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Text File | 1996-11-06 | 11KB | 231 lines

@083 CHAP 9

        ┌───────────────────────────────────────────────┐
        │      DEPRECIATING ASSETS FOR TAX PURPOSES     │
        └───────────────────────────────────────────────┘

The Tax Reform Act of 1986 put an end to the highly favorable
"ACRS" (Asset Cost Recovery System) rules that had been
enacted in 1981. Since January 1, 1987, taxpayers have had to
learn a whole new, and more complex system of depreciation.
Before then, virtually all assets a typical small business
acquired were written off over 5 years, a few, like cars,
over 3 years, and real estate over 19 years (or 15 or 18
years if acquired before May 9, 1985).  You must still use
the ACRS tables on assets placed in service between 1981 and
1986, in general, however.

        ┌───────────────────────────────────────────────┐
        │THE "MACRS" (MODIFIED ACCELERATED COST RECOVERY│
        │        SYSTEM) DEPRECIATION SYSTEM            │
        └───────────────────────────────────────────────┘

Under the MACRS depreciation system, most assets are now
assigned to 3-, 5-, 7-, 10-, 15- or 20-year recovery period
categories, except for real estate, which is depreciated
over 31.5 years, or 39 years if placed in service after May
12, 1993.  Residential rental property is depreciated over
a period of 27.5 years.  Under the MACRS system, all personal
property in the 3-, 5-, 7-, and 10-year categories is
depreciated using the old 200% declining balance method of
depreciation from pre-1981 days, and 15- and 20-year property
is depreciated under the 150% declining balance method.  Real
estate may now only be depreciated on a straight-line basis.

Assets other than real estate are mostly assigned to the
various recovery periods based on the old Asset Depreciation
Range ("ADR") system "midpoint class lives" that were
published by the IRS back in the early 1970s.  The "class
life" guidelines vary from industry to industry and are
quite numerous and technical.  For the most part, you will
need to rely on your tax adviser to tell you what recovery
period applies to various depreciable assets you purchase
in your business. However, the MACRS system does specifically
assign some types of assets to recovery classes, such as
autos and light trucks, which are now 5-year property (they
were 3-year property under the former ACRS rules).  Most of
the "information-handling equipment" (other than computers)
used in an office, such as calculators, typewriters, etc.,
are 5-year property, and computers and peripherals are
generally 7-year property.

Generally, under MACRS, a half-year of depreciation can be
taken in the year an asset is first placed in service,
regardless of whether it is put in service on the first day
of the tax year or the last day (except for real estate).
However, when more than 40% of such property is put in
service in the last 3 months of the tax year, you are
instead required to use a "mid-quarter" convention, which
assumes that all the assets placed in service in each
calendar quarter were placed in service at the midpoint of
such quarter.

Under recent final MACRS tax regulations [Regs. Section
1.168(d)-1(b)()(ii) ], no depreciation is allowed at all
for property that is acquired and disposed of in the same
taxable year, regardless of which convention applies.  As
such, such assets are ignored in determining whether the
40% limit has been exceeded and thus whether the mid-quarter
convention applies to other assets acquired during the year.

For real property, all real property that is placed in
service in a particular month is assumed to have been
placed in service at the mid-point of that month.

        ┌───────────────────────────────────────────────┐
        │   DEPRECIATION LIMITS FOR LUXURY AUTOMOBILES  │
        └───────────────────────────────────────────────┘

Limits are placed on the amount of depreciation that can
be taken each year on so-called "luxury automobiles" used
in a business.  In effect, if you buy an auto for business
use (other than for hauling, or carrying passengers for
hire), you are limited to the following maximum annual
depreciation deductions for cars placed in service in 1994,
1995 and 1996 (1996 limits remain the same as for 1995):

                               1994           1995-96
                              ------          -------

       1st Year               $2,960          $3,060
       2nd Year               $4,700          $4,900
       3rd Year               $2,850          $2,950
       Each Subsequent Year*  $1,675          $1,775

(* Until the entire cost is written off.  This could take
   several decades for a Rolls-Royce.)

The above amounts assume the car is used 100% for business.
If you use it for business, e.g., only 80% of the time, then
your maximum deduction would be 80% of the above numbers.

Similar treatment is given to leases, based on the value of
the car, except that you must include certain "phantom"
income on your return from the IRS "inclusion amount" tables,
for cars with above a certain value.  Thus, a taxpayer who
leases a car for business deducts the full amount of the
lease payments, but then must add back to taxable income an
"inclusion" amount for "luxury automobiles" that increases
with the value of the auto in question (without regard to
the amount of the lease payments).

Both the above annual limits on auto depreciation and the
leased car "inclusion tables" kick in at price levels that
you or most ordinary citizens definitely would not consider
"luxury car" prices.  Congressmen apparently have a very
different idea than most of us as to what constitutes a
luxury automobile.  (But then, if one is accustomed to being
driven around in big, black chauffeured limousines, paid for
by the taxpayers, how could one be expected to know how much
a "luxury car" costs?)

Taxpayers who do not wish to deal with the complexity of
keeping track of automobile expenses and computing annual
depreciation deductions for an auto used wholly or partly
for business purposes may instead to elect to merely keep
track of business miles driven, and deduct a flat 31 cents
per business mile (in 1996 -- or 30 cents a mile for 1995).
In some cases, this may even yield a larger deduction, for
a lower-priced, gasoline-efficient automobile.

        ┌───────────────────────────────────────────────┐
        │EXPENSING OF EQUIPMENT IN THE YEAR OF PURCHASE │
        └───────────────────────────────────────────────┘

Small businesses are allowed to expense up to $17,500 a
year of equipment, in the year of purchase, rather than
depreciating it.  Thus, for example, if you buy a $5,000
computer in your small business, you can "expense" its
entire cost in the year of purchase, rather than slowly
depreciating it over a 7-year period.  This would ordinarily
improve your cash flow, by giving you a full $5,000 tax
deduction right now, rather than a few hundred dollars a
year over 7 years.

This benefit phases out dollar for dollar if you acquire
more than $200,000 of eligible property during the tax
year.  If your business acquires $217,500 or more of such
eligible assets in one year, it won't be able to elect to
expense ANY of it.  Thus, a business that acquires a large
amount of depreciable personal property each year is not
able to take advantage of this tax break (but is still able
to depreciate it).  Eligible property is generally tangible
personal property that would have qualified for the investment
tax credit under prior law.  Note that this expensing
election is not allowed if it would create a loss for the
taxpayer -- it is only allowable to the extent the taxpayer
has taxable income.

NOTE:  The $17,500 limit on the expensing deduction will
increase over a period of years to a $25,000 limit, under
new 1996 legislation signed into law on August 20, 1996.

        ┌───────────────────────────────────────────────┐
        │       AMORTIZATION OF INTANGIBLE ASSETS       │
        └───────────────────────────────────────────────┘

For all practical purposes, "amortization" is essentially
another way of saying "depreciation," except that amortization
implies that the cost of an item is written off in equal
amounts over a period of years or months.  This is really the
same as "straight-line" depreciation.  (Other depreciation
methods, such as 200% declining balance, allow a bigger
percentage write-off in the initial years after an asset is
purchased.)  Accountants like to use the term "depreciation"
when referring to the write-off of TANGIBLE assets and
"amortization" when referring to the write-off of INTANGIBLE
assets.

The Revenue Reconciliation Act of 1993 now provides for
the amortization, generally over 15 years, of most kinds
of INtangible assets, many of which, like "goodwill" value
in the purchase of a business, were not depreciable or
amortizable at all before the new law was enacted, on August
10, 1993.  (And you can even elect to apply the new law
retroactively to all intangible property acquired after July
25, 1991).  Certain kinds of intangible property can be
amortized over periods shorter than 15 years, like most
computer software (36 months under the new law), but certain
kinds of intangibles, like sports franchises or certain
"self-created" intangibles, are not amortizable at all.

@CODE: CA

        ┌───────────────────────────────────────────────┐
        │      CALIFORNIA DEPRECIATION DIFFERENCES      │
        └───────────────────────────────────────────────┘

Over the years since the ACRS depreciation system came into
being for federal tax purposes, one of the most important
differences between federal and California tax law has been
with regard to depreciation.  However, in 1987 and 1988,
California finally enacted legislation to allow unincorporated
businesses and S corporations to use the new MACRS depreciation
for state income tax purposes.  Even so, regular corporations
subject to tax in California are still prohibited from using
either the ACRS or MACRS depreciation systems for state tax
purposes (most regular corporations are subject to the
California franchise tax, rather than income tax, on their
income).  Regular ("C") corporations still must use the old
pre-1981 methods that were used for both federal and
California purposes before 1981, unless ACRS or MACRS
deductions are considered "a reasonable allowance."

Also, while 1993 federal legislation increased the first-year
depreciation write-off for machinery, equipment and other
depreciable personal property from $10,000 to $17,500, no
such increase was adopted for California individual taxpayers.
Indeed, for corporations, California never even conformed to
the $10,000 write-off, but still retains the old federal
provision from many years ago allowing only "bonus
depreciation" in the first year of 20% or $2,000 of the cost
of eligible depreciable assets.

One benefit of California's failure to conform to federal
depreciation changes, however, is that (non-corporate)
taxpayers in California can still write off non-residential
real property over 31 1/2 years, rather than the 39 year
period now required under federal law.

@CODE:EN