable income.

What convention does MACRS follow? What if the asset is disposed of before the end of the recovery period?

MACRS follows the half-year convention, meaning there is half a year of depreciation in year 1, and half a year of depreciation in the year after year N (i.e., if N = 7, there is half a year of depreciation in year 8). This also means that if the asset is disposed of early, only half the normal depreciation is allowed the year of disposal.

What are the two types of real properties, and how long are their lives?

One is residential property, depreciated over 27.5 years, and the other is commercial properties, depreciated over 39 years.

What is the cost basis of an asset?

The cost basis is the portion of an asset's expense that is depreciable. For example, if you buy a building + land, the cost basis would be only the cost of the building, since the land is not depreciable.

How does the declining balance (DB) method work? What's something important to remember as this method approaches the salvage value?

The declining balance method has a new decreasing depreciation amount each period, making it a curved trajectory. The depreciation amount is calculated using a given multiplier, typically 1.5 (aka 150% DB) or 2.0 (aka 100% DB or double DB). It's important to remember that this method should stop depreciating once it reaches the salvage value, as it is possible to accidently go past it! Any book value lower than the salvage value should be changed to the salvage value and the depreciation charge updated to reflect this.

How does the straight line (SL) method work?

The straight line method is linear depreciation, meaning the value of the asset goes down by the same amount in every period. Depreciation ends at the salvage value.

What depreciation methods are used in book deprecation?

The three different methods used in book depreciation are the straight line (SL), declining balance (DB), and unit of production methods.

How does the units of production (UP) method work?

The units of production method depreciates an asset as a function of usage rather than time, so Dn is based on the number of service units used during year n.

Define depreciation.

The value a fixed asset loses over time through normal deterioration.

What is salvage value?

The value of the asset at the end of its life.

What is depreciation charge (Dn)?

The value of the depreciation of the asset in each period.

What is the average tax rate?

Total taxes paid divided by total taxable income (a percentage).

Besides a physical asset, what else can cost basis include?

Transportation, onsite preparation, and installation of the asset(s).

How do you depreciate real properties?

Using the SL method and the midmonth convention, meaning that it allows half a month of depreciation the month of purchase/implementation and the month of disposal.