1
EA Exam Lite
Part 2
Businesses - I
Figures
Figure / Description1 / Summary of the MACRS Procedure
2 / Example – MACRS Calculations
3 / Examples – Sec. 1031 Like-kind Exchanges
4 / Examples – Sec. 1033 Involuntary Conversions
5 / 5-Column Worksheet Format for Property Tansactions Netting
6 / Example – 5-Column Netting Worksheet
7 / Sec. 1245 Recapture Summary
8 / Sec. 1250 Recapture Summary
9 / Examples – Sec. 721 Transfers to a Partnership
Figure 1
Summary of the MACRS ProcedureAsset / Class
Life / Qualifying
Property
/ BasisReduction / Recovery
Table Method / Acquisition
Year Assumption
P
E
R
S
O
N
A
L
T
Y / 3 / Property with class lives of 4 years or less, except for autos, lightweight trucks, and horses other than race horses more than 2 years old / 50% of any allowable energy credit / 200% declining balance / Half-year (Mid-Qtr. if > 40% is placed in service last 3 months)
5 / Property with class lives of more than 4 years but less than 10 years, also including autos, light-weight trucks, R&D equipment, computers and printers, and rental personalty / Same as above / 200% declining balance / Same as above
7 / Property with class lives of at least 10 years but less than 16 years, including single-purpose agricultural equipment, railroad tracks, agricultural machinery, and (by default) other personalty having no class live given / Same as above / 200% declining balance (150% for agri-cultural equip.) / Same as above
10 / Property with class lives of at least 16 years but less than 20 years / Same as above / 200% declining balance / Same as above
15 / Property with class lives of at least 20 years but less than 25 years, plus including land improvement such as fencing. / Same as above / 150% declining balance method / Same as above
20 / Property with class lives of at least 20 years, including sewer pipes and irrigation systems, but not including realty with a class life of 27.5 years or more / Same as above / 150% declining balance method / Same as above
R
E
A
L
T
Y / 27.5 / Residential rental property (at least 80% of gross rents of the building are from dwelling units; otherwise, the realty is classified as nonresidential realty below) / 100% of any allow-able reha-bilitation credit / Straight-line Method /
Mid-month for all
31.5 / Nonresidential (all other) realty placed in service after 1986 and before May 13, 1993 / Same as above / Straight-line Method / Mid-month for all39 / Nonresidential (all other) realty placed in service on or after May 13, 1993 / Same as above / Straight-line Method / Mid-month for all
Figure 2
Example – MACRS Calculations
Sara Billups, a calendar-year sole proprietor placed into service various business assets and a rental property during the current tax year. For each asset, determine the maximum cost recovery deduction, assuming that Billups elects to deduct as much of the cost of the office equipment as possible in the year of acquisition, including any Sec. 179 immediate expensing deduction where applicable. Assume a 2007 tax year.
Asset Class Life Cost Date Acquired
Business Auto 5 years $ 12,000 6/2
Office Equipment 10 years 40,000 7/2
Punch Machine 8 years 18,000 10/4
Drill Machine none given 130,000 11/2
Cutting Machine 10 years 352,000 12/2
Factory Warehouse none given 100,000 6/2
Rental Apt. Building none given 200,000 6/3
Note – Mid-quarter rule for personalty, since (482,000 - $73,000)/($552,000-$73,000) > 40%
(Note also that any Sec. 179 deduction is not included in the 40% mid-quarter testing.)
Asset / CostRecovery Method / Depr.
Base $ / Applicable
Cost Recovery Rate / Deduction / Rf
Business Auto / MACRS / 12,000 / .2500 (5-yr, 2nd qtr) / 3,000 / a
Office Equip. / MACRS / 40,000 / .1071 (7-yr, 3rd qtr) / 4,284 / b
Punch Mach. / MACRS / 18,000 / .0500 (5-yr, 4th qtr) / 900 / c
Drill Mach. / MACRS / 130,000 / .0357 (7-yr, 4th qtr) / 4,641 / d
Cutting Mach. / Sec. 179 / N/A / N/A / 73,000 / e
Cutting Mach. / MACRS / 279,000 / .0357 (7-yr, 4th qtr) / 9,960 / f
Warehouse / MACRS / 100,000 / .01391 (39-yr, 6th mo) / 1,391 / g
Rental Apts. / MACRS / 200,000 / .01970 (27.5yr, 6th mo) / 3,940 / h
Total / $101,116
a. $12,000 x .2500
b. $40,000 x .1071
c. $18,000 x .0500
d. $130,000 x .0357
e. $125,000 maximum Sec. 179 – ($552,000 – $500,000) reduction
f. ($352,000 cost - $73,000 Sec. 179 deduction) x .0357
g. $100,000 x .01391
h. $200,000 x .01970
Figure 3
Examples - Sec. 1031 Like-kind Exchanges
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Example 1 - A Corporation exchanged an old machine (adjusted basis $10,000, fair market value $13,000) for a new machine with a fair market value of $13,000.
Realized gain = $13,000 - $10,000 = $3,000
Recognized gain = $0 (solely like-kind exchange)
Adjusted basis of new - Method 1 = $10,000 + 0 + 0 - 0 - 0 = $10,000
Adjusted basis of new - Method 2 = $13,000 + 0 - 3000 = $10,000
Example 2 - Same as 1, except that the fair market value of the new and the old machine is $8,000.
Realized loss = $8,000 - $10,000 = ($2,000)
Recognized loss = $0 (solely like-kind exchange)
Adjusted basis of new - Method 1 = $10,000 + 0 + 0 - 0 - 0 = $10,000
Adjusted basis of new - Method 2 = $8,000 + 2,000 - 0 = $10,000
Example 3 - B Corporation exchanged an old machine (adjusted basis $10,000, fair market value $12,000) and $1,000 cash for a new machine worth $13,000.
Realized gain = $13,000 - ($10,000 + $1,000) = $2,000
Recognized gain = $0 (monetary boot given)
Adjusted basis of new - Method 1 = $10,000 + 0 + 1,000 - 0 - 0 = $11,000
Adjusted basis of new - Method 2 = $13,000 - 2,000 + 0 = $11,000
Example 4 - Same as 3, except that the boot given by B Corporation was 100 shares of stock worth $1,000 (which were purchased in 1990 for $600)
Realized gain = $13,000 - ($10,000 + $600) = $2,400
Recognized gain = $400 (nonmonetary boot given; gain on the boot taxed as if sold for cash)
Adjusted basis of new - Method 1 = $10,000 + 400 + 600 - 0 - 0 = $11,000
Adjusted basis of new - Method 2 = $13,000 - 2,000 + 0 = $11,000
Example 5 - C Corporation exchanged an old machine (adjusted basis $10,000, fair market value $13,000) for a new machine worth $12,000 and $1,000 cash.
Realized gain = ($12,000 + $1,000) - $10,000 = $3,000
Recognized gain = $1,000 (gain is lesser of $3,000 accounting gain or $1,000 boot rec’d)
Adjusted basis of new - Method 1 = $10,000 + $1,000 + 0 - 0 - $1,000 = $10,000
Adjusted basis of new - Method 2 = $12,000 + 0 - $2,000 = $10,000
Example 6 - Same as 5, except that C received a new machine worth $8,000 and $5,000 cash.
Realized gain = ($8,000 + $5,000) - $10,000 = $3,000
Recognized gain = $3,000 (acct’g gain; gain is lesser of $3,000 acct’g gain or $5,000 boot rec’d)
Adjusted basis of new - Method 1 = $10,000 + $3,000 + 0 - 0 - $5,000 = $8,000
Adjusted basis of new - Method 2 = $8,000 + 0 - 0 = $8,000
Example 7 - D Corporation exchanged an old machine (adjusted basis $10,000, fair value $13,000 subject to a $4,000 mortgage) for a new machine (fair value $12,000, subject to a $3,000 mortgage).
Realized gain = ($12,000 + $1,000) - $10,000 = $3,000
Recognized gain = $1,000 (net liabilities assumed by the other party of $1,000; treat as boot rec)
Adjusted basis of new - Method 1 = $10,000 + 1,000 + 0 - 0 - $1,000 = $10,000
Adjusted basis of new - Method 2 = $12,000 + 0 - $2,000 = $10,000
Figure 4
Examples - Sec. 1033 Involuntary Conversions
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T Company’s warehouse ($100,000 adjusted basis) was destroyed by a fire. T’s recognized taxable gain (loss) assuming various costs of replacement properties would be as follows:
A B C D E
Insurance Proceeds Received 98,000 108,000 108,000 108,000 108,000
Adjusted Basis of Warehouse (100,000) (100,000) (100,000) (100,000) (100,000)
Realized (Acct’g) Gain (Loss) ( 2,000) 8,000 8,000 8,000 8,000
======
Insurance Proceeds Received 98,000 108,000 108,000 108,000 108,000
Cost of Replacement Warehouse (103,000) (113,000) ( 96,000) (105,000) (101,000)
Limit on Recognized Gain NA 0 12,000 3,000 7,000
======
Recognized (Tax) Gain (Loss) ( 2,000) 0 8,000 3,000 7,000
======
Basis of Replacement 103,000 105,000 96,000 100,000 100,000
======
v v v v v
v v v v v
(103 - 0) (113 - 8) (96 - 0) (105 - 5) (101 - 1)
Figure 5
5-Column Worksheet Format for Property Transactions Netting
======
Personal Bus & Inv
Cas & Theft Cas & Theft Sec. 1231 Capital Ordinary
Gains/Losses Gains/Losses Gains/Losses Gains/Losses Income
ST:
XXXX XXXX XXXX XXXX XXXX
(XXXX) (XXXX) (XXXX) (XXXX)
[ A ] XXXX [ D ]
===== [ B ] Gain XXXX LT:
==== [ C ] * Gain XXXX
===== (XXXX) [ F ]
XXXX
Gain XXXX
[ E ]
Loss
|
Loss [ G ]
[ H ]
XXXX
(XXXX)
Adjusted Gross Income (AGI) XXXX
Loss
(Less 10% of AGI) [ I ]
(XXXX)
(XXXX)
Taxable Income XXXX
=====
Tax Form Locations:
[A] Form 4684, Page 1, Section A, lines 15 and 16
[B] Form 4684, Page 2, Section B, lines 38 and 39
[C] Form 4797, Page 1, Part I, lines 7 and 9
[D] Schedule D, Page 1, Part I
[E] Schedule D, Page 1, Part 2
[F] Form 1040, Line 13
[G] Form 1040, Line 14
[H] Form 1040, Line 14
[ I] Schedule A, Line 19
* Any Sec. 1231 recapture gain reportable as ordinary income is subtracted and transferred to ordinary income
Figure 6
Example – 5-Column Netting Worksheet
Personal Bus & Inv
Cas & Theft Cas & Theft Sec. 1231 Capital Ordinary
Gains/Losses Gains/Losses Gains/Losses Gains/Losses Income
ST: 92,000
3,000 4,500 6,300 1,000 1,400
( 900) (2,200) (7,400) (4,600) 800
2,100 ( 800) (3,600)------
===== 1,500--Gain--->1,500 LT: |
| ===== 400--Gain---> 400 |
| ===== (2,100) ---> (2,500)
| 700 |
--Gain------> 2,100 |
1,100------
(4,200)
Adjusted Gross Income (AGI) 87,500
Personal Exemption (3,400)
Itemized Deductions (12,700)
Taxable Income 71,400
Figure 7
Sec. 1245 Recapture Summary
Facts: Jill Wade placed in service a machine in 2004 at a cost of $100,000. Jill deducted a total of $40,000 depreciation, and she sold the machine in 2007. The tax results of selling the machine at three different assumed amounts realized are:
Case A Case B Case C
Amount Realized $53,000 $85,000 $106,000
Adjusted Basis ($100,000 - $40,000) (60,000) (60,000) ( 60,000)
Total Gain (Loss) ($ 7,000) $25,000 $ 46,000
======
Composition of Gain:
Sec. 1245 (Ordinary Income) - - $25,000 $ 40,000
Sec. 1231 Gain - - - - 6,000
Sec. 1231 Loss ($7,000) - - - -
Case A: Machine is sold at a loss; Sec. 1245 recapture rules do not apply
Case B: Gain is all ordinary income under Sec. 1245, since gain is less than the $40,000
total depreciation taken
Case C: Gain is ordinary income to the extent of total depreciation taken ($40,000), and
the remaining gain is Sec. 1231 gain. (Note – The machine was sold for $6,000
more than it originally cost, and since this amount was never depreciated, that
excess represents Sec. 1231 gain that will not be recaptured.)
Figure 8Sec. 1250 Recapture Summary
Facts: Taylor Martin placed a new building costing $500,000 in service. Total cost recovery deductions using accelerated recovery totaled $200,000; straight-line recovery deductions would have been $160,000. Taylor sold the building during the current year for $550,000, yielding a $250,000 gain ($550,000 amount realized - $300,000 adjusted basis. The portion of the total gain that must be reported as Sec. 1250 recapture gain (ordinary income) under various scenarios would be as follows:
Date Placed
In Service
/ Assuming Property is Nonresidential Realty / Assuming Property is Residential Realty1978 (Old Depreciation Rules) / $40,000
(100% of excess depreciation) / $40,000 *
(100% of excess depreciation)
1982 ( Old ACRS Rules) / $200,000 **
(100% of total depreciation) / $40,000
(100% of excess depreciation)
1987 (Current MACRS Rules) / Not Applicable ***
(No excess depreciation) / Not Applicable ***
(No excess depreciation)
* Only includes excess depreciation taken after 1975
** Sec. 1245 recapture rule applies; however, if taxpayer elects straight-line recovery, property reverts to Sec. 1250 and there is no recapture (since no excess depreciation)
*** Only straight-line recovery is allowed for MACRS
Figure 9
Examples - Sec. 721 Transfers to a Partnership
Example 1: Sue Mason exchanges land ($20,000 adjusted basis, $30,000 fair market value) for a 1/3 interest in MNO Partnership worth $24,000 and $6,000 cash.
Realized Gain = ($24,000 + $6,000) - $20,000 = $10,000
Recognized Gain = $10,000 (Sec. 721 does not apply when boot is received--sale)
Basis of partnership interest to Sue = $24,000 (taxable exchange - use values)