9
Capital Recovery: Depreciation Amortization and Depletion
Solutions to Cumulative Problems
9-43 Below are the calculations to compute the taxable income of David and Lauren
Hammack.
Note: This return is completed for 2011. For this purpose, the special reduction in
social security taxes in 2011 is taken in to account in computing self-employment
taxes so the rate is 13.3%. In addition, the mileage rate for the entire year was
assumed to be 51 cents per mile in 2011.
Income
Salary—David $60,000
Salary—Lauren’s teaching 5,400
Interest
Although a 1099-INT for interest of $30 on the AT&T bond was received, this
entire amount is not treated as interest. The amount that had accrued to date of
purchase, $25 ($1,000 × 6% × 5/12), is considered part of the purchase price.
Thus when the $30 payment is received, $25 represents a nontaxable return of
capital and the other $5 is taxable interest income. 5
Interest related to the Treasury Bill is reported in the year the instrument is
redeemed.
Schedule C: Lauren’s clothing business
Sales $120,000
Cost of goods sold (50,000)
Gross profit $ 70,000
Advertising expense (6,000)
Insurance
No deduction for car insurance premium of $200 because the automatic
mileage method is used.
The entire $1,200 prepayment of fire insurance is deductible even though she
is on the cash basis because she is contractually obligated to pay the expense
and the coverage does not extend beyond the close of the next tax year. (1,200)
Rent
Same explanation as fire insurance above (9,000)
Wages (15,000)
Employment taxes (2,000)
Car expense
Only the car expense relating to the clothing business is reported on this
schedule (20,000 × $0.51 for 2011). The remaining car expense is reported as
an employee business expense on Schedule 2106. (10,200)
Travel expenses to Paris
Since more than 25 percent of the time is spent on business, the entire $500 travel
expense is deductible and six days of meals, $90 ($30 × 6 × 50%), and lodging,
$600 ($100 × 6), as well. (1,190)
Net income and self-employment income $25,410
One-half of self-employment tax (in 2011 the deduction is computed using 15.3%
and not 13.3%)
[($25,410 × 92.35% = $23,466) × 15.3% = $3,590] × ½ (1,795)
A.G.I. $89,020
Deductions:
Schedule A: Itemized deductions
State income taxes $ 5,500
County income taxes 500
Real estate taxes 2,400
Mortgage interest on their home 3,600
Charitable contributions 2,000
Miscellaneous:
Form 2106, Lauren (mileage) (see below) $408
Form 2106, David (see below) 3,636
Total $4,044
Less: 2% floor (2% × $89,020) (1,780)
2,264
Total itemized deductions $16,264
Adjusted gross income $89,020
Itemized deductions (16,264)
Personal and dependent exemptions (3 × $3,700 in 2011) (11,100)
Taxable income $61,656
Tax on taxable income using tax table $ 8,401
Child tax credit (1,000)
Income tax after credits $ 7,401
Self-employment tax 3,121
Total taxes $10,522
Schedule 2106: Lauren
Transportation
Lauren may deduct transportation expenses of driving from one job to another. Here,
she may deduct the cost of the lesser of the mileage from home to work (10 miles)
or from the first job to the second job (16 miles) The deduction is $408 [(80 trips ×
10 miles = 800) × $0.51 in 2011)] and is subject to the 2% floor on miscellaneous
itemized deductions.
Schedule 2106: David
Automobile:
Original cost $ 30,000
Business use × 60%
Depreciable basis $ 18, 000
Less: Portion elected to expense (0)
Unadjusted basis for recovery $ 18, 000
Recovery percentage for five-year property × 20%
Depreciation deduction before limitation $ 3,600
Section 280F limitation in 2011 (ignore bonus depreciation) $ 3,060
Business use × 60%
Limitation on depreciation $1,836
Depreciation deduction $1,836
Total operating expenses $ 3,000
Business use × 60%
Business operating expenses 1,800
Total automobile expense $3,636
Other items
The employer of Lauren Hammack withheld more social security than was
required ($429 instead of $413). The taxpayer must ask the employer for a
refund of the excess. The amount cannot be claimed as a credit on the tax
return.
• Medical insurance premiums of $750 paid by corporation are excluded.
• Life insurance proceeds of $40,000 are excluded.
• Specific bequest of stock of $30,000 is excluded.
• Redemption of Treasury Bill: the difference between the purchase price
and redemption value is considered interest and is reported when the
instrument is redeemed, not as it accrues.
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9-44 The computations for the 2011 tax return of Michelle Kay appear below. (Note
that the self-employment tax is computed at the temporary 13.3% rate for 2011
and 2012.)
Form 1040 Computations
Gross income:
Alimony received $ 15,000
Business income (loss) from Schedule C 21,347
Subtotal $ 36,347
Adjustments to income:
IRA deduction $ 2,000
Self-employed health insurance: $1,000 × 100% 1,000
One-half of self-employment tax (½ × ($21,347 × 92.35% × 15.3% (rather than 13.3%) =
$3,016)) 1,508 (4,508)
Adjusted gross income $ 31,839
Less: Greater of itemized deductions or standard deduction:
Itemized deductions from Schedule A $15,500
Standard deduction (2011) 8,500 (15,500)
Personal and dependency exemptions: 1 × $3,700 (2011) (3,700)
Taxable income $ 12,639
Regular income tax liability before credits* $ 1,286
Less: Retirement savings credit (200)
Regular income tax liability after credits (zero or greater) $ 1,086
Other taxes:
Self-employment tax from Schedule SE 2,622
Total tax $ 3,708
Less: Prepayments (16,000)
Balance due (refund) $(12,292)
*Note regarding filing status: Ms. Kay files as head of household. She is
unmarried and provides over half the cost of the home in which she and her
son live. The son is not required to be her dependent for head-of-household
purposes. However, Ms. Kay does not qualify for the child credit because the
child must be a dependent and the dependent exemption was not surrendered
by the custodial parent. Ms. Kay is entitled to a retirement credit due to her
contribution to an individual retirement account. The amount of the credit is a
function of the taxpayer’s income.
Schedule A Computations Itemized Deductions
Taxes:
Real estate $ 2,000
State income taxes3,500
County income taxes 1,500 $ 7,000
Interest
Deductible home mortgage interest 5,600
Gifts to charity 2,900
Total itemized deductions $15,500
Gross receipts $950,000
Cost of goods sold 625,000
Gross margin $325,000
Operating expenses:
Advertising $ 25,000
Depreciation from Form 4562 80,583
(see discrepancy below)
Insurance 3,000
Interest 60,000
Legal services 20,000
Meals and entertainment
Gross amount $ 2,500
Less 50% (1,250) 1,250
Real estate taxes 4,000
Wages for employees 100,000
Payroll taxes per schedule (below) 9,820
Total operating expenses $303,676
Net profit or loss $ 21,347
Supporting Schedule for Payroll Taxes on Schedule C
Annual Earnings FUTA at 6.2% ($434 Maximum) FICA at
7.65% Payroll Tax
Employee #1 $ 20,000 $ 434 $1,530 $1,964
Employee #2 20,000 434 1,530 1,964
Employee #3 20,000 434 1,530 1,964
Employee #4 20,000 434 1,530 1,964
Employee #5 20,000 434 1,530 1,964
Total $100,000 $2,170 $7,650 $9,820
Schedule SE Computations Social Security Self-Employment Tax
Net earnings from self-employment before special deduction $21,347
Less:
Self-employed health insurance (not deducted on Schedule C but on Form 1040 Line 29;
not deductible in computing self-employment income in 2011) (—)
Subtotal $21,347
Portion subject to self-employment tax × 92.35%
Subtotal $19,714
Self-employment tax rate (after 2 percentage point reduction for 2011) × 13.3%
Self-employment tax $ 2,622
Form 4562 Computations: Depreciation and Amortization
Section 179 immediate expensing:
Machinery $30,000
Personal computer* 14,000
Printer* 2,000
Seven-year property:
Office furniture and fixtures 20,000
$66,000
Nonresidential real estate:
Building $650,000 × 2.247%** = 14,583
Total expensing and depreciation $80,583
*Note: The computer and printer are not considered listed property (for
purposes of Form 4562—Depreciation) because they are used exclusively at a
regular business establishment.
**Note: 2.247% is the depreciation rate published by the IRS in Publication
946; however, tax software normally uses 2.24353% which appears to be
correct (1/39 × 10.5/12). In such case, the depreciation would be $14,583 or
$23 less. The solution uses $14,583 the amount derived using the software.
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9
Capital Recovery: Depreciation Amortization and Depletion
Solutions to Tax Research Problems
9-45 Internal Revenue Code § 167 provides as a depreciation deduction a reasonable
allowance for the exhaustion, wear and tear of property used in a trade or
business, or of property held for the production of income. In order to be eligible
for a depreciation deduction, property must have a determinable useful life so that
the cost of the property may be allocated among several periods, as is implied by
Regulation § 1.167(a)-2. The regulation indicates that the allowance for
depreciation does not apply to land, apart from the improvements or physical
developments added to it.
In this case, there is no doubt that S should be allowed a depreciation
deduction for the shopping mall and the office building, as these items are
property held by S, as a land developer, for the production of income. These items
are improvements made to land, which have a determinable useful life, and are
therefore depreciable. A deduction for depreciation allowance will be allowed
under the Modified Accelerated Cost Recovery System (MACRS) according to
Internal Revenue Code §§ 167(a) and 168, since these assets would qualify as
recovery property.
Regarding the landscaping costs, it is questionable whether these items are
eligible for a depreciation deduction. The earlier U.S. Tax Court decisions held
that landscaping items were nondepreciable, because they were inextricably
associated with the land and therefore had an indeterminable useful life, as
opposed to other improvements on the land. See Algernon Blair, Inc., 29 T.C.
1205 (1958). However, the Tax Court altered its position in Alabama-Georgia
Syrup Co., 36 T.C. 747 (1961), reversed on other grounds, 1963-1 USTC ¶9124,
10 AFTR2d 6136, 311 F.2d 640 (1963), where it held that shrubbery and trees
planted next to a recreation lodge were depreciable assets.
The Commissioner later ruled that landscaping, including shrubbery and trees
placed close to a building, were depreciable over the life of the building, basing
this decision on the rationale that these shrubbery and trees would have to be
destroyed with the building at the end of its useful life. The Commissioner
disallowed a depreciation allowance for trees and shrubbery planted far enough
from the building that they would not have to be destroyed with the building at
the end of its useful life; see Revenue Ruling 74-265, 1974-1 C.B. 56. According
to this latter ruling, S could deduct a depreciation allowance for the trees, gardens,
and shrubbery close to those buildings; however, no depreciation allowance could
be deducted for the items planted far enough away from the buildings so that they
would not have to be destroyed if the buildings were removed at the end of their
useful lives. It should be noted that any landscaping items subject to depreciation
would be depreciated under MACRS.
With regard to the art work, which includes the sculpture and the hanging
pictures, S would not be allowed a depreciation deduction. It is generally held that
a useful life for an art work cannot be estimated, and for this reason no
depreciation deduction can be taken for it [see Rev. Rul. 68-232, 1968-1 C.B. 79,
and J. R. Thompson Co., 73-1 USTC ¶9369, 31 AFTR2d 73-1207, 477 F.2d 164
(1973)]. In the latter case the depreciation deduction was denied because the art
works’ decline in value was deemed to be caused by a change in the art market
rather than by a loss in the commercial usefulness of the art. In D. Judge, 35 T.
C.M. 1264 (1976), the court held that although the art works were depreciable
business assets, since they were office decorations instead of pure art, they were
still allowed no depreciation deduction because their useful lives could not be
estimated.
The above decisions indicate that art work is typically not allowed a
depreciation deduction because of the difficulty encountered in assigning it an
estimated useful life. S will not be allowed a depreciation for his hanging pictures
or his sculpture unless he can show that the items are business-property
decorations rather than true art, and establish a useful life for each item. S may
possibly be able to estimate a useful life for the sculpture based on the useful life
of the complex, if it could be shown that the sculpture would have to be destroyed
or would be of no further value when the complex reached the end of its useful
life (and was presumably to be destroyed). S may look to the landscaping items
placed close to the building for an analogy. In any event, S should be prepared to
litigate the issue of the depreciation deduction for the art works, given the position
of the Internal Revenue Service under Revenue Ruling, 68-232, supra. As with
the other items, if a depreciation allowance were to be permitted, the depreciation
would be done under MACRS rules.
9-46 Treasury Regulation § 1.167(a)-3 provides the general rule for depreciation of
intangible assets (i.e., amortization). The regulation states, “If an intangible asset
is known from experience or other factors to be of use in the business or in the
production of income for only a limited period, the length of which can be
estimated with reasonable accuracy, such an intangible asset may be the subject of
a depreciation allowance.” The regulation further states, “An intangible asset, the
useful life of which is not limited, is not subject to the allowance for depreciation.
No allowance will be permitted merely because in the unsupported opinion of the
taxpayer, the intangible asset has a limited useful life.”
A license is clearly considered an intangible asset that may or may not be
subject to a depreciation allowance; see Browning Co., 6 B.T.A. 914 (1927), Dec.
2363 (Acq.).
The issue raised in this case is whether or not a license with a renewal
privilege may be subject to a depreciation allowance. Regulation § 1.167(a)-3
clearly states that an intangible asset with an unlimited life is not subject to a
depreciation allowance. The question then becomes whether the renewal privilege
of the license in this case causes the license to be viewed as having an unlimited
useful life.
The U.S. Court of Appeals for the Fifth Circuit has ruled on this issue, stating
that a liquor license that is renewable has an indeterminable useful life, since the
renewal privilege is of indefinite duration. The court stated that because the
renewal privilege was dependent on the taxpayer’s wishes as well as upon the
license-granting city’s future course of action, there was no rational basis for
prediction as to duration. [See Morris Nachman v. Comm., 51-2 USTC ¶9483, 41
AFTR 172, 191 F.2d 934 (1951)]. The U.S. Tax Court reached a similar
conclusion regarding a liquor license in E. W. Hill, 38 TCM 481, Dec. 26,
979(M), TC Memo, 1964-253. Aff’d on another issue, 66-2 USTC ¶9707, Sec.
79, 103 P-H Memo TC, 367 F.2d 646 (1981).
In this case, which dealt with taxicab licenses, the U.S. Tax Court examined at
great length the factual and legal situation of a taxpayer asserting that a renewable
taxicab license was limited in life due to doubts about the future actions of the
license-granting city. The court dismissed this argument, stating that the taxpayers
did not establish from experience (or any other source) that the license was of
limited useful life; thus, the court disallowed a depreciation allowance for the
license, quoting the pertinent provisions of Regulation § 1.167(a)-3 in the opinion.
(See W. K. Co. v. Comm., 56 T.C. 434 (1971), aff’d in unpublished order by 7th
Cir., 5/21/73.) In making its decision, the court also cited Toledo TV Cable Co.,
55 T.C. 1107 (1971), wherein the U.S. Tax Court held that taxpayers failed to
establish that certain municipal franchises for cable television had determinable
useful lives, and thus disallowed depreciation deductions. The court cited
numerous cases and stated the rule that whether or not a franchise will be renewed
indefinitely is a question of fact to be answered in accordance with the facts
known or reasonably anticipated at the end of the period for which the return is
filed; the court noted that the burden of establishing a useful life is on the
taxpayer and concluded that the taxpayer had not carried such burden. In that case
the court emphasized the importance of foreseeable circumstances that could
adversely affect a renewal privilege, indicating that if a taxpayer could show that
the intangible asset (i.e., here, a franchise) would probably not be renewed, it
would be deemed to have a limited life and be allowed a depreciation deduction.
In the case at hand, there is significant uncertainty over whether the license of
Cabletech will be renewed, the latter being contingent on the city’s satisfaction
with the services provided. Given the current regulations and case authority on
this issue, it appears that Cabletech will not be able to carry a burden of proof to
establish that renewal will not be granted if it bases its assertion only on the
premise that such renewal is contingent on customer satisfaction. This argument
did not carry sufficient weight in W. K. Co., supra; and even when the
environment was shown to be fraught with substantial uncertainties and
negotiations concerning renewal of franchises, the taxpayer did not establish a
reasonable certainty that his franchise would not be renewed and was therefore of
limited life; see Toledo TV Cable Co. supra. Thus, Cabletech will not be able to
show that its license has a limited life that would allow it to be subject to
depreciation under Regulation § 1.167(a)-3, given the factual setting of the
problem.
9
Capital Recovery: Depreciation Amortization and Depletion
Test Bank
True or False
________ 1. All methods of depreciation permitted by the IRS prior to the 1981
introduction of ACRS provided taxpayers the opportunity to manipulate
the depreciation deduction by underestimating the useful lives of their
property.
________ 2. The facts-and-circumstances approach to determining the useful life of
an asset remains permitted under some circumstances.
________ 3. Property used in an income-producing activity that is neither a trade nor
a business may be depreciated.
________ 4. A depreciation deduction may be claimed for a decline in value that
occurred while an item of property was held for personal purposes.
________ 5. Taxpayer N purchased numerous tax texts totaling $1,000 while
obtaining his master’s degree in taxation. This year he began teaching
taxation when the books were valued at $700. Assuming he uses the
texts as references in his profession, he may compute depreciation using
a basis of $1,000.
________ 6. The straight-line method must be used for amortizing intangible property
such as copyrights.
________ 7. During 2004, Y purchased a new warehouse, which he sold on June 10,
2013. In 2013, Y may claim depreciation equal to 6/12 of the MACRS
statutory percentage.
________ 8. All depreciable property is eligible to be depreciated by means of at least
one straight-line method.
________ 9. In computing depreciation using MACRS, a taxpayer who elects to
expense all or a portion of an asset must adjust the basis of the asset.
________ 10. Auto leasing for business purposes yields the same tax advantage as auto
ownership despite the limitations applied to depreciation of automobiles.
________ 11. The use of MACRS is precluded for property placed in service prior to
the enactment of either version of MACRS, unless the property is
transferred in a transaction where both the owner and the user change.
________ 12. Taxpayers may use component depreciation to depreciate the various
components (e.g., plumbing, electrical) of a building under MACRS.
________ 13. A covenant not to compete may be amortized over the period of the
covenant.
________ 14. Sellers prefer allocating a portion of their sales price to goodwill rather
than a covenant not to compete even though a buyer is generally
indifferent.
________ 15. A deduction for percentage depletion is allowed even though the entire
cost of the asset has been recovered (i.e., the basis of the asset is zero).
________ 16. The entire cost of recovery property that constitutes a research and
experimental expenditure (e.g., lab equipment costing $50,000) can be
expensed entirely in the year of acquisition.
________ 17. Expenditures for research and experimentation that are deferred must be
amortized ratably over a period of 17 years.
________ 18. Capitalizing an expenditure for research and experimentation decreases
the basis of the property to which the expense relates.
________ 19. Livestock owned by ranchers and farmers and held for resale may be
depreciated as a capital expenditure.
________ 20. Farmers may deduct expenditures for ponds and drainage ditches rather
than capitalize them.
Multiple Choice
________ 21. Which is not depreciable under the Modified Accelerated Cost Recovery
System (MACRS)?
a. New buildings
b. Used buildings
c. Used machinery
d. Patents
________ 22. Which statement concerning depreciation is not true?
a. Only property that has a determinable life is depreciable.
b. Deductions for depreciation must be claimed for the year when the
depreciation occurred or they will be forfeited.
c. Personal property converted to business use is not depreciable since
it was once used for personal purposes.
d. Land is not depreciable.
________ 23. Which of the following statements is true regarding depreciation and
amortization?
a. Goodwill can be amortized for tax purposes.
b. Property used in a trade or business may be eligible for depreciation
if it has been used previously for personal purposes.
c. Only property used in a trade or business is depreciable.
d. More than one of the above are true.
e. None of the above is true.
________ 24. Which of the following statements is true?
a. Salvage value is not considered for any of the depreciation methods
allowed under MACRS.
b. The taxpayer’s estimate of an asset’s useful life is totally irrelevant in
computing depreciation under MACRS.
c. All methods of depreciation under MACRS reflect a half-year’s
depreciation in the year of acquisition.
d. More than one but less than all of the above statements are true.
e. All of the above are true.
________ 25. MACRS prescribes rates of depreciation determined by three criteria.
What are they?
a. Useful life, property classification, and recovery period
b. Accounting convention, useful life, and property classification
c. Accounting convention, useful life, and recovery period
d. Accounting convention, property classification, and recovery period
________ 26. Which property is depreciable using MACRS?
a. Manufacturing equipment purchased new
b. Automobiles used in a business
c. Apartment building purchased from a previous, unrelated owner
d. Computers used in a business
e. All of the above are depreciable using MACRS.
________ 27. Which statement concerning class life and recovery period is not true?
a. The class life of an asset and its recovery period under the
Alternative Depreciation System (ADS) are generally the same.
b. Except for very short-lived property, the recovery period of an asset
under MACRS is generally less than its class life.
c. A class life has been assigned by the IRS to each asset to which a
recovery period has been assigned.
d. The class life of an asset is constant, regardless of which straight-line
method is used to calculate its depreciation.
________ 28. During the year, Fine Furnishings, a manufacturer of furniture,
purchased the following assets:
Date Asset Cost
February 15 Lathes $ 40,000
March 3 Saws 50,000
October 9 Warehouse 110,000
In computing depreciation of these assets, which of the following
conventions will be used?
a. Half-year, mid-month
b. Mid-quarter, mid-month
c. Half-year, mid-quarter, mid-month
d. Mid-quarter
e. Some combination other than those given above
________ 29. Company G, a calendar year taxpayer, purchased a five-story building on
April 2 of the current year for $1 million. The building, which has no
historical or architectural significance, was constructed in 1946 by the
previous owner, who had fully depreciated it before selling it to
Company G. The first floor is occupied by shops and restaurants, the
other four by apartments. Income will be $50,000 from commercial rents
and $150,000 from residential rents. The deduction for depreciation that
the company may claim for the building is about
a. $0
b. $18,162
c. $19,231
d. $25,104
e. $25,758
________ 30. Personal property is
a. Not depreciable
b. Depreciable using the 150 percent declining-balance and 200 percent
declining-balance methods only
c. Depreciable using the 150 percent declining-balance, 200 percent
declining-balance, and straight-line methods
d. Depreciable using only those methods available for real property
________ 31. Which of the following statements is true regarding the computation of
depreciation under MACRS?
a. A full year of depreciation is never allowed in the year of
acquisition.
b. The averaging conventions ensure that never more than a half-year of
depreciation is allowed with respect to personal property.
c. Straight-line is used in the year of acquisition for five-year property
only if the taxpayer so elects.
d. More than one of the above are true.
e. None of the above is true.
________ 32. On March 27 of the current year, T Inc., a greeting card manufacturer,
placed a new building in service to house its operations. The portion of
the cost allocated to the building was $200,000. T’s maximum
depreciation deduction for the year is
a. $3,970
b. $4,060
c. $3,214
d. $5,128
e. None of the above
________ 33. Placid Places Incorporated, a calendar year taxpayer, purchased an
apartment building on October 1 of the current year for $1,200,000, of
which $200,000 was allocable to the land. The corporation’s depreciation
for the building for the year will be the product of the building’s basis
and
a. 1/27.5 and 2.5/12
b. 1/27.5 and 9.5/12
c. 1/39 and 2..5/12
d. 1/39 and ½
e. 1/39 and 9..5/12
________ 34. Riverview Incorporated, a calendar year taxpayer, purchased an
apartment building on June 1 last year for $1,200,000, of which
$200,000 was allocable to the land. The corporation sold the property on
June 27 of the current year. The corporation’s depreciation for the
building for the current year will be approximately
a. $0
b. $16,665
c. $18,180
d. $36,360
e. None of the above
________ 35. In November of this year, Creative Corn Products, a calendar year
taxpayer, placed in service its only equipment purchased during the year.
The equipment cost $700,000. All of the equipment qualified as five-
year property under MACRS. Ignore bonus depreciation. The maximum
deduction that the taxpayer may claim with respect to the equipment is
a. $35,000
b. $87,500
c. $125,000
d. $240,000
e. $140,000
________ 36. During the year a calendar year taxpayer, Heavenly Hamhocks, a chain
of specialty food shops, purchased equipment as follows:
Date Asset Cost
February 15 Ovens $ 400,000
March 3 Refrigerators 500,000
October 9 Equipment 1,100,000
Assuming the property is all seven-year property, depreciation for the
assets this year would be
a. $71,400
b. $264,270
c. $285,800
d. $500,000
e. None of the above
________ 37. Which statement is not true of straight-line depreciation under MACRS?
a. Each of the three accounting conventions (half-year, mid-month, and
mid-quarter) are eligible for MACRS straight-line depreciation.
b. MACRS straight-line depreciation is required for real property.
c. MACRS straight-line depreciation must be used for either all or none
of the assets of a given class placed in service during a given year.
d. The class life of an asset is used as its recovery period.
________ 38. During the year, R purchased two items of machinery. One item is five–
year property and the other is seven-year property. Which of the
following statements is true regarding his options for depreciation?
a. If R elects to depreciate the five-year property using the straight-line
method alternative, he may adopt any other method under MACRS
for the seven-year property.
b. If R elects the straight-line method alternative for a particular asset,
he must depreciate all other assets placed into service during the year
under the straight-line method.
c. If R elects the straight-line method alternative for the five-year
property, he may still use accelerated MACRS percentages for the
other assets in that property class.
d. None of the above is true.
________ 39. Which of the following statements is true regarding the alternative
depreciation system (ADS)?
a. ADS always must be used in computing depreciation for listed
property not used more than 50 percent for business.
b. Depreciation for real property is the same under ADS and MACRS
because the straight-line method must be used under both systems.
c. ADS is identical to MACRS if the straight-line alternative under
MACRS is elected to depreciate personal property.
d. More than one of the above are true.
e. All of the above are true.
________ 40. During the year, T purchased the items shown below. Indicate which
item qualifies for both § 179 limited expensing and bonus depreciation.
a. A new computer used to monitor his investments
b. A new office building to be used in his business
c. A truck purchased from XYZ Corporation, which had used it in its
sand and gravel business
d. New office furniture for the new office building
e. None of the above
________ 41. In 2012 Kay Smart operates a cosmetic manufacturing business. During
the year, the business placed in service $560,000 of five-year property
eligible for limited expensing under § 179. Ms. Smart wisely elected §
179. The maximum amount that she can expense under § 179 is
a. $0
b. $65,000
c. $125,000
d. $500,000
e. None of the above
________ 42. In 2012, B purchased a crane to be used entirely for business. He spent a
total of $475,000. He decided to use the limited-expensing election.
What is the total depreciable basis for the mini-computer?
a. $500,000
b. $475,000
c. $0
d. $350,000
e. None of the above
________ 43. Which of the following is not considered eligible property for limited
expensing under § 179?
a. Automobile used by a salesman
b. Warehouse purchased by XYZ Corporation to store inventory
c. Computer used by Nick Knight to do the accounting for his video
tape rental business
d. Equipment used by Serendipity Tea Company in its operations
e. All of the above are eligible.
________ 44. In 2012, Ozzie Ostentatious purchased a new Porsche convertible for
$80,000 to be used in his business, Tract Homes Are Us. Ozzie drove the
car 80 percent of the time for business. The maximum amount of the
car’s cost that Ozzie may deduct this year (ignoring bonus depreciation)
is
a. $3,160
b. $1,775
c. $64,000
d. $2,528
e. None of the above
________ 45. S purchased a used automobile to be used in his sole proprietorship. For
the year, S’s business mileage was 20,000 miles, while his personal
mileage was 30,000 miles. S may
a. Claim no depreciation because the car was used predominantly for
personal purposes
b. Elect limited expensing under § 179
c. Deduct a maximum of $3,160 (2012) of depreciation
d. Claim depreciation using the straight-line method
e. More than one of the above statements are true
________ 46. Due to the ceiling on the amount of first-year expensing and depreciation
deductions that may be claimed for automobiles, the basis of a car
a. Is fully recovered in less time than is that of a car costing less
b. Is fully recovered in the same amount of time as that of a car costing
less
c. Is fully recovered in more time than is that of a car costing less
d. Is never fully recovered
________ 47. Certain “listed property” is subject to limitations regarding capital
recovery if it is not used more than 50 percent for business. What
category below is not a kind of listed property?
a. Computer equipment not used exclusively at a regular business
establishment
b. Passenger automobiles
c. Motorcycles
d. Photographic equipment
e. Furniture
________ 48. Taxpayer K purchased a used stereo system for $12,000 in May. K uses
the system 20 hours each week for her business as a music critic, and she
and her family use it 30 hours each week for educational and personal
purposes. How much may K claim in deductions for depreciation and
current expenses associated with the system? (Assume that stereo
equipment has a recovery period of five years, regardless of the
depreciation method employed.)
a. $0 depreciation, $0 expensed
b. $80 depreciation, $4,000 expensed
c. $0 depreciation, $4,800 expensed
d. $480 depreciation, $0 expensed
e. $960 depreciation, $0 expensed
________ 49. What conditions are necessary and sufficient to demonstrate that the use
of personal use property is qualified business use?
I. Use is for the convenience of the employer.
II. Use is for a business or trade.
III. Use is required as a condition of employment.
a. I. only
b. II only
c. III. only
d. I. and II. only
e. I., II. and III.
________ 50. Rapid Reproduction Corporation provides automobiles for all of their
salespersons. Most of the salespersons, including Sam Sell, use their cars
for business as well as personal use. Assuming Sam uses the car 90
percent for business and 10 percent for personal purposes, which of the
following statements best describes the corporation’s treatment of the
car?
a. The corporation can depreciate only 90 percent of the cost of Sam’s
car.
b. The corporation can depreciate 100 percent of the cost of Sam’s car if
Sam includes as income an amount equal to the value of the personal
use.
c. The corporation can depreciate 100 percent of the cost of Sam’s car if
Sam pays the corporation an amount equal to the value of the
personal use that the corporation includes as income and that Sam
may deduct.
d. Assuming Sam owns 30 percent of the Rapid stock, the corporation
can depreciate 100 percent of the cost of the car if Sam includes the
entire value of the car’s use (business and personal) as income.
________ 51. Last year, Taxpayer N purchased a car for $12,000 and used it entirely
for his construction business. Depreciation that year was $2,400. N hired
his son T in February of the current year and allowed him to put the car
to personal use on weekends. The value of T’s personal use of the car
was included as part of his income. If T’s personal use of the car this
year represented 60 percent of its total use, what income and
depreciation expense related to the car should N include on the tax return
for his business?
a. $0 income, $960 depreciation
b. $0 income, $1,920 depreciation
c. $1,200 income, $960 depreciation
d. $1,200 income, $1,920 depreciation
e. $2,400 income, $0 depreciation
________ 52. The keeping of records required for listed property is extensive but not
limitless. What is not required to substantiate the use of listed property?
a. The date of use
b. The amount of each business use
c. The amount of each nonbusiness use
d. The amount of total use
e. The amount of each expenditure related to the property
________ 53. The Bloomingulch Company mines limestone. During the year the
company purchased property south of town for $180,000. Engineers
estimate that 200,000 tons of limestone are recoverable from the
property. Given the following information, compute the company’s
depletion deduction for year two. Assume the depletion rate is 5 percent.
Year Tons Sold Gross Income Taxable Income before
Depletion
One 150,000 $3,000,000 $290,000
Two 45,000 600,000 100,000
a. $30,000
b. $31,500
c. $40,500
d. $50,000
e. None of the above
________ 54. Ageless Oil Corporation is still eligible to use percentage depletion.
During the year its only well produced 6,000 barrels of oil at a cost of $6
per barrel. The corporation subsequently sold all of their production for
$8 per barrel. Assuming that the production and sale of oil represented
all revenues and expenses for the year, the corporation’s deduction for
percentage depletion would be (assume the statutory depletion rate for
oil is 22%)
a. $3,950
b. $10,560
c. $30,000
d. $6,000
e. None of the above
9
Capital Recovery: Depreciation Amortization and Depletion
Solutions to Test Bank
True or False
