Taxation for Decision Makers, 2012 Edition

chapter 6

Property Acquisitions And Cost Recovery Deductions

CHAPTER OUTLINE

Setting the Stage—An Introductory Case

Capital Expenditures

Basis of Property

Cash Flow and After-Tax Cost

MACRS

Provisions Limiting Depreciation

Depletion

Amortization

Revisiting the Introductory Case

Summary

Key Terms

Test Yourself

Problem Assignments

Answers to Test Yourself

The cost of a long-lived asset is usually recovered over the accounting periods in which it produces income through depreciation (for most tangible property), depletion (for natural resources), or amortization (for intangible assets). The method and timing of the cost recovery deductions used for tax reporting affect the after-tax cost of the asset. The earlier a taxpayer can recover the cost of an asset through depreciation deductions, the greater the present value of the tax savings and the lower the net after-tax cost of the asset.

The choice of method and useful life for cost recovery are restricted for tax purposes. The current Modified Accelerated Cost Recovery System (MACRS) dictates the recovery life and the averaging convention and restricts the choice of method to a predetermined accelerated method or an alternative straight-line method.

There are significant limits on tax depreciation deductions for certain assets that are often used for both business and personal purposes, such as automobiles and computers. Incentive tax provisions, including Section 179 expensing and bonus depreciation, encourage investment in long-lived ...