Ind.chapter 10vv

Prentice Hall's Federal Taxation 2013 Individuals, 26e (Pope)

Chapter I10 Depreciation, Cost Recovery, Amortization, and Depletion

1) On its tax return, a corporation will use the same depreciation, amortization and depletion methods used in its financial statements issued to shareholders.Answer: FALSEExplanation: While they follow the same concept of spreading the cost over asset lives, unique tax rules apply.Page Ref.: I:10-2Objective: 1

2) Recovery property includes business, investment, and personal-use assets.Answer: FALSEExplanation: Recovery property does not include personal-use assets.Page Ref.: I:10-2Objective: 1

3) In order for an asset to be depreciated in the year of purchase, it must be placed in service before year's end.Answer: TRUEPage Ref.: I:10-3Objective: 1

4) The basis of an asset must be reduced by the depreciation allowable.Answer: TRUEPage Ref.: I:10-3Objective: 1

5) Land, buildings, equipment, and stock are examples of tangible property.Answer: FALSEExplanation: Stock is intangible property.Page Ref.: I:10-3Objective: 1

6) If personal-use property is converted to trade or business use, the basis for depreciation is the lesser of adjusted basis or FMV on the date of conversion.Answer: TRUEPage Ref.: I:10-3Objective: 1

7) Under the MACRS rules, salvage value is not considered in the computation of the cost-recovery or depreciation amount.Answer: TRUEPage Ref.: I:10-4Objective: 1

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8) Under the MACRS system, depreciation rates for real property must always use the mid-month convention in the year of acquisition.Answer: TRUEPage Ref.: I:10-4Objective: 1

9) Under MACRS, tangible personal property used in trade or business purchased and placed into service on March 1, 2012 should be depreciated for 10 months in 2012. Assume the business uses a calendar tax year.Answer: FALSEExplanation: The half-year convention, which assumes that all asset acquisitions occur at midpoint of the tax year, is used.Page Ref.: I:10-4; Example I:10-3Objective: 1

10) MACRS recovery property includes tangible personal and real property that is used in a trade or business.Answer: TRUEPage Ref.: I:10-5Objective: 1

11) Under the MACRS system, automobiles and computers are classified as seven-year property.Answer: FALSEExplanation: Automobiles and computers are five-year property.Page Ref.: I:10-5Objective: 1

12) In computing MACRS depreciation in the year of disposition of personal property used in a trade or business, the half-year convention must be applied to the amounts in the tables if the half-year convention was used in the year the asset was placed into service.Answer: TRUEPage Ref.: I:10-5Objective: 1

13) Intangible assets are subject to MACRS depreciation.Answer: FALSEPage Ref.: I:10-5Objective: 1

14) Section 179 allows taxpayers to immediately expense up to $139,000 (for 2012), subject to limitations, of the cost of real and personal property placed into service in a trade or business.Answer: FALSEExplanation: Section 179 does generally apply to real estate.Page Ref.: I:10-6Objective: 1


15) The Section 179 expensing election is available on an annual basis for property purchased during the year.Answer: TRUEPage Ref.: I:10-6Objective: 1

16) Personal property used in a rental activity qualifies for the Section 179 expensing election.Answer: FALSEExplanation: Only property used in a trade or business qualifies.Page Ref.: I:10-7Objective: 1

17) Sec. 179 tax benefits are recaptured if at any time an asset is converted to personal use.Answer: TRUEPage Ref.: I:10-7Objective: 1

18) Any Section 179 deduction that is not allowed currently due to the taxable income limitation may be carried over and deducted in future years.Answer: TRUEPage Ref.: I:10-7Objective: 1

19) Under the MACRS system, if the aggregate basis of all personal property placed in service during the last three months of the year exceeds 40% of the cost of all personal property placed in service during the tax year, the mid-quarter convention is required.Answer: TRUEPage Ref.: I:10-8Objective: 1

20) The mid-quarter convention applies to personal and real property.Answer: FALSEExplanation: The mid-quarter convention does not apply to real property.Page Ref.: I:10-8Objective: 1

21) Under the MACRS system, the same convention that applies in the year of acquisition (e.g., half-year, mid-quarter, or mid-month) also applies in the year of disposition.Answer: TRUEPage Ref.: I:10-9Objective: 1

22) Residential rental property is defined as property from which more than 80% of the gross rental income is rental income from dwelling units.Answer: TRUEPage Ref.: I:10-10Objective: 1


23) The MACRS system requires that residential real property and nonresidential rental property be depreciated using the straight-line method.Answer: TRUEPage Ref.: I:10-10Objective: 1

24) Capital improvements to real property must be depreciated over the remaining life of the property on which the improvements were made.Answer: FALSEExplanation: Capital improvements are depreciated over the full life of the improvement.Page Ref.: I:10-10Objective: 1

25) Expenditures that enlarge a building, any elevator or escalator, any structural component that benefits a common area or the internal structural framework are not considered qualified leasehold improvement property.Answer: TRUEPage Ref.: I:10-10Objective: 1

26) The straight-line method may be elected for depreciating tangible personal property placed in service after 1986.Answer: TRUEPage Ref.: I:10-11Objective: 1

27) The election to use ADS is made on a year-by-year, property-class by property-class basis for real and personal property.Answer: FALSEExplanation: The election for real property is made on a property-by-property basis.Page Ref.: I:10-11Objective: 1

28) If the business use of listed property is 50% or less of the total usage, the alternative depreciation system must be used.Answer: TRUEPage Ref.: I:10-12Objective: 1

29) If the business use of listed property decreases to 50% or less of the total usage, the property is subject to depreciation recapture.Answer: TRUEPage Ref.: I:10-13Objective: 1


30) Once the business use of listed property falls to 50% or below, the alternative depreciation system must be used for the current year and all subsequent years, even if the business use percentage increases to more than 50% in a subsequent year.Answer: TRUEPage Ref.: I:10-13Objective: 1

31) If a new luxury automobile is used 100% for business and placed in service in 2012, the maximum MACRS depreciation on the vehicle for 2012 is $11,160.Answer: TRUEPage Ref.: I:10-13 and I:10-14; Example I:10-23Objective: 1

32) MACRS depreciation on an SUV weighing over 6,000 pounds is limited to $3,160 for the first year placed in service.Answer: FALSEExplanation: The limit in 2012 is $3,360 for the large SUVs or $11,360 if the SUV is eligible for bonus depreciation.Page Ref.: I:10-16Objective: 1

33) When a taxpayer leases an automobile for 100% business purposes, the entire lease payment is deductible.Answer: FALSEExplanation: The deduction will be reduced by the lease inclusion amount.Page Ref.: I:10-16Objective: 1

34) If a company acquires goodwill in connection with the acquisition of a business, the goodwill is amortizable over a 60-month period.Answer: FALSEExplanation: Goodwill is amortizable over a 15-year period.Page Ref.: I:10-18; Example I:10-29Objective: 2

35) Amounts paid in connection with the acquisition of a business which represent a covenant not to compete are amortizable over the covenant's remaining life.Answer: FALSEExplanation: The covenant must be amortized over 15 years even if the remaining life is less than 15 years.Page Ref.: I:10-18Objective: 2

36) Unless an election is made to expense or defer and amortize research and experimental expenditures, these costs must be capitalized.Answer: TRUEPage Ref.: I:10-19Objective: 2


37) Most taxpayers elect to expense R&E expenditures because of the immediate tax benefit.Answer: TRUEPage Ref.: I:10-19Objective: 2

38) Off-the-shelf computer software that is purchased for use in the taxpayer's trade or business is amortized over 36 months, or it can be immediately expensed under a Sec. 179 election.Answer: TRUEPage Ref.: I:10-21Objective: 2

39) Taxpayers are entitled to a depletion deduction if they have an economic interest in the natural resource property.Answer: TRUEPage Ref.: I:10-22Objective: 3

40) A taxpayer owns an economic interest in an oil and gas property. She is allowed to deduct the smaller of cost depletion or percentage depletion.Answer: FALSEExplanation: A taxpayer can deduct the larger of cost or percentage depletion.Page Ref.: I:10-22Objective: 3

41) Intangible drilling and development costs (IDCs) may be deducted as an expense or may be capitalized.Answer: TRUEPage Ref.: I:10-23Objective: 3

42) Joan bought a business machine for $15,000 on January 1, 2011, and later sold the machine for $12,800 when the total allowable depreciation is $8,500. The depreciation actually taken on the tax returns totaled $8,000. Joan must recognize a gain (or loss) ofA) no gain or loss.B) ($3,200).C) $6,800.D) $6,300.Answer: DExplanation: D) Selling Price (Amount Realized) $12,800 Cost $15,000 Minus: Depreciation allowed or allowable ( 8,500) Equals: Adjusted Basis ( 6,500)Gain $6,300

Page Ref.: I:10-3; Example I:10-1Objective: 1


43) In April 2012, Emma acquired a "used" machine for $60,000 for use in her business. The machine is classified as 7-year property. Emma does not expense the asset under Sec. 179. Emma's depreciation on the machine this year isA) $30,000.B) $60,000.C) $6,428.D) $8,574.Answer: DExplanation: D) $60,000 × .1429 = $8,574. The property is not eligible for bonus depreciation because its use does not originate with the taxpayer.Page Ref.: I:10-5; Example I:10-6Objective: 1

44) In May 2012, Cassie acquired a "used" machine for $30,000 to use in her business. The machine is classified as 5-year property. Cassie does not expense the property under Sec. 179. Cassie's depreciation on the machine this year isA) $3,000.B) $6,000.C) $12,000.D) $15,000.Answer: BExplanation: B) $30,000 × .20 = $6,000. The property is not eligible for bonus depreciation because its use does not originate with the taxpayer.Page Ref.: I:10-5Objective: 1

45) On January 3, 2009, John acquired and placed into service business tools costing $10,000. The tools have a 3-year class life. No other assets were purchased during that year. The depreciation in 2012 for those tools is (Sec. 179 and bonus depreciation were not applied)A) $-0-.B) $741.C) $1,920.D) $3,333.Answer: BExplanation: B) (0.0741 × $10,000) = $741 per MACRS tablesPage Ref.: I:10-5; Example I:10-6Objective: 1

46) When depreciating 5-year property, the final year of depreciation will be yearA) 3.B) 4.C) 5.D) 6.Answer: DExplanation: D) Because, under the half-year convention, an asset is depreciated half-year in the year it is purchased and placed into service, the last "half-year's" depreciation extends into an additional year.Page Ref.: I:10-6Objective: 1

47) In August of 2012, David acquires and places into service business equipment costing $550,000. The equipment is classified as 5-year recovery property. No other acquisitions are made during the year. The property is not eligible for bonus depreciation. David elects to expense the maximum amount under Sec. 179. David's total deductions for the year (including Sec. 179 and depreciation) are


A) $110,000.B) $550,000.C) $500,000.D) $221,200.Answer: DExplanation: D) Section 179 immediate expensing $139,000MACRS depreciation: Basis for depreciation: ($550,000 cost - $139,000 Sec. 179) × .20 82,200 Total depreciation $221,200


48) Leo purchases and places in service in 2012 personal property costing $610,000. What is the maximum Sec. 179 deduction that Leo can deduct, ignoring any taxable income limitation?A) $0B) $50,000C) $89,000D) $139,000Answer: CExplanation: C) $610,000 - $560,000 limitation on property placed in service equals $50,000 reduction in Sec. 179 deduction. $139,000 - $50,000 equals $89,000 maximum deduction.Page Ref.: I:10-7; Example I:10-8Objective: 1


49) Cate purchases and places in service property costing $150,000 in 2012. She wants to elect the maximum Sec. 179 deduction allowed. Her business income is $50,000. What is the amount of her allowable Sec. 179 deduction and carryover, if any?A) 179 deduction Carryover$139,0000 0

B) 179 deduction Carryover$150,000 0

C) 179 deduction Carryover$50,000 $100,000

D) 179 deduction Carryover$50,000 $89,000

Answer: DExplanation: D) The current year 179 potential deduction is $139,000, but it is limited to Cate's business income.Page Ref.: I:10-7Objective: 1

50) Elaine owns an unincorporated manufacturing business. In 2012, she purchases and places in service $620,000 of qualifying five-year equipment for use in her business. Her taxable income from the business before any Sec. 179 deduction is $70,000. Elaine takes the maximum allowable deduction under section 179. Which of the following statements is true regarding the Sec. 179 election?A) Elaine can deduct $79,000 as a section 179 deduction in 2012 with no carryover to next year.B) Elaine can deduct $139,000 as a section 179 deduction in 2012.C) Elaine can deduct $70,000 as a section 179 deduction in 2012; $9,000 may be carried over to next year.D) Elaine can deduct $70,000 as a section 179 deduction in 2012 with no carryover to next year.Answer: CExplanation: C) The maximum potential Sec. 179 deduction is $79,000 ($139,000 - ($620,000 - 560,000), but it is further limited to to Elaine's taxable income from the business. She has a carryover of $9,000 ($79,000 - 70,000).Page Ref.: I:10-7; Example I:10-8Objective: 1


51) Terra Corporation, a calendar-year taxpayer, purchases and places into service machinery with a 7-year life that cost $157,000. The mid-quarter convention does not apply, and the property is not eligible for bonus depreciation. Terra elects to depreciate the maximum under Sec. 179. Terra's taxable income for the year before the Sec. 179 deduction is $700,000. What is Terra's total depreciation deduction related to this property?A) $11,218B) $22,435C) $139,000D) $141,572Answer: DExplanation: D) Maximum Sect. 179 deduction $139,000MACRS Depreciation [($157,000 - $139,000) × .1429] = 2,572 Total depreciation $141,572


52) Tanya owns an unincorporated manufacturing business. In 2012, she purchases and places in service $580,000 of qualifying five-year equipment for use in her business. Her taxable income from the business before any Sec. 179 deduction is $100,000. Tanya elects to expense the maximum under Sec. 179. The asset is not eligible for bonus depreciation. What is Tanya's maximum total cost recovery deduction for 2012?A) $227,200B) $192,200C) $196,000D) $116,000Answer: BExplanation: B) Maximum Sec, 179 immediate expensing for 2012 $139,000 Less: Limit one ($580,000 - $560,000) ( 20,000) Sec. 179 after Limit one $119,000Limit two: Taxable income—Sec. 179 currently allowed 100,000 Sec. 179 carryover to subsequent year $ 19,000 Sec. 79 immediate expensing $ 100,000

MACRS depreciation: Basis for depreciation: Cost $580,000 Basis for depreciation: Sec. 179 deduction (including carryover) ( 119,000) Basis for depreciation: Minus: Basis to depreciate $461,000 Depreciation ($461,000 × 0.20) $92,200 Total deductions ($100,000 + $92,200) = $192,200 Page Ref.: I:10-7; Example I:10-8Objective: 1


53) Which of the following statements regarding Sec. 179 is true?A) If a taxpayer places in service property costing more than the Sec. 179 ceiling on the amount of property placed in service, the excess can be carried over to subsequent years.B) Amounts of the Sec. 179 election in excess of the taxable income limitation are carried forward.C) Sec. 179 carryforwards expire after five years.D) All of the above statements are true.Answer: BExplanation: B) Sec. 179 allows an unlimited carryforward for amounts exceeding the taxable income limitation for the year.Page Ref.: I:10-8Objective: 1

54) Lunar Corporation purchased and placed in service new five-year MACRS equipment costing $500,000 on January 5, 2012. Lunar is the original user of this equipment. Assume Lunar had no other additions this year, has high taxable income and wishes to maximize the 2012 total cost recovery deduction. How much can it deduct this year? A) $355,600B) $250,000C) $139,000D) $100,000Answer: AExplanation: A) Sec. 179 $139,00050% bonus on remaining basis ($500,000 - 139,000) 180,500Depreciation on depreciable basis: $500,000 - 139,000 - 180,500 = $180,500 × .20 36,100Maximum cost recovery deduction $355,600

Page Ref.: I:10-8 and I:10-9; Example I:10-11Objective: 1

55) In November 2012, Kendall purchases a computer for $4,000. She does not use Sec. 179 or bonus depreciation. She only uses the most accelerated depreciation method possible. The computer is the only personal property which she places in service during the year. What is her total depreciation deduction for 2012?A) $200B) $572C) $800D) $1,000Answer: AExplanation: A) MACRS depreciation is $200 (4,000 × .05) since the computer was placed in service during the 4th quarter and was the only personal property placed in service for the year.Page Ref.: I:10-8 and I:10-9; Example I:10-11Objective: 1


56) On October 2, 2012, Dave acquired and placed into service 5-year business equipment costing $70,000. No other acquisitions were made during the year. Dave does not use Sec. 179 or bonus depreciation. The depreciation for this year is using the most accelerated method possible isA) $0.B) $3,500.C) $7,000.D) $10,003.Answer: BExplanation: B) 0.05 × $70,000 = $3,500. (Mid-quarter convention).Page Ref.: I:10-8 and I:10-9; Example I:10-11Objective: 1

57) On November 3, this year, Kerry acquired and placed into service 7-year business equipment costing $80,000. In addition, on May 5th of this year, Kerry had also placed in business use 5-year recovery property costing $15,000. Kerry did not elect Sec. 179 immediate expensing, and the assets are not eligible for bonus depreciation. No other assets were purchased during the year. The depreciation for this year isA) $3,606.B) $6,606.C) $13,576.D) $14,432.Answer: BExplanation: B) Equipment placed in service in last 3 months of year: $80,000/$95,000 = 84% of all equipment; therefore, the mid-quarter convention must be used on all personal property placed in service during the year.

7-year equipment: $80,000 × .0357 = $2,8565-year property: $15,000 × .25 = 3,750Total Depreciation $6,606

Page Ref.: I:10-8 and I:10-9; Example I:10-11Objective: 1

58) Paul bought a computer for $15,000 for business use on March 18, 2010. This was his only purchase for that year. Paul used the most accelerated depreciation method available, but did not elect Sec. 179. Bonus depreciation was not available. Paul sells the machine in 2012. The depreciation on the computer for 2012 isA) $0.B) $1,440.C) $1,500.D) $2,880.Answer: BExplanation: B) [.1920 × $15,000 × 1/2 year] = $1,440Page Ref.: I:10-9; Example I:10-13Objective: 1


59) On April 12, 2011, Suzanne bought a computer for $20,000 for business use. This was the only purchase for that year. Suzanne used the most accelerated depreciation method available and did not use Sec. 179. Bonus depreciation was not available. Suzanne sells the machine in 2012. The depreciation on the computer for 2012 isA) $2,000.B) $3,200.C) $4,000.D) $6,400.Answer: BExplanation: B) [0.32 × $20,000 × 1/2 year] = $3,200Page Ref.: I:10-9; Example I:10-13Objective: 1

60) Harrison acquires $65,000 of 5-year property in June 2010 that is required to be depreciated using the mid-quarter convention (because of other purchases that year). He did not elect Sec. 179 immediate expensing. Bonus depreciation was not available. If Harrison sells the property on August 23, 2012, what is the amount of depreciation claimed in 2012?A) $6,500.00B) $7,312.50C) $11,700.00D) $9,289.00Answer: BExplanation: B) [$65,000 × .18 × 2.5/4] = $7,312.50Page Ref.: I:10-9; Example I:10-14Objective: 1

61) For real property placed in service after 1986, depreciation under the MACRS system is calculated using theA) straight-line method and a half-year convention in the year of acquisition and in the year of disposition.B) straight-line method and a mid-month convention in the year of acquisition and in the year of disposition.C) 200% DB method and a mid-month convention in the year of acquisition and in the year of disposition.D) 200% DB method and a half-year convention in the year of acquisition and in the year of disposition.Answer: BExplanation: B) Real property is depreciated using the straight-line method and the mid-month convention.Page Ref.: I:10-10Objective: 1


62) On August 11, 2012, Nancy acquired and placed into service residential rental property, which cost $430,000; the cost of the land has been excluded. Nancy annually elects the maximum allowed Sec. 179 deduction. The total depreciation for the year is (rounded)A) $5,865.B) $4,141.C) $5,117.D) $15,636.Answer: AExplanation: A) $430,000 × .01364 = $5,865. Real property is not eligible for Sec. 179 depreciation.Page Ref.: I:10-10Objective: 1

63) Lincoln purchases nonresidential real property costing $300,000 and places it in service in March 2011. What is Lincoln's 2012 depreciation on the property?A) $6,099B) $7,692C) $8,637D) $10,908Answer: BExplanation: B) Depreciation for the second year on 39-year property is .02564 × $300,000 = $7,692Page Ref.: I:10-10Objective: 1

64) Atiqa took out of service and sold a residential rental property on October 31 of this year. She had originally acquired the property ten years ago. The building (excluding the value of the land) cost $1,000,000. How much is her current year depreciation deduction?A) $30,300B) $36,360C) $18,182D) $28,785Answer: DExplanation: D) $1,000,000 × .03636 × 9.5/12 = $28,785Page Ref.: I:10-9 and I:10-10Objective: 1

65) All of the following are true with regard to the alternative depreciation system exceptA) the principal type of property for which ADS is required is any tangible property which is used predominantly outside of the United States.B) the ADS election is available to real property on a property by property basis.C) the ADS election is available to personal property on a property by property basis.D) once the ADS election is made for specified property, it is irrevocable.Answer: CExplanation: C) For personal property, the ADS election applies to all property within a class.Page Ref.: I:10-11Objective: 1


66) If the business usage of listed property is less than or equal to 50% of its total usage, depreciation is calculated using theA) regular MACRS tables.B) alternative depreciation system.C) it may not be depreciated.D) regular MACRS tables and a mid-month convention.Answer: BExplanation: B) ADS straight-line must be used for listed property which is not used more than 50% in the trade or business.Page Ref.: I:10-12Objective: 1

67) Eric is a self-employed consultant. In May of the current year, Eric acquired a computer system (5-year property) for $6,000 and used the computer 80% for business and 20% for personal purposes. Eric does not take any Sec. 179 deduction or bonus depreciation. The maximum depreciation deduction for isA) $600.B) $800.C) $960.D) $1,200.Answer: CExplanation: C) Although the computer is listed property, since it is used more than 50% in trade or business, MACRS depreciation may be used. Depreciation is $6,000 × .20 × .80 = $960. Only the portion used for trade or business is depreciable.Page Ref.: I:10-12; Example I:10-19Objective: 1

68) Eric is a self-employed consultant. In May of the current year, Eric acquired a computer system (5-year property) for $7,000 and used the computer 30% for business. Eric does not use Sec. 179. The maximum depreciation deduction for isA) $210.B) $420.C) $700.D) $2,100.Answer: AExplanation: A) Because the computer is listed property which is not used more than 50% in trade or business, ADS straight-line must be used. Depreciation is $7,000 × .10 × .30 = $210.Page Ref.: I:10-12; Example I:10-20Objective: 1


69) In the current year George, a college professor, acquired a computer system (5-year property) for $1,000 and used the computer 80% for teaching and research-related activities and the remaining 20% for personal use. Because George's employer provides him with a computer in his office at the university, the employer does not require him to have a computer at home. No election was made regarding Sec. 179. The maximum depreciation deduction isA) $0.B) $200.C) $160.D) $800.Answer: AExplanation: A) In order for an employee to take a deduction for listed property used in employment-related activities, the property must be used more than 50% for trade or business and must be for the convenience of the employer and be required as a condition of employment. Since George is not required to purchase a computer for home, no depreciation is allowed.Page Ref.: I:10-12 and I:10-13; Example I:10-21Objective: 1

70) In April of 2011, Brandon acquired five-year listed property (not an automobile) for $30,000 and used it 70% for business. No election was made regarding Sec. 179 and bonus depreciation was not available. In 2012, his business use of the property dropped to 40%. Which of the following statements is true?A) The change does not affect Brandon's previous depreciation.B) Brandon must recapture $2,100 as ordinary income.C) Brandon must recapture $4,200 as ordinary income.D) Brandon must amend the previous tax return and recompute depreciation.Answer: BExplanation: B) The 2011 depreciation taken was:Regular MACRS depreciation assuming 100% business use $30,000 × .20 =Total depreciation if 100% business use $6,000Business-use percentage .70 Total depreciation at 70% business use $4,200Depreciation under ADS straight-line:* $30,000 × .10 × .70 = 2,100 Recapture of excess depreciation in 2012 $ 2,100

*Must use ADS straight-line because the computer is listed property used 50% or less in trade or business.Page Ref.: I:10-13; Example I:10-22Objective: 1


71) In July of 2012, Pat acquired a new automobile for $28,000 and used the automobile 80% for business. No election is made regarding Sec. 179. Assuming her business use remains at 80%, Pat can take a maximum depreciation deduction in 2012 ofA) $2,528.B) $3,160.C) $8,928.D) $11,160.Answer: CExplanation: C) $11,160 maximum depreciation (including bonus) × .80 = $8,928Page Ref.: I:10-13 and I:10-14; Example I:10-24Objective: 1

72) On January l Grace leases and places into service an automobile with a FMV of $50,000. The business use of the automobile is 60%. The "inclusion amount" for the initial year of the lease from the IRS tables is $20. The annual lease payments are $8,000. What are the tax consequences of this lease?A) deduction for lease payments of $4,782B) deduction for lease payments of $4,800C) deduction for lease payments of $6,000D) deduction for lease payment of $8,982Answer: AExplanation: A) Lease payments of $8,000 × .60 = $4,800 are initially allowed. The inclusion amount is $20 × .60 = $12. $4,800 - $12 = $4,782.Page Ref.: I:10-16; Example I:10-27Objective: 1

73) On January 1, 2012, Charlie Corporation acquires all of the net assets of Rocky Corporation for $2,000,000. The following intangible assets are included in the purchase agreement:

Assets Acquisition CostGoodwill and going concern value $105,000Licenses $ 45,000Patents $ 60,000Covenant not to compete for five years $120,000

What is the total amount of amortization allowed in 2012?A) $15,000B) $22,000C) $31,000D) $38,000Answer: BExplanation: B) All of the intangible assets qualify as Section 197 intangible assets and are amortizable over 15 years. The 15-year amortization period applies to the covenant not to compete even though the covenant is only for five years. The total is computed as follows: ($105,000 + $45,000 + $60,000 + $120,000)/15 years = $22,000.Page Ref.: I:10-18; Example I:10-29Objective: 2


74) In accounting for research and experimental expenditures, all of the following alternatives are available with the exception ofA) expense R&E costs in the year paid or incurred.B) expense R&E costs in the year in which a product or process becomes marketable.C) defer and amortize R&E costs as a ratable deduction over a period of 60 months or more.D) capitalize and write off R&E costs only when the research project is abandoned or is worthless.Answer: BExplanation: B) In the year paid or incurred, the expenditures may be expensed, capitalized and amortized over 60 months, or capitalized.Page Ref.: I:10-19Objective: 2

75) Costs that qualify as research and experimental expenditures include all of the following exceptA) depreciation of laboratory equipment.B) management studies.C) costs incurred in developing product improvements.D) costs of obtaining a patent such as attorney fees.Answer: BExplanation: B) Management studies are specifically listed as items that do not qualify.Page Ref.: I:10-20; Table I:10-4Objective: 2

76) This year Bauer Corporation incurs the following costs in development of new products:

Laboratory supplies $ 55,000Laboratory equipment purchased (5-year recovery property)

50,000

Salaries (lab personnel) 90,000Utilities 20,000 Total $215,000

No benefits are realized from the research expenditures until next year. If Bauer Corporation elects to expense the research expenditures, the deduction isA) $10,000 this year and $175,000 next year.B) $175,000 next year.C) $175,000 this year.D) $215,000 this year.Answer: CExplanation: C) Deductible costs include:

Laboratory supplies $ 55,000Laboratory equipment ($50,000 × 0.20) 10,000Salaries 90,000Utilities 20,000 Total $175,000


77) Galaxy Corporation purchases specialty software from a software development firm for use in its business as of January 1 of the current year at a cost of $90,000. No hardware


was acquired. How much of the cost can Galaxy deduct this year? A) $18,000B) $15,000C) $30,000D) $90,000Answer: CExplanation: C) Purchased software that is not (1) acquired in connection with hardware or (2) is not a Sec. 197 intangible is amortized over 36 months. $90,000 × 12/36 = $30,000. Sec. 179 is not available because it is not off-the-shelf software.Page Ref.: I:10-20; Table I:10-4Objective: 2

78) In calculating depletion of natural resources each period,A) cost depletion must be used.B) percentage depletion must be used.C) the greater of cost depletion or percentage depletion must be used.D) the smaller of cost depletion or percentage depletion must be used.Answer: CExplanation: C) The method that is used in any year is the one that results in the largest deduction.Page Ref.: I:10-22Objective: 3


79) J.R. acquires an oil and gas property interest for $300,000. J.R. expects to recover 50,000 barrels of oil. Intangible drilling and development costs are $80,000 and are charged to expense. Other expenses are $20,000. During the year, 13,000 barrels of oil are sold for $170,000. J.R.'s depletion deduction isA) $25,500.B) $35,000.C) $70,000.D) $78,000.Answer: DExplanation: D) Larger of cost depletion or percentage depletion:

Cost depletion = $300,000/50,000 barrels = $6 per barrel.Total Cost Depletion = $6 × 13,000 barrels = $78,000

Percentage depletion calculation:Percentage Depletion: $170,000 × 0.15 = $25,500but not greater than gross income ceiling:Gross income $170,000 Minus: IDCs and expenses ( 100,000)Taxable income before depletion $ 70,000 $ 25,500

The taxpayer may use the greater of cost or percentage depletion so the $78,000 cost depletion will be deducted.Page Ref.: I:10-22 and I:10-23; Examples I:10-35 and I:10-36Objective: 3


80) Everest Corp. acquires a machine (seven-year property) on January 10, 2012 at a cost of $575,000. Everest makes the election to expense the maximum amount under Sec. 179, but elects out of bonus depreciation.a. Assume that the taxable income from trade or business is $1,000,000.

(1) What is the amount of the Section 179 expensing deduction for the current year?(2) What is the amount of the Section 179 carryover to the next tax year?(3) What is the amount of depreciation allowed?

b. Assume instead that the taxable income from trade or business is $100,000. (1) What is the amount of the Section 179 expensing deduction for the current year?(2) What is the amount of the Section 179 carryover to the next tax year?(3) What is the amount of depreciation allowed this year?

Answer: a. (1)Sec. 179 ceiling: $139,000

Minus: Equipment cost exceeding $560,000 ( 15,000)Allowable 179 deduction $124,000 Taxable income for the year $1,000,000 Sec. 179 expense (lesser of two preceding amounts) $124,000

(2) None. There is no carryover because there was no taxable income limitation.

(3) Basis for depreciation:Cost $575,000 Sec. 179 deduction (including amount carried over) ( 124,000)Minus: Basis to depreciate $451,000 Depreciation ($451,000 × 0.1429) $ 64,448Sec. 179 expense allowed 124,000Total deductions $188,448

b. (1) Sec. 179 ceiling: $139,000 Minus: Equipment cost exceeding $2,000,000 ( 15,000)Equals amount over threshold $124,000 Taxable income for the year $ 100,000 Sec. 179 expense (lesser of two preceding amounts) $ 100,000

(2) $124,000 allowable - $100,000 currently deductible = $24,000 carryover.

(3) Basis for depreciation:Cost $575,000 Sec. 179 potential deduction (including amount carried over)(124,000)Minus: Basis to depreciate $451,000 Depreciation ($451,000 × 0.1429) $ 64,448Sec. 179 expense allowed 100,000Total deductions $164,448

Page Ref.: I:10-7Objective: 1


81) In August 2012, Tianshu acquires and places into service 7-year business equipment (tangible personal property qualifying under Sec. 179) for $270,000. This is the only asset that she purchased during the year; her taxable income from her trade or business is $130,000. She decides to limit her 179 election to the maximum amount allowable in her business for the current year. What is her maximum cost recovery (Sec. 179 and depreciation) deduction for 2012?Answer: Section 179 immediate expensing (limited to income)$130,000MACRS depreciation:

($270,000 - $130,000) = $140,000 × .1429 = 20,006Total depreciation $150,006Page Ref.: I:10-7; Example I:10-8Objective: 1

82) On June 30, 2012, Temika purchased office furniture costing $59,000 and computers with a cost of $100,000. She uses Sec. 179. Her business income is $300,000 without considering Sec. 179. How should she allocate the 179 election in order to maximize her total cost recovery deductions (depreciation and Sec. 179) for 2012 (assume that bonus depreciation is not available)?Answer: If Temika assigns the Section 179 deduction first to the office furniture, then to the computers:Office furniture - Sec. 179 $59,000Computers- Sec. 179 (139,000 - 59,000) 80,000Computers-depreciation (.2 × (100,000 - 80,000) 4,000Total cost recovery $143,000

If Temika assigns the Section 179 deduction first to the computers, then to the furniture:Computers - Sec. 179 $100,000Office Furniture (139,000 - 100,000) 39,000Depreciation on office furniture[(59,000 - 39,000) × .1429] 2,858Total cost recovery $141,858

Temika should allocate the Sec. 179 deduction first to the office furniture to maximize her cost recovery deductions.Page Ref.: I:10-7Objective: 1


83) Mehmet, a calendar-year taxpayer, acquires 5-year tangible personal property in 2012 and does not use Sec. 179. Bonus depreciation is not available. Mehmet places the property in service on the following schedule:

Date placed in service Acquisition CostJanuary 15 $50,000May 25 $100,000November 8 $200,000

What is the total depreciation for 2012?Answer: Placed in Service MACRS DepreciationJanuary 15 $50,000 × .35 =$17,500May 25 $100,000 × .25 =$25,000November 8 $200,000 × .05 =$10,000

$52,500

Morethan 40% of the assets are placed in service in the last quarter of the year so the mid-quarter convention must be used.Page Ref.: I:10-8 and I:10-9; Example I:10-11Objective: 1

84) Greta, a calendar-year taxpayer, acquires 5-year tangible personal property in 2012 and places the property in service on the following schedule:

Date placed in service Acquisition CostJanuary 15 $ 80,000May 25 $30,000November 8 $147,000

Greta elects to expense the maximum under Section 179, and selects the property placed into service on November 8. Her business 's taxable income before section 179 is $700,000. What is the total cost recovery deduction (depreciation and Sec. 179) for 2012?Answer: Placed in Service Section 179 MACRS DepreciationJanuary 15 $80,000 × .20 =$16,000May 25 $30,000 × .20 =$6,000November 8 $139,000 $8,000 × .20 = $ 1,600

$139,000 + $23,600 = $162,600Page Ref.: I:10-9; Example I:10-12Objective: 1


85) During the year 2012, a calendar year taxpayer, Marvelous Munchies, a chain of specialty food shops, purchased equipment as follows:

Date Asset Cost March 3 Refrigerators 600,000October 9 Equipment 1,200,000

Assume the property is all 5-year property. Marvelous Munchies does not use Sec. 179, and bonus depreciation is not available. What is the maximum depreciation that may be deducted for the assets this year, 2012, assuming the alternative depreciation system is not chosen?Answer: The mid-quarter convention must be used because $1,200,000/$1,800,000 or 66 2/3% of the assets were purchased in the last quarter of the year.

$600,000 × .35 =$210,000$1,200,000 × .05= 60,000Total $270,000Page Ref.: I:10-9; Example I:10-12Objective: 1

86) On May 1, 2007, Empire Properties Corp., a calendar year taxpayer, purchased an apartment building for $1,000,000, of which $400,000 was allocable to the land. The corporation sold the property this year on September 23, 2012.a. What was the corporation's depreciation for the building, using statutory percentages under MACRS for 2007?b. What was the corporation's depreciation for the building, using statutory percentages under MACRS for 2012?Answer: a. $600,000 × .02273 = $13,638. p. C-7. Table 7 in Appendix C.b. $600,000 × .03636 × 8.5/12 = $15,453. p. C-7. Table 7 in Appendix C.Page Ref.: I:10-10Objective: 1

87) On May 1, 2011, Empire Properties Corp., a calendar year taxpayer, purchased an office building for $1,000,000, of which $400,000 was allocable to the land. The corporation sold the property this year on September 23, 2012.a. What was the corporation's depreciation for the building, using statutory percentages under MACRS for 2007?b. What was the corporation's depreciation for the building, using statutory percentages under MACRS for 2012?Answer: a. $600,000 × .01605 = $9,630. p. C-9. Table 9 in Appendix C.b. $600,000 × .02564 × 8.5/12 = $10,897. p. C-9. Table 9 in Appendix C.Page Ref.: I:10-10; Example I:10-15Objective: 1


88) In January of 2012, Brett purchased a Porsche for $100,000 to be used in his business. Brett drove the car 83 percent of the time for business. What is the maximum amount (including including regular MACRS depreciation, bonus depreciation and Section 179 expensing) that Brett may deduct in 2012?Answer: $11,160 × .83 = $9,263.Page Ref.: I:10-13 and I:10-14; Example I:10-24Objective: 1

89) Stellar Corporation purchased all of the assets of Bellavia Company as of January 1 this year for $1 million. Included in the assets are acquired are the following intangible assets:

Asset Useful Life CostPatent 10 year $120,000Covenant not to complete 3 years 30,000Goodwill Indefinite 300,000

What is Stellar's maximum amortization deduction for the year?Answer: The assets are Sec. 179 acquisition-related intangibles so regardless of their legal or economic lives, they must be amortized over 15 years.

Patent $120,000/15 $8,000Covenant not to compete $30,000/15 2,000Goodwill $300,000/15 20,000Total amortization deduction $30,000


90) Jack purchases land which he plans on developing as a golf course. The land costs $20,000,000 and the cost of clearing the land, earthmoving, constructing hazards, bunkers and greens, and installing irrigation systems will cost an additional $6,000,000. What tax issues should Jack consider?Answer: Are the costs of constructing the course considered depreciable land improvements or are they considered part of the cost of land, and not depreciable?Page Ref.: I:10-2Objective: 1

91) Debbie's Donuts is planning a major expansion over the next several months, opening many new locations around the state. The company will be spending several million dollars on new equipment and furnishings. The company is debating whether whether to push to get them all opened by December 2011 or whether to gradually roll out the new locations from December through March. Discuss the tax considerations that should be taken into account?Answer: A significant consideration is the availability of bonus depreciation. For qualifying property placed in service by December 31, 2012, bonus depreciation is 50%, allowing the much of the cost of of all of the qualifying equipment and furnishings to be deducted in 2012. Bonus depreciation is scheduled to expire as December 31, 2012.Page Ref.: I:10-8Objective: 1


92) Eduardo is planning to purchase some new pizza ovens for his business. He knows that there are various incentives in the tax law to acquire new assets in 2012. Discuss the tax incentives available and the issues to consider in deciding whether to elect them.Answer: There are two potential incentives for new depreciable personal property acquired in 2012. The Section 179 expensing is currently $139,000, with a phaseout starting at $560,000. Sec. 179 is limited by the taxpayer's preliminary taxable income. Second, for new personal property (the original use of the asset begins with the taxpayer), 50% bonus depreciation is available. Bonus depreciation, unless extended by Congress, expire as of December 31, 2012. The taxpayer is assumed to choose to use bonus depreciation on a qualifying asset and must elect out of it if he does not wish to apply it. On the other hand, the taxpayer must elect to apply Section 179 expensing. The decision of the taxpayer should be based on his marginal tax rate in the current year versus expected marginal tax rate in future years, taking time value of money into account. Page Ref.: I:10-6 through I:10-8Objective: 1

93) Bert, a self-employed attorney, is considering either purchasing or leasing a $50,000 automobile for use in his business. What are the issues he should consider in making his decision?Answer: Bert should be aware of the fact that in addition to being considered listed property and, therefore, subject to some limitations when it comes to depreciation methods, automobiles are also subject to the luxury automobile depreciation limits. Depreciation on automobiles used more than 50% of the time for trade or business is the lesser of MACRS depreciation or a specific statutory ceiling. Depreciation on automobiles used 50% or less in trade or business is the lesser of ADS straight-line depreciation or the specific statutory ceiling. On the other hand, lease payments are fully deductible (subject to usage percentages). However, an "inclusion amount" obtained from an IRS table must be included in gross income.Page Ref.: I:10-13 through I:10-16Objective: 1

94) Why would a taxpayer elect to capitalize and amortize intangible drilling costs (IDCs) rather than expense such costs?Answer: An election to expense IDCs reduces pre-depletion taxable income and thus results in a smaller percentage depletion deduction. Capitalization and amortization of such costs would generally result in a higher pre-depletion taxable income, which would result in a higher percentage depletion deduction if it was anticipated that this limitation would apply. Otherwise, it would be more beneficial to expense the IDCs since the higher of percentage or cost depletion is utilized.Page Ref.: I:10-23Objective: 3

95) Discuss the options available regarding treatment of an amount paid in excess of the FMV of an acquired company's net assets in a business combination.Answer: Any amount paid in excess of the FMV of the acquired company's net assets may be treated as a payment for goodwill, a payment for a covenant not to compete, and/or a payment for some other type of intangible asset. The sales agreement should specify the amount of the purchase price allocated to each type of asset. Under current tax law, a wide variety of intangible assets are subject to amortization. Within reason, the purchaser should attempt to have greater amounts allocated to those assets that will provide large current depreciation or amortization deductions. Since intangibles are given a 15 year life, there will be a tendency to allocate more of the purchase price to tangible personal property.Page Ref.: I:10-24Objective: 4


96) Why would a taxpayer elect to use the alternative depreciation system rather than the MACRS rules?Answer: Use of the alternative depreciation system would be preferred if the taxpayer anticipates losses over the next few years or if the taxpayer has an NOL carryover or substantial business credit carryovers. Use of alternative depreciation would result in lower depreciation charges, thus resulting in higher taxable income to offset anticipated losses or the NOL carryover, resulting in low taxes or no taxes. Without election of the alternative depreciation system, the NOL carryovers might be lost. Thus, the alternative method permits use of the NOL carryovers and also results in higher depreciation in later years of the asset's life when higher deductions may be preferred due to higher marginal rates.Page Ref.: I:10-24Objective: 4


Ind.chapter 10vv

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Transcript of Ind.chapter 10vv