SOLUTIONS MANUAL - Copyright © 2018 McGraw-Hill Education. All ri...

Solutions Manual – McGraw-Hill’s Taxation, by Spilker et al.Copyright © 2018 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.Chapter 2 Property Acquisition and Cost Recovery

SOLUTIONS MANUAL

Discussion Questions 1.[LO 1] Explain why the tax laws require the cost of certain assets to be capitalized and recovered over time rather than immediately expensed.Assets with an expected life of more than one year must be 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 Examples Personal propertyAutomobiles, equipment, furniture, and machinery Real property Land and items attached to land such as buildings (warehouse, office building, and residential dwellings) Intangibles Start-up and organizational costs, copyrights, patents, covenants not to compete and goodwill Natural ResourcesCommodities such as oil, coal, copper, timber, and gold 3.[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).

There are three types of cost recovery: depreciation, amortization, and

depletion. Each is similar in that they recover the cost basis of long-lived Taxation of Business Entities 2018 Edition 9th Edition Spilker Solutions Manual Visit TestBankDeal.com to get complete for all chapters

Solutions Manual – McGraw-Hill’s Taxation, by Spilker et al.Copyright © 2018 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.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 Cost Recovery Type, Characteristics Personal propertyMACRS 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.Real property MACRS depreciation, characterized by straight-line method, mid-month convention, and longer recovery periods.Intangibles Amortization, characterized by straight-line method, full-month convention, various recovery periods (usually not based on actual life) depending on intangible type.Natural ResourcesDepletion (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.

4.[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 nontaxable exchange, gift, and inheritance.The basis of purchased assets is historical cost. The basis rules for other acquisitions depend on whether the transaction was taxable or not. For

Solutions Manual – McGraw-Hill’s Taxation, by Spilker et al.Copyright © 2018 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.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 Basis Rules Purchase The initial basis is historical cost plus all costs incurred to get the asset to its destination and in working order.Conversion from personal use 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.Non-taxable exchange 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).GiftThe 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.Inheritance 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.

6.[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 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

Solutions Manual – McGraw-Hill’s Taxation, by Spilker et al.Copyright © 2018 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.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 expense. 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 expense 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 half- year 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% 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 expense 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 expense. As a result, taxpayers are better off taking the depreciation expense even if it creates a net operating loss or is taxed at a relatively low marginal tax rate.

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 expense over the same recovery period.Nevertheless, profitable taxpayers will elect to use the 200% DB method because it minimizes the after-tax cost of the asset by maximizing the present value of the depreciation expenses—through accelerating the depreciation expenses. 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