Property Acquisition and Cost Recovery
1. [LO 1] Explain the reasoning 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 assets during a purchase (e.g. goodwill). Each of these has an expected useful life of more than one year.
|Asset Type |Examples | |Personal property |Automobiles, 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 Resources |Commodities 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 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 property |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. | |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...
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