This course examines the U.S. federal tax system as it relates to property transactions of business owners and shareholders. Topics include cost recovery, such as depreciation, amortization, and depletion; calculation of realized versus recognized gains and losses; evaluation of the potential tax effects of nontaxable exchanges; and the combining, or netting, gains and losses that are different in nature. Assignments facilitate self-discovery of knowledge and development of a variety of professional skills.
Depreciation of Business Use Realty
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来自 University of Illinois at Urbana-Champaign 的课程
Federal Taxation II: Property Transactions of Business Owners and Shareholders
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从本节课中
Module 1 Cost Recovery: Depreciation
In this module, you will be introduced to concepts of cost recovery used by U.S. Taxpayers. The nature of property will be discussed designating the difference between realty and personalty. The Modified Accelerated Cost Recovery System (MACRS) will be explained along with its classification of both real and personal assets as well as applicable conventions used in depreciating property. Finally, learners will discover how to use the tax depreciation tables to aid in the determination of allowable cost recovery deductions.
与讲师见面
Matthew HutchensLecturer of Accountancy
Department of Accountancy
Petro Lisowsky, PhD, CPAAssociate Professor of Accountancy
College of Business: Department of Accountancy
Welcome back. Recall in our previous videos,
that there are 3 types of cost recovery methods.
Depreciation, amortization, and depletion.
We've already looked at depreciation, specifically,
at the cost recovery methods that deals with business use tangible property,
whether it's real property or personal property.
In order to calculate depreciation,
we need to know the original basis of
the property which is usually what we paid for, the asset.
We also need to know the class life of the property and the convention,
whether half-year or mid-quarter.
Recall that we use the IRS tables to find the correct depreciation rate,
and we multiply that rate by
the original basis to calculate the depreciation deduction for that year.
Note however, that this was how we calculated
the depreciation on business use tangible personal property.
What about calculating depreciation on business use tangible real property,
like a warehouse or an office building?
In this video, we'll look at how to calculate depreciation of business use realty.
Depreciation of realty does not use
the same convention as the depreciation of personalty.
That is, it does not use the half-year or mid-quarter conventions.
Instead, real property is depreciated using what's known as the mid-month convention.
The mid-month convention means that the taxpayer is allowed to deduct one half
of 1 month's worth of depreciation in the month the realty is placed into service,
and one half of 1 month's worth of depreciation in the month the realty is disposed of.
The logic here is similar to half-year convention or the mid-quarter convention.
Recall that the half-year convention allow the taxpayer to deduct half a year's worth of
depreciation in the first and last year of using business personalty,
while the mid-quarter convention allowed the taxpayer to deduct half a quarter's worth of
depreciation in the first and last quarter of using business personalty.
The window shrinks even more for
business use realty and the taxpayers are allowed to depreciate
half a month's worth of depreciation in
the first and last month of using business realty.
Also, what's different with realty is that the asset is depreciated straight line.
Recall the business use personalty is depreciated using accelerated depreciation;
meaning a greater depreciation deduction is allowed
early in the asset's life compared to the end of the asset's life.
Under straight line however,
realty is depreciated evenly over time.
An important distinction with realty is whether the realty is residential
or non-residential because the class life period is different.
Residential real property is defined as property where 80% or more of
the gross rental revenues are from non-transient dwelling units, for example, apartments.
So, think of an apartment building in a big city,
maybe New York, or Chicago, or San Francisco.
Maybe the first 2 floors are reserved as retail space for stores or restaurants,
which are considered non-residential since nobody lives in a store or restaurant.
However, the rest of the building contains apartment units.
If more than 80% of the rental income that the landlord
receives from the building occupants are received from the apartments tenants,
then the entire building is considered residential and can be depreciated straight line
over a shorter period than if it were classified as a non-residential building.
Therefore, the cost recovery is quicker for residential rental properties,
and thus as you can imagine,
if the basis of the building is the same,
the depreciation deductions will be higher for
a residential property than for a non-residential property.
Other examples of non-residential properties are office buildings or warehouses,
as well as, hotels because the units are for transient dwellers.
Meaning, very short-term living.
If you own one of these non-residential properties,
the depreciation life is much longer.
Finally, recall that the land itself is never depreciated,
only the buildings on the land are depreciated.
The tax law does not consider land to be subject to wear and tear.
In terms of calculating the depreciation deduction for business use realty,
we need to look at Table 4.
There are in fact 2 sets of tables.
One for residential property depreciated over 27.5 years,
and the other for non-residential property.
The non-residential property is further split into
property placed into service between December 31st,
1986 and May 12, 1993,
which is depreciated over 31.5 years,
and property placed into service after May 12,
1993 which is depreciated using 39 years.
We'll basically use 2 tables;
the residential real property table,
and the non-residential real property table,
for property placed into service after May 12,
1993, simply because it's more recent and often used table.
So, here are what the 2 depreciation tables look like.
The top table is for residential real property,
and the bottom table is for
non-residential real property placed into service after May 12, 1993.
So, how do we read these tables?
Well, the columns are set up to follow
the month of the tax year during which you place property into service.
If you're a December 31 calendar year and tax-payer,
then column1 will correspond to January,
column 2 will correspond to February,
column 3 will correspond to March, and so on.
For example, if you're a landlord and you place
into service an apartment building that has
a residential real property on August 4th of the current year,
then you look at the top panel because that's the residential real-estate panel,
and you look in column 8 because August is the eighth month of the year.
If it's the first year you've placed the asset into service,
then the depreciation rate is at the intersection of column eight
and row 1 or 1.364%.
You would multiply 1.364% by the basis in
the apartment building to figure out the depreciation deduction for year 1.
For year 2, you just drop down 1 row and
look at the intersection of column 8 and row 2.
Here, the rate is 3.636%.
You would multiply 3.636% by the basis in
the apartment building to figure out the depreciation deduction for year 2.
Because real estate is depreciated straight line that is spread evenly over time,
the depreciation rates between the first and last years are roughly the same.
So, if you stay in column 8 and look at the percentages in row 2 to 18,
row 19 to 27, and row 28,
they're all basically the same,
either 3.636% or 3.637%.
The rates are slightly different to accommodate rounding.
But this is the idea of straight line,
that the depreciation rate is the same over time.
The bottom table shows the depreciation rates for non-residential real property.
Same idea here.
If you're a landlord or a business owner,
and you place into service an office building or a warehouse that is
non-residential real property on August 4th of the current year,
then you look at the bottom panel because this is the non-residential real estate panel,
and you look in column 8 because August is the eighth month of the year.
If it's the first year you place the asset into service,
then the depreciation rate is at the intersection of column
8 and row 1 or 0.963%.
You would multiply 0.963% by the basis in the apartment building
to figure out the depreciation deduction for year 1.
For year 2, you just drop down
1 row and look at the intersection of column 8 and row 2.
Here, the rate is 2.564%.
You would multiply 2.564% by the basis in
the apartment building to figure out the depreciation deduction for year 2,
and because real estate is depreciated straight line that is spread evenly over time,
the depreciation rates between the first and the last years are the same.
So, if you stay in column 8 and look at the percentages in row 2 to 39,
they're all the same, at 2.564%.
Again, the tables are split into months because
real property is depreciated using the mid-month convention.
So, the assumption is that regardless of
when during the month you place the asset into service,
or when during the month you dispose of the asset,
you are allowed half a month's worth of depreciation.
So, in our example, if you placed realty into service on August 4th,
it's assumed that you placed the realty into service on August 15th.
Same goes for if you placed the asset into service on August 10th,
or August 20th, or August 30th,
it's assumed that you placed the asset into service on August 15th,
that is in the middle of the month.
So, let's work through an example using the realty tables and the mid-month convention.
On July 12, year 20x1,
Blue Company purchases and places into service
a warehouse and the land it resides on for $170,000,
where $120,000 is allocated to the building.
What is the amount of depreciation on the property in year 20x1,
and what about in year 20x2?
First, we need to figure out whether the warehouse is residential or non-residential.
Well, warehouses by definition do not include dwelling units.
Warehouses are used for business storage,
inventory, and logistics management.
So, we can consider the warehouse to be non-residential.
Therefore, we look at the non-residential depreciation rate table, and here it is.
Now, in order to find the right depreciation rate,
we need to identify the correct column and row.
The columns correspond to the months.
The warehouse, in our case,
was placed into service on July 12.
July is the seventh month,
so we will look at column seven.
Year 20x1 is the first recovery year,
so the correct year is 1.
The intersection of column 7 and row 1 will give us
the depreciation rate of 1.177%.
So, now that we have this 1.177 percent rate,
what do we multiply it by?
Do we multiply it by the $170,000 value which includes both the warehouse and the land,
or do we multiply it by just the value of the warehouse,
that is the $120,000?
Well, we're only allowed to depreciate buildings, not the land.
So, the basis we use for the calculation is $120,000.
We take the $120,000 basis of only the building and multiply
it by 1.177% to get $1,412.
Therefore, in year 20x1,
the first year of use,
the warehouse will generate a depreciation deduction of $1,412.
Now, what about the next year?
What is the depreciation deduction in year 20x2?
Well, we go back to the non-residential realty depreciation table,
and we stay in column 7 because July was
the original month the warehouse was placed into service.
But we are now in year 2,
so we simply drop down1 row and stay in column seven.
So here the rate is 2.564%.
Now that we have this 2.564% rate,
we need to multiply it by the 120,000 original basis.
Therefore, once we multiply out the $120,000 basis times the
2.564% depreciation rate, we get $3,077.
Therefore, in your 20x2,
the second year of use,
the warehouse will generate a depreciation deduction of $3,077.
In all, remember that with business use realty,
we need to differentiate between residential and non-residential realty.
Depreciation only applies to buildings, not the land,
and the IRS requires taxpayers to use the mid-month convention,
which uses straight-line depreciation.
Once you identify the correct depreciation rate from the IRS tables,
simply multiply it by the original basis of
the realty value to obtain the depreciation deduction for the year,
and that's how we depreciate business use realty.
