Solutions

CHAPTER 8 Depreciation, Cost Recovery, Amortization, and Depletion 8-5

DISCUSSION QUESTIONS

1. If property which is classified as personalty is used in a trade or business or incomeproducing activity, it is subject to cost recovery. Personalty that is held for personal useis not eligible for cost recovery. p. 8-3

2. The basis of the property must be reduced by the amount of cost recovery that shouldhave been deducted (i.e., the cost recovery “allowable”). p. 8-4

3. Land is not eligible for cost recovery. However, improvements to the land such aslandscaping are eligible for cost recovery. pp. 8-6 and 8-9

4. The relevant issues for Henry are:

• Can a portion of the purchase costs of a ski resort, which are allocated to theconstruction costs of the resort’s mountain roads, trails, and slopes, be depreciated?

• If such costs can be depreciated, what is the correct recovery period?

• Can costs incurred subsequent to the purchase, attributable to maintenance of suchmountain roads, trails, and slopes, be depreciated?

pp. 8-5 and 8-9

5. The relevant issues for Pale are:

• What property qualifies for cost recovery?

• Is the property used in Pale’s trade or business?

• What is the cost recovery period for the property?

pp. 8-5 and 8-9

6. The half-year convention must be used for all MACRS personalty except when the mid-quarter convention applies. The mid-quarter convention must be used when more than40% of the value of property, other than real property, is placed in service during the lastquarter of the tax year. pp. 8-8 and 8-9

7. The asset is treated as if it were sold in the middle of the year, and hence, one-half yearof cost recovery is allowed for the year of the sale. p. 8-7 and Concept Summary 8-2

8. Real property does not enter into the 40% test to determine whether the mid-quarterconvention must be used for personalty. In addition, only personalty that is purchased inthe fourth quarter is included in making the 40% determination. p. 8-8

9. The asset is treated as if it were sold in the middle of the quarter, and hence, one-halfquarter of cost recovery is allowed in the quarter of the sale. If the sale is in the firstquarter, the fraction is 0.5/4; in the second quarter 1.5/4; in the third quarter 2.5/4; and inthe fourth quarter 3.5/4. p. 8-9

8-6 2006 Comprehensive Volume/Solutions

10. The relevant tax issues for Jed are:

• Whether the costs associated with the tin added to the original “bath” mixture may bededucted as business expenses or must be capitalized.

• If the costs must be capitalized, what is the period of their cost recovery?

• Whether the costs associated with the additional tin added to the “bath” mixture maybe deducted as business expenses or must be capitalized.

pp. 8-1 to 8-9

11. The MACRS straight-line election may be made on a portion of the assets, but it mustapply to all assets in a particular class. p. 8-10

12. Even if MACRS straight-line is elected, personal property is still subject to the mid-quarter convention if more than 40% of the value of property, other than real property, isplaced in service during the last quarter of the tax year. pp. 8-10, 8-12, and ConceptSummary 8-3

13. An asset used in connection with an individual’s personal investments would not be anasset used in a trade or business. Therefore, the asset would not qualify for the § 179expensing election. Neither investment property nor personal use property is eligible forthe § 179 expensing election. Investment property is eligible for cost recovery, however.pp. 8-5 and 8-10

14. The basis of the asset is reduced by the § 179 limited expensing deduction (after applyingthe $420,000 limitation and before the taxable income limitation) before computing theMACRS cost recovery. pp. 8-11 and 8-12

15. The § 179 amount eligible for expensing in a carryforward year is limited to the lesser of(1) the statutory dollar amount $105,000 reduced by the cost of § 179 property placed inservice in excess of $420,000 in the carryforward year or (2) the business incomelimitation in the carryforward year. p. 8-11

16. Taxable income, for § 179 purposes, is defined as the aggregate amount of taxableincome of any trade or business of the taxpayer without regard to the amount expensedunder § 179. Therefore, the taxable income computation for purposes of the § 179 limitincludes the deduction for MACRS. pp. 8-11 and 8-12

17. The following issues are relevant for Ana:

• Is the new motor home inventory?

• Is the new motor home an asset subject to cost recovery?

• Does the new motor home qualify for the § 179 expensing election?

pp. 8-5, 8-6, and 8-10

18. An automobile is listed property and consequently must pass the predominantly businessuse test to be eligible for MACRS statutory percentage cost recovery. However, byweighing more than 6,000 pounds, the automobile is not subject to the statutory dollarlimits on cost recovery. However, the AJCA of 2004 provides that SUVs with a GVW

Depreciation, Cost Recovery, Amortization, and Depletion 8-7

between 6,000 pounds and 14,000 pounds are subject to a $25,000 ceiling in calculatingthe § 179 expense rather than the normal ceiling for 2005 of $105,000. pp. 8-14 and 8-15

19. Passenger automobiles are subject to the statutory dollar limits on cost recoveryregardless of whether they meet the more-than-50 percent business use test. p. 8-15

20. The purpose of the lease inclusion amount is to prevent taxpayers from circumventing thecost recovery dollar limitations by leasing instead of purchasing an automobile. Thedollar amount is taken from an IRS table and is prorated for the number of days of thelease term included in the taxable year. This amount is then adjusted to reflect thebusiness and income producing use of the automobile. pp. 8-17 and 8-18

21. The amortization period for a § 197 intangible is 15 years regardless of the actual usefullife. p. 8-20

22. Self-created goodwill is not eligible for amortization. For goodwill to qualify foramortization, it must be purchased. p. 8-20

23. The following issues are relevant for Orange Motors:

• Does the noncompete agreement come under § 197 for intangibles?

• Was the noncompete agreement in connection with the acquisition of a trade orbusiness?

• Can the cost of the noncompete agreement be amortized over a period other than thenormal statutory period if the noncompete agreement is legally enforceable for ashorter period of time?

• What is the normal statutory period for amortizing intangibles?

p. 8-20

24. Intangible drilling and development costs can either be written off as an expense in theyear in which they are incurred or capitalized and written off through depletion. p. 8-22

25. To calculate cost depletion, the adjusted basis of the asset (e.g., mineral interest) isdivided by the estimated recoverable units of the asset to arrive at the depletion per unit.The depletion per unit is then multiplied by the number of units sold in that particularyear to arrive at the deduction for depletion (assuming the percentage depletion amount isnot larger). pp. 8-22 and 8-23

PROBLEMS

26. Cost of asset $100,000Less: Greater of allowed and allowable cost recovery:

2003 $ 4552004 3,636 (4,091)

Basis at the end of 2004 $ 95,909Less: Cost recovery for 2005 ($100,000 X 3.636% X .5/12) (152)Basis on date of sale $ 95,757


Gain on sale of asset ($98,000 – $95,757) $ 2,243

pp. 8-4, 8-9, and Table 8-8

27. José’s basis for cost recovery is $175,000 because the fair market value of the house atthe date of the conversion from personal use to rental property ($210,000) is greater thanthe $175,000 adjusted basis. p. 8-4

28. MACRS cost recovery ($150,000 X 14.29%) (Table 8-1) $21,435

The property is 7-year property. Exhibit 8-1

pp. 8-5 to 8-9

29. MACRS cost recovery ($220,000 X .10) (Table 8-1) $22,000

pp. 8-5 to 8-9

30. a. 2005MACRS ($200,000 X 20%) (Table 8-1) $40,000

b. 2006MACRS cost recovery [$200,000 X 32% (Table 8-1) X 1/2] $32,000

pp. 8-5 to 8-9

31. The mid-quarter convention must be used because the cost of the computers acquired inthe 4th quarter exceeds 40% of the cost of all the personal property acquired during theyear ($600,000/$140,000 = 43%).

Furniture (7-year class)

MACRS cost recovery($50,000 X .1785) (Table 8-2) $ 8,925

Trucks (5-year class)

MACRS cost recovery($30,000 X .15) (Table 8-2) 4,500

Computers (5-year class)

MACRS cost recovery($60,000 X .05) (Table 8-2) 3,000

Total cost recovery $16,425

pp. 8-5 to 8-9

32. a. 1996: $850,000 X 1.177% (Table 8-8) $10,005

b. 2005: $850,000 X 2.564% (Table 8-8) X 4.5/12 $8,173

pp. 8-9 and 8-10


33. The building does not meet the 80% gross receipts from dwelling units test. Therefore, itis classified as nonresidential real property. The building’s depreciable basis is$1,500,000 [$2,000,000 (cost) – $500,000 (land)].

$1,500,000 X 1.819% (Table 8-8) = $27,285

p. 8-9

34. 2005: $2,000,000 X .321% (Table 8-8) = $6,420

2016: $2,000,000 X 2.564% (Table 8-8) X .5/12 = $2,137

pp. 8-9 and 8-10

35. The building’s depreciable basis is $1,200,000 [$1,400,000 (cost) – $200,000 (land)].

a. 2005: $1,200,000 X .0197 (Table 8-8) = $23,640

b. 2011: $1,200,000 X .03636 (Table 8-8) X 10.5/12 = $38,178

pp. 8-9 and 8-10

36. a. CopierImmediate expense deduction under § 179 $ 30,000

FurnitureImmediate expense deduction under § 179 75,000MACRS cost recovery

[($112,000 – $75,000) X .1429] 5,287Total deduction $110,287

b. FurnitureImmediate expense deduction under § 179 $105,000MACRS cost recovery

[($112,000 – $105,000) X .1429] 1,000

CopierMACRS cost recovery

($30,000 X .20) 6,000Total deduction $112,000

c. The deduction for the year would be $1,713 ($112,000 – $110,287) larger if § 179expense is allocated to the furniture (i.e., the longer lived asset).

pp. 8-5 to 8-11 and Table 8-1

37. § 179 deduction before adjustments $105,000Less: Dollar limitation reduction ($428,000 – $420,000) (8,000)§ 179 potential deduction $ 97,000

Business income limitation $80,000

§ 179 deduction allowed $80,000


§ 179 deduction carryforward from 2004 ($4,000) and 2005 ($17,000) $21,000

The carryforward is subject to the effect of the $420,000 ceiling and the business incomelimitation in the carryforward year.

pp. 8-11 and 8-12

38. Cost recovery for furnitureMACRS cost recovery[($132,000 – $105,000) X 14.29%] 3,858

Income limitationIncome before § 179 and cost recovery $180,000Cost recovery ($86,000 + $3,858) (89,858)Income before § 179 amount $ 90,142

Section 179 amount of $105,000 but limited to $90,142 90,142Total deduction with respect to the furniture in 2005 $94,000

Section 179 carryforward to 2006 ($105,000 – $90,142) $14,858

pp. 8-11, 8-12, Exhibit 8-1, and Table 8-1

39. a. Yoon must use the mid-quarter convention.3-year class ($20,000 X 58.33%) $11,6665-year class ($127,000 X 5%) 6,350Total cost recovery $18,016

b. Section 179 amount on 5-year class property $105,0003-year class ($20,000 X 58.33%) 11,6665-year class [($127,000 – $105,000) X 5%] 1,100Total deduction $117,766

c. Section 179 election—total deduction $117,766No § 179 election—total deduction (18,016)Increase in deduction from § 179 election $ 99,750

Tax benefit (.33 X $99,750) $32,918

pp. 8-5 to 8-8, 8-11, 8-12, and Table 8-2

40. Net income before cost recovery and § 179 deduction $22,000

§ 179 income limit $22,000

§ 179 potential deduction ($5,000 + $40,000) $45,000§ 179 deduction for 2005 (22,000)§ 179 carryforward $23,000

pp. 8-11 and 8-12


41. Willis, Hoffman, Maloney, and Raabe, CPAs5191 Natorp Boulevard

Mason, OH 45040

December 20, 2004

Mr. John Johnson100 Morningside DriveClinton, MS 39058

Dear Mr. Johnson:

I am responding to your inquiry concerning the amount of cost recovery you may deductin the first year of operation of a new taxi. If the automobile is purchased at thebeginning of 2005 for $35,000, the total recovery in the first year would be $35,000.

Because the car will be used as a taxi, it is not subject to the cost recovery limitationsimposed on passenger automobiles. This $35,000 recovery assumes that your incomefrom your taxi business before considering this recovery would be at least $35,000 andan election is made under § 179 to expense the maximum allowable amount.

If you need additional information or need clarification of our calculations, please contactme.

Sincerely yours,

John J. Jones, CPAPartner

TAX FILE MEMORANDUM

December 20, 2004

FROM: John J. Jones

SUBJECT: John Johnson: Calculations for cost recovery in year of acquisition

Facts. John Johnson is considering purchasing an automobile at the beginning of 2005 tobe used 100% as a taxi. The cost of the automobile is $35,000. John wants to know thetotal recovery for the year of acquisition of the car.

Calculations. Because the automobile will be used as a taxi, it is not subject to the costrecovery limitations for passenger automobiles. Therefore, John can elect § 179expensing. In deducting the § 179 amount of $35,000, the assumption is made thatJohn’s income from the taxi business before considering the § 179 expense will equal orexceed $35,000.

pp. 8-13 to 8-16


42. Cost $30,000Statutory percentage (mid-quarter convention) X 5%Cost recovery but subject to the limitation $ 1,500

Recovery limit (limited to $2,960*) $ 1,500Less: Personal usage (20% X $1,500) (300)Cost recovery $ 1,200

*These cost recovery limits are indexed annually. The 2004 amounts are used becausethe 2005 amounts were not available yet.


43. Deduction for 2005[($18,000 X 20%) = $3,600] limited to $2,960* $2,960

Deduction for 2006[($18,000 X 32%) = $5,760] limited to $4,800 $4,800



44. Because the Ford Excursion has a GVW rating in excess of 6,000 pounds, it is not apassenger automobile and hence is not subject to the cost recovery limitations.

However, since the vehicle is an SUV with a GVW between 6,000 and 14,000 pounds,the § 179 expense amount is limited to $25,000.

§ 179 expense $25,000MACRS cost recovery [($60,000 – $25,000) X 20%] 7,000Total deduction $32,000


45. Deduction for 2005[($20,000 X 20%) = $40,000] limited to $2,960* X 80% $2,368

Deduction for 2006Straight-line [($20,000 X 20% = $4,000) X 70%] $2,800

Cost recovery recapture in 20062005 deduction $2,368Straight-line [($20,000 X 10% = $2,000) X 80%] (1,600)Excess $ 768


pp. 8-13 to 8-16 and Tables 8-1 and 8-5


46. 100% business use[$4,000 X 20% (Table 8-1)] X 100% $800

45% business use[($4,000 X 10%) (Table 8-5)] X 45% (180)

Reduced cost recovery if personal use occurs $620

Tax cost ($620 X 28%) $174

pp. 8-13 to 8-16

47. Because the computer is not used in a trade or business, Abdel may not elect § 179expensing. The computer is listed property which does not satisfy the predominantbusiness usage test. Therefore, Abdel must use straight-line cost recovery for thecomputer.

$8,000 X 10% X 80% production of income usage (Table 8-5) = $640

pp. 8-13 to 8-16

48. Deduction for lease payments:

$700 X 6 months X 65% = $2,730

Inclusion amount:

$80 X 1/2 X 65% = $26

Example 27


Mason, OH 45040

December 20, 2004

Mr. Dennis Harding150 Avenue IMemphis, TN 38112

Dear Mr. Harding:

I am writing in response to your request concerning the tax consequences of purchasingversus leasing an automobile. Our calculations are based on the data you provided in ourtelephone conversation.

If the automobile is purchased, the total cost recovery deductions for the five years wouldbe $13,960. If the automobile is leased, lease payment deductions would total $22,500.In addition, you also would have to include $779 in your gross income.

If you need additional information or need clarification of our calculations, please contactus.


Sincerely yours,


TAX FILE MEMORANDUM

December 20, 2004

FROM: John J. Jones

SUBJECT: Dennis Harding: Calculation of lease versus purchase

Facts. Dennis Harding is considering purchasing or leasing an automobile on January 1,2005. The purchase price of the automobile is $35,000. The lease payments for fiveyears would be $375 per month. The inclusion dollar amounts for the next five yearswould be $52, $115, $171, $205, and $236. Dennis wants to know the effect on hisadjusted gross income for the purchase versus the lease of the automobile for five years.

Calculations

Purchase: cost recovery deductions2005 [$35,000 X 20% = $7,000] limited to $2,960* $ 2,9602006 [$35,000 X 32% (limited to $4,800)] 4,8002007 [$35,000 X 19.2% (limited to $2,850)] 2,8502008 [$35,000 X 11.52% (limited to $1,675)] 1,6752009 [$35,000 X 11.52% (limited to $1,675)] 1,675Total cost recovery deductions $13,960


Lease:Lease payments ($375 X 60) $22,500

Inclusion dollar amounts ($52 + $115 + $171 + $205 + $236) $ 779

pp. 8-13 to 8-17

50. $90,000 X 5.26% = $4,734

pp. 8-18, 8-19, and Table 8-5

51. For regular income tax liability

MACRS cost recovery ($14,000 X .20) $2,800

For AMT liability

($14,000 X .15) $2,100

pp. 8-5 to 8-7, 8-18, 8-19, and Table 8-5


52. a. Cost $800,000Rate (7-year class, Table 8-1) X 14.29%Cost recovery $114,320

b. Cost $800,000Rate (7-year class, Table 8-4) X 10.71%Cost recovery $ 85,680

pp. 8-5 to 8-7, 8-18 and 8-19

53. MACRS:Year 1 [$100,000 X 14.29% (Table 8-1)] $14,290Year 2 ($100,000 X 24.49%) 24,490Year 3 ($100,000 X 17.49%) 17,490Total cost recovery $56,270

ADS:Year 1 [$100,000 X 10.71% (Table 8-4)] $10,710Year 2 ($100,000 X 19.13%) 19,130Year 3 ($100,000 X 15.03%) 15,030Total cost recovery (44,870)

Cost recovery lost by electing ADS $11,400

Tax cost of election ($11,400 X 28%) $ 3,192

pp. 8-5 to 8-7, 8-18 and 8-19

54. $0. Self-created goodwill is not a § 197 intangible and therefore cannot be amortized.p. 8-20


Mason, OH 45040

October 15, 2005

Mr. Mike Saxon200 Rolling Hills DriveShavertown, PA 18708

Dear Mr. Saxon:

This letter is in response to your request concerning the tax consequences of allocatingthe purchase price of a business between the two assets purchased: a warehouse andgoodwill.

If the purchase price of $2,000,000 is allocated $1,200,000 to the warehouse and$800,000 to goodwill, the total recovery in the first year of operations would be $82,865.Cost recovery on the warehouse would be $29,532 and amortization of the goodwillwould be $53,333. If the purchase price is allocated $1,500,000 to the warehouse and$500,000 to goodwill, the total recovery in the first year of operations would be $70,248.


Cost recovery on the warehouse would be $36,915 and amortization of the goodwillwould be $33,333.

Therefore, under the first option, your deductions in the first year would be $12,617greater ($82,865 – $70,248). The building is written off over 39 years, while thegoodwill is written off over 15 years. Thus, the higher the allocation to goodwill, thefaster the write-off will be. Should you need more information or clarification ofcalculations, please contact us.

Sincerely yours,


TAX FILE MEMORANDUM

October 15, 2005

FROM: John J. Jones

SUBJECT: Mike Saxon: Calculations of amount of recovery depending on theallocation of purchase price between a warehouse and goodwill

Facts. Mike is negotiating the purchase of a business. The final purchase price ($2million) has been determined, but the allocation of the purchase price between awarehouse and goodwill is still subject to discussion. Two alternatives are beingconsidered. The first alternative would allocate $1,200,000 to the warehouse and$800,000 to goodwill. The second alternative would allocate $1,500,000 to thewarehouse and $500,000 to goodwill. Mike wants to know the total recovery during thefirst year of operations from the two alternatives.

Calculations

Alternative 1Warehouse [$1,200,000 X 2.461% (Table 8-8)] $29,532Goodwill ($800,000/15 years) 53,333Total recovery $82,865

Alternative 2Warehouse [$1,500,000 X 2.461% (Table 8-8)] $36,915Goodwill ($500,000/15 years) 33,333Total recovery $70,248

Additional deductions in first year under alternative 1 ($82,865 – $70,248) $12,617

pp. 8-9 and 8-20

56. Gross income $12,000,000Less: Expenses (5,000,000)Taxable income before depletion $ 7,000,000


Cost depletion ($10,000,000/250,000 X 45,000) = $1,800,000Percentage depletion (22% X $12,000,000 = $2,640,000, limited

to 50% X $7,000,000 = $3,500,000) (2,640,000) Taxable income $4,360,000

pp. 8-22 to 8-24

57. Not expensed

Gross income $3,840,000Less: Expenses (1,240,000)Taxable income before depletion $2,600,000Cost depletion ($6* X 120,000) $720,000Percentage depletion (15% X $3,840,000) $576,000Greater of cost or percentage depletion (720,000)Taxable income $1,880,000

Expensed

Gross income $3,840,000Less: Expenses, including IDC (2,240,000)Taxable income before depletion $1,600,000Cost depletion ($4** X 120,000) $480,000Percentage depletion (15% X $3,840,000) $576,000Greater of cost or percentage depletion (576,000)Taxable income $1,024,000

*Oil interest cost plus IDC ($2,000,000 plus $1,000,000) ÷ 500,000 equals $6.

**Oil interest cost of $2,000,000 ÷ 500,000 equals $4.

pp. 8-22 to 8-24 and Example 36

CUMULATIVE PROBLEMS


Mason, OH 45040

December 21, 2005

Mr. John Smith1045 Center StreetLindon, UT 84059

Dear Mr. Smith:

I am writing in response to your request concerning the effects on your 2005 adjustedgross income of selling IBM stock and using some of the proceeds to purchase anautomobile to be used in your business.


If the stock is not sold and the car is not purchased, your adjusted gross income would be$203,000. If the stock is sold and the car purchased, your adjusted gross income wouldbe $265,040. The supporting calculations follow:

No sale of stock and no purchase of car

Fees for services $500,000Less: Business expenses

Building rental $36,000Office furniture and equipment rental 5,000Office supplies 2,500Utilities 4,000Salaries ($35,000 + $42,000) 77,000Payroll taxes 9,000Fuel and oil 21,000Cost recovery (Note 3): Front end loaders 57,000 Dump truck 10,000

Total business expenses (221,500) Business income before § 179 deduction $278,500Less: § 179 deduction (Note 1) (95,000) Business income $183,500Interest income 10,000Dividend income 9,500Adjusted gross income $203,000

Notes

(1) Section 179 deduction of $95,000 [$105,000 (normal limit) – $10,000 (reductionin limit: $430,000 – $420,000)].

(2) The inheritance of IBM stock from Aunt Mildred is excludible under § 101.

(3) Cost recovery

Front end loadersMACRS cost recovery ($380,000 – $95,000) X 20% $57,000

Dump truckMACRS cost recovery ($50,000 X 20%) $10,000

Sale of stock and purchase of car


Building rental $36,000Office furniture and equipment rental 5,000Office supplies 2,500Utilities 4,000Salaries ($35,000 + $42,000) 77,000Payroll taxes 9,000Fuel and oil 21,000


Cost recovery (Note 3): Front end loaders 72,000 Dump truck 10,000 Car 2,960

Total business expenses (239,460)Business income before § 179 deduction $260,540Less: § 179 deduction (Note 1) (20,000)Business income $240,540Interest income 10,000Dividend income 9,500Gain on stock sale (Note 2) 5,000Adjusted gross income $265,040

Notes


(2) The inheritance of IBM stock from Aunt Mildred is excludible under § 101.John’s recognized gain on the sale of the IBM stock is $5,000 ($115,000 amountrealized – $110,000 adjusted basis) and is classified as a long-term capital gain.

(3) Cost recovery

Front end loaderMACRS cost recovery ($380,000 – $20,000 X 20%) $72,000


Car[($75,000 X 20% = $15,000) (limited to $2.960)*] $2,960

*The cost recovery limits are indexed annually. The 2004 amounts are usedbecause the 2005 amounts were not available yet.

Should you need more information or need for us to clarify our calculations, pleasecontact us.

Sincerely,


TAX FILE MEMORANDUM

December 20, 2004

FROM: John J. Jones

SUBJECT: John Smith: Calculation of adjusted gross income for (1) no sale of stockor purchase of car versus (2) sale of stock and purchase of car


Facts. John is considering selling inherited IBM stock with an adjusted basis to him of$110,000 for $115,000 on December 29, 2005. He would use $75,000 of the proceeds topurchase a car that would be used 100% for business. John wants to know the effectthese transactions would have on his adjusted gross income.

No sale of stock and no purchase of car


Building rental $ 36,000Office furniture and equipment rental 5,000Office supplies 2,500Utilities 4,000Salaries ($35,000 + $42,000) 77,000Payroll taxes 9,000Fuel and oil 21,000Cost recovery (Note 3): Front end loaders 57,000 Dump truck 10,000

Total business expenses (221,500) Business income before § 179 deduction $278,500Less: § 179 deduction (Note 1) (95,000) Business income $183,500Interest income 10,000Dividend income 9,500Adjusted gross income $203,000

Notes


(2) The inheritance of IBM stock from Aunt Mildred is excludible under § 101.

(3) Cost recovery

Front end loadersMACRS cost recovery [($380,000 – $95,000) X 20%] $57,000


Sale of stock and purchase of car


Building rental $36,000Office furniture and equipment rental 5,000Office supplies 2,500Utilities 4,000Salaries ($35,000 + $42,000) 77,000Payroll taxes 9,000Fuel and oil 21,000


Cost recovery (Note 3): Front end loaders 72,400 Dump truck 10,000 Car 2,960

Total business expenses (239,460)Business income before § 179 deduction $260,540Less: § 179 deduction (Note 1) (20,000)Business income $240,540Interest income 10,000Dividend income 9,500Gain on stock sale (Note 2) 5,000Adjusted gross income $265,040

Notes


(2) The inheritance of IBM stock from Aunt Mildred is excludible under § 101.John’s recognized gain on the sale of the IBM stock is $5,000 ($115,000 amountrealized – $110,000 adjusted basis) and is classified as a long-term capital gain.

(3) Cost recovery

Front end loaderMACRS cost recovery [($380,000 – $20,000) X 20%] $72,000


Car[($75,000 X 20% = %15.000) (limited to $2,960)*] $2,960

*The cost recovery limits are indexed annually. The 2004 amounts are usedbecause the 2005 amounts were not available yet.

59. Net income from Writers Anonymous (Note 1) $21,900Interest income 4,000Self-employment tax (Note 2) (1,547)Adjusted gross income $24,353Less: Itemized deductions (Note 3) (10,700)

Personal exemption (3,100) Taxable income $10,553

Tax on $10,553 from 2004 Tax Table $1.229Self-employment tax 3,094Less: Estimated tax payments (5,000) Net tax payable (or refund due) for 2004 ($ 677)

Notes

(1) The net income of Writers Anonymous is calculated as follows:


Income from sales $115,000Less: Rent $16,500

Utilities 7,900Supplies 1,800Insurance 5,000Travel excluding meals ($3,500 – $1,200) 2,300Meals ($1,200 – $600) 600Depreciation (Note 4) 59,000 (93,100)

Net income $ 21,900

(2) The self-employment tax is calculated as follows:

1. Net earnings from self-employment $21,9002. Multiply line 1 by 92.35% 20,2253. If the amount on line 2 is $87,900 or less,

multiply the line 2 amount by 15.3%.This is the self-employment tax. $ 3,094

One half of the self-employment tax, or $1,547, is a deduction for AGI.

(3) The itemized deductions are as follows:State income tax $ 2,000Home mortgage interest 6,000Property taxes on home 1,500Charitable contributions 1,200Total itemized deductions $10,700

(4) Furniture and fixtures:§ 179 limited expensing $19,000

Computer equipment:§179 limited expensing 40,000

Total deduction $59,000


59.


59. continued


59. continued


59. continued


59. continued


59. continued


59. continued

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