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Assignment 8 Cost Recovery Deductions Limitations of “Passive Activity” Losses and Credits

Basic Conditions for the Allowance of Cost Recovery Deductions Depreciation Causes of Asset Obsolescence ACRS and MACRS Methods – When to Apply MACRS Recovery Periods – Types of 3-Year Property– Types of 5-Year Property Types of 7-Year Property Types of 27 ½ -Year Property

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Assignment 8 Cost Recovery Deductions Limitations of “Passive Activity” Losses and Credits

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  1. Basic Conditions for the Allowance of Cost Recovery Deductions Depreciation Causes of Asset Obsolescence ACRS and MACRS Methods – When to Apply MACRS Recovery Periods – Types of 3-Year Property– Types of 5-Year Property Types of 7-Year Property Types of 27 ½ -Year Property Types of 39-Year Property Types of 3-Year, 5-Year, 7-Year, and 10-Year Property Types of 27 ½-Year, 31 ½-Year and 39-Year Property Straight-line method for entire useful life Cost Recovery Conventions and Their Applications Alternative to MACRS Election to Expense Certain Depreciable Assets Cost Recovery Limitations – Types of Listed Property If Listed Property Is Used Less than 50% for Business Deductions for Amortization of Intangibles – Recovery Period and Method Accelerated Cost Recovery System (ACRS) Property Modified Accelerated Cost Recovery System (MACRS) Property Deductibility of Losses – Limits Three General Categories of Income The Active Participation Exception – Restrictions Material Participation Passive Activity Portfolio Income Key notes will appear in this box automatically as the audio review proceeds. When the professor (s) announce the session has concluded, you can continue with the quiz at the end of the lesson by following the links. Assignment 8Cost Recovery DeductionsLimitations of “Passive Activity” Losses and Credits

  2. Basic Conditions for the Allowance of Cost Recovery Deductions Depreciation Causes of Asset Obsolescence ACRS and MACRS Methods – When to Apply MACRS Recovery Periods – Types of 3-Year Property– Types of 5-Year Property Types of 7-Year Property Types of 27 ½ -Year Property Types of 39-Year Property Types of 3-Year, 5-Year, 7-Year, and 10-Year Property Types of 27 ½-Year, 31 ½-Year and 39-Year Property Straight-line method for entire useful life Cost Recovery Conventions and Their Applications Alternative to MACRS Election to Expense Certain Depreciable Assets Cost Recovery Limitations – Types of Listed Property If Listed Property Is Used Less than 50% for Business Deductions for Amortization of Intangibles – Recovery Period and Method Accelerated Cost Recovery System (ACRS) Property Modified Accelerated Cost Recovery System (MACRS) Property Deductibility of Losses – Limits Three General Categories of Income The Active Participation Exception – Restrictions Material Participation Passive Activity Portfolio Income Recovery Method The rate at which an asset’s cost is recovered, typically expressed as a formula Recovery Period The length of time over which the cost of an asset is recovered Basic Conditions for the Allowance of Cost Recovery Deductions The asset must be either used in the taxpayer’s business activity or held for the production of income The Taxpayer must have an ownership interest in the asset The taxpayer must have a depreciable basis in the property The asset must be considered to have a limited useful life Assignment 8Cost Recovery DeductionsLimitations of “Passive Activity” Losses and Credits

  3. Basic Conditions for the Allowance of Cost Recovery Deductions Depreciation Causes of Asset Obsolescence ACRS and MACRS Methods – When to Apply MACRS Recovery Periods – Types of 3-Year Property– Types of 5-Year Property Types of 7-Year Property Types of 27 ½ -Year Property Types of 39-Year Property Types of 3-Year, 5-Year, 7-Year, and 10-Year Property Types of 27 ½-Year, 31 ½-Year and 39-Year Property Straight-line method for entire useful life Cost Recovery Conventions and Their Applications Alternative to MACRS Election to Expense Certain Depreciable Assets Cost Recovery Limitations – Types of Listed Property If Listed Property Is Used Less than 50% for Business Deductions for Amortization of Intangibles – Recovery Period and Method Accelerated Cost Recovery System (ACRS) Property Modified Accelerated Cost Recovery System (MACRS) Property Deductibility of Losses – Limits Three General Categories of Income The Active Participation Exception – Restrictions Material Participation Passive Activity Portfolio Income ACRS and MACRS Methods – When to Apply ACRS – Assets placed into service between Jan. 1, 1981 through Dec. 31, 1986 MACRS – Assets placed into service after Dec. 31, 1986 Assignment 8Cost Recovery DeductionsLimitations of “Passive Activity” Losses and Credits

  4. Basic Conditions for the Allowance of Cost Recovery Deductions Depreciation Causes of Asset Obsolescence ACRS and MACRS Methods – When to Apply MACRS Recovery Periods – Types of 3-Year Property– Types of 5-Year Property Types of 7-Year Property Types of 27 ½ -Year Property Types of 39-Year Property Types of 3-Year, 5-Year, 7-Year, and 10-Year Property Types of 27 ½-Year, 31 ½-Year and 39-Year Property Straight-line method for entire useful life Cost Recovery Conventions and Their Applications Alternative to MACRS Election to Expense Certain Depreciable Assets Cost Recovery Limitations – Types of Listed Property If Listed Property Is Used Less than 50% for Business Deductions for Amortization of Intangibles – Recovery Period and Method Accelerated Cost Recovery System (ACRS) Property Modified Accelerated Cost Recovery System (MACRS) Property Straight-line Method Deductibility of Losses – Limits Three General Categories of Income The Active Participation Exception – Restrictions Material Participation Passive Activity Portfolio Income Depreciation The decrease in the value of an asset over a period of time; for income tax purposes, the most common type of cost recovery deduction Straight-line method A method used to compute depreciation. The taxpayer divides the depreciable basis in the property by the number of years of the property’s applicable recovery period to arrive at an annual deduction that remains the same over the course of the recovery period Declining-balance method A method used to compute depreciation in which a fixed percentage of the taxpayer’s original basis in the depreciable property is allowed in the first year; in each following year, the same percentage is applied to the basis of the property as adjusted to that point Assignment 8Cost Recovery DeductionsLimitations of “Passive Activity” Losses and Credits

  5. Basic Conditions for the Allowance of Cost Recovery Deductions Depreciation Causes of Asset Obsolescence ACRS and MACRS Methods – When to Apply MACRS Recovery Periods – Types of 3-Year Property– Types of 5-Year Property Types of 7-Year Property Types of 27 ½ -Year Property Types of 39-Year Property Types of 3-Year, 5-Year, 7-Year, and 10-Year Property Types of 27 ½-Year, 31 ½-Year and 39-Year Property Straight-line method for entire useful life Cost Recovery Conventions and Their Applications Alternative to MACRS Election to Expense Certain Depreciable Assets Cost Recovery Limitations – Types of Listed Property If Listed Property Is Used Less than 50% for Business Deductions for Amortization of Intangibles – Recovery Period and Method Accelerated Cost Recovery System (ACRS) Property Modified Accelerated Cost Recovery System (MACRS) Property Deductibility of Losses – Limits Three General Categories of Income The Active Participation Exception – Restrictions Material Participation Passive Activity Portfolio Income Obsolescence Occurs when an asset becomes economically useless to the taxpayer who owns it Causes of Asset Obsolescence Technological or scientific advances in a given business or industry Changes in applicable laws Changes in economic conditions Deterioration of asset’s condition more rapidly than expected Assignment 8Cost Recovery DeductionsLimitations of “Passive Activity” Losses and Credits

  6. Basic Conditions for the Allowance of Cost Recovery Deductions Depreciation Causes of Asset Obsolescence ACRS and MACRS Methods – When to Apply MACRS Recovery Periods – Types of 3-Year Property– Types of 5-Year Property Types of 7-Year Property Types of 27 ½ -Year Property Types of 39-Year Property Types of 3-Year, 5-Year, 7-Year, and 10-Year Property Types of 27 ½-Year, 31 ½-Year and 39-Year Property Straight-line method for entire useful life Cost Recovery Conventions and Their Applications Alternative to MACRS Election to Expense Certain Depreciable Assets Cost Recovery Limitations – Types of Listed Property If Listed Property Is Used Less than 50% for Business Deductions for Amortization of Intangibles – Recovery Period and Method Accelerated Cost Recovery System (ACRS) Property Modified Accelerated Cost Recovery System (MACRS) Property Deductibility of Losses – Limits Three General Categories of Income The Active Participation Exception – Restrictions Material Participation Passive Activity Portfolio Income MACRS Recovery Periods– Types of 3-Year Property Ranchers and breeding hogs Tractors Certain manufacturing tools Qualified rent-to-own property Certain computer software Types of 5-Year Property Cars and most trucks Computers, copiers, typewriters, and other qualified technological equipment Breeding and dairy cattle Solar & wind energy equipment Semiconductor manufacturing equipment Types of 7-Year Property Office furniture and fixtures Most machinery and industrial equipment Railroad equipment Types of 27 ½-Year Property Residential Real Estate Types of 39-Year Property Nonresidential rental equipment such as office buildings, factories and warehouses If placed in service before May 13, 1993, the recovery period is 31 ½-Years. Assignment 8Cost Recovery DeductionsLimitations of “Passive Activity” Losses and Credits

  7. Basic Conditions for the Allowance of Cost Recovery Deductions Depreciation Causes of Asset Obsolescence ACRS and MACRS Methods – When to Apply MACRS Recovery Periods – Types of 3-Year Property– Types of 5-Year Property Types of 7-Year Property Types of 27 ½ -Year Property Types of 39-Year Property Types of 3-Year, 5-Year, 7-Year, and 10-Year Property Types of 27 ½-Year, 31 ½-Year and 39-Year Property Straight-line method for entire useful life Cost Recovery Conventions and Their Applications Alternative to MACRS Election to Expense Certain Depreciable Assets Cost Recovery Limitations – Types of Listed Property If Listed Property Is Used Less than 50% for Business Deductions for Amortization of Intangibles – Recovery Period and Method Accelerated Cost Recovery System (ACRS) Property Modified Accelerated Cost Recovery System (MACRS) Property Deductibility of Losses – Limits Three General Categories of Income The Active Participation Exception – Restrictions Material Participation Passive Activity Portfolio Income MACRS Recovery Periods – Types of 3-Year, 5-Year, 7-Year, and 10-Year property MACRS recovery periods – 27 ½-Year, 31 ½-Year, and 39-Year Class Property MACRS Recovery Periods – 27 ½lYear, 31 ½-Year and 39-Year Class Property Straight-line method for entire useful life Double declining balance method Switch to straight-line when straight-line method produces a higher deduction Assignment 8Cost Recovery DeductionsLimitations of “Passive Activity” Losses and Credits

  8. Basic Conditions for the Allowance of Cost Recovery Deductions Depreciation Causes of Asset Obsolescence ACRS and MACRS Methods – When to Apply MACRS Recovery Periods – Types of 3-Year Property– Types of 5-Year Property Types of 7-Year Property Types of 27 ½ -Year Property Types of 39-Year Property Types of 3-Year, 5-Year, 7-Year, and 10-Year Property Types of 27 ½-Year, 31 ½-Year and 39-Year Property Straight-line method for entire useful life Cost Recovery Conventions and Their Applications Alternative to MACRS Election to Expense Certain Depreciable Assets Cost Recovery Limitations – Types of Listed Property If Listed Property Is Used Less than 50% for Business Deductions for Amortization of Intangibles – Recovery Period and Method Accelerated Cost Recovery System (ACRS) Property Modified Accelerated Cost Recovery System (MACRS) Property Deductibility of Losses – Limits Three General Categories of Income The Active Participation Exception – Restrictions Material Participation Passive Activity Portfolio Income Cost Recovery Conventions and Their Applications Half-year convention (assets in the property classes of 20 or fewer years Mid-quarter convention (assets in the property classes of 20 or fewer years if over 40% of all property was placed into service during the last 3 months of the year) Mid-month convention (all depreciable real estate) Assignment 8Cost Recovery DeductionsLimitations of “Passive Activity” Losses and Credits

  9. Basic Conditions for the Allowance of Cost Recovery Deductions Depreciation Causes of Asset Obsolescence ACRS and MACRS Methods – When to Apply MACRS Recovery Periods – Types of 3-Year Property– Types of 5-Year Property Types of 7-Year Property Types of 27 ½ -Year Property Types of 39-Year Property Types of 3-Year, 5-Year, 7-Year, and 10-Year Property Types of 27 ½-Year, 31 ½-Year and 39-Year Property Straight-line method for entire useful life Cost Recovery Conventions and Their Applications Alternative to MACRS Election to Expense Certain Depreciable Assets Cost Recovery Limitations – Types of Listed Property If Listed Property Is Used Less than 50% for Business Deductions for Amortization of Intangibles – Recovery Period and Method Accelerated Cost Recovery System (ACRS) Property Modified Accelerated Cost Recovery System (MACRS) Property Deductibility of Losses – Limits Three General Categories of Income The Active Participation Exception – Restrictions Material Participation Passive Activity Portfolio Income Alternative to MACRS Straight-line method may replace any declining-balance method ADS – alternative depreciation system (longer than MACRS) Assignment 8Cost Recovery DeductionsLimitations of “Passive Activity” Losses and Credits

  10. Basic Conditions for the Allowance of Cost Recovery Deductions Depreciation Causes of Asset Obsolescence ACRS and MACRS Methods – When to Apply MACRS Recovery Periods – Types of 3-Year Property– Types of 5-Year Property Types of 7-Year Property Types of 27 ½ -Year Property Types of 39-Year Property Types of 3-Year, 5-Year, 7-Year, and 10-Year Property Types of 27 ½-Year, 31 ½-Year and 39-Year Property Straight-line method for entire useful life Cost Recovery Conventions and Their Applications Alternative to MACRS Election to Expense Certain Depreciable Assets Cost Recovery Limitations – Types of Listed Property If Listed Property Is Used Less than 50% for Business Deductions for Amortization of Intangibles – Recovery Period and Method Accelerated Cost Recovery System (ACRS) Property Modified Accelerated Cost Recovery System (MACRS) Property Deductibility of Losses – Limits Three General Categories of Income The Active Participation Exception – Restrictions Material Participation Passive Activity Portfolio Income Amortization The cost recovery of an intangible asset over the lifetime of that asset for income tax and/or book-income purposes, similar to the depreciation of tangible assets Deductions for Amortization of Intangibles – Recovery Period and Method Recovery Period – 180 months Recovery Method: Straight-line No “timing” conventions apply ACRS Property Applies to depreciable assets placed in service between January 1, 1981, and December 31, 1986, for determining the recovery of investment capital for income tax purposes Assignment 8Cost Recovery DeductionsLimitations of “Passive Activity” Losses and Credits

  11. Basic Conditions for the Allowance of Cost Recovery Deductions Depreciation Causes of Asset Obsolescence ACRS and MACRS Methods – When to Apply MACRS Recovery Periods – Types of 3-Year Property– Types of 5-Year Property Types of 7-Year Property Types of 27 ½ -Year Property Types of 39-Year Property Types of 3-Year, 5-Year, 7-Year, and 10-Year Property Types of 27 ½-Year, 31 ½-Year and 39-Year Property Straight-line method for entire useful life Cost Recovery Conventions and Their Applications Alternative to MACRS Election to Expense Certain Depreciable Assets Cost Recovery Limitations – Types of Listed Property If Listed Property Is Used Less than 50% for Business Deductions for Amortization of Intangibles – Recovery Period and Method Accelerated Cost Recovery System (ACRS) Property Modified Accelerated Cost Recovery System (MACRS) Property Deductibility of Losses – Limits Three General Categories of Income The Active Participation Exception – Restrictions Material Participation Passive Activity Portfolio Income Cost Recovery Limitations – Types of Listed Property Passenger vehicles weighing up to 6,000 pounds Computers and peripheral equipment Other property used for entertainment Less than 50% for Business Depreciation of the listed property must be computed using MACRS alternative depreciation system (ADS), which means straight-line depreciation must be used over the applicable ADS period Assignment 8Cost Recovery DeductionsLimitations of “Passive Activity” Losses and Credits

  12. Basic Conditions for the Allowance of Cost Recovery Deductions Depreciation Causes of Asset Obsolescence ACRS and MACRS Methods – When to Apply MACRS Recovery Periods – Types of 3-Year Property– Types of 5-Year Property Types of 7-Year Property Types of 27 ½ -Year Property Types of 39-Year Property Types of 3-Year, 5-Year, 7-Year, and 10-Year Property Types of 27 ½-Year, 31 ½-Year and 39-Year Property Straight-line method for entire useful life Cost Recovery Conventions and Their Applications Alternative to MACRS Election to Expense Certain Depreciable Assets Cost Recovery Limitations – Types of Listed Property If Listed Property Is Used Less than 50% for Business Deductions for Amortization of Intangibles – Recovery Period and Method Accelerated Cost Recovery System (ACRS) Property Modified Accelerated Cost Recovery System (MACRS) Property Deductibility of Losses – Limits Three General Categories of Income The Active Participation Exception – Restrictions Material Participation Passive Activity Portfolio Income Election to Expense Certain Depreciable Assets – Requirements Depreciable tangible property that is acquired by purchase for active use in that taxpayer’s trade or business (real estate and investment property do NOT qualify) Assignment 8Cost Recovery DeductionsLimitations of “Passive Activity” Losses and Credits

  13. Basic Conditions for the Allowance of Cost Recovery Deductions Depreciation Causes of Asset Obsolescence ACRS and MACRS Methods – When to Apply MACRS Recovery Periods – Types of 3-Year Property– Types of 5-Year Property Types of 7-Year Property Types of 27 ½ -Year Property Types of 39-Year Property Types of 3-Year, 5-Year, 7-Year, and 10-Year Property Types of 27 ½-Year, 31 ½-Year and 39-Year Property Straight-line method for entire useful life Cost Recovery Conventions and Their Applications Alternative to MACRS Election to Expense Certain Depreciable Assets Cost Recovery Limitations – Types of Listed Property If Listed Property Is Used Less than 50% for Business Deductions for Amortization of Intangibles – Recovery Period and Method Accelerated Cost Recovery System (ACRS) Property Modified Accelerated Cost Recovery System (MACRS) Property Deductibility of Losses – Limits Three General Categories of Income The Active Participation Exception – Restrictions Material Participation Passive Activity Portfolio Income Deductibility of Losses – Limits Excess of allowable deductions from the taxpayer’s passive activities over the amount of income from the taxpayer’s passive activities must be deferred to subsequent tax years when the taxpayer has excess passive income (no net loss from passive activity may be claimed in a given year Three General Categories of Income Portfolio Income – dividends, interest, royalties, gain from disposition of assets Active Income – wages and other compensation Passive Income – income generated from activities of nonmaterial participation Assignment 8Cost Recovery DeductionsLimitations of “Passive Activity” Losses and Credits

  14. Basic Conditions for the Allowance of Cost Recovery Deductions Depreciation Causes of Asset Obsolescence ACRS and MACRS Methods – When to Apply MACRS Recovery Periods – Types of 3-Year Property– Types of 5-Year Property Types of 7-Year Property Types of 27 ½ -Year Property Types of 39-Year Property Types of 3-Year, 5-Year, 7-Year, and 10-Year Property Types of 27 ½-Year, 31 ½-Year and 39-Year Property Straight-line method for entire useful life Cost Recovery Conventions and Their Applications Alternative to MACRS Election to Expense Certain Depreciable Assets Cost Recovery Limitations – Types of Listed Property If Listed Property Is Used Less than 50% for Business Deductions for Amortization of Intangibles – Recovery Period and Method Accelerated Cost Recovery System (ACRS) Property Modified Accelerated Cost Recovery System (MACRS) Property Deductibility of Losses – Limits Three General Categories of Income The Active Participation Exception – Restrictions Material Participation Passive Activity Portfolio Income The Active Participation Exception – Restrictions Taxpayer must own at least 10% of the rental real estate Taxpayer must participate in the rental activity Up to $25,000 loss may be deducted Material Participation Involvement in the operations of an activity on a regular, continuous, and substantial basis; a standard of participation for purposes of applying the passive-loss limitations Passive Activity A trade or business in which the taxpayer does not materially participate Assignment 8Cost Recovery DeductionsLimitations of “Passive Activity” Losses and Credits

  15. This concludes the assignment. Please follow the links to proceed to the review questions and answers

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