ACCT 5400 Quiz #6
Cost recovery: Timing
A firm starts recovering the cost of an asset once the asset is placed in service
Gain (loss) realized
Amount realized - Adjusted basis
Example 10-1: Cost recovery Bob purchased machinery on April 8th of the current year. The relevant costs for the year are as follows: Machinery for $10,000, $800 shipping, $50 delivery insurance, $500 for installation, $750 for sales tax, $150 for the annual tune up, and $200 of property taxes (an annual tax on business property). What is Bob's tax basis for the machinery?
Answer: $12,100 An asset's basis consists of all of the costs to purchase, install, and place the asset in service. The annual tune up is a repair and the annual property tax is a general business expense. ($10,000 + $800 + $50 + $500 + $750)
Ordinary assets
Assets created or used in a taxpayer's trade or business Examples: Inventory, accounts receivable, and other assets used in a trade or business (such as machinery and equipment) if they have been used in the business for one year or less Ordinary gains → Taxed at ordinary rates Ordinary losses → Deductible against other ordinary income
Cost depletion
Based on estimates of the natural resource and deducted in the year they produce or extract the natural resource
Percentage depletion
Based on the gross income from selling the resource multiplied by a fixed percentage Depletion can actually exceed the cost basis of the natural resources Depletion cannot exceed 50% of taxable income in a given year
Asset's basis when asset was acquired through a nontaxable exchange (like-kind exchange)
Basis = Basis of assets transferred in the transaction
Asset's basis when asset was acquired through inheritance
Basis = FMV
Asset's basis when asset was converted from personal use
Basis = Lesser of (1) Cost or (2) FMV on the date of conversion
Asset's basis when asset was received as a gift
Basis = the donor's basis in the asset (i.e., recovery basis)
Cost basis for inherited assets
Basis equal to FMV on date of death or estate valuation
Cost basis for property converted from personal to business use
Basis equal to the lesser of basis or FMV on the conversion date
Research and experimentation expenditures: Cost recovery
Businesses can immediately expense these costs or they can elect to capitalize these costs and amortize them using the straight-line method over the determinable useful life or, if there is not determinable useful life, over a period of not less than 60 months (5 years). If R&E leads to a patent, unamortized costs are included in the basis of the patent and amortized over the patent's life.
Organizational expenditures: Cost recovery
Businesses can immediately expense up to $5,000 of organizational expenditures. $5,000 immediate expense is phased-out dollar for dollar for expenditures exceeding $50,000. Expenditures not immediately expensed are amortized using the straight-line method over a recovery period of 15 years (180 months).
Start-up costs: Cost recovery
Businesses can immediately expense up to $5,000 of organizational expenditures. $5,000 immediate expense is phased-out dollar for dollar for expenditures exceeding $50,000. Non-deductible costs are capitalized and amortized using the straight-line method over 180 months (5 years) using the straight-line method.
Depreciation recapture: Basics
Congress intended for businesses to receive favorable treatment on gains resulting from economic appreciation of §1231 assets. Congress did not intend to provide favorable treatment on gains that were artificially created as a result of depreciation deductions (that offset ordinary income). Congress created to address the tax treatment of artificial gains created as a result of prior cost recovery deductions.
§ 197 purchased intangibles
Examples: Customer lists, patents, trademarks, trade names, goodwill, going-concern value, covenants not to compete, etc. Recovery period: 180 months (15 years), regardless of their actual life Applicable amortization convention: Full-month convention
Organizational expenditures
Expenditures to form and organize a business in the form of a corporation or partnership Generally incurred prior to the starting of business (or shortly thereafter) but relate to creating the business entity Examples: Costs of organizational meetings, state fees, accounting service cots incident to organization, legal service expenditures such as document drafting, creating terms of the original stock certificates, etc. Note: Costs of selling or marketing stock do not qualify and cannot be amortized
Costs for routine maintenance of asset
Expense costs immediately (do not affect the asset's tax basis)
Mid-quarter convention: % of full year's depreciation in year of disposition
First quarter: 1.5/12 = 12.5% Second quarter: 4.5/12 = 37.5% Third quarter: 7.5/12 = 62.5% Fourth quarter: 10.5/12 = 87.5%
Cost basis
Generally equal to the purchase price of the asset and costs to place the asset into service
Depreciation recapture: Types of gains/losses
Losses: Rules do not apply Gains: Potentially apply to gains on the sale of depreciable or amortizable business property
Bonus depreciation
Policymakers occasionally implement to stimulate the economy Taxpayers immediately expense 100% of qualified property through 2022, and lesser amounts thereafter Taxpayer can elect out for any/all classes of assets
MACRS depreciation
To compute, a taxpayer must know: - The asset's original cost (i.e., starting basis) - The applicable depreciation method - The asset's recovery period (or depreciable life) - The applicable depreciation convention
Patents and copyrights: Cost recovery
Purchased patents or copyrights (not in an asset acquisition to which § 197 applies) are amortized over the remaining life of the patents or copyrights. Self-created patents and copyrights are amortized over their legal lives.
Costs that significantly extent asset's useful life
Record a new asset separate from the original asset
Listed property
Refers to business assets that tend to be used for both business and personal purposes. Examples: computers, cell phones, automobiles, etc.
Personal property: Depreciation conventions
Specify the portion of a full year's depreciation the business can deduct for an asset in the year the asset is first placed in service and in the year the asset is sold → Half-year convention → Mid-quarter convention
Real property: Depreciation method
Straight-line method
Immediate expensing (§ 179)
To incentivize/subsidize purchases of tangible personal property and qualified real property to be used in a trade or business Allows taxpayers to immediately expense up to $1,000,000 of tangible personal property or qualified real property (qualified leasehold improvement, qualified retail improvement, and qualified restaurant property) placed in service during 2018 Note: Intangible assets, tangible personal property that are sued less than 50% for business, and most real property are generally not eligible for immediate expensing
§1250 recapture
Subset of §1231 property Includes depreciable real property (e.g., office building, warehouse, etc.) When a taxpayer sells: Amount of gain recaptured as ordinary income is limited to the excess of accelerated depreciation over the amount that would have been deducted had the taxpayer used the straight-line method of depreciation to depreciate the asset. Amount of §1231 gain = the remainder of the recognized gain NOTE: Real property is now depreciated using the straight-line method. Thus, §1250 Depreciation Recapture no longer applies. A modified version of the recapture rules called §291 depreciation recapture applies to corporations and is still relevant.
§1245 property
Subset of §1231 property Includes tangible personal property (e.g., machinery, equipment, and automobiles) and amortizable intangible property (e.g., patents, copyrights, and purchased goodwill) When a taxpayer sells: Amount of ordinary income (depreciation recapture) = the lesser of: (1) the recognized gain on the sale, or (2) the total accumulated depreciation (or amortization) on the asset Amount of gain = the remainder of the recognized gain
Timing of gains/losses
Taxpayers generally recognize in the year realized. In certain circumstances, may be deferred to a later period or permanently excluded from income.
Immediate expensing (§ 179): Effect on MACRS depreciation
Taxpayers must reduce the basis of the assets § 179 expense before computing depreciation. Taxpayers must reduce the basis of assets § 179 expense before computing whether the mid-quarter convention applies. Taxpayers get to choose which assets are expensed under § 179.
No depreciation/amortization for
→ Personal use property → Inventory (How? COGS) → Land (Why? No determinable life) → Stocks (Why? No determinable life)
Net §1231 gain exceptions
Two exceptions that may change the character of a net §1231 gain: Exception 1: §1231 gains on the sale of individual depreciable assets may be re characterized as ordinary income under the depreciation recapture rules Exception 2: §1231 gains may also be re characterized as ordinary income under the §1231 lookback rule
Personal property: Recovery periods
Under double declining balance method. Predetermined by the IRS in Revenue Procedure 87-56. There are 3,5,7, 10, 15, and 20 year personal property assets. Office furniture, fixtures, machinery, & equipment → 7 years Cars, light-duty trucks, computers, & peripheral equipment → 5 years
Example 10-2a: MACRS Schrute Exporters purchased a truck for $30,000 on August 5, 2014 and sold the truck on January 31, 2017. This was the only acquisition for the year in 2014. What is maximum depreciation allowed for 2014, 2015, 2016, and 2017? (Assume (1) § 179 and bonus depreciation do not apply and (2) this is not a luxury automobile)
Use MACRS half-year convention depreciation rates for 5-year recovery period. 2014: 30,000 x 20% = $6,000 2015: 30,000 x 32%= $9,600 2016: 30,000 x 19.2% = $5,760 2017: 30,000 x 11.52% x 50% = $1,728
Example 10-2b: MACRS Schrute Exporters purchased a truck for $30,000 on October 5, 2014 and sold the truck on January 31, 2017. This was the only acquisition for the year in 2014. What is maximum depreciation allowed for 2014, 2015, 2016, and 2017? (Assume (1) § 179 and bonus depreciation do not apply and (2) this is not a luxury automobile)
Use MACRS mid-quarter convention for property place din service in the fourth quarter depreciation rates for 5-year recovery period. 2014: 30,000 x 5% = $1,500 2015: 30,000 x 38% = $11,400 2016: 30,000 x 22.8% = $6,840 2017: 30,000 x 13.68% x $1.5/12 = 513
Depreciation recapture: Effects
When applicable, recharacterize (all or part of) the gains from §1231 gain to ordinary income. Recapture rules do not affect the amount of gain.
Uncaptured §1250 gain for individuals
When individuals sell §1250 property at a gain, they are not required to recapture any of the gain as ordinary income under the depreciation recapture rules. All §1250 gains become §1231 gains and are netted with other §1231 gains and losses. If netting process results in a net §1231 gain → the portion of the gain caused by depreciation deductions (i.e., the unrecaptured §1250 gain) is taxed at a maximum rate of 25%, not the lower 15% rate applicable to other long-term capital gains. This means that the unrecaptured §1250 gain taxed at 25% is the lesser of: the (1) recognized gain or (2) the accumulated depreciation on the asset
Organizational expenditures and start-up costs
While the rules are the same, the limitations are computed separately for organizational expenditures and start-up costs. Thus, a business could immediately expense $5,000 of organizational expenditures AND $5,000 of start-up costs.
Example 11-3: §291 Recapture Givens, Inc. decides to sell one production warehouse for $350,000. The warehouse was purchased a few years ago for $275,000 and Givens has deducted $15,000 of straight-line depreciation as of the date of the sale. What is Givens' recognized gain/loss on the sale? What is the character of the gain/loss?
Adjusted basis = 275,000 - 15,000 = 260,000 Gain realized = 350,000 - 15,000 = 90,000 Accumulated depreciation 15,000 < recognized gain 90,000 §291 recapture = 20% x 15,000 = 3,000 Ordinary gain = $3,000 §1231 LTCG = $87,000
Asset's cost basis
All expenses needed to purchase the asset, prepare it for use, and begin using it
§1239 recapture
All gain recognized from selling property that is a depreciable asset to a related-party buyer is ordinary income
Personal property
All tangible property other than real property
Example 10-4: Organizational expenditures and start-up costs MSPC Inc. incurred the following costs in the initial year of business: Legal fees to draft the corporate charter = $22,000 on 8/31/X1 Accounting fees to set up accounting system = $31,000 on 9/17/X1 Salaries = $6,000 on 12/31/X1 attributable to November and December X1 Rent = $2,000 for November and December X1 MSPC begins operations on 11/1/X1. How much can they include as a deduction for organizational expenditures on its first tax return for the year ended 12/31/X1?
Answer: $2,567 Salaries and rent are normal business Legal fees..............................................22,000 Accounting fees..................................31,000 Organizational expenditures = $53,000 Phase-out limit...................................(50,000) Phase-out immediate expense = $3,000 Organizational expenditure deduction = (5,000 - 3,000) + (53,000 - 2,000) x 2/180 = 2,000 + 567 = $2,567
Example 11-2b: §1245 Recapture Crowder, Inc., a calendar year taxpayer, purchased a machine (7 year life) 2 years ago on September 15th for $20,000 and depreciated it using the default method and the half-year convention. What is the amount and character of the gain/loss if it is sold for $14,000?
Answer: $3,505 ordinary §1231 gain Depreciation: (MACRS half-year convention table depreciation rates for 7-year recovery period) Year 1: 20,000 x 14.29% = 2,858 Year 2: 20,000 x 24.49% = 4,898 Year 3: 20,000 x 17.49% x 1/2 = 1,749 Total depreciation = 9,505 Adjusted basis = 20,000 - 9,505 = 10,495 14,000 - 10,495 = 3,505 §1231 gain → Took depreciation → Gain < accumulated depreciation → All ordinary
Example 11-1c: Sale of §1231 property On 12/31/2018, Markham LLP sold ten acres of land that it had been using in its business for $100,000. What type of gain/loss would be generated and what would be the character of the gain/loss in the following scenarios? Scenario 3: The land was purchased on 6/1/2017 for $70,000.
Answer: $30,000 long-term capital gain Held more than one year, used in trade or business → §1231 gain → LTCP 100,000 - 70,000 = 30,000
Example 11-1a: Sale of §1231 property On 12/31/2018, Markham LLP sold ten acres of land that it had been using in its business for $100,000. What type of gain/loss would be generated and what would be the character of the gain/loss in the following scenarios? Scenario 1: The land was purchased on 6/1/2018 for $70,000.
Answer: $30,000 ordinary gain < 1 year → Ordinary 100,000 - 70,000 = 30,000
Example 11-1b: Sale of §1231 property On 12/31/2018, Markham LLP sold ten acres of land that it had been using in its business for $100,000. What type of gain/loss would be generated and what would be the character of the gain/loss in the following scenarios? Scenario 2: The land was purchased on 6/1/2018 for $130,000.
Answer: $30,000 ordinary loss < 1 year → Ordinary 100,000 - 130,000 = (30,000)
Example 11-1d: Sale of §1231 property On 12/31/2018, Markham LLP sold ten acres of land that it had been using in its business for $100,000. What type of gain/loss would be generated and what would be the character of the gain/loss in the following scenarios? Scenario 4: The land was purchased on 6/1/2017 for $130,000.
Answer: $30,000 ordinary loss Held more than one year, used in trade or business → §1231 loss → ordinary 100,000 - 130,000 = (30,000)
Example 11-2a: §1245 Recapture Crowder, Inc., a calendar year taxpayer, purchased a machine (7 year life) 2 years ago on September 15th for $20,000 and depreciated it using the default method and the half-year convention. What is the amount and character of the gain/loss if it is sold for $10,000?
Answer: $495 ordinary §1231 loss Depreciation: (MACRS half-year convention table depreciation rates for 7-year recovery period) Year 1: 20,000 x 14.29% = 2,858 Year 2: 20,000 x 24.49% = 4,898 Year 3: 20,000 x 17.49% x 1/2 = 1,749 Total depreciation = 9,505 Adjusted basis = 20,000 - 9,505 = 10,495 10,000 - 10,495 = (495)
Example 10-3a: Depreciation and § 179 Assume that Halpert Corporation has current year taxable income of $900,000 (before MACRS depreciation and § 179 expense). Assume (1) no bonus depreciation and (2) Halpert acquired the following assets in the current year. What is the maximum amount of § 179 expense that Halpert can elect to claim in the current year? Machinery: Placed in service September 12; $1,620,000 basis; 7-year recovery period Computer equipment: Placed in service February 10; $200,000 basis; 5-year recovery period Delivery trucks: Placed in service August 21; $550,000 basis; 5-year recovery period Furniture: Placed in service April 2; $400,000 basis; 7-year recovery period Total basis = $2,770,000
Answer: $730,000 Property placed in service............2,770,000 § 179 phase-out threshold.............2,500,000 Immediate expense phase-out = $270,000 Max § 179 expense...................1,000,000 Less: Phase-out.............................270,000 Deductible § 179 expense = $730,000
Example 11-2c: §1245 Recapture Crowder, Inc., a calendar year taxpayer, purchased a machine (7 year life) 2 years ago on September 15th for $20,000 and depreciated it using the default method and the half-year convention. What is the amount and character of the gain/loss if it is sold for $22,000?
Answer: $9,505 ordinary §1231 gain + $2,000 long-term §1231 capital gain Depreciation: (MACRS half-year convention table depreciation rates for 7-year recovery period) Year 1: 20,000 x 14.29% = 2,858 Year 2: 20,000 x 24.49% = 4,898 Year 3: 20,000 x 17.49% x 1/2 = 1,749 Total depreciation = 9,505 Adjusted basis = 20,000 - 9,505 = 10,495 22,000 - 10,495 = 11,505 §1231 gain → Took depreciation → Gain > accumulated depreciation → 9,505 ordinary and 2,000 LTCG
Capital assets
Any property other than: - Inventory or stock in trade held for sale in the ordinary course of business to customers - Accounts and notes receivable from the performance of services or sale of inventory in the ordinary course of business - Real and depreciable property used in a trade or business - Copyrights and artistic literary compositions created by the taxpayer pr acquired by gift or nontaxable exchange from the creator Generally held by taxpayers for investment purposes, personal-use purposes, and the production of income Tax treatment: Chapter 7
Amount realized
Cash received + FMV of assets received + Buyer's assumption of liabilities - Seller's expenses
Chapter 10: Property Acquisition & Cost Recovery
Chapter 10: Property Acquisition & Cost Recovery
Chapter 11: Property dispositions
Chapter 11: Property dispositions
Character of gains/losses
Characterized as either ordinary or capital (short-term or long-term). Character determines effect on a taxpayer's tax liability. Character of assets for: → Trade or business, holding period ≤ 1 year: Ordinary → Trade or business, holding period > 1 year: § 1231 (Gains/losses eventually characterized as ordinary or long-term capital) → Investment or personal-use (gains only), holding period ≤ 1 year: Short-term capital → Investment or personal-use (gains only), holding period > 1 year: Long-term capital → Inventory or A/R, holding period ≤ 1 year: Ordinary → Inventory or A/R, holding period > 1 year: Ordinary
Real property: Mid-month convention
Compute depreciation in: → Year of acquisition: Depreciation tables account for year of purchase → Year of disposition: (Full year's depreciation)*[(Month in which asset was disposed - 0.5)/12]
200 percent (double) declining method
Default method for depreciation of personal property Takes twice the straight-line amount of depreciation each year until switching to the straight-line method in the year that the straight-line method over the remaining life provides a greater depreciation expense
§1231 assets
Depreciable assets and land used in a trade or business (including rental property) held by taxpayers for more than one year When sold, generate §1231 gains/losses Ultimate character of gains/losses: Net §1231 gains → long-term capital gains Net §1231 losses → ordinary losses
Personal property: Depreciation methods
Depreciation methods that can be used: - 200 percent (double) declining method - 150 percent declining balance method - Straight-line method Each year, businesses elect the depreciation method for the assets placed in service during that year. Must select one depreciation method per asset class per year.
Luxury automobiles
Depreciation on automobiles weighing less than 6,000 lbs is subject to luxury automobile provisions. Luxury automobiles have a maximum depreciation limit for each year. Listed property rules are also applicable to luxury automobiles. IRS provides a maximum depreciation schedule for automobiles placed in service during particular tax years (cheat sheet).
Adjusted basis
Cost basis - Cost recovery deductions
Asset's adjusted basis (tax basis)
Cost basis minus accumulated depreciation
Amortization
Cost recovery method for intangible property Four general categories of intangible assets for tax purposes: 1. § 197 purchased intangibles 2. Start-up expenditures and organizational costs 3. Research and experimentation costs 4. Patents and copyrights
1. Depreciation 2. Amortization 3. Depletion
Cost recovery: Methods
Start-up costs
Costs incurred to start a business Include costs that are normally deductible as ordinary business expense except that they don't qualify because the business has not started yet (e.g., costs to train employees before business starts) Also include costs associated with investigating whether to create or purchase a business
Modified Accelerated Cost Recovery System (MACRS)
How businesses calculate their tax depreciation
Cost basis of gifts
If FMV > Basis on gift date, basis carries over from the giftor. If FMV < Basis on gift date, basis is the gift's basis if sold for a gain and the FMV on gift date if sold for a loss (dual basis).
Listed property: Depreciation
If business-use > 50% → Deductible depreciation = MACRS depreciation * Business-use % If business-use ≤ 50% → Deductible depreciation = MACRS straight-line method depreciation/MACRS recovery period * Business-use % If business-use is initially greater than 50% but subsequently falls to 50% or below, complex rules apply.
Example 10-3b: Depreciation and § 179. Assume that Halpert Corporation has current year taxable income of $900,000 (before MACRS depreciation and § 179 expense). Assume (1) no bonus depreciation and (2) Halpert acquired the following assets in the current year. What is the maximum total depreciation expense, including § 179 expense, that Halpert may deduct in the current year on the assets placed in service? Assume that Halpert (1) elected to claim the maximum § 179 expense and (2) allocated the § 179 expense in order to maximize total depreciation expense in the current year. Machinery: Placed in service September 12; $1,620,000 basis; 7-year recovery period Computer equipment: Placed in service February 10; $200,000 basis; 5-year recovery period Delivery trucks: Placed in service August 21; $550,000 basis; 5-year recovery period Furniture: Placed in service April 2; $400,000 basis; 7-year recovery period Total: $2,770,000 basis
Machinery: § 179 expense = (730,000); Adj basis = 890,000; Deprec = 127,181 Computer: No § 179 expense; Adj basis = 200,000; Deprec = 40,000 Trucks: No § 179 expense; Adj basis 550,000; Deprec = 110,000 Furniture: No § 179 expense; Adj basis 400,000; Deprec = 57,160 Total MACRS depreciation = $334,341 Deductible § 179 expense is the lesser of: $730,000 (from 10-3a) OR $565,659 (900,000 - 334,341) Deductible § 179 expense = $565,659 Total depreciation deduction: MACRS depreciation........................ 334,341 Plus: Deductible § 179 expense....565,659 Total depreciation deduction = $900,000 § 179 expense carryforward = 730,000 - 565,659 = $164,341
Depreciation recapture: Method determination
Method for computing is determined by the type of §1231 assets sold: Land → Pure §1231 property Personal property and intangibles → §1245 property Depreciable real property → §1250 property
Depletion
Method taxpayers use to recover their investment in natural resources Two methods: 1. Cost depletion 2. Percentage depletion Deduct the larger of cost depletion or percentage depletion
Alternative minimum tax: Depreciation
Method: 150% declining balance or straight-line method to depreciate tangible personal property (double-declining method not allowed) Recall: Difference between regular tax depreciation and AMT depreciation is an adjustment that is added back or subtracted from regular taxable income in computing the AMT tax base § 179 expense and bonus depreciation are the same for AMT
Tax basis when acquiring multiple assets for one purchase price
Must allocate a portion of the purchase price to each asset based on the assets' value relative to the total value of all the assets acquired in the same purchase
Personal property: Half-year convention
One half of a year's depreciation is allowed in the first year of an asset's depreciable life, and One half of a year's depreciation is allowed in the earlier of - The last year of an asset's depreciable life, or - The year the asset was disposed of Note: If asset is held until it is fully depreciated → IRS tables automatically account for the half-year convention If asset is sold prior to being fully depreciated → Multiply the depreciation percentage disclosed in the IRS table by 50% to determine the allowed depreciation percentage for the year of sale
§291 recapture
Only applicable to corporations Recapture for depreciable real property Amount of ordinary income = 20% of the lesser of: (1) recognized gain or (2) accumulated depreciation Amount of §1231 gain = the remainder of the recognized gain
Immediate expensing (§ 179): Phase-out
Phase-out (in 2018): Each dollar over $2,500,000 reduces the maximum § 179 deduction by that dollar (dollar for dollar). § 179 expenses are limited to a business taxable income before the § 179 expense. § 179 expenses cannot create losses. The eligible amount that goes unused due to loss limitations can be carried forward indefinitely.
Personal property: Mid-quarter convention
Required when more than 40% of a taxpayer's personal property placed in service during the year was placed in service during the fourth quarter Steps for determining whether convention applies: Step 1: Sum the total basis of the tangible personal property placed in service during the year. Basis is adjusted for § 179 but not bonus deprecation. Step 2: Sum the total basis of the tangible personal property placed in service during the fourth quarter. Step 3: Divide the outcome of Step 2 by the outcome of Step 1. If greater than 40%, must use the convention for all tangible personal property placed in service during the year. Assets are treated as if they were placed in service during the middle of the quarter in which the business actually places the assets in service. If an asset is disposed of before it is fully depreciated, the business must multiply the amount of depreciation it would have been able to claim on the asset if it had not sold the asset (a full year's depreciation) by the applicable percentage in chart
Real property
Residential rental property or nonresidential property
Real property: Recovery periods
Residential → 27.5 years Nonresidential (placed in service on or after 5/13/93) → 39 years Nonresidential (placed in service before 5/13/93) → 31.5 years Substantial improvement → Recovery period matches above per type of real property
Example 10-5: Depletion Scranton Mine purchased a platinum deposit for $3,500,000. It estimated it would extract 17,000 ounces of platinum from the deposit. Scranton mined the platinum and sold it reporting gross receipts of $500,000 and $8 million for years 1 and 2, respectively. During years 1 and 2, Scranton reported net income (loss) from the platinum deposit activity in the amount of ($100,000) and $3,800,000, respectively. In years 1 and 2, Scranton actually extracted 2,000 and 8,000 ounces of platinum. What is Scranton's depletion expense for years 1 and 2 if the applicable percentage depletion for platinum is 22 percent?
Year 1: Cost = 3.5M x 2,000/17,000 = 411,765 Percentage = 0 due to net taxable loss Depletion deduction = $411,765 Year 2: Cost = 3.5M x 8,000/17,000 = 1,647,059 Percentage = 8M x 22% = 1,760,000 Percentage limit = 3.8M x 50% = 1,900,000 Depletion deduction = $1,760,000
