Business Assets
Chapter 7 pp. 209-252
2012 National Income
Tax Workbook™
Business Assets pp. 209-252
 Depreciation basics
 First-year cost recovery
 Sales of business assets
 Installment sales
 Like-Kind Exchanges
 Casualty Gains and Losses
Learning Objectives
1.
2.
3.
4.
5.
6.
p. 209
Determine if property is depreciable
Explain first-year options
Prepare Form 4797 to report sale
Compute installment sale gain
Decide if exchange is like-kind
Calculate casualty gain or loss
Depreciation Basics
p. 210
 Useful life that can be estimated
 Owned by taxpayer
 Used in trade or business, or
held for production of income
 Asset placed in service (ready
and available for use)
Depreciation Methods
pp. 210-212
 MACRS assigns recovery periods
and depreciation methods
 GDS generally shorter than ADS
 ADS is always straight-line
 Figure 7.1: Comparisons
 ADS is required for some assets
Listed Property
pp. 211-212
 Assets with sizeable potential for
personal as well as business use
 ADS required unless asset is used
more than half the time in business
 Assets include vehicles, audio and
video equipment, computers used
outside a business, and so forth
Conventions
pp. 212-213
 First and last years’ deductions are less
than a full year’s cost recovery
 Tangible personal property usually
limited to a half-year deduction, but
substantial purchases late in year
trigger mid-quarter convention
 Real estate treated as placed in service
in middle of month
Mid-Quarter Convention
p. 213
 Look at non-real estate assets placed
in service during last 3 months of tax
year, no matter how short the year is
 If the depreciable basis of those assets
> 40% of the basis of all such property
placed in service during the year, midquarter convention must be used for all
of the new non-real estate assets
Avoiding MQ Convention
p. 213
 Use of I.R.C. § 179 deduction
removes assets from calculation
 Example 7.1: Taxpayer must use
MQ convention (40.59%)
 Example 7.2: Small § 179 election
gives taxpayer HY depreciation for
other property (40%)
Applying MQ Convention
p. 214
 Divide tax year into quarters and
assign assets (Example 7.3)
 Middle of quarter is 1½ months
 Pub. 947 includes tables
 Early disposition requires full-year
depreciation modification
(Examples 7.4 and 7.5)
MACRS
pp. 215-216
 Determine recovery class, select
GDS or ADS, choose method,
establish convention, use tables
(Example 7.6)
 Early disposition requires
adjustment (Example 7.7)
First-Year Options
p. 216
 I.R.C. § 179 deduction
▪ Up to 100% of cost
▪ Dollar and investment limits
▪ Business income limitation
 Additional first-year depreciation
▪ Up to 50% of cost for 2012
▪ Can create net operating loss
I.R.C. § 179
pp. 216-217
 More than 50% use in active business
 New or used tangible § 1245 property
 Acquired by purchase from unrelated
party (trade-in basis is not eligible)
 Generally cannot be used for assets
purchased for lease to others (two
exceptions) or by lodging enterprise
I.R.C. § 179
pp. 217
 2012 dollar limit is $139,000
 Dollar-for-dollar phaseout begins at
$560,000 of eligible asset acquisitions
(Example 7.8)
 Election made at entity level; dollar
limit─but not investment limit─also
applies at owner level (Example 7.9)
I.R.C. § 179
pp. 217-218
 Separate purchases by partners who
contribute only the use of property can
boost total deduction (Example 7.10)
 Elections by multiple flow-through
entities can result in lost deductions
(Example 7.11)
 For tax years 2003–2012, changes can
be made on amended returns
I.R.C. § 179
pp. 218-219
 Business income limit uses aggregate
of all business income, such as wages
 If joint return is filed, both spouses’ net
business income is considered
 Taxpayer can elect larger amount, but
excess carries forward (indefinite
number of years)
I.R.C. § 179
pp. 219-220
 Active trade or business income does
not include passive activity or hobby
 “Meaningful participation” in business’s
management or operation
 Examples include Schedule C or F
profit or loss, partnership/S corporation
flow-through, Form 4797 gains and
losses, salaries and wages
I.R.C. § 179
p. 220
 Elected amount reduces asset’s basis,
basis in flow-through entity
 Recapture required if business use
drops to 50% or less
▪ Recapture amount is the excess of the
deduction over allowable MACRS
▪ Reported on Form 4797 and business
income schedule
Additional First-Year
Depreciation
pp. 220-223
 Qualifying MACRS property
 New property (original user)
 Acquired by purchase after 2007
 Placed in service before 2013
 AFYD is default; taxpayer must
elect out to avoid its application
 Some corporations may use credit
Comparison
1.
2.
3.
4.
5.
6.
7.
pp. 221-222
Used property: § 179 only
20-year property: AFYD only
Transferred basis: AFYD only
Trigger MQ convention: § 179 only
Limits on amounts: § 179 only
Year (calendar/AFYD; tax/§ 179)
Recapture (all/§ 179; listed/AFYD)
Example 7.12
Cost of asset
§ 179 election
Basis for MACRS
AFYD
Remaining basis
14.29% MACRS
Total deduction
pp. 222-223
$439,000
(139,000)
$300,000
(150,000)
150,000
(21,435)
$310,435
Sales of Business Assets
p. 223
 § 1231 is best of both worlds
 Net gain is treated as capital
 Net loss is treated as ordinary
 Depreciable and nondepreciable
assets if holding period is met
 Net all sales on Form 4797
Sales of Business Assets
p. 224
 5-year recapture period if gains
follow losses (gain is ordinary
income to extent of prior loss)
 Example 7.13: Sales in same
year are netted; tax benefit is
maximized by timing gain in
Year 1 and loss in Year 2
§ 1245 Property pp. 224-225
 Most depreciable or amortizable
property except for buildings
 Includes other land improvements
 Gain on disposition is ordinary
income to extent of prior basis
reductions (not just depreciation)
§ 1250 Property pp. 225-226
 Depreciable real property that was
never and is not § 1245 property
 Gain equal to basis reductions in
excess of straight-line depreciation
is ordinary income
 Top tax rate on capital gain equal
to straight-line depreciation is 25%
§ 1250 Property pp. 225-226
 Gain due to appreciation is taxed
at regular capital gain rate
 Example 7.14: Gain on pole barn
includes ordinary income, § 1250
gain, and other capital gain
 Corporations must treat 20% of
§.1250 gain as ordinary income
§§ 1252 and 1255 Property
pp. 226-227
 10-year recapture period for soil
and water conservation expenses
(Example 7.15)
 20-year recapture period for
conservation payment exclusion
Form 4797
pp. 227-230
 Part I: § 1231 gains and losses
 Part II: Ordinary gains and losses
 Part III: Basis reduction recapture
(§§ 1245, 1250, 1252, 1254, 1255)
 Part IV: § 179, §280F recapture
 Examples 7.16 and 7.17
Related Issues
p. 231
 Allowable depreciation must be
recaptured even if not deducted
 File Form 3115 to deduct catchup amount in year of disposition
 Below-market sale is partly a gift
 Prorate basis on Form 4797
 File Form 706 to start statute
Installment Sale Rules
pp. 231-232
 Seller-financing can spread out
taxation of gain on eligible sale
 Need to balance tax, credit risks
 At least 1 payment in later year
 Ordinary income not deferred,
regardless of payment received
Installment Sales
p. 232
 Selling price: Total value received
 Contract price: Sales price minus debt
assumed by buyer (not > than basis)
 Gross profit: Gain on sale reduced by
ordinary income recapture and (for
sale of main home) excludable gain
 Gross profit percentage: Gross profit
divided by contract price
Payments in Year of Sale
pp. 232-233
1. Debt relief in excess of basis
2. Buyer’s payment of seller’s
costs
3. Buyer’s note only if is payable
on demand or readily tradable
4. Prior deposit (earnest money)
Installment Sales
pp. 233-234
Example 7.18: Sale of machinery
Gain
$ 150,000
Depreciation
(60,000)
Gross profit
$ 90,000
Gross profit percentage
$90,000 ÷ $350,000 = 25.714%
Installment Sales
pp. 233-237
Example 7.18: Sale of machine
$100,000 × 25.714%
$ 25,714
Depreciation recapture* 60,000
Gross income for 2012 $ 85,714
(See Figures 7.12 and 7.13)
* Recognized even if no payment
Unstated and Imputed Interest
p. 238
 Sellers usually prefer capital gain
 Buyers usually want deduction
instead of capital expense
 Arm’s length transaction generally
results in adequate interest so
that buyer gets some deduction
and seller gets FMV for property
Unstated and Imputed Interest
p. 238
 I.R.C. §§ 483 and 1274 require
interest on installment sales
 IRS publishes AFRs each month
 If stated interest is inadequate, part
of principal is recharacterized
 Lower sales price reduces gross
profit, but difference is interest paid
by buyer and received by seller
Related Party Resale Rule
pp. 238-239
 Installment sale made to related party
 Buyer resells property within 2 years
but does not pay off installment debt
 Seller is deemed to receive resale
price up to amount due on contract,
thus accelerating gain recognition
 Waived if no tax avoidance motive
Like-Kind Exchanges
pp. 239
 I.R.C. § 1031 mandates deferral of
realized gain in like-kind exchange
1. Used in business or for income
2. Not held for personal use
3. Same nature or character
 Report transaction on Form 8824
Like-Kind Exchanges
p. 240
 Basis transfers to new property
 Boot = cash or unlike property
 Boot received is taxable to
extent of realized gain
 Boot paid increases basis of
property received in exchange
Example 7.19
pp. 240-242
FMV received
Basis in old asset
Boot (cash) paid
Basis transferred
Gain realized
Deferred gain
$1,500,000
$ 800,000
250,000
(1,050,000)
$ 450,000
$ 450,000
Example 7.20
pp. 242-243
FMV relinquished
FMV received
Boot received
Basis transferred
Gain realized
Gain recognized
$1,250,000
$1,000,000
250,000
(800,000)
$ 450,000
$ 250,000
Like-Kind Exchange
p. 244
 Potential depreciation recapture
transfers to new property
 I.R.C. § 1031 is not elective
 Separate sale can avoid deferral
of built-in loss or lower basis for
depreciation of new asset
 Example 7.21 (Rev. Rul. 61-119)
Casualty Gains and Losses
pp. 244-245
 Sudden, unexpected, or unusual
 Loss if business asset is destroyed
is tax basis minus any recovery
 Loss if business asset is damaged
is lesser of decrease in FMV or tax
basis, minus any recovery
Example 7.22
p. 245
FMV before fire
$225,000
Adjusted basis
$212,377
Insurance settlement (155,000)
Casualty loss
$ 57,377
Report on:
Form 4684 (Form 4797) Form 1040
Example 7.23
pp. 246-248
FMV before fire
$225,000
Adjusted basis
$212,377
Insurance settlement (225,000)
Casualty gain
$ 12,623
If no reinvestment, report on:
Form 4684, Form 4797, Form 1040
Example 7.24
pp. 248-250
Cost of bulldozer
FMV before loss
Basis (after § 179)
Insurance settlement
§ 1245 recapture
§ 1231 gain
$125,000
$142,000
0
$142,000
$125,000
$ 17,000
Postponement of Gain p. 251
 Reinvest entire proceeds to avoid
recognizing any gain
 Similar or related in service or use
 Attach statement to tax return in
gain year and replacement year
 Time limits vary from 2 to 5 years
Example 7.25
Replacement property
Insurance settlement
(deferred gain)
Additional cost
Basis in lost asset
Basis in replacement
p. 252
$185,000
(142,000)
$ 43,000
0
$43,000
Questions?