Solution Manual For McGraw-Hill's Taxation of Business Entities 2020 Edition, 11th Edition

Solutions Manual –Taxation of Business Entities, by Spilker et al. Chapter 2 Property Acquisition and Cost Recovery SOLUTIONS MANUAL Discussion Questions 1. [LO 1] Explain why certain long-lived assets are capitalized and recovered over time rather than immediately expensed. Assets with an expected life of more than one year are capitalized and recovered through depreciation, amortization, or depletion deductions— depending on the type of underlying asset. The policy attempts to match the revenues and expenses for these assets because the assets have a useful life of more than one year. 2. [LO 1] Explain the differences and similarities between personal property, real property, intangible property, and natural resources. Also, provide an example of each type of asset. Personal property, real property, and natural resources are all tangible property than can be seen and touched. Natural resources are assets that occur naturally (e.g. timber or coal). Real property is land and all property that is attached to land (e.g. buildings). Personal property is all tangible property that is not a natural resource or real property. Intangibles are all intellectual property rights (e.g. patents and copyrights) and any other value not assigned as a tangible asset during a purchase (e.g. goodwill). Each of these has an expected useful life of more than one year. Asset Type Personal property Real property Intangibles Natural Resources 3. Examples Automobiles, equipment, furniture, and machinery Land and items attached to land such as buildings (warehouse, office building, and residential dwellings) Start-up and organizational costs, copyrights, patents, covenants not to compete and goodwill Commodities such as oil, coal, copper, timber, and gold [LO 1] Explain the similarities and dissimilarities between depreciation, amortization, and depletion. Describe the cost recovery method used for each of the four asset types (personal property, real property, intangible property, and natural resources). Copyright © 2020 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education. 1 Solutions Manual –Taxation of Business Entities, by Spilker et al. There are three types of cost recovery: depreciation, amortization, and depletion. Each is similar in that they recover the cost basis of long-lived assets. Depreciation for real property, amortization, and cost depletion are on a straight-line basis. (Taxpayers may elect straight-line on tangible personal property as well.) The primary difference is that they are used for property with unique characteristics. Depreciation of tangible personal property is done on an accelerated (most often double-declining balance) method. Percentage depletion assigns a statutory rate that may recover more than the original cost of the asset. Asset Type Personal property Real property Intangibles Natural Resources 4. Cost Recovery Type, Characteristics MACRS depreciation, characterized by double declining balance method (although 150% DB or straight-line may be elected), half-year convention (although mid-quarter may be required), and shorter recovery periods. MACRS depreciation, characterized by straightline method, mid-month convention, and longer recovery periods. Amortization, characterized by straight-line method, full-month convention, various recovery periods (usually not based on actual life) depending on intangible type. Depletion (cost or percentage), cost depletion allocates the cost of a natural resource based on resource estimates (tons, ounces, barrels, etc.), straight-line method, based on actual extraction quantities, percentage depletion allocates a statutory expense (depending on resource type) based on gross income, but limited to 50% (100% for oil and gas property) of net income, and is the only cost recovery method that allows a taxpayer to recover more than the original basis of an asset. [LO 1] Is an asset’s initial or cost basis simply its purchase price? Explain. The initial basis of any purchased business asset is historical cost. This is generally the purchase price, plus any other expenses (e.g. sales tax and installation costs) incurred to get the asset in working condition. This does not include costs which constitute a betterment, restoration, or adaptation to a new or different use for an asset such as a building addition. 5. [LO 1] Compare and contrast the basis of property acquired via purchase, conversion from personal use to business or rental use, a tax-deferred exchange, gift, and inheritance. Copyright © 2020 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education. 2 Solutions Manual –Taxation of Business Entities, by Spilker et al. The basis of purchased assets is historical cost. The basis rules for other acquisitions depend on whether the transaction was taxable or not. For taxable transactions there is usually a step-up in basis to fair market value. For non-taxable transactions, there is usually a carryover basis. Conversion of assets from personal use gets the lesser of the two values. The specific rules are as follows: Acquisition Type Purchase Conversion from personal use Non-taxable exchange Gift Inheritance 6. Basis Rules The initial basis is historical cost plus all costs incurred to get the asset to its destination and in working order. The depreciable basis would be the lesser of the fair market value of the asset on the date of conversion or the adjusted basis of the transferor. The basis is a carryover basis of the transferor since there is no recognition of gain or loss on the transfer (not a taxable transaction). The basis is generally a carryover basis, because these transactions usually aren’t taxable. If gift tax is paid, the basis may be increased by a portion of the gift tax paid. The basis is the fair market value on the date of death or the alternate valuation date six months later (if elected by the estate). The fair market value is used because the transfer arises from a taxable transaction. [LO 1] Explain why the expenses incurred to get an asset in place and operable should be included in the asset’s basis. Additional expenses, including sales tax, shipping, installation costs, and the like are capitalized into an asset’s basis because all costs required to place an asset into service are required to be included into its basis. That is, without these costs, the taxpayer would not be able to place in service or use the asset in a business. 7. [LO 1] Graber Corporation runs a long-haul trucking business. Graber incurs the following expenses: replacement tires, oil changes, and a transmission overhaul. Which of these expenditures may be deducted currently and which must be capitalized? Explain. An expense that results in a betterment, restoration, or adaptation for a new or different use for the property will be capitalized as a new asset— depreciated over the same MACRS recovery period of the original asset rather than the remaining life of the existing asset. Alternatively, expenses that constitute routine maintenance or meet the other safe harbor rules Copyright © 2020 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education. 3 Solutions Manual –Taxation of Business Entities, by Spilker et al. should be expensed immediately. An engine overhaul is likely to be a capitalized expense as a restoration. Tires and oil changes are likely to be expensed currently. However, all expenses are subject to a facts and circumstances test. 8. [LO 2] MACRS depreciation requires the use of a recovery period, method, and convention to depreciate tangible personal property assets. Briefly explain why each is important to the calculation. MACRS depreciation calculations are straightforward once you know the recovery period (life), method, and convention for the asset. Recovery period is the statutory life or the period over which a taxpayer will allocate the depreciation deduction. Profitable taxpayers prefer the recovery period to be as short as possible so that they may recoup the basis as quickly as possible. The method is generally the double-declining (200% DB) method. However, taxpayers may elect to use either the 150% DB method (useful if they are subject to AMT, to avoid calculating both regular and AMT depreciation) or straight-line method (to lengthen depreciation deduction for taxpayers in an expiring NOL situation). The convention determines how much depreciation is taken in both the year of acquisition and the year of disposition. The halfyear convention is used to simplify calculating depreciation based on the number of days an asset was owned during the year, but the mid-quarter convention is required if more than 40 percent of the tangible personal property placed in service during the year was placed in service during the fourth quarter. 9. [LO 2] Can a taxpayer with very little current-year income choose to not claim any depreciation deduction for the current year and thus save depreciation deductions for the future when the taxpayer expects to be more profitable? Taxpayers must reduce the basis of depreciable property by the depreciation allowed or allowable (§1011). Therefore, taxpayers must reduce their basis whether or not they claim the depreciation deduction. As a result, taxpayers are better off taking the depreciation deduction even if it creates a net operating loss or is taxed at a relatively low marginal tax rate. However, taxpayers may elect out of bonus depreciation and may choose not to take §179 expense which would reduce the current depreciation deduction otherwise available. 10. [LO 2] [Planning] What depreciation methods are available for tangible personal property? Explain the characteristics of a business likely to adopt each method. Taxpayers may elect to use the 200% DB, 150% DB, or the straight-line method for tangible personal property. It is important to note that all three methods allow the same depreciation deduction over the same recovery period. Nevertheless, profitable taxpayers will elect to use the 200% DB Copyright © 2020 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education. 4 Solutions Manual –Taxation of Business Entities, by Spilker et al. method because it minimizes the after-tax cost of the asset by maximizing the present value of the depreciation deductions—through accelerating the depreciation deductions. Taxpayers traditionally subject to the AMT may elect to use the 150% DB method because it saves them the administrative inconvenience of calculating depreciation under two separate methods. Taxpayers may elect to use the straight-line method if they want to slow down depreciation—which is counterintuitive but often occurs for companies that regularly incur NOLs and would like to preserve these losses for a time when they expect profitability or will be acquired by another taxpayer that may be able to utilize the NOLs. 11. [LO 2] If a business places several different assets in service during the year, must it use the same depreciation method for all assets? If not, what restrictions apply to the business’s choices of depreciation methods? Taxpayers may generally choose the depreciation method used for assets placed in service. The MACRS general depreciation system generally uses the 200% DB method for tangible personal property and the straight-line method for real property. However, taxpayers may elect either the 150% DB or straight-line method for tangible personal property on a property class by property class basis (§168(g)(7)). For example, if a taxpayer places in service a computer (5-year property), a delivery truck (5-year property), and machinery (7-year property) an election could be made to use the straightline method for all 5-year property and continue to use the 200% DB method for the 7-year property. Alternatively, an election could be made to use the straight-line method for only the 7-year property or all tangible personal property placed in service during the year. Once made, the method choice is an accounting method election and is irrevocable. 12. [LO 2] Describe how you would determine the MACRS recovery period for an asset if you did not already know it. Rev. Proc. 87-56 is the definitive authority for determining the recovery period of all assets under MACRS. This guidance divides assets into asset classes (groups of similar property) upon which the recovery period is determined as the midpoint of the asset depreciation range (ADR) (the system developed by the IRS for pre-ACRS property). However, the “87” in the citation indicates that the Rev. Proc. was issued in 1987. As a result, taxpayers, or their advisors, must verify that the guidance is still valid. For example, motorsports entertainment complexes and qualified Alaska natural gas pipeline are examples of assets to which Congress has given preferential recovery periods since 1987 (§168(e)(3)(C)). 13. [LO 2] [Research] Compare and contrast the recovery periods used by MACRS and those used under generally accepted accounting principles (GAAP). Copyright © 2020 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education. 5 Solutions Manual –Taxation of Business Entities, by Spilker et al. Rev. Proc. 87-56 is the definitive authority for determining the recovery period of all assets under MACRS. However, Congress in §168 has recently modified the recovery period of some assets. Financial accounting rules are vague at best. FASB Concept Statement 5 indicates that assets should be recognized over the accounting period of their life. FASB Concept Statement 6 defines an asset as a probable future benefit. ASC 360-10-35 indicates that the cost should be spread over the asset’s useful life in a systematic and rational manner. In addition, it requires companies, through financial statement disclosure, to disclose to investors current depreciation deduction, depreciation method, and recovery period used for assets. As a result, companies could use any rational recovery period for financial accounting purposes. 14. [LO 2] What are the two depreciation conventions that apply to tangible personal property under MACRS? Explain why Congress provides two methods. The two depreciation conventions that apply to tangible personal property under MACRS are the half-year convention and the mid-quarter convention. MACRS uses a simplifying half-year convention. The half-year convention allows one-half of a full year’s depreciation in the year the asset is placed in service, regardless of when it was actually placed in service. For example, when the half-year convention applies, an asset placed in service on either January 30 or December 17 is treated as though it was placed in service on July 1 which is the middle of the calendar year. The original ACRS system included only the half-year convention; however, Congress felt that some taxpayers were abusing the system by purposely acquiring assets at the end of the year that they otherwise would have acquired at the beginning of the next taxable year (allowable tax planning under ACRS). In 1987, as part of MACRS, the mid-quarter convention was implemented. The mid-quarter convention treats assets as though they were placed in service during the middle of the quarter in which the business actually placed the asset into service. For example, when the mid-quarter convention applies, if a business places an asset in service on December 1 (in the fourth quarter) it must treat the asset as though it was placed in service on November 15, which is the middle of the fourth quarter. 15. [LO 2] A business buys two identical tangible personal property assets for the same price. It buys one at the beginning of the year and one at the end of year. Under what conditions would the taxpayer’s depreciation on each asset be exactly the same? Under what conditions would it be different? MACRS has two conventions: half-year and mid-quarter conventions. The half-year convention is the general rule and simplifies the depreciation process by allowing one half year of depreciation taken on all assets placed in service during the year. The mid-quarter convention is required if more Copyright © 2020 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education. 6 Solutions Manual –Taxation of Business Entities, by Spilker et al. than 40 percent of a taxpayer’s tangible personal property is placed in service during the fourth quarter of the year. The depreciation on the two assets would be the same if the taxpayer was using the half-year convention—which would apply if the taxpayer purchased and placed in service other assets during the year so that the 40 percent placed in service fourth quarter test is failed. The depreciation on the two assets would be different if the two assets were the only assets placed in service during the year—so that 50 percent was placed in service during the 4th quarter and the mid-quarter convention was required to be used. 16. [LO 2] AAA Inc., acquired a machine in year 1. In May of year 3, it sold the asset. Can AAA find its year 3 depreciation percentage for the machine on the MACRS table? If not, what adjustment must AAA make to its full-year depreciation percentage to determine its year 3 depreciation? The applicable depreciation convention applies in the year of disposal as well as the year of acquisition. The MACRS tables cannot anticipate an asset’s disposal and therefore assume the asset was used in a trade or business for the entire year. As a result, AAA must apply the applicable convention to the table percentage upon disposal to arrive at the correct percentage. For instance, for assets under the half-year convention, multiplying the MACRS table full year depreciation by 50 percent (one-half of a year’s depreciation) provides the correct percentage. 17. [LO 2] There are two recovery period classifications for real property. What reasons might Congress have to allow residential real estate a shorter recovery period than nonresidential real property? Non-residential property currently has a recovery period of 39 years while residential property has a recovery period of 27.5 years. Non-residential has longer lives because the construction methods are more substantial which results in longer lives. For example, non-residential often uses steel frame with concrete and/or block floors and walls. In contrast, residential uses balloon construction using 2×4 timbers for structure. The non-residential components often are built with more substantial materials as well. Some argue that residential property receives higher use percentages and is subject to more wear and tear. In addition, some political arguments suggest that the faster recovery period for residential suggests that Congress wants to encourage construction of housing, which in turn would make rental properties more affordable. 18. [LO 2] Discuss why Congress has instructed taxpayers to depreciate real property using the mid-month convention as opposed to the half-year convention used for tangible personal property. Copyright © 2020 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education. 7 Solutions Manual –Taxation of Business Entities, by Spilker et al. The purpose of MACRS conventions is to simplify the calculation of depreciation. Real property is characterized by higher basis and less frequent acquisition than tangible personal property. These two reasons suggest that mid-month convention approximates actual wear and tear on real property better than the half-year and mid-quarter conventions would. For example, if a building was purchased in January or December it would be entitled to .5 or 11.5 months, respectively, of depreciation under the midmonth convention–which is close to the actual time the asset was placed in service. This contrasts with the half-year convention that would allow 6 months or the mid-quarter convention that would allow 10.5 or 1.5 months, respectively, of depreciation. 19. [LO 2] [Research] If a taxpayer has owned a building for 10 years and decides that it should make significant improvements to the building, what is the recovery period for the improvements? MACRS generally classifies additions to property as a new asset placed in service subject to the same depreciable life as the original asset. For example, if a $2,000,000 addition is made to an office building (nonresidential property) then the asset’s basis is $2,000,000 and its recovery period is 39 years. However, if the improvements are in the form of minor repairs that simply maintain the integrity of the structure they would be expensed. 20. [LO 2] Compare and contrast computing the depreciation deduction for tangible personal property versus computing the depreciation deduction for real property under both the regular tax and alternative tax systems. MACRS allows the 200% DB method to be used whereas AMT requires the 150% DB method to be used for tangible personal property. Both MACRS and AMT require the straight-line method for real property. Therefore, the AMT adjustment for tangible personal property is the difference between depreciation calculated under the 200% DB and the 150% DB methods. There is no AMT adjustment required for real property. For taxpayers that elect either the 150% DB or straight-line method for tangible personal property there is no AMT adjustment required with respect to that property. 21. [LO 3] Discuss how the property limitation restricts large businesses from taking the §179 expense. The tax law allows for expensing of tangible personal property for certain businesses. However, the deduction is phased out for taxpayers that place more than a certain amount of tangible personal property in service during the year (the property limitation). Since many large businesses place more than the limit of property in service, they are ineligible for the §179 deduction. Copyright © 2020 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education. 8 Solutions Manual –Taxation of Business Entities, by Spilker et al. 22. [LO 3] Explain the two limitations placed on the §179 deduction. How are they similar? How are they different? The §179 deduction has two limitations: the property placed in service and the taxable income limitation. The property limitation phases out the maximum deduction amount dollar for dollar for property placed in service over the $2,550,000 limit (up from $2,500,000 in 2018). After being limited by the property placed in service limitation, the §179 deduction is further limited to the taxpayer’s taxable income after regular MACRS depreciation but before deducting any §179 expense. The two limitations are similar in that they both limit the §179 deduction. However, the first limitation was designed to limit the amount of property that can be expensed as a means of defining small businesses while the second limitation prevents the expense from creating or enhancing a loss for the taxable year. 23. [LO 3] Compare and contrast the types of businesses that would and would not benefit from the §179 expense. The availability of the §179 expense is limited by the property placed in service and income limitations. The property placed in service limitation phases out the §179 expense ($1,020,000 in 2019) dollar for dollar for tangible personal property placed in service over the 2019 $2,550,000 threshold. Thus, firms that place $3,570,000 or more of property in service during the year are ineligible to deduct any §179 expense. As a result, firms that place in service smaller amounts of property are eligible for the expensing election while those that place large amounts of property in service are ineligible. The second limitation is that firms can only currently expense assets up to taxable income (before the §179 expense, but after bonus and regular MACRS depreciation deduction). As a result, profitable firms are eligible for the §179 expense while firms in a loss position are currently ineligible but may carry the amount forward. Consequently, profitable firms that place a relatively small amount of property in service are able to elect the §179 expense. In contrast, firms that place in service too much property or are unprofitable are unable to currently expense property under § 179. 24. [LO 3] What strategies will help a business maximize its current depreciation deductions (including §179)? Why might a taxpayer choose not to maximize its current depreciation deductions? There are several planning strategies that will help a taxpayer maximize its current depreciation deductions. For example, if a taxpayer is close to exceeding the 4th quarter placed in service limitation, which would require the mid-quarter convention resulting in less depreciation, the taxpayer could put off purchases to the beginning of the next taxable year. A taxpayer can Copyright © 2020 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education. 9 Solutions Manual –Taxation of Business Entities, by Spilker et al. elect to expense under §179 assets that are 7-year assets rather than 5-year assets because the first-year depreciation percentage is lower for 7-year assets (14.29% versus 20%). As another example, a taxpayer otherwise eligible for §179 expensing can elect to expense assets placed in service during the 4th quarter because expensed assets are not included in the midquarter test. Taxpayers may want to take less than the maximum depreciation otherwise allowed because they do not want to create a larger tax loss for the current year or because they are in a lower marginal tax bracket in the current year than they anticipate being in for future years. 25. [LO 3] Why might a business elect to claim a reduced §179 expense amount in the current year rather than claiming the maximum amount? Businesses can elect to expense §179 currently, and carry over the expense to future years if they meet the placed-in-service limitation but do not have sufficient income to expense the assets currently. However, a business may elect to expense only the amount it can currently deduct if it believes that maximizes the present value of current and future depreciation deductions. This may occur because carryovers of §179 expense are subject to future placed-in-service and income limitations. For example, a business could elect the expense in the current year (which reduces current and future MACRS depreciation deductions) and not be able to deduct the expense under §179 because the business is also limited in future years—so businesses that are generally limited would be wise not to make the election. Additionally, if taxpayers typically elect the maximum §179 expense annually, the amount would be suspended anyway. 26. [LO3] Describe assets that are considered to be listed property. Why do you think Congress requires them to be “listed”? Listed property comprises business assets that taxpayers may wish to use for both business and personal purposes. For example, automobiles, planes, boats, and recreation vehicles are considered to be listed property. The IRS wants to track both the personal and business use of these assets to limit depreciation to the business use portion. Additionally, if the business use portion dips below 50 percent, then taxpayers must use the straight-line method and potentially recapture excess depreciation deductions. 27. [LO 3] Are taxpayers allowed to claim depreciation on assets they use for both business and personal purposes? What are the tax consequences if the business use drops from above 50 percent in one year to below 50 percent in the next? Yes, taxpayers may depreciate mixed use assets (those used for both business and personal use). However, the otherwise allowable depreciation is reduced by the non-business use, so that depreciation is only allowed to the extent of the business use. If the business use falls below 50 percent in Copyright © 2020 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education. 10 Solutions Manual –Taxation of Business Entities, by Spilker et al. any subsequent year, then the taxpayer must re-compute depreciation for all prior years as if it had been using the straight-line method over the ADS recovery period. If the prior depreciation deductions exceed both the prior depreciation deductions and the current year expense then the taxpayer must recapture the difference into income during the current year. 28. [LO 3] Discuss why Congress limits the amount of depreciation deduction businesses may claim on certain automobiles. Automobiles have historically been the most abused, as well as expensive, type of listed property. To prevent subsidizing business owners’ automobiles through deductible depreciation, Congress decided to place a maximum allowable depreciation amount on them. One exception to this rule is bonus depreciation. Congress allows an additional expense of $8,000 in the first year for automobiles placed into service. However, one important exception from the luxury auto rules are that vehicles weighing more than 6,000 pounds are not subject to the limit, and are allowed to expense up to $25,500 during the first year under §179 and may qualify for bonus depreciation. 29. [LO 3] Compare and contrast how a Land Rover SUV and a Mercedes-Benz sedan are treated under the luxury auto rules. Also include a discussion of the similarities and differences in available §179 expense. A Mercedes-Benz sedan is less than 6,000 pounds and qualifies as a luxury automobile. This limits depreciation to the restrictive luxury auto amounts. In contrast, the Land Rover is more than 6,000 pounds and escapes the luxury auto rules. This is advantageous for three reasons: (1) the buyer may currently expense $25,500 under §179, (2) the property is not subject to the luxury auto limits, and (3) qualifies for 100 percent bonus depreciation. 30. [LO 4] What is a §197 intangible? How do taxpayers recover the costs of these intangibles? How do taxpayers recover the cost of a §197 intangible that expires (such as a covenant not to compete)? A §197 intangible is a purchased intangible including: goodwill, going concern value, workforce in place, patents, customer lists, and similar assets. §197 intangibles are amortized over 180 months (15 years) using the straight-line method, and the full-month convention. To prevent gameplaying among the basis allocations of various §197 intangibles acquired together, no loss is allowed on a §197 intangible until the last intangible purchased together is disposed of. For example, in the past, taxpayers would allocate substantial basis to a 3-year covenant not to compete or some other short-lived intangible rather than goodwill (with a longer recovery period). If a §197 intangible expires or is disposed of before the 180-month amortization period expires any remaining basis of the disposed intangible is allocated among the remaining intangibles purchased at the same time. Copyright © 2020 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education. 11 Solutions Manual –Taxation of Business Entities, by Spilker et al. 31. [LO 4] Compare and contrast the tax and financial accounting treatment of goodwill. Are taxpayers allowed to deduct amounts associated with self-created goodwill? US GAAP requires goodwill to be capitalized and tested annually for impairment. If and when the goodwill is impaired, the difference between the book value and the new fair value will be expensed. For tax purposes, goodwill is treated like any other §197 intangible. §197 intangibles are amortized over 180 months (15 years) using the straight-line method, and the full-month convention. With respect to self-created assets taxpayers must amortize any capitalized costs (any unamortized research and experimentation expenses and with fees necessary to create the asset) over the life of the asset. For financial accounting these costs are normally expensed. 32. [LO 4] Compare and contrast the similarities and differences between organizational expenditures and start-up costs for tax purposes. Organizational expenditures and start-up costs are sometimes confused because both expense types are similar in that they are both incurred about the time the business begins. However, the expenses relate to different concerns. Start-up costs are costs that would be deductible as ordinary trade or business expense under §162, except for the fact that the trade or business had not started. An example of start-up costs is employee wages incurred before actual production begins at the factory. Alternatively, organizational expenditures relate to professional fees related to creating the entity. An example of organizational expenditures is attorney fees incurred for preparation of the corporate charter or partnership agreement. Additionally, all businesses can deduct start-up costs, but only corporations and partnerships can deduct organizational expenditures. 33. [LO 4] Discuss the method used to determine the amount of organizational expenditures or start-up costs that may be immediately expensed in the year a taxpayer begins business. Start-up costs can be expensed up to $5,000 and organizational expenditures can each be expensed, up to $5,000, in the year the business begins. However, the current expense is reduced dollar for dollar if the expenses exceed a threshold amount. The threshold for both start-up costs and organizational expenditures is $50,000. Any remaining expenses can be amortized over 15 years (180 months) for both types of costs. For example, if a taxpayer incurs $23,000 of organizational costs, it may currently expense $5,000—since the total expense is less than the $50,000 threshold. The remaining $18,000 ($23,000 – $5,000 expense) may be amortized at a rate of $100 per month ($18,000 / 180 months). Copyright © 2020 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education. 12 Solutions Manual –Taxation of Business Entities, by Spilker et al. 34. [LO 4] Explain the amortization convention applicable to intangible assets. MACRS uses the half-year, mid-quarter, and mid-month conventions. These simplifying conventions assume that the asset was placed in service during the middle of the year, quarter, or month, respectively. Intangibles are amortized using the full-month convention. This convention allows a full or entire month of amortization in each month the asset is owned—beginning with the month the intangible is placed in service. 35. [LO 4] Compare and contrast the recovery periods of §197 intangibles, organizational expenditures, start-up costs, and research and experimentation expenses. All intangibles are amortized using the full-month convention over the applicable recovery period. §197 assets must be amortized over a 15-year recovery period. Organizational expenditures and start-up costs are eligible for up to $5,000 of expensing in the year the business begins. This expense is reduced dollar for dollar over a $50,000 threshold. The remaining expenses are amortized over a 15-year recovery period. Research and experimentation expenses may be capitalized or amortized over the determinable useful life, or if no determinable life, not less than 60 months. Any unamortized expense that is allocable to a self-created intangible such as a patent is amortized over the intangible’s life. 36. [LO 5] Compare and contrast the cost and percentage depletion methods for recovering the costs of natural resources. What are the similarities and differences between the two methods? Both cost and percentage depletion methods are used to recoup the cost of natural resources. A taxpayer is allowed to deduct the depletion method that results in the largest deduction in the current year. Cost depletion is a cost recovery method based on the amount of the estimated raw materials used during the year. The basic premise is that a business ratably recovers the cost basis of the resource as it is used up. Cost depletion is taken until the basis of the asset is recovered. If the natural resource is exhausted before the basis is recovered then the remaining basis is expensed. In contrast, percentage depletion is a statutory method that allows an expense based on the lesser of 50 percent of net income from the activity or a percentage (statutorily determined) of the gross receipts from the business during the current year. Percentage depletion is allowed to continue even after the asset’s basis has been fully recovered. 37. [LO 5] Explain why percentage depletion has been referred to as a government subsidy. Copyright © 2020 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education. 13 Solutions Manual –Taxation of Business Entities, by Spilker et al. Percentage depletion is often referred to as a government subsidy because it is an expense designed to encourage production of specific resources. For example, oil and gas, coal, and many other natural resources are assigned specific percentage depletion rates (between 5 percent and 22 percent), while timber is excluded from resources applicable to the method. To encourage development of a certain resource, Congress can simply raise the statutory percentage for the resource type. In addition, percentage depletion expense can transcend reality. How many expenses are allowed to exceed the taxpayer’s basis in an asset? Very few expenses, if any are allowed in excess of basis. Savvy taxpayers can underestimate the estimate of a natural resource, accelerate its cost recovery through cost depletion, and then continue to receive depletion benefits through percentage depletion. For these reasons, percentage depletion is referred to as a subsidy. Problems 38. [LO 1] Jose purchased a delivery van for his business through an online auction. His winning bid for the van was $24,500. In addition, Jose incurred the following expenses before using the van: shipping costs of $650; paint to match the other fleet vehicles at a cost of $1,000; registration costs of $3,200 which included $3,000 of sales tax and a registration fee of $200; wash and detailing for $50; and an engine tune-up for $250. What is Jose’s cost basis for the delivery van? $29,150, cost basis in the delivery van, computed as follows: Amount Explanation* Description Purchase price $24,500 Shipping costs 650 Business preparation cost Paint 1,000 Business preparation cost Sales tax 3,000 Business preparation cost Total cost basis $29,150 *Note that the registration fee, washing and detailing, and engine tune-up are costs for repairs and maintenance that are not required to be capitalized. 39. [LO 1]{Research} Emily purchased a building to store inventory for her business. The purchase price was $760,000. Emily also paid legal fees of $300 to acquire the building. In March, Emily incurred $2,000 to repair minor leaks in the roof (from storm damage earlier in the month) and $5,000 to make the interior suitable for her finished goods. What is Emily’s cost basis in the new building? Copyright © 2020 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education. 14 Solutions Manual –Taxation of Business Entities, by Spilker et al. $765,300 cost basis, computed as follows: Amount Explanation Description Purchase price $760,000 Improvements 5,000 Business preparation costs 300 Business preparation costs Legal fees Cost basis in building $765,300* *Note that the $2,000 repair for the roof was not capitalized. The repair is likely a routine maintenance expenditure rather than a capitalized cost under Reg. 1.263(a)-3. The roof repair is reasonably expected to occur more than once in a 10-year period. However, if the expense resulted in a betterment, restoration or adaptation to new or different use, it would be capitalized. The legal fees would be capitalized as expenses to purchase the building and the costs to modify the interior would be capitalized as improvement costs. 40. [LO 1]{Research} In January, Prahbu purchased a new machine for use in an existing production line of his manufacturing business for $90,000. Assume that the machine is a unit of property and is not a material or supply. Prahbu pays $2,500 to install the machine, and after the machine is installed, he pays $1,300 to perform a critical test on the machine to ensure that it will operate in accordance with quality standards. On November 1, the critical test is complete, and Prahbu places the machine in service on the production line. On December 3, Prahbu pays another $3,300 to perform periodic quality control testing after the machine is placed in service. How much will Prahbu be required to capitalize as the cost of the machine? $93,800 cost basis, computed as follows: Description Purchase price Installation costs Critical test costs Cost basis in machine Amount Explanation $90,000 2,500 Business preparation costs 1,300 Business preparation costs $93,800 Under Reg. §1.263(a)-2(d)(1) Prahbu must capitalize amounts paid to acquire or produce a unit of personal property machinery and equipment. Amounts paid to acquire or produce a unit of personal property include the invoice price, transaction costs, and costs for work performed prior to the date that the unit of property is placed in service by the taxpayer. The amounts paid for the installation and the critical test performed before the machine is placed in service must be capitalized as amounts to acquire the machine. However, the $3,300 paid for periodic quality control testing after Prahbu placed the machine in service is not required to be Copyright © 2020 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education. 15 Solutions Manual –Taxation of Business Entities, by Spilker et al. capitalized as amounts paid to acquire the machine. This amount is expensed as routine maintenance under Reg §1.263(a)-3(i). 41. [LO 1] Dennis contributed business assets to a new business in exchange for stock in the company. The exchange did not qualify as a tax-deferred exchange. The fair market value of these assets was $287,000 on the contribution date. Dennis’s original basis in the assets he contributed was $143,000, and the accumulated depreciation on the assets was $78,000. a. What is the business’s basis in the assets it received from Dennis? b. What would be the business’s basis if the transaction qualified as a taxdeferred exchange? a. Because this exchange is a fully taxable transaction, the business’s basis in Dennis’s assets is the $287,000 fair market value of the assets. b. If the transaction qualified as a tax-deferred exchange, the business would take the same adjusted basis in the assets that Dennis had. That is, the business will receive an exchanged basis of $65,000 ($143,000 original basis minus accumulated depreciation of $78,000) in the assets. 42. [LO 1] Brittany started a law practice as a sole proprietor. She owned a computer, printer, desk, and file cabinet she purchased during law school (several years ago) that she is planning to use in her business. What is the depreciable basis that Brittany should use in her business for each asset, given the following information? Asset Purchase Price Computer Printer Desk File cabinet $5,500 $3,300 $4,200 $3,200 FMV at Time Converted to Business use $3,800 $3,150 $4,000 $3,225 The basis of assets converted from personal use to business use is the lesser of (1) fair market value on date of conversion or (2) basis on the date of conversion. The depreciable basis of each asset is as follows: (1) FMV (2) Basis on Date of Conversion Depreciable Basis $3,800 $3,150 $4,000 $3,225 $5,500 $3,300 $4,200 $3,200 $3,800 $3,150 $4,000 $3,200 Asset Computer Printer Desk File cabinet Lesser of (1) or (2) Copyright © 2020 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education. 16 Solutions Manual –Taxation of Business Entities, by Spilker et al. 43. [LO 1] Meg O’Brien received a gift of some small-scale jewelry manufacturing equipment that her father had used for personal purposes for many years. Her father originally purchased the equipment for $1,500. Because the equipment is out of production and no longer available, the property is currently worth $4,000. Meg has decided to begin a new jewelry manufacturing trade or business. What is her depreciable basis for depreciating the equipment? The basis of a gift is a carryover basis from the donor; therefore, Meg’s depreciable basis in the property is $1,500. 44. [LO 1] Gary inherited a Maine summer cabin on 10 acres from his grandmother. His grandparents originally purchased the property for $500 in 1950 and built the cabin at a cost of $10,000 in 1965. His grandfather died in 1980 and when his grandmother recently passed away, the property was appraised at $500,000 for the land and $700,000 for the cabin. Since Gary doesn’t currently live in New England, he decided that it would be best to put the property to use as a rental. What is Gary’s basis in the land and in the cabin? The basis of inherited property is the fair market value on the date of death or, if elected by the estate, the alternate valuation date if less. Consequently, Gary’s basis will be $500,000 in the land and $700,000 for the cabin. 45. [LO 1] Wanting to finalize a sale before year-end, on December 29, WR Outfitters sold to Bob a warehouse and the land for $125,000. The appraised fair market value of the warehouse was $75,000, and the appraised value of the land was $100,000. a. What is Bob’s basis in the warehouse and in the land? b. What would be Bob’s basis in the warehouse and in the land if the appraised value of the warehouse is $50,000 and the appraised value of the land is $125,000? c. Which appraisal would Bob likely prefer? NOTE: This is a bargain purchase. The sales price is less than the appraised value. This solution uses the relative appraised values of the land and the warehouse to allocate the purchase price between these two assets. a. Bob’s cost basis in the land is $71,429. Because the purchase price is less than the appraised values for the land and the warehouse, the purchase price must be allocated between the land and the warehouse. The $71,429 basis for the land is the amount of the $125,000 purchase price that is allocated to the land based on the relative value of the land ($100,000) to the value of the land ($100,000) plus the value of the warehouse ($75,000) based on the appraisal. The formula used to determine the basis allocated to the land is $125,000 (purchase price) x $100,000/($100,000 + 75,000). Copyright © 2020 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education. 17 Solutions Manual –Taxation of Business Entities, by Spilker et al. Use the same process to determine that Bob’s basis in the warehouse is $53,571 [125,00 x $75,000/(100,000 + $75,0000]. b. Bob’s cost basis for the land is $89,286. Because the purchase price is less than the appraised values for the land and the warehouse, the purchase price must be allocated between the land and the warehouse. The $89,286 basis for the land is the amount of the $125,000 purchase price that is allocated to the land based on the relative value of the land ($125,000) to the value of the land ($125,000) plus the value of the warehouse ($50,000) based on the appraisal. The formula used to determine the basis allocated to the land is $125,000 (purchase price) x $125,000/($50,000 + 125,000). Use the same process to determine that Bob’s basis in the warehouse is $35,714 [$125,000 x $50,000/($50,000 + $125,000)]. c. Bob would likely prefer the appraisal from part (a), because the appraisal allows him to allocate more basis to the warehouse, which is depreciable.c 46. [LO 2] At the beginning of the year, Poplock began a calendar-year dog boarding business called Griff’s Palace. Poplock bought and placed in service the following assets during the year: Asset Computer equipment Dog grooming furniture Pickup truck Commercial building Land (one acre) Date Acquired 3/23 5/12 9/17 10/11 10/11 Cost Basis $5,000 $7,000 $10,000 $270,000 $80,000 Assuming Poplock does not elect §179 expensing and elects not to use bonus depreciation, answer the following questions: a. What is Poplock’s year 1 depreciation deduction for each asset? b. What is Poplock’s year 2 depreciation deduction for each asset? Asset a. $5,445, under the half-year convention for personal property, calculated as follows: (1) Purchase Quarter Recovery Original (2) (1) x (2) Date period Basis Rate Depreciation Computer equipment Dog grooming furniture Pickup truck Building 23-Mar 1st 5 years $5,000 20.00% $1,000 12-May 17-Sep 11-Oct 2nd 3rd 4th 7 years 5 years 39 years $7,000 $10,000 $270,000 14.29% 20.00% 0.535% $1,000 $2,000 $1,445 Copyright © 2020 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education. 18 Solutions Manual –Taxation of Business Entities, by Spilker et al. $5,445 b. $13,437, calculated as follows: Asset Computer equipment Dog grooming furniture Pickup truck Building (1) Original Basis (2) Rate (1) x (2) Depreciation Purchase Date Quarter Recovery period 23-Mar 1st 5 years $5,000 32.00% $1,600 12-May 17-Sep 11-Oct 2nd 3rd 4th 7 years 5 years 39 years $7,000 $10,000 $270,000 24.49% 32.00% 2.564% $1,714 $3,200 $6,923 $13,437 47. [LO 2] DLW Corporation acquired and placed in service the following assets during the year: Asset Computer equipment Furniture Commercial building Date Acquired 2/17 5/12 11/1 Cost Basis $10,000 $17,000 $270,000 Assuming DLW does not elect §179 expensing and elects not to use bonus depreciation, answer the following questions: a. What is DLW’s year 1 cost recovery for each asset? b. What is DLW’s year 3 cost recovery for each asset if DLW sells all of these assets on 1/23 of year 3? Asset a. $5,296, under the half-year convention for personal property, calculated as follows: (1) Purchase Quarter Recovery Original (2) (1) x (2) Date period Basis Rate Depreciation Computer equipment Furniture Building 17-Feb 12-May 1-Nov 1st 2nd 4th 5 years 7 years 39 years $10,000 $17,000 $270,000 20.00% 14.29% 0.321% $2,000 $2,429 $867 $5,296 b. $2,735, under the half-year convention for personal property, calculated as follows: Asset Computer equipment Furniture Building Original Basis Recovery period Rate Portion of Year Depreciation Expense $10,000 $17,000 $270,000 5 years 7 years 39 years 19.2% 17.49% 2.564% 50.00% 50.00% 4.17% $960 $1,487 $288 Copyright © 2020 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education. 19 Solutions Manual –Taxation of Business Entities, by Spilker et al. $2,735 Total Depreciation Deduction 48. [LO 2] At the beginning of the year, Anna began a calendar-year business and placed in service the following assets during the year: Asset Computers Office desks Machinery Office building Date Acquired 1/30 2/15 7/25 8/13 Cost Basis $28,000 $32,000 $75,000 $400,000 Assuming Anna does not elect §179 expensing and elects not to use bonus depreciation, answer the following questions: a. What is Anna’s year 1 cost recovery for each asset? b. What is Anna’s year 2 cost recovery for each asset? a. $24,743, using the half-year convention for personal property, as calculated below. Asset Computers Office desks Machinery Office building Purchase Date Recovery period (1) Original Basis (2) Rate 30-Jan 15-Feb 25-Jul 13-Aug 5 years 7 years 7 years 39 years $28,000 32,000 75,000 400,000 20.00% 14.29% 14.29% 0.963% (1) x (2) Cost Recovery $5,600 4,573 10,718 3,852 $24,743 b. $45,421, using the half-year convention for personal property, calculated as follows: (1) (2) (1) x (2) Purchase Recovery Original Cost Asset Date period Basis Rate Recovery Computers Office desks Machinery Office building 30-Jan 15-Feb 25-Jul 13-Aug 5 years 7 years 7 years 39 years $28,000 32,000 75,000 400,000 32.00% 24.49% 24.49% 2.564% $8,960 7,837 18,368 10,256 $45,421 49. [LO 2] {Planning} Parley needs a new truck to help him expand Parley’s Plumbing Palace. Business has been booming and Parley would like to accelerate his tax deductions as much as possible (ignore §179 expense and bonus depreciation for this problem). On April 1, Parley purchased a new delivery van for $25,000. It is now September 26 and Parley, already in need of another vehicle, has found a deal on Copyright © 2020 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education. 20 Solutions Manual –Taxation of Business Entities, by Spilker et al. buying a truck for $22,000 (all fees included). The dealer tells him if he doesn’t buy the truck (Option 1), it will be gone tomorrow. There is an auction (Option 2) scheduled for October 5 where Parley believes he can get a similar truck for $21,500, but there is also a $500 auction fee. Parley makes no other asset acquisitions during the year. a. Which option allows Parley to generate more depreciation deductions this year (the vehicles are not considered to be luxury autos)? b. Assume the original facts except that the delivery van was placed in service one day earlier on March 31 rather than April 1. Which option generates more depreciation deduction? a. Option 1 generates more depreciation. Option 1 generates $9,400 of depreciation and Option 2 generates $7,350. Option 1: Half-year convention applies Asset Delivery Van Option 1 Total Date Placed in Service April 1 September 26 (1) Original Basis $25,000 $22,000 (2) (1) x (2) Rate Depreciation 20.00% $5,000 20.00% $4,400 $9,400 Option 2: Mid-quarter convention applies Asset Delivery Van Option 2 Total Date Placed in Service April 1 October 5 Quarter 2nd 4th (1) Original Basis $25,000 $22,000 (2) (1) x (2) Rate Depreciation 25.00% $6,250 5.00% $1,100 $7,350 b. Option 2 generates more depreciation ($9,850 vs. 9,400). Under Option 1, because the half-year convention applies, the depreciation deduction is $9,400, the same as it is in part (a). Under Option 2, because the mid-quarter convention applies and the Delivery Van was placed in service in the first quarter (on March 31), Parley is allowed to deduct more depreciation overall. The depreciation under Option 2 in this scenario is $9,850, computed as follows: Option 2: Mid-quarter convention applies Asset Date Placed in Service Quarter (1) Original Basis (2) Rate (1) x (2) Depreciation Copyright © 2020 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education. 21 Solutions Manual –Taxation of Business Entities, by Spilker et al. Delivery van Option 2 Total 1st 4th March 31 October 5 $25,000 $22,000 35.00% 5.00% $8,750 $1,100 $9,850 50. [LO 2] Way Corporation disposed of the following tangible personal property assets in the current year. Assume that the delivery truck is not a luxury auto. Calculate Way Corporation’s 2019 depreciation deduction (ignore §179 expense and bonus depreciation for this problem). Asset Furniture (7 year) Machinery (7 year) Delivery truck (5 year)* Machinery (7 year) Computer (5 year) Date acquired 5/12/15 3/23/16 9/17/17 10/11/18 10/11/19 Date sold 7/15/19 3/15/19 3/13/19 8/11/19 12/15/19 Convention HY MQ HY MQ HY Original Basis $55,000 $72,000 $20,000 $270,000 $80,000 Depreciation is $51,851, calculated as follows: Asset Furniture Machinery Delivery truck Machinery Computer Original Basis $55,000 $72,000 $20,000 $270,000 $80,000 Total Depreciation Quarter If mid quarter n/a 1st n/a 4th n/a Rate Portion of Year Depreciation Deduction 8.93% 10.93% 19.20% 27.55% 0.00% 50.00% 12.50% 50.00% 62.50% 50.00% $2,456 $984 $1,920 $46,491 $0** $51,851 *Used 100 percent for business. **No depreciation for assets acquired and disposed of in the same year. 51. [LO 2] On November 10 of year 1 Javier purchased a building, including the land it was on, to assemble his new equipment. The total cost of the purchase was $1,200,000; $300,000 was allocated to the basis of the land and the remaining $900,000 was allocated to the basis of the building. a. Using MACRS, what is Javier’s depreciation deduction on the building for years 1 through 3? b. What would be the year 3 depreciation deduction if the building was sold on August 1 of year 3? c. Answer the question in part (a), except assume the building was purchased and placed in service on March 3 instead of November 10. d. Answer the question in part (a), except assume that the building is residential property. Copyright © 2020 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education. 22 Solutions Manual –Taxation of Business Entities, by Spilker et al. e. What would be the depreciation for 2019, 2020, and 2021 if the property were nonresidential property purchased and placed in service November 10, 2002 (assume the same original basis)? a. The depreciation for the 3 years is computed as follows: Year 1 2 3 Method SL Recovery Period 39 Date Placed in Service Nov. 10 (1) (2) (1) x (2) Original Basis Rate Depreciation $900,000 0.321% $2,889 $900,000 2.564% $23,076 $900,000 2.564% $23,076 b. The depreciation for year 3 would be $14,423 and is computed as follows (The building is sold in month 8 so depreciation for the year is for 8 minus one-half month =7.5 months.): Recovery Period 39 Date Placed in Service Nov. 10 (1) (2) (1) x (2) Basis Rate Depreciation $900,000 2.564% $23,076 Partial year x 7.5/12 $14,423 Year 3 Method SL Year 1 2 3 c. The depreciation for years 1 – 3 is computed as follows (note that years 2 and 3 are the same): Date (1) (2) (1) x (2) Recovery Placed in Original Method Period Service Basis Rate Depreciation SL 39 March 3 $900,000 2.033% $18,297 $900,000 2.564% $23,076 $900,000 2.564% $23,076 Year 1 2 3 d. If the property was residential real property, the building is depreciated over 27.5 years instead of 39 years. The depreciation for years 1 – 3 is computed as follows: Date (1) (2) (1) x (2) Recovery Placed in Original Method Period Service Basis Rate Depreciation SL 27.5 Nov. 10 $900,000 0.455% $4,095 $900,000 3.636% $32,724 $900,000 3.636% $32,724 e. If the property was nonresidential real property purchased in 2002, the depreciation for the 3 years is computed as follows for years 2019, 2020, and 2021 in the depreciation table: Copyright © 2020 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education. 23 Solutions Manual –Taxation of Business Entities, by Spilker et al. Year 2019 2020 2021 Method SL Recovery Period 39 Date Placed in Service 2002 (1) (2) (1) x (2) Original Basis Rate Depreciation $900,000 2.564% $23,076 $900,000 2.564% $23,076 $900,000 2.564% $23,076 52. [LO 2] Carl purchased an apartment complex for $1.1 million on March 17 of year 1. Of the purchase price, $300,000 was attributable to the land the complex sits on. He also installed new furniture into half of the units at a cost of $60,000. a. What is Carl’s allowable depreciation deduction for his real property for years 1 and 2? b. What is Carl’s allowable depreciation deduction for year 3 if the real property is sold on January 2 of year 3? Year 1 2 a. The depreciation on the real property for the 2 years is computed as follows: Date (1) (2) (1) x (2) Recovery Placed in Original Method Period Service Basis Rate Depreciation SL 27.5 March 17 $800,000 2.879% $23,032 $800,000 3.636% $29,088 Note that the furniture is depreciable personal property. b. The depreciation for year 3 is computed as follows: Date Placed in Service March 17 (1) (1) x (2) Recovery Original Year Method Period Basis Rate Depreciation 3 SL 27.5 $800,000 3.636% $29,088 Partial year* x .5/12 $1,212 *mid- month convention applies to real property in year of acquisition and year of disposition. 53. [LO 2, LO 3] Evergreen Corporation (calendar-year-end) acquired the following assets during the current year: Asset Machinery Computer equipment Used delivery truck* Furniture Placed in Service Date October 25 February 3 August 17 April 22 Original Basis $70,000 $10,000 $23,000 $150,000 *The delivery truck is not a luxury automobile. Copyright © 2020 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education. 24 Solutions Manual –Taxation of Business Entities, by Spilker et al. a. What is the allowable MACRS depreciation on Evergreen’s property in the current year assuming Evergreen does not elect §179 expense and elects out of bonus depreciation? b. What is the allowable MACRS depreciation on Evergreen’s property in the current year if Evergreen does not elect out of bonus depreciation? a. $38,038, under the half-year convention, calculated as follows: Asset Computer equipment (5 year) Furniture (7 year) Used delivery truck (5 year) Machinery (7 year) Total Placed in Service February 3 April 22 August 17 October 25 (1) Original Basis $10,000 $150,000 $23,000 $70,000 $253,000 (2) (1) x (2) Rate Depreciation 20.00% $2,000 14.29% $21,435 20.00% $4,600 14.29% $10,003 $38,038 b. $253,000, using 100 percent bonus depreciation. All of Evergreen’s assets placed in service during the year are eligible for bonus depreciation. Asset Computer equipment (5 year) Furniture (7 year) Used delivery truck (5 year) Machinery (7 year) Total Placed in Service February 3 April 22 August 17 October 25 Quarter 1st 2nd 3rd 4th (1) Original Basis $10,000 $150,000 $23,000 $70,000 $253,000 (2) Rate 100% 100% 100% 100% (1) x (2) Depreciation $10,000 $150,000 $23,000 $70,000 $253,000 54. [LO 2, LO 3] Convers Corporation (calendar year-end) acquired the following assets during the current tax year: Asset Machinery Computer Equipment Used Delivery Truck* Furniture Total Placed in Service Date October 25 February 3 March 17 April 22 Original Basis $70,000 $10,000 $23,000 $150,000 $253,000 *The delivery truck is not a luxury automobile. In addition to these assets, Convers installed new flooring (qualified improvement property) to its office building on May 12 at a cost of $300,000. a. What is the allowable MACRS depreciation on Convers’s property in the current year assuming Convers does not elect §179 expense and elects out of Copyright © 2020 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education. 25 Solutions Manual –Taxation of Business Entities, by Spilker et al. bonus depreciation? b. What is the allowable MACRS depreciation on Convers’s property in the current year assuming Convers does not elect out of bonus depreciation (but does not take §179 expense)? a. $42,853, under the half-year convention, as computed below: Asset Machinery (7 year) Computer Equipment (5 year) Used delivery truck (5 year) Furniture (7 year) Qualified improvement property (39-year) Total Placed in Service October 25 February 3 March 17 April 22 May 12 (1) Original Basis $70,000 10,000 $23,000 150,000 300,000 $553,000 (2) (1) × (2) Rate 14.29% 20.00% 20.00% 14.29% Depreciation $10,003 2,000 4,600 21,435 1.605% 4,815 $42,853 b. $257,815, under the half-year convention, as computed below. Note that the qualified improvement property does not qualify for bonus depreciation and must be depreciated over a 39-year period. Asset Machinery (7 year) Computer Equipment (5 year) Used delivery truck (5 year) Furniture (7 year) Qualified improvement property (39-year) Total Placed in Service October 25 February 3 March 17 April 22 May 12 (1) Original Basis $70,000 10,000 $23,000 150,000 300,000 $553,000 (2) (1) × (2) Rate 100% 100% 100% 100% Depreciation $70,000 10,000 23,000 150,000 1.605% 4,815 $257,815 55. [LO 2, LO 3] Harris Corp. is a technology start-up and is in its second year of operations. The company didn’t purchase any assets this year but purchased the following assets in the prior year: Asset Placed in Service Basis Office Equipment August 14 $10,000 Manufacturing Equipment April 15 68,000 Computer System June 1 16,000 Total $94.000 Harris did not know depreciation was tax deductible until it hired an accountant this year and didn’t claim any depreciation deduction in its first year of operation. a) What is the maximum amount of depreciation deduction Harris Corp. can deduct in its second year of operation? Copyright © 2020 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education. 26 Solutions Manual –Taxation of Business Entities, by Spilker et al. b) What is the basis of the office equipment at the end of the second year? a) $-0-. Harris is limited to the regular MACRS depreciation using the secondyear depreciation rates. However, in the prior year, Harris did not file an election out of bonus depreciation. As a result, the depreciation allowable in the prior year would be 100 percent of the depreciable basis (cost) under the bonus depreciation rules. After reducing the basis by the bonus depreciation, no basis remains for depreciation in year 2. b) $-0-. The basis of the office equipment at the end of the second year is calculated by subtracting the depreciation allowable from the original basis. In this case, Harris must reduce the basis by the first year’s depreciation that was not taken but was allowable of $10,000, leaving no remaining basis at the end of year 1 and year 2. 56. [LO 2, LO 3] Assume AMP Corporation (calendar-year-end) has 2019 taxable income of $1,900,000 for purposes of computing the §179 expense. During 2019, AMP acquired the following assets: Asset Machinery Computer Equipment Office Building Total Placed in Service September 12 February 10 April 2 Basis $1,550,000 365,000 480,000 $2,395,000 a) What is the maximum amount of §179 expense AMP may deduct for 2019? b) What is the maximum total depreciation, including §179 expense, that AMP may deduct in 2019 on the assets it placed in service in 2019, assuming no bonus depreciation? a. The maximum §179 expense is $1,020,000. Description (1) Property placed in service in 2019 Amount Explanation (4) Maximum 179 expense before phase-out $1,915,000 Total §179 qualified property (2,550,000) 2019 amount [§179(b)(2)] $-0- (1) – (2) (permanently disallowed), not less than $0. $1,020,000 2019 amount [§179(b)(1)] (5) Phase-out of maximum §179 expense Maximum §179 expense after phase-out $-0- From (3) $1,020,000 (4) – (5) (2) Threshold for §179 phase-out (3) Phase-out of maximum §179 expense Copyright © 2020 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education. 27 Solutions Manual –Taxation of Business Entities, by Spilker et al. b. The maximum depreciation deduction is $1,177,468 (half-year convention). Depreciation is maximized by applying the §179 expense against 7-year rather than 5year property. Asset Machinery (7-year) Computer Equipment (5year) Office building (39 year) Original Basis §179 Expense Remaining Basis $1,550,000 $1,020,000 $365,000 $480,000 Depreciation Deduction Rate $530,000 14.29% $75,737 $365,000 $480,000 20.00% 1.819% $73,000 $8,731 $1,020,000 $1,177,468 §179 Expense Total cost recovery 57. [LO 2, LO 3] Assume TDW Corporation’s (calendar-year-end) has 2019 taxable income of $650,000 for purposes of computing the §179 expense. The company acquired the following assets during 2019: Asset Machinery Computer Equipment Furniture Total Placed in Service September 12 February 10 April 2 Basis $2,270,000 263,000 880,000 $3,413,000 a) What is the maximum amount of §179 expense TDW may deduct for 2019? b) What is the maximum total depreciation, including §179 expense, that TDW may deduct in 2019 on the assets it placed in service in 2019, assuming no bonus depreciation? a. The maximum §179 expense is $157,000. Description (1) Property placed in service in 2019 (2) Threshold for §179 phase-out (3) Phase-out of maximum §179 expense (4) Maximum 179 expense before phase-out (5) Phase-out of maximum §179 expense (6) Maximum §179 expense after phase-out Amount Explanation $3,413,000 Total qualified property (2,550,000) 2019 amount [§179(b)(2)] $863,000 (1) – (2) (permanently disallowed) $1,020,000 2019 amount [§179(b)(1)] $863,000 From (3) $157,000 (4) – (5) b. The maximum depreciation deduction is $637,300. Copyright © 2020 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education. 28 Solutions Manual –Taxation of Business Entities, by Spilker et al. Depreciation is maximized by applying the §179 expense against 7-year rather than 5year property, and in this case, depreciation is maximized by applying the §179 expense against the machinery. Asset Machinery (7-year) Computer Equipment (5- year) Furniture (7 year) Original Basis §179 Expense Remaining Basis Rate $2,270,000 $157,000 $2,113,000 14.29% $301,948 $263,000 $880,000 20.00% 14.29% 52,600 125,752 157,000 $637,300 $263,000 $880,000 §179 Expense Total cost recovery Depreciation Deduction 58. [LO 2, LO 3] Assume Timberline Corporation’s 2019 taxable income of $240,000 for purposes of computing the §179 expense. It acquired the following assets in 2019: Asset Furniture (7-year) Computer Equipment (5-year) Copier (5-year) Machinery (7-year) Total Purchase Date December 1 February 28 July 15 May 22 Basis $450,000 90,000 30,000 480,000 $1,050,000 a) What is the maximum amount of §179 expense Timberline may deduct for 2019? What is Timberline’s §179 carryforward to 2020, if any? b) What would Timberline’s maximum depreciation deduction be for 2019 assuming no bonus depreciation? c) What would Timberline’s maximum depreciation deduction be for 2019 if the machinery cost $3,000,000 instead of $480,000 and assuming no bonus depreciation? a) The maximum §179 expense would be $240,000 and the carryforward to 2020 would be $780,000. Description (1) Property placed in service (2) Threshold for §179 phase-out (3) Phase-out of maximum §179 expense (4) Maximum 179 expense before phase-out Amount Explanation $1,050,000 Total qualified assets (2,550,000) 2019 amount (§179(b)(2)) $0 (1) – (2) (permanently disallowed), not less than $0. $1,020,000 2019 amount (§179(b)(1)) (5) Phase-out of maximum §179 expense (6) Maximum §179 expense after phase-out $0 From (3) $1,020,000 (4) – (5) Copyright © 2020 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education. 29 Solutions Manual –Taxation of Business Entities, by Spilker et al. (7) Taxable income before §179 deduction (8) §179 expense after taxable income limitation. §179 carryforward to next year $240,000 Given in problem $240,000 Lesser of (6) and (7) $780,000 (6) – (8) b) The half-year convention applies because none of its personal property was placed in service in the 4th quarter assuming Timberline applied the §179 expense to the furniture acquired in December. After the §179 election, the remaining $30,000 of property is all placed in service prior to the fourth quarter. (Because the mid-quarter test is applied after taking §179 expense, it is optimal to take the §179 expense against qualified property placed into service during the fourth quarter.) Timberline’s depreciation deduction is $362,601 computed as follows: Original Asset Basis Furniture $450,000 Computer Equipment $90,000 Copier $30,000 Machinery $480,000 §179 Expense Total Depreciation Deduction* §179 Expense $240,000 Remaining Basis $210,000 $90,000 $30,000 $480,000 Rate 14.29% 20.00% 20.00% 14.29% Depreciation Deduction $30,009 $18,000 $6,000 $68,592 $240,000 $362,601 *Depreciation is maximized by applying the §179 expense against 7-year instead of 5year property. c) The maximum §179 expense would be $0, computed as follows: Description Amount Explanation (1) Property placed in service $3,570,000 Total of qualifying assets (2) Threshold for §179 phase-out (2,550,000) 2019 amount (§179(b)(2)) (3) Phase-out of maximum §179 expense $1,020,000 (1) – (2) (permanently disallowed) (4) Maximum 179 expense before phase$1,020,000 2019 amount [§179(b)(1)] out (5) Phase-out of maximum §179 expense $1,020,000 From (3) Maximum §179 expense after phase-out $0 (4) – (5), but not below 0 The maximum depreciation deduction for 2019 using the half-year convention would be $517,005, computed as follows: Asset Furniture Computer Equipment Copier Original Basis $450,000 $90,000 $30,000 §179 Expense Remaining Basis $450,000 Rate 14.29% Depreciation Deduction $64,305 $90,000 $30,000 20.00% 20.00% 18,000 6,000 Copyright © 2020 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education. 30 Solutions Manual –Taxation of Business Entities, by Spilker et al. Machinery $3,000,000 §179 Expense Total Depreciation Deduction $3,000,000 14.29% 428,700 -0$517,005 59. [LO 2, LO 3] {Planning} Dain’s Diamond Bit Drilling purchased the following assets this year. Assume its taxable income was $53,000 for purposes of computing the §179 expense (assume no bonus depreciation). Asset Drill Bits (5-year) Drill Bits (5-year) Commercial Building Purchase Date January 25 July 25 April 22 Original Basis $90,000 95,000 220,000 a) What is the maximum amount of §179 expense Dain’s may deduct for the year? b) What is Dain’s maximum depreciation deduction for the year (including §179 expense)? c) If the January drill bits’ original basis was $2,875,000, what is the maximum amount of §179 expense Dain’s may deduct for the year? d) If the January drill bits’ basis was $3,875,000, what is the maximum amount of §179 expense Dain may deduct for the year? a) The maximum §179 expense is $53,000, computed as follows: Description Amount Explanation (1) Property placed in service this year $185,000 Total of qualifying assets (2) Threshold for §179 phase-out (2,550,000) 2019 amount (§179(b)(2)) (3) Phase-out of maximum §179 expense $0 (1) – (2) (permanently disallowed), not less than $0 (4) Maximum 179 expense before phase-out $1,020,000 2019 amount (§179(b)(1)) (5) Phase-out of maximum §179 expense $0 From (3) (6) Maximum §179 expense after phase-out $1,020,000 (4) – (5) (7) Taxable income before §179 deduction $53,000 Assumed in problem §179 expense deductible after taxable income $53,000 Lesser of (6) and (7) limitation. b) Dain’s depreciation deduction would be $83,402, calculated as follows: Asset Drill Bits (5 year) Drill Bits (5 year) Commercial Building (39 year) Original Basis $90,000 $95,000 $220,000 §179 Expense Total Depreciation Deduction §179 Expense $53,000 Remaining Basis $37,000 $95,000 $220,000 Rate 20.00% 20.00% 1.819% Depreciation Deduction $7,400 $19,000 $4,002 $53,000 $83,402 Copyright © 2020 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education. 31 Solutions Manual –Taxation of Business Entities, by Spilker et al. Note that in order to maximize the current year’s total depreciation deduction, Dain would only elect §179 expense equal to the taxable income limitation. c) The maximum section 179 expense would be $53,000: Description Amount Explanation (1) Property placed in service $2,970,000 Total of qualifying assets (2) Threshold for §179 phase-out (2,550,000) 2019 amount (§179(b)(2)) (3) Phase-out of maximum §179 expense $420,000 (1) – (2) (permanently disallowed) (4) Maximum 179 expense before phase-out $1,020,000 2019 amount (§179(b)(1)) (5) Phase-out of maximum §179 expense (6) Maximum §179 expense after phase-out (7) Taxable income before §179 deduction Maximum §179 expense after taxable income limitation. $420,000 $600,000 $53,000 $53,000 From (3) (4) – (5) Assumed in problem Lesser of (6) and (7) d) The maximum section 179 expense would be $0: Description Amount Explanation (1) Property placed in service $3,970,000 Total of qualifying assets (2) Threshold for §179 phase-out (2,550,000) 2019 amount (§179(b)(2)) (3) Phase-out of maximum §179 expense $1,420,000 (1) – (2) (permanently disallowed) (4) Maximum 179 expense before phase-out $1,020,000 2019 amount (§179(b)(1)) (5) Phase-out of maximum §179 expense $1,420,000 From (3) (6) Maximum §179 expense after phase-out $0 (4) – (5) , not less than $0 (7) Taxable income before §179 deduction $53,000 Assumed in problem Maximum §179 expense after taxable $0 Lesser of (6) and (7) income limitation. 60. [LO 2, LO 3] {Research} Assume that ACW Corporation has 2019 taxable income of $1,500,000 for purposes of computing the §179 expense. The company acquired the following assets during 2019 (assume no bonus depreciation): Asset Machinery Computer equipment Delivery truck Qualified improvement property Total Placed in Service September 12 February 10 August 21 April 2 Basis $470,000 70,000 93,000 1,380,000 $2,013,000 a) What is the maximum amount of §179 expense ACW may deduct for 2019? Copyright © 2020 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education. 32 Solutions Manual –Taxation of Business Entities, by Spilker et al. b) What is the maximum total depreciation deduction that ACW may deduct in 2019 on the assets it placed in service in 2019? a. The maximum §179 expense is $1,020,000. Description Amount (1) Qualifying property placed in service during year (2) Threshold for §179 phase-out (3) Phase-out of maximum §179 expense Explanation (4) Maximum 179 expense before phase-out $2,013,000 Total of qualifying assets (2,550,000) 2019 amount [§179(b)(2)] $-0- (1) – (2) (permanently disallowed), not less than $0 $1,020,000 2019 amount [§179(b)(1)] (5) Phase-out of maximum §179 expense Maximum §179 expense after phase-out $-0- From (3) $1,020,000 (4) – (5) b. The maximum depreciation deduction is $1,126,311 (half year convention). Depreciation is maximized by applying the §179 expense against the qualified improvement property up to its maximum amount. The remaining basis in the qualified improvement property is then depreciated over 39 years. Asset Machinery (7-year) Computers (5- year) Delivery Truck (5-year) Qualified improvement property (39-year) Original Basis §179 Expense Remaining Basis* Rate Depreciation Deduction $470,000 $470,000 14.29% $67,163 $70,000 $93,000 $70,000 $93,000 20.00% 20.00% $14,000 $18,600 $360,000 1.819% 6,548 $1,020,000 $1,126,311 $1,380,000 1,020,000 §179 Expense Total Depreciation Deduction 61. (LO2, LO3) Chaz Corporation has taxable income in 2019 of $312,000 for purposes of computing the §179 expense and acquired the following assets during the year: Asset Office furniture Computer equipment Delivery truck Qualified improvement property Total Placed in Service September 12 February 10 August 21 September 30 Basis $780,000 930,000 68,000 1,500,000 $3,278,000 What is the maximum total depreciation that Chaz may deduct in 2019? Copyright © 2020 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education. 33 Solutions Manual –Taxation of Business Entities, by Spilker et al. The maximum depreciation deduction is $2,079,048 determined as follows: Description Amount (1) Property placed in service (2) Threshold for §179 phase-out (3) Phase-out of maximum §179 expense (4) Maximum 179 expense before phase-out Explanation $3,278,000 Total of qualifying assets (2,550,000) 2019 amount [§179(b)(2)] $728,000 (1) – (2) (permanently disallowed) $1,020,000 2019 amount [§179(b)(1)] (5) Phase-out of maximum §179 expense Maximum §179 expense after phase-out 728,000 From (3) $ 292,000 (4) – (5), not limited by taxable income Chaz will receive the most benefit by applying the §179 amount to the qualified improvement property. The remaining basis is recovered through regular MACRS. The furniture, computers, and delivery truck are recovered using bonus depreciation. Asset Furniture (7-year) Computers (5- year) Delivery truck (5 year) Qualified improvement property (39-year) Original Basis Remaining Basis Bonus Depreciation Remaining Basis Rate Depreciation Deduction $780,000 $780,000 780,000 -0- 14.29% $0 930,000 930,000 930,000 -0- 20.00% 0 68,000 68,000 68,000 -0- 20.00% 0 1,208,000 n/a 1,278,000 0.749% 9,048 $1,500,000 §179 Expense $292,000 §179 Expense $292,000 Bonus depreciation $1,778,000 $1,778,000 Total Depreciation Deduction $2,079,048 62. (LO2, LO3) {Planning} {Research} Woolard Supplies (a sole proprietorship) has taxable income in 2019 of $240,000 before any depreciation deductions (§179, bonus, or MACRS) and placed some office furniture into service during the year. The furniture had been used previously by Liz Woolard (the owner of the business) before it was placed in service by the business. Placed in Asset Service Office furniture (used) March 20 Basis $1,200,000 a. If Woolard elects $50,000 of §179, what is Woolard’s total depreciation deduction for the year? Copyright © 2020 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education. 34 Solutions Manual –Taxation of Business Entities, by Spilker et al. b. If Woolard elects the maximum amount of §179 for the year, what is the amount of deductible §179 expense for the year? What is the total depreciation that Woolard may deduct in 2019? What is Woolard’s §179 carryforward to next year, if any? c. Woolard is concerned about future limitations on its §179 expense. How much §179 expense should Woolard expense this year if it wants to maximize its depreciation this year and to avoid any carryover to future years? a. Woolard’s total deductible depreciation is $214,335 calculated as follows: Description Amount Explanation (1) Property placed in service (2) Elected §179 amount (3) Remaining asset basis (4) MACRS depreciation rate (5) MACRS depreciation (6) Taxable income limitation for §179 (7) Deductible §179 (7) Total deductible depreciation $1,200,000 Total of qualifying assets (50,000) Given in problem $1,150,000 (1) – (2) 14.29% 7-yr, half-year convention $164,335 (3) x (4) 75,665 $240,000 – (5); 50,000 Lesser of elected amount or (6) $214,335 (5) + (7) a. Woolard deducts $214,278 of §179. Woolard carries forward §179 expense of $805,722 to next year. The total deductible depreciation is $240,000 determined as follows: Description (1) Property placed in service (2) Threshold for §179 phase-out (3) Phase-out of maximum §179 expense (4) Maximum 179 expense before phase-out (5) Phase-out of maximum §179 expense (6) Maximum §179 expense after phase-out (7) Remaining basis in furniture (8) MACRS depreciation rate Amount Explanation $1,200,000 Total of qualifying assets (2,550,000) 2019 amount [§179(b)(2)] 0 (1) – (2) (permanently disallowed), not less than $0 $1,020,000 2019 amount [§179(b)(1)] 0 From (3) $1,020,000 (4) – (5), limited to amount of qualifying property placed in service. This is the amount Woolard elects for the year. 180,000 (1) – (6) 14.29% 7-year, half-year convention Copyright © 2020 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education. 35 Solutions Manual –Taxation of Business Entities, by Spilker et al. (9) MACRS depreciation (10) §179 taxable income limitation (11) Maximum deductible §179 expense after taxable income limitation. Excess §179 expense carried forward Woolard’s total depreciation deduction 25,722 (7) x (8) $214,278 $240,000 – (9) $214,278 Lesser of (6) or (10) $805,722 (6) – (11) $240,000 (9) + (11) Woolard elects the maximum allowed for the year and must reduce the assets’ bases by this amount. The remaining basis is subject to regular MACRS depreciation. The §179 taxable income limitation is taxable income after regular depreciation deductions but before the §179 expense. Woolard’s §179 deduction is limited to this taxable income amount. The remaining §179 amount that Woolard elected but is not allowed to deduct this year can be carried over to future years. b. Woolard should elect to expense $79,944 of §179 to maximize its depreciation this year and to avoid any carryover determined as follows: Description (1) Property placed in service (2) Threshold for §179 phase-out (3) Phase-out of maximum §179 expense (4) Maximum 179 expense before phase-out (5) Phase-out of maximum §179 expense (6) Maximum §179 expense after phase-out (7) §179 amount Woolard elects to maximize the current year total depreciation deduction (8) Remaining basis in furniture (9) MACRS depreciation rate (10) MACRS depreciation (11) §179 taxable income limitation (12) Maximum §179 expense after taxable income limitation. Excess §179 expense Woolard’s total depreciation deduction Amount Explanation $1,200,000 Total of qualifying assets (2,550,000) 2019 amount [§179(b)(2)] 0 (1) – (2) (permanently disallowed) $1,020,000 2019 amount [§179(b)(1)] 0 From (3) $1,020,000 (4) – (5) $79,944 See discussion below 1,120,056 (1) – (7) 14.29% 7-year, half-year convention 160,056 (9) x (8) $79,944 $240,000 – (10) $79,944 Lesser of (6) or (11). This is the amount Woolard elects for the year. $-0- (7) – (12) $240,000 (10) + (12) Woolard must determine the maximum §179 amount allowed for the year without being limited by the taxable income limitation. To do this, Woolard determines the §179 amount as follows: Copyright © 2020 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education. 36 Solutions Manual –Taxation of Business Entities, by Spilker et al. §179 amount = Taxable income before any depreciation minus regular MACRS depreciation. The MACRS depreciation amount is determined after the §179 elected amount because the depreciable basis is reduced by the elected §179 amount and would be determined as follows: MACRS depreciation = Depreciation rate x (asset cost minus elected §179) To solve this, assume the following labels: I = taxable income before any depreciation R = MACRS depreciation rate C = asset cost S = §179 expense The elected §179 amount will equal: S = I – R(C – S) Rearranging and solving for S: S = (I – RxC)/(1 – R) Substituting in Woolard’s facts: S = ($240,000 – 14.29% x $1,200,000)/(1 – 14.29%) S = $79,944. This amount of §179 minimizes Woolard’s required basis reduction of its assets and produces the most depreciation Woolard is eligible to take this year. 63. [LO 2, LO 3] {Planning} Assume that Sivart Corporation has 2019 taxable income of $1,750,000 for purposes of computing the §179 expense and acquired several assets during the year. Assume the delivery truck does not qualify for bonus depreciation. Asset Machinery Computer equipment Delivery truck Furniture Total Placed in Service June 12 February 10 August 21 April 2 Basis $1,440,000 70,000 93,000 310,000 $1,913,000 a) What is the maximum amount of §179 expense Sivart may deduct for 2019? b) What is the maximum total depreciation (§179, bonus, MACRS) that Sivart may deduct in 2019 on the assets it placed in service in 2019? Copyright © 2020 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education. 37 Solutions Manual –Taxation of Business Entities, by Spilker et al. a. The maximum §179 expense is $1,020,000. Description Amount (1) Property placed in service during year (2) Threshold for §179 phase-out (3) Phase-out of maximum §179 expense (4) Maximum §179 expense before phase-out (5) Phase-out of maximum §179 expense (6) Maximum §179 expense after phase-out Explanation $1,913,000 Total of tangible assets 2,550,000 2019 amount [§179(b)(2)] $0 (1) – (2) (permanently disallowed), not less than $0 $1,020,000 2019 amount [§179(b)(1)] $0 From (3) $1,020,000 (4) – (5), not limited by taxable income b. The maximum depreciation deduction is $1,913,000. Depreciation is maximized by (1) applying the §179 expense against delivery truck first because the truck is not eligible for bonus depreciation. Sivart would then apply the remaining §179 amount to 7-year rather than 5-year property. As a general rule, the taxpayer will maximize current year depreciation deduction by applying the §179 expense against the asset with the lowest depreciation percentage. The remaining assets are eligible for 100 percent bonus. Alternatively, Sivart could elect only $93,000 of §179 expense and take bonus on the remaining assets with the same outcome. Asset Machinery (7-year) Computer equipment (5- year) Delivery Truck (5 year) Furniture (7 year) Original Basis §179 Expense Remainin g Basis Bonus Depreciation Remaining Basis Rate Depreciation Deduction $1,440,000 $927,000 $513,000 $513,000 $0 14.29% $0 70,000 70,000 0 20.00% 0 20.00% 0 70,000 93,000 93,000 310,000 _________ §179 Expense 310,000 310,000 0 14.29% 0 $1,020,000 Bonus depreciation $1,020,000 $893,000 $893,000 Total Depreciation Deduction $1,913,000 64. [LO 2, LO 3] {Planning} Acorn Construction (calendar-year-end C corporation) has had rapid expansion during the last half of the current year due to the housing market’s recovery. The company has record income and would like to maximize its cost recovery deduction for the current year. Acorn provided the following information: Assets Placed in Service Basis Copyright © 2020 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education. 38 Solutions Manual –Taxation of Business Entities, by Spilker et al. New Equipment and Tools Used Light Duty Trucks Used Machinery Total August 20 January 17 February 6 $1,800,000 1,500,000 525,000 $3,825,000 The used assets had been contributed to the business by its owner in a taxdeferred transaction. a) What is Acorn’s maximum cost recovery expense in the current year? b) What planning strategies would you advise Acorn to consider? a) a) Acorn is not eligible for §179 expensing because its new assets exceed the $2,550,000 threshold by more than $1,020,000; therefore, its maximum §179 amount is reduced to zero. Acorn is eligible to take bonus depreciation (100 percent) on its new assets. The used assets are not eligible for bonus depreciation because they had been previously used by the taxpayer. In addition, because Acorn places more than 40 percent of its assets into service in the last quarter of the year, it must use the midmonth convention to determine depreciation. Acorn’s maximum cost recovery is $1,893,743, calculated as follows: Asset New Equipment and Tools (7-year) Used Light Duty Trucks (5- year) Used Machinery (7-year) Bonus depreciation Total Original Basis Bonus Depr $1,800,000 1,500,000 525,000 3,825,000 Remaining Basis MACRS Rate Depreciation Deduction $1,800,000 0 10.71% $0 -0-0- 1,500,000 525,000 5.00% 3.57% 75,000 18,743 1,800,000 $1,893,743 b) Acorn may want to consider the timing of its asset contributions. It may want to spread the contributions out over two years to reduce the §179 expense limitation on these assets. b) Acorn may want to consider the timing of its asset contributions. It may want to spread the contributions out over two years to reduce the §179 expense limitation on these assets. 65. [LO 3] Phil owns a ranch business and uses four-wheelers to do much of his work. Occasionally, though, he and his boys will go for a ride together as a family activity. During year 1, Phil put 765 miles on the four-wheeler that he bought on January 15 for $6,500. Of the miles driven, only 175 miles were for personal use. Assume four-wheelers qualify to be depreciated according to the 5-Year MACRS schedule and the four-wheeler was the only asset Phil purchased this year. a. Calculate the allowable depreciation for year 1 (ignore the §179 expense and bonus depreciation). Copyright © 2020 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education. 39 Solutions Manual –Taxation of Business Entities, by Spilker et al. b. Calculate the allowable depreciation for year 2 if total miles were 930 and personal-use miles were 400 (ignore the §179 expense and bonus depreciation). a) The depreciation deduction will be $1,003 in year 1, calculated as follows: Description (1) Original basis of 4-wheeler (2) MACRS depreciation rate (3) Full MACRS depreciation (4) Business use percentage Depreciation deduction for year ` Amount Explanation $6,500 Assumed in problem 20% 5-yr prop, yr. 1, ½ yr. convention. $1,300 (1) x (2) 77.12% 590 miles/765 miles $1,003 (3) x (4) b) The depreciation deduction will be $1,185 in year 2, calculated as follows: Description (1) Original basis of 4-wheeler (2) MACRS depreciation rate (3) Full MACRS depreciation (4) Business use percentage Depreciation deduction for year Amount Explanation $6,500 Assumed in problem 32% 5-yr prop, yr. 1, ½ yr. convention. $2,080 (1) x (2) 56.99% 530 miles/930 miles $1,185 (3) x (4) 66. [LO 3] Assume that Ernesto purchased a digital camera on July 10 of year 1 for $3,000. In year 1, 80 percent of his camera usage was for his business and 20 percent was for his personal photography activities. This was the only asset he placed in service during year 1. Ignoring any potential §179 expense and bonus depreciation, answer the questions for each of the following alternative scenarios: a. What is Ernesto’s depreciation deduction for the camera in year 1? b. What would be Ernesto’s depreciation deduction for the camera in year 2 if his year 2 usage were 75 percent business and 25 percent for personal use? c. What would be Ernesto’s depreciation deduction for the camera in year 2 if his year 2 usage were 45 percent business and 55 percent for personal use? d. What would be Ernesto’s depreciation deduction for the camera in year 2 if his year 2 usage were 30 percent business and 70 percent for personal use? a) The depreciation deduction will be $480 in year 1, calculated as follows: Description (1) Original basis of camera (2) MACRS depreciation rate Amount Explanation $3,000 Assumed in problem 20% 5-yr prop, yr. 1, ½ yr. convention. (3) Full MACRS depreciation (4) Business use percentage $600 (1) x (2) 80% Assumed in the problem Copyright © 2020 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education. 40 Solutions Manual –Taxation of Business Entities, by Spilker et al. Depreciation deduction for year $480 (3) x (4) b) The depreciation deduction will be $720 in year 2, calculated as follows: Description (1) Original basis of camera (2) MACRS depreciation rate Amount Explanation $3,000 Assumed in problem 32% 5-yr prop, yr. 1, ½ yr. convention. (3) Full MACRS depreciation (4) Business use percentage Depreciation deduction for year $960 (1) x (2) 75% Assumed in the problem $720 (3) x (4) c) $30. Because his business usage is below 50 percent, Ernesto must use the straight-line method to determine depreciation. Using this method, his depreciation deduction for year 2 is $270. However, because his business usage dropped from above to below 50 percent, he must also recalculate prior year depreciation using the straight-line method. Any accelerated depreciation that he claimed in the prior year in excess of the straight-line amount for that prior year reduces the $270 of depreciation deduction for year 2. In this case, the excess $240 depreciation reduces the $270, leaving $30 of depreciation deduction as computed below. Description Amount Explanation (1) Straight-line depreciation in current $270 $3,000/5 years x 45% year business (2) Prior year straight-line depreciation $240 $3,000/5 x ½ year convention x 80% business use percentage (3) Prior year accelerated depreciation (4) Excess accelerated depreciation $480 From part “a” above $240 (3) – (2) Current year depreciation deduction $30 (1) – (4). d) Income of $60 (no depreciation deduction). Because his business usage in year 2 is below 50 percent, Ernesto must use the straight-line method to determine depreciation. Using this method, his depreciation deduction is $180 in year 2 because his business use is 30%. Moreover, because the camera is listed property and fell below 50 percent business use, depreciation for year 1 must be recalculated using the straight-line method and any excess depreciation reduces the year 2 depreciation amount. In this case, the excess depreciation of $240 is $60 greater than the $180 straight line depreciation so Ernesto does not get to deduct depreciation deduction in year 2, but instead he must recognize ordinary income of $60. The $60 of income is computed as follows: Description Amount Explanation (1) Straight-line depreciation in current $180 $3,000/5 years x 30% year business Copyright © 2020 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education. 41 Solutions Manual –Taxation of Business Entities, by Spilker et al. (2) Prior year straight-line depreciation $240 $3,000/5 x ½ year convention x (3) Prior year accelerated depreciation (4) Excess accelerated depreciation $480 From part “a” above $240 (3) – (2) Current year income ($60) (1) – (4). 80% business use percentage 67. [LO 3] Lina purchased a new car for use in her business during 2019. The auto was the only business asset she purchased during the year and her business was extremely profitable. Calculate her maximum depreciation deductions (including §179 expense unless stated otherwise) for the automobile in 2019 and 2020 (Lina doesn’t want to take bonus depreciation for 2019 or 2020) in the following alternative scenarios (assuming half-year convention for all): a. b. c. d. The vehicle cost $35,000 and business use is 100 percent (ignore §179 expense). The vehicle cost $80,000, and business use is 100 percent. The vehicle cost $80,000, and she used it 80 percent for business. The vehicle cost $80,000, and she used it 80 percent for business. She sold it on March 1 of year 2. e. The vehicle cost $80,000, and she used it 20 percent for business. f. The vehicle cost $80,000 and is an SUV that weighed 6,500 pounds. Business use was 100 percent. a. The depreciation deduction is $7,000 in 2019 and $11,200 in 2020, calculated as follows: 2019 2020 Description Amount Amount Explanation (1) Original basis of auto $35,000 $35,000 Given in problem (2) MACRS depreciation rate 20% 32% 5-yr prop, yr. 1, ½ yr. convention. (3) Full MACRS depreciation $7,000 $11,200 (1) x (2) (4) Maximum auto depreciation $10,000 $16,000 Luxury auto limits Depreciation deduction for year $7,000 $11,200 Lesser of (3) or (4)) b. The depreciation deduction is $10,000 in 2019 and $16,000 in 2020, calculated as follows: 2019 2020 Description Amount Amount Explanation (1) Original basis of auto $80,000 $80,000 Given in problem (2) MACRS depreciation rate 20% 32% 5-yr prop, yr. 1, ½ yr. convention. (3) Full MACRS depreciation $16,000 $25,600 (1) x (2) (4) Maximum auto depreciation $10,000 $16,000 Luxury auto limits Depreciation deduction for year $10,000 $16,000 Lesser of (3) or (4) Note that when the depreciation is limited by the automobile limitations, §179 expense will not provide any additional benefit, so it does not make sense to elect §179. Copyright © 2020 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education. 42 Solutions Manual –Taxation of Business Entities, by Spilker et al. c. The depreciation deduction will be $8,000 in 2019 and $12,800 in 2020, calculated as follows: 2019 2020 Description Amount Amount Explanation (1) Original basis of auto $80,000 $80,000 Given in problem (2) MACRS depreciation rate 20% 32% 5-yr prop, yr. 1, ½ yr. convention. (3) Full MACRS depreciation $16,000 $25,600 (1) x (2) (4) Maximum auto depreciation $10,000 $16,000 Luxury auto limits (5) Depreciation deduction for year based on 100% business use $10,000 $16,000 Lesser of (3) or (4) (6) Business use percentage 80% 80% Assumed in problem Depreciation deduction for year $8,000 $12,800 (5) x (6) d. The depreciation deduction will be $8,000 in 2019 (as calculated in part c above). The depreciation deduction will be $6,400 in 2020, calculated as follows: 2020 Description Amount Explanation (1) Original basis of auto $80,000 Given in problem (2) MACRS depreciation rate 32% 5-yr prop, yr. 1, ½ yr. convention. (3) Full MACRS depreciation (4) Maximum auto depreciation (5) Depreciation for entire year (6) Partial year (7) Depreciation deduction for year (8) Business use percentage Depreciation deduction for year $25,600 (1) x (2) $16,000 Luxury auto limit year 2 $16,000 Lesser of (3) or (4) Half year of depreciation 50% (half-year convention) $8,000 80% Assumed in problem $6,400 (7) x (8) e. The depreciation deduction will be $1,600 in 2019 and $3,200 in 2020, calculated as follows: 2019 2020 Description Amount Amount Explanation (1) Original basis of auto $80,000 $80,000 Given in problem (2) MACRS (Straight-line) 5-yr straight-line, ½ yr. depreciation rate 10% 20% convention. (3) Full MACRS depreciation $8,000 $16,000 (1) x (2) (4) Maximum auto depreciation $10,000 $16,000 Luxury auto limits (5) Depreciation deduction for year based on 100% business use $8,000 $16,000 Lesser of (3) or (4) (6) Business use percentage 20% 20% Assumed in problem Depreciation deduction for year $1,600 $3,200 (5) x (6) Copyright © 2020 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education. 43 Solutions Manual –Taxation of Business Entities, by Spilker et al. f. The depreciation deduction will be $36,400 in 2019 and $17,600 in 2020, calculated as follows: Description 2019 2020 Explanation Amount Amount (1) Original basis of auto $80,000 N/A Given in problem Maximum §179 (2) Section 179 expense $25,500 N/A expense for SUV (3) Depreciable basis $54,500 $55,000 (1) – (2) 5-yr prop, yr. 1, ½ yr. (4) MACRS depreciation rate 20% 32% convention. (5) Full MACRS depreciation $10,900 $17,600 (3) x (4) Depreciation deduction in including §179 expense for year $36,400 $17,600 (2) + (5) The depreciation deduction on the SUV is not restricted by the automobile limitations because the vehicle weighs more than 6,000 pounds and therefore is excluded from these limitations. Note that the depreciation is maximized in b – e even without the §179 expense. 68. [LO 2, LO 3] Tater Meer purchased a new car for use in her business during 2019 for $75,000. The auto was the only business asset she purchased during the year and her business was very profitable. Calculate Tater’s maximum depreciation deductions for the automobile in 2019 and 2020 under the following scenarios: a. Tater does not want to take §179 expense and she elects out of bonus depreciation. b. Tater wants to maximize her 2019 depreciation using bonus depreciation. a. The depreciation deduction is $10,000 in 2019 and $16,000 in 2020, calculated as follows: 2019 2020 Description Amount Amount Explanation (1) Original basis of auto $75,000 $75,000 Given in problem (2) MACRS depreciation rate 20% 32% 5-yr prop, yr. 1, ½ yr. convention. (3) Full MACRS depreciation $15,000 $24,000 (1) x (2) (4) Maximum auto depreciation $10,000 $16,000 Luxury auto limits Depreciation deduction for year $10,000 $16,000 Lesser of (3) or (4) b. The depreciation deduction is $18,000 in 2019 and $16,000 in 2020, calculated as follows: Description (1) Automobile (2) Bonus percentage (3) MACRS depreciation Amount $75,000 100% $75,000 Explanation Given in problem §168(k)(1) and §168(k)(6)(A)(i) (1) x (2) Copyright © 2020 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education. 44 Solutions Manual –Taxation of Business Entities, by Spilker et al. (4) Luxury car limitation 18,000 Depreciation deduction for 2019 $18,000 Description (1) Year 1 depreciation (2) Adjusted depreciable basis (3) Depreciation rate (4) Year 2 calculated depreciation before limitation (4) Depreciation deduction for 2020 Luxury car limitation [$10,000 (§280F(a)(1)) + $8,000 (§168(k)(2)(F))] Lesser of (3) or (4) Amount Explanation $18,000 Calculated above 57,000 Adjusted depreciable basis is initial basis less depreciation taken in the first year ($18,000) 32% From Appendix Table 1 (5-year property, year 2 MACRS percentage) 18,240 (2) x (3) $ 16,000 Lesser of (4) or $16,000 (Year 2 limitation) 69. [LO 2, LO 3] Burbank Corporation (calendar-year end) acquired the following property this year: Placed in Asset Service Basis Used copier November 12 $7,800 New computer equipment June 6 14,000 Furniture July 15 32,000 New delivery truck October 28 19,000 Luxury auto January 31 70,000 Total $142,800 Burbank acquired the copier in a tax-deferred transaction when the shareholder contributed the copier to the business in exchange for stock. a) Assuming no bonus or §179 expense, what is Burbank’s maximum cost recovery for this year? b) Assuming Burbank would like to maximize its cost recovery by electing bonus and §179 expense, which assets should Burbank immediately expense? c) What is Burbank’s maximum cost recovery this year assuming it elects §179 expense and claims bonus depreciation? a) Burbank Corporation uses the half-year convention to determine its cost recovery and the cost recovery on the luxury auto is limited to the maximum $10,000 for the year. Burbank’s cost recovery is $22,733, calculated as follows: Asset Used Copier (5 yr) Original Depreciation Basis Rate Deduction $7,800 20.00% $1,560 Copyright © 2020 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education. 45 Solutions Manual –Taxation of Business Entities, by Spilker et al. New Computer Equipment (5 yr) Furniture (7 yr) New Delivery Truck (5 yr) Luxury Auto (5 yr – limited) Total 14,000 32,000 19,000 70,000 20.00% 14.29% 20.00% – 2,800 4,573 3,800 10,000 $22,733 b) Burbank is not subject to the §179 property limitation ($2,550,000) and may expense all of its assets using §179 expense except the used copier and the luxury auto. The copier is not eligible for either §179 or bonus depreciation because the taxpayer had prior use of the copier. The depreciation on the copier remains at $1,560 as in part (a). The luxury auto depreciation will be limited to $18,000 using §179 expense and bonus depreciation. c) Burbank’s maximum cost recovery assuming it elects bonus and §179 expense is $84,560. Burbank cannot use §179 expense or bonus depreciation for the copier because it is ineligible (acquired in a tax-deferred transaction). The depreciation for the other assets will be the same under either §179 or bonus depreciation except for the luxury auto. Burbank should use bonus depreciation to recover the luxury auto to increase the automobile depreciation limitation by $8,000 this year. Asset Copier (5-year) Computer Eq (5- year) Furniture (7-year) Delivery Truck (5 year) Luxury Auto (5-year) Original Basis §179 Expense Remaining Basis Bonus Depreciation Depreciation Deduction $7,800 $0 $7,800 $-0- $1,560 14,000 32,000 14,000 32,000 -0-0- -0-0- -0-0- 19,000 $70,000 19,000 0 -070,000 -08,000 -010,000 §179 Expense $65,000 Bonus depreciation $8,000 Total Cost Recovery $8,000 $84,560 70. [LO 3] [Research] Paul Vote purchased the following assets this year (ignore §179 expensing and bonus depreciation when answering the questions below): Asset Machinery Computers Warehouse Purchase Date May 12 August 13 December 13 Basis $23,500 $20,000 $180,000 a. What is Paul’s allowable MACRS depreciation for the property? b. What is Paul’s allowable alternative minimum tax (AMT) depreciation for the property? You will need to find the AMT depreciation tables to compute the depreciation. Copyright © 2020 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education. 46 Solutions Manual –Taxation of Business Entities, by Spilker et al. a. $7,551, under the half-year convention, calculated as follows: Original Basis Asset Depreciation Deduction Rate Machinery $23,500 Computers $20,000 Nonresidential building $180,000 Total Depreciation Deduction 14.29% 20.00% 0.107% $3,358 $4,000 $193 $7,551 b. $5,710, using the AMT table and the half-year convention, calculated as follows: Asset Machinery (7-year 150% DB) Computers (5-year 150% DB) Nonresidential building (39-year straight-line) Total Depreciation Deduction Original Basis Rate Depreciation Deduction $23,500 10.71% $20,000 15.00% $2,517 $3,000 $180,000 0.107% $193 $5,710 71. [LO 4] After several profitable years running her business, Ingrid decided to acquire the assets of a small competing business. On May 1 of year 1, Ingrid acquired the competing business for $300,000. Ingrid allocated $50,000 of the purchase price to goodwill. Ingrid’s business reports its taxable income on a calendar-year basis. a. b. How much amortization expense on the goodwill can Ingrid deduct in year 1, year 2, and year 3? In lieu of the original facts, assume that Ingrid purchased only a phone list with a useful life of 5 years for $10,000. How much amortization expense on the phone list can Ingrid deduct in year 1, year 2, and year 3? a. Ingrid could deduct $2,222 amortization expense on the goodwill in year 1 and $3,333 of amortization expense on the goodwill in years 2 and 3, computed as follows: Description Amount Explanation (1) Basis of Goodwill $50,000 Provided (2) Recovery period 180 15 years (3) Monthly amortization $277.78 (1) / (2) (4) Months in year 1 x 8 May through December (5) Year 1 straight-line amortization $2,222 (3) x (4) (6) Months in years 2 and 3 x 12 January through December (7) Years 2 and 3, annual straight-line amortization $3,333 (3) x (6) Copyright © 2020 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education. 47 Solutions Manual –Taxation of Business Entities, by Spilker et al. b. Ingrid’s amortization for the phone list for year 1 is $444, years 2 and 3 is $667, computed as follows: Description Phone List (1) Basis of phone list $10,000 (2) Recovery period in months 180 (3) Monthly amortization $55.55 (4) Months in year 1 x 8 (5) Year 1 straight-line amortization $444 (6) Months in years 2 and 3 x 12 (7) Years 2 and 3, annual straight-line $667 amortization Although Ingrid purchased only the phone list, it is still considered a §197 intangible and will be amortized over 180 months (see §197). 72. [LO 4] Juliette formed a new business to sell sporting goods this year. The business opened its doors to customers on June 1. Determine the amount of startup costs Juliette can immediately expense (not including the portion of the expenditures that are amortized over 180 months) this year in the following alternative scenarios. a. b. c. d. e. She incurred start-up costs of $2,000. She incurred start-up costs of $45,000. She incurred start-up costs of $53,500. She incurred start-up costs of $63,000. How would you answer parts (a) through (d) if she formed a partnership or a corporation and she incurred the same amount of organizational expenditures rather than start-up costs (how much of the organizational expenditures would be immediately deductible)? a. $2,000, computed as follows: Start-up Expenses Description Amount Explanation (1) Maximum immediate expense $5,000 (2) Total start-up costs $2,000 Given in problem (3) Phase-out threshold 50,000 (4) Immediate expense phase-out Allowable immediate expense $0 (2) – (3) Lesser of (2) or [(1) $2,000 minus – (4)] b. $5,000, computed as follows: Start-up Expenses Copyright © 2020 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education. 48 Solutions Manual –Taxation of Business Entities, by Spilker et al. Description (1) Maximum immediate expense (2) Total start-up costs (3) Phase-out threshold Amount Explanation $5,000 $45,000 Given in problem 50,000 $0 (2) – (3), not less than $0 Lesser of (2) or [(1) $5,000 minus – (4)] (4) Immediate expense phase-out Allowable immediate expense c. $1,500, computed as follows: Description (1) Maximum immediate expense (2) Total start-up costs (3) Phase-out threshold Start-up Expenses Amount Explanation $5,000 $53,500 Given in problem 50,000 (4) Immediate expense phase-out Allowable immediate expense $3,500 (2) – (3), not less than $0 Lesser of (2) or [(1) $1,500 minus – (4)] d. $0, computed as follows: Organizational Expenditures Description Amount Explanation (1) Maximum immediate expense $5,000 (2) Total start-up costs $63,000 Given in problem (3) Phase-out threshold 50,000 (4) Immediate expense phase-out Allowable immediate expense $13,000 (2) – (3) Lesser of (2) or [(1) minus – (4)] (not less $0 than $0) e. The answers would be the same if these were organizational expenditures instead of start-up costs. Note, however, that organizational expenditures only apply to corporations and partnerships and do not apply to businesses organized as sole proprietorships. 73. [LO 4] Nicole organized a new corporation. The corporation began business on April 1 of year 1. She made the following expenditures associated with getting the corporation started: Expense Attorney fees for articles of incorporation March 1 – March 30 wages Date Amount February 10 March 30 $32,000 $4,500 Copyright © 2020 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education. 49 Solutions Manual –Taxation of Business Entities, by Spilker et al. March 1 – March 30 rent Stock issuance costs April 1 – May 30 wages March 30 April 1 May 30 $2,000 $20,000 $12,000 a. What is the total amount of the start-up costs and organizational expenditures for Nicole’s corporation? b. What amount of the start-up costs and organizational expenditures may the corporation immediately expense in year 1 (excluding the portion of the expenditures that are amortized over 180 months)? c. What amount can the corporation deduct as amortization expense for the organizational expenditures and for the start-up costs for year 1 (not including the amount determined in part [b])? d. What would be the total allowable organizational expenditures if Nicole started a sole proprietorship instead of a corporation? a. The only qualifying organizational expenditure is the $32,000 of attorney fees related to the drafting articles of incorporation. The start-up costs are the wages ($4,500) and rent ($2,000) before business began. Therefore, total start-up costs are $6,500. b. The corporation may immediately expense $5,000 of the organizational expenditure and $5,000 of the start-up costs because the amount of organizational expenditures is under $50,000 and the amount of start-up costs is under $50,000. c. The corporation will deduct amortization expense of $1,350 for organizational expenditures and $75 of amortization for start-up costs, computed as follows: Description (1) Maximum immediate expense (2) Total start-up expenditures (3) Phase-out threshold Start-up costs Amount Explanation $5,000 §195(b)(1)(A)(ii) $6,500 50,000 §195(b)(1)(A)(ii) (4) Immediate expense phase-out (5) Allowable immediate expense (6) Remaining organizational expenditures (7) Recovery period in months (8) Monthly straight-line amortization (9) Teton business months during year 1 Year 1 straight-line amortization for startup costs Description $0 $5,000 $1,500 180 8.33 x 9 (2) – (3), not less than $0 (1) – (4) (2) – (5) 15 years §195(b)(1)(B) (6) / (7) April through December $75 (8) x (9) Organizational expenditures Amount Explanation Copyright © 2020 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education. 50 Solutions Manual –Taxation of Business Entities, by Spilker et al. (1) Maximum immediate expense (2) Total organizational expenditures (3) Phase-out threshold $5,000 §248(a)(1) $32,000 Given in problem 50,000 §248(a)(1)(B) (4) Immediate expense phase-out (5) Allowable immediate expense (6) Remaining organizational expenditures (7) Recovery period in months (8) Monthly straight-line amortization (9) Teton business months during year 1 $0 $5,000 $27,000 180 150 x 9 Year 1 straight-line amortization for organizational expenditures $1,350 (8) x (9) (2) – (3), not less than $0 (1) – (4) (2) – (5) 15 years §248(a)(2) (6) / (7) April through December d. Organizational expenditures are only authorized for corporations (§248) and partnerships (§709). They are not authorized for sole proprietorships. Typically, sole proprietorships do not incur many of the expenses that would qualify as organizational expenditures anyway. 74. [LO 4] Bethany incurred $20,000 in research and experimental costs for developing a specialized product during July of year 1. Bethany went through a lot of trouble and spent $10,000 in legal fees to receive a patent for the product in August of year 3. Bethany expects the patent to have a remaining useful life of 10 years. a. What amount of research and experimental expenses for year 1, year 2, and year 3 may Bethany deduct if she elects to amortize the expenses over 60 months? b. How much patent amortization expense would Bethany deduct in year 3 assuming she elected to amortize the research and experimental costs over 60 months? c. If Bethany chose to capitalize but not amortize the research and experimental expenses she incurred in year 1, how much patent amortization expense would Bethany deduct in year 3? a. The amortization of the research expenditures is $2,000 in year 1, $4,000 in year 2, and $2,333 in year 3, computed as follows: Description Amount Explanation (1) Research and experimental expenses $20,000 Given in problem (2) Recovery period in months 60 60 months §174 (3) Monthly straight-line amortization 333.33 (1) / (2) (4) Bethany’s business months during year 1 x 6 July through December (5) Year 1 straight-line amortization (6) Bethany’s business months during year 2 $2,000 (3) x (4) 12 January through December (7) Year 2 straight-line amortization $4,000 (3) x (6) Copyright © 2020 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education. 51 Solutions Manual –Taxation of Business Entities, by Spilker et al. (8) Bethany’s business months during year 3 before patent is issued in August (9) Year 3 straight-line amortization on research and experimentation costs (10) Accumulated amortization through July of year 3 (11) Unamortized research and experimentation expenditures as of August, year 3 7 January through July, year 3 2,333 (3) x (8) 8,333 (5) + (7) + (9) (1) – (10) $11,667 Used in answer to part b b. The patent amortization is $902.79, computed as follows: Description (1) Unamortized research and experimental expenses (2) Legal expenses related to patent (3) Amortizable expenses for patent (4) Recovery period in months (5) Monthly straight-line amortization (6) Bethany’s business months from August through December Year 3 straight-line amortization for patent Amount $11,667 $10,000 $21,667 120 180.56 Explanation See (11) part a above Given in problem (1) + (2) 10-year useful life (3) / (4) x 5 $902.79 (5) x (6) c. The patent amortization is $1,250, computed as follows: Description Amount (1) Research and experimental expenses (2) Legal expenses related to patent (3) Amortizable expenses (4) Recovery period in months (5) Monthly straight-line amortization (6) Bethany’s business months from August through December Year 3 straight-line amortization for patent $20,000 $10,000 $30,000 120 250 Explanation Given in problem (not amortized) Given in problem (1) + (2) 10-year useful life (3) / (4) x 5 $1,250 (5) x (6) 75. [LO 5] Last Chance Mine (LCM) purchased a coal deposit for $750,000. It estimated it would extract 12,000 tons of coal from the deposit. LCM mined the coal and sold it, reporting gross receipts of $1 million, $3 million, and $2 million for years 1 through 3, respectively. During years 1 – 3, LCM reported net income (loss) from the coal deposit activity in the amount of ($20,000), $500,000, and $450,000, respectively. In years 1 – 3, LCM actually extracted 13,000 tons of coal as follows: (1) Tons of Coal (2) Basis Depletion (2)/(1) Rate Tons extracted per year Year 1 Year 2 Year 3 Copyright © 2020 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education. 52 Solutions Manual –Taxation of Business Entities, by Spilker et al. 12,000 $750,000 $62.50 2,000 7,200 3,800 a. What is LCM’s cost depletion for years 1, 2, and 3? b. What is LCM’s percentage depletion for each year (the applicable percentage for coal is 10 percent)? c. Using the cost and percentage depletion computations from parts (a) and (b), what is LCM’s actual depletion expense for each year? a. LCM’s cost depletion is $125,000 for year 1, $450,000 for year 2, and $175,000 for year 3, calculated as follows: Year 1 Year 2 Year 3 Explanation (1) Tons extracted 2,000 7,200 3,800 (2) Depletion rate $62.50 $62.50 $62.50 Cost Depletion Expense $125,000 $450,000 $175,000* (1) x (2) *This is the remaining basis. Under the cost depletion method, the taxpayer’s amortization is limited to the cost basis in the natural resource. The full amount of amortization would have been $237,500 if this were not the case. b. LCM’s percentage depletion for each year is calculated as follows: Year 1 (1) Net income from activity (before depletion expense) (2) Gross Income (3) Percentage (4) Percentage Depletion Expense before limit (5) 50% of net income limitation Allowable percentage depletion Year 2 Year 3 Explanation ($20,000) $500,000 $450,000 Given in problem $1,000,000 $3,000,000 $2,000,000 x 10% x 10% x 10% $100,000 $0 $0 $300,000 $250,000 $250,000 $200,000 (2) x (3) $225,000 (1) x 50% $200,000 Lesser of (4) or (5) Note that percentage depletion is not limited to the basis in the property. c. Depletion expense is the greater of cost depletion or percentage depletion calculated as follows: Tax Depletion Expense (1) Cost depletion (2) Percentage depletion Deductible depletion expense Year 1 Year 2 $125,000 $450,000 $0 $250,000 $125,000 $450,000 Year 3 Explanation $175,000 Part a $200,000 Part b $200,000 Greater of (1) or (2) Copyright © 2020 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education. 53 Solutions Manual –Taxation of Business Entities, by Spilker et al. Comprehensive Problems 76. Karane Enterprises, a calendar year manufacturer based in College Station, Texas began business in 2018. In the process of setting up the business, Karane has acquired various types of assets. Below is a list of assets acquired during 2018: Asset Office furniture Machinery Used delivery truck* Cost $150,000 1,560,000 40,000 Date Place in Service 02/03/2018 07/22/2018 08/17/2018 *Not considered a luxury automobile. During 2018, Karane was very successful (and had no §179 limitations) and decided to acquire more assets in 2019 to increase its production capacity. These are the assets acquired during 2019: Asset Computers & Info. System Luxury Auto† Assembly Equipment Storage Building † Cost $400,000 80,000 1,200,000 700,000 Date Place in Service 03/31/2019 05/26/2019 08/15/2019 11/13/2019 Used 100% for business purposes. Karane generated taxable income in 2019 of $1,732,500 for purposes of computing the §179 expense limitation. Required a. Compute the maximum 2018 depreciation deductions including §179 expense (ignoring bonus depreciation). b. Compute the maximum 2019 depreciation deductions including §179 expense (ignoring bonus depreciation). c. Compute the maximum 2019 depreciation deductions, including §179 expense, but now assume that Karane would like to take bonus depreciation. d. Now assume that during 2019, Karane decides to buy a competitor’s assets for a purchase price of $1,350,000. Compute the maximum 2019 cost recovery, including §179 expense and bonus depreciation. Karane purchased the following assets for the lump-sum purchase price. Asset Inventory Office furniture Machinery Patent Goodwill Cost $220,000 230,000 250,000 198,000 2,000 Date Placed in Service 09/15/2019 09/15/2019 09/15/2019 09/15/2019 09/15/2019 Copyright © 2020 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education. 54 Solutions Manual –Taxation of Business Entities, by Spilker et al. Building Land 430,000 20,000 09/15/2019 09/15/2019 e. Complete Part I of Form 4562 for part (b) (use the most current form available). a) The 2018 depreciation deduction is $1,109,459. Description Cost §179 Expense MACRS Basis Current MACRS Depreciation Total Depreciation Deduction Office furniture 150,000 – 150,000 $ $ 1,560,000 1,000,000 560,000 80,024 1,080,024 40,000 – 40,000 8,000 8,000 1,750,000 1,000,000 750,000 Machinery Delivery truck Totals 21,435 21,435 109,459 $ 1,109,459 MACRS Basis Current MACRS Depreciation Total Depreciation Deduction b) The 2019 depreciation deduction is $1,324,648. Description Sec. 179 Expense Cost 2018 Assets Office furniture Machinery Used delivery truck 150,000 1,560,000 40,000 – 150,000 560,000 40,000 36,735 137,144 12,800 36,735 137,144 12,800 2019 Assets Computers & Info. System Luxury Auto 400,000 – 400,000 80,000 80,000 80,000 – Assembly Equipment 1,200,000 80,000 180,000 10,000 25,722 10,000 1,045,722 700,000 1,020,000 – 700,000 2,247 2,247 4,130,000 1,020,000 2,110,000 304,648 $1,324,648 Storage Building Totals c) The 2019 depreciation deduction is $1,806,926. §179 Expense Description Cost 2018 Assets Office Furniture Machinery Used Delivery Truck 150,000 1,560,000 – 40,000 – Bonus Current MACRS Depreciation Total Depreciation Deduction 150,000 560,000 36,735 137,144 36,735 137,144 40,000 12,800 12,800 MACRS Basis Copyright © 2020 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education. 55 Solutions Manual –Taxation of Business Entities, by Spilker et al. 2019 Assets Computers & Info. System Luxury Auto Assembly Equipment Storage Building Totals 400,000 – 400,000 – – 400,000 80,000 – 8,000 72,000 10,000 18,000 1,200,000 1,020,000 180,000 – – 1,200,000 700,000 – – 700,000 2,247 2,247 4,130,000 1,020,000 588,000 1,522,000 198,926 $ 1,806,926 Current MACRS Depreciation Total Depreciation Deduction d) 2019 cost recovery is $2,294,591. Description Cost §179 Expense Bonus MACRS Basis 2018 Assets Office Furniture Machinery 150,000 – 150,000 36,735 36,735 1,560,000 – 560,000 137,144 137,144 40,000 – 40,000 12,800 12,800 Computers & Info. System Luxury Auto 400,000 – 400,000 – – 400,000 80,000 – 8,000 72,000 10,000 18,000 Assembly Equipment Storage Building 1,200,000 1,020,000 180,000 700,000 – Inventory Office Furniture Machinery 220,000 Used Delivery Truck 2019 Assets – 1,200,000 – 700,000 2,247 2,247 – n/a – – – 230,000 – 230,000 – – 230,000 250,000 – 250,000 – – 250,000 Patent 198,000 – – 198,000 4,400 4,400 Goodwill 2,000 – – 2,000 44 44 Building 430,000 – – 430,000 3,221 3,221 Land 20,000 – – n/a – – Totals $ 5,480,000 $1,020,000 $1,068,000 $2,152,000 $ 206,591 $ 2,294,591 Copyright © 2020 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education. 56 Solutions Manual –Taxation of Business Entities, by Spilker et al. e) Complete Part I of Form 4562 for part b. Copyright © 2020 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education. 57 Solutions Manual –Taxation of Business Entities, by Spilker et al. 77. While completing undergraduate school work in information systems, Dallin Bourne and Michael Banks decided to start a technology support company called eSys Answers. During year 1, they bought the following assets and incurred the following start-up fees: Copyright © 2020 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education. 58 Solutions Manual –Taxation of Business Entities, by Spilker et al. Year 1 Assets Computers (5-year) Office equipment (7-year) Furniture (7-year) Start-up costs Purchase Date October 30, Y1 October 30, Y1 October 30, Y1 October 30, Y1 Basis $15,000 $10,000 $3,000 $17,000 In April of year 2, they decided to purchase a customer list from a company providing virtually the same services, started by fellow information systems students preparing to graduate. The customer list cost $10,000 and the sale was completed on April 30th. During their summer break, Dallin and Michael passed on internship opportunities in an attempt to really grow their business into something they could do full-time after graduation. In the summer, they purchased a small van (for transportation, not considered a luxury auto) and a pinball machine (to help attract new employees). They bought the van on June 15, Y2 for $15,000 and spent $3,000 getting it ready to put into service. The pinball machine cost $4,000 and was placed in service on July 1, Y2. Year 2 Assets Van Pinball Machine (7-year) Customer List Purchase Date June 15, Y2 July 1, Y2 April 30, Y2 Basis $18,000 $4,000 $10,000 Assume that eSys Answers does not claim any §179 expense or bonus depreciation. a. What are the maximum cost recovery deductions for eSys Answers for Y1 and Y2? b. Complete eSys Answers’ Form 4562 for Y1 (use the most current form available). c. What is eSys Answers’ basis in each of its assets at the end of Y2? a. eSys Answers’ Y1 cost recovery deductions are $6,414, including the expensing of the start-up costs. eSys Answers’ Y2 cost recovery deductions are $14,754. Y1 Cost Recovery Asset Computer Equipment Office Equipment Furniture Start-up costs Original Basis Remaining Expense Basis $15,000 $10,000 $3,000 $17,000 $5,000 Quarter Rate $15,000 $10,000 $3,000 4th 4th 4th $12,000 N/A 5.00% 3.57% 3.57% See below Cost Recovery Expense Copyright © 2020 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education. $750 $357 $107 $200 59 Solutions Manual –Taxation of Business Entities, by Spilker et al. Start-up immediate expense Total Cost Recovery Expense Description (1) Maximum immediate expense (2) Total start-up costs (3) Phase-out threshold $5,000 $6,414 Start-up costs Y1 Amount Explanation $5,000 §195 $17,000 Given in problem 50,000 §195 (4) Immediate expense phase-out (5) Allowable immediate expense (6) Remaining start-up costs (7) Recovery period in months (8) Monthly straight-line amortization (2) – (3); not less than $0 (1) – (4) (2) – (5) 15 years §195 (6) / (7) October through x 3 December $0 $5,000 $12,000 180 66.67 (9) eSys’ business months during year 1 Year 1 straight-line amortization for startup costs $200 (8) x (9) Y2 Cost Recovery Asset Computer Equipment Office Equipment Furniture Original Basis Expense $15,000 $10,000 $3,000 Start-up costs Delivery van Pinball machine $17,000 $18,000 $4,000 Customer List $10,000 Remaining Basis $15,000 $10,000 $3,000 $5,000 $12,000 Quarter Rate th 4 38.00% 4th 27.55% 4th 27.55% $66.67 N/A x 12 HY 20.00% HY 14.29% See N/A below Total Cost Recovery Expense Description (1) Customer list (§197 intangible) (2) Recovery period in months (3) Monthly straight-line amortization (4) April through December Year 1 straight-line amortization for customer list Cost Recovery Expense $5,700 $2,755 $827 $800 $3,600 $572 $500 $14,754 Amount Explanation $10,000 180 §197(a) 55.56 (1) / (2) x 9 $500 (3) x (4) b. eSys Answers’ Form 4562 is as follows: Copyright © 2020 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education. 60 Solutions Manual –Taxation of Business Entities, by Spilker et al. Copyright © 2020 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education. 61 Solutions Manual –Taxation of Business Entities, by Spilker et al. c. eSys Answers’ basis is as follows: Adjusted Basis Expense Year 1 Cost Recovery $15,000 10,000 3,000 17,000 18,000 4,000 10,000 $5,000 $750 357 107 200 $77,000 $5,000 Asset Original Basis Computer Equipment Office Equipment Furniture Start-up costs Delivery van Pinball machine Customer List Totals Year 2 Cost Recovery Y2 Ending Basis _______ $5,700 2,755 827 800 3,600 572 500 $8,550 6,888 2,066 11,000 14,400 3,428 9,500 $1,414 $14,754 $55,832 78. Diamond Mountain was originally thought to be one of the few places in North America to contain diamonds, so Diamond Mountain Inc. (DM) purchased the land for $1,000,000. Later, DM discovered that the only diamonds on the mountain had been planted there and the land was worthless for mining. DM engineers discovered a new survey technology and discovered a silver deposit estimated at 5,000 pounds on Diamond Mountain. DM immediately bought new drilling equipment and began mining the silver. In years 1-3 following the opening of the mine, DM had net (gross) income of $200,000 ($700,000), $400,000 ($1,100,000), and $600,000 ($1,450,000), respectively. Mining amounts for each year were as follows: 750 pounds (year 1), 1,450 pounds (year 2), and 1,800 pounds (year 3). At the end of year 2, engineers used the new technology (which had been improving over time) and estimated there was still an estimated 6,000 pounds of silver deposits. DM also began a research and experimentation project with the hopes of gaining a patent for its new survey technology. Diamond Mountain Inc. chooses to capitalize Copyright © 2020 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education. 62 Solutions Manual –Taxation of Business Entities, by Spilker et al. research and experimentation expenditures and amortize the costs over 60 months or until it obtains a patent on its technology. In March of year 1, DM spent $95,000 on research and experimentation. DM spent another $75,000 in February of year 2 for research and experimentation. DM realizes benefits from the research and experimentation expenditures when the costs are incurred. In September of year 2, DM paid $20,000 of legal fees and was granted the patent in October of year 2 (the entire process of obtaining a patent was unusually fast). The patent’s life is 20 years. Answer the following questions regarding DM’s activities (assume that DM tries to maximize its deductions if given a choice). a. What is DM’s depletion expense for years 1 – 3? b. What is DM’s research and experimentation amortization for years 1 and 2? c. What is DM’s basis in its patent and what is its amortization for the patent in year 2? a. DM’s depletion expense is as follows, actual cost and percentage depletion are shown below: Actual Depletion Original basis Year 1 depletion (cost depletion) Year 1 Ending basis Year 2 depletion (cost depletion) Year 2 Ending basis Year 3 depletion (percentage depletion) Year 3 Ending basis $ 1,000,000 (150,000) 850,000 (165,431) 684,569 (217,500) 467,069 Cost Depletion Method Year 1 Beginning basis Estimated pounds of silver in mine at beginning of year Basis depletion per pound Pounds of silver mined in year Year depletion Basis at end of year Year 1 $1,000,000 Year 2 $850,000 Year 3 $684,569 5,000 $ 200 750 $150,000 $ 850,000 7,450 $ 114.09 1,450 $165,431 $ 684,569 6,000 $114.09 1,800 $205,362 $ 479,207 Year 1 $ 200,000 $ 700,000 15% Year 2 $ 400,000 $1,100,000 15% Year 3 $ 600,000 $ 1,450,000 15% Percentage Depletion Method Net income Gross income Percentage Copyright © 2020 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education. 63 Solutions Manual –Taxation of Business Entities, by Spilker et al. Percentage depletion expense before limit 50% of net income limitation Allowable percentage depletion $ 105,000 $ 165,000 $ 217,500 $ $ 100,000 100,000 $ 200,000 $ 165,000 $ $ 300,000 217,500 b. DM’s research and experimentation amortization for years 1 and 2 are as follows: Description Year 1 Year 2 Amount Amount Research and experimental expenses $95,000 $75,000 Recovery period in months 60 60 Monthly straight-line amortization $1,583.33 $1,250 DM’s business months during year 1 10 0 Year 1 straight-line amortization $15,833 $ DM’s business months during year 2 before the 9 8 patent is issued Year 2 straight-line amortization $14,250 $10,000 Accumulated amortization through September of year 2 Unamortized Research and experimentation $30,083 $10,000 $64,917 $65,000 $129,917 c. DM’s basis in its patent and amortization for patent in year 2 are as follows: Description Amount Unamortized research and experimental expenses $129,917 Legal expenses related to patent $20,000 Amortizable expenses for patent $149,917 Recovery period in months 240 Monthly straight-line amortization 624.65 DM’s business months from October through December 3 Year 2 straight-line amortization for patent $1,874 Copyright © 2020 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education. 64