 Income tax 2022-2023 makers depreciation examples part number two using tax software. Let's do some wealth preservation with some tax preparation. Here we are in our example Form 1040 populated using LASERT tax software. You don't need tax software to follow along, but it's a great tool to run scenarios with. You can also get access to the Form 1040 related forms and schedules at the IRS website, IRS.gov, IRS.gov. Starting point, single filer, Mr. Anderson living in Beverly Hills 90210. No W-2 income. We've got the Schedule C flowing into Line 8. Let's check that flow through. Schedule C as we can see, profit or loss from business. Income minus the expenses. The net income flowing into Schedule 1. There it is on Schedule 1, flowing into the first page of the Form 1040 online number 8. We also have self-employment tax. We need to consider the Schedule C then. Bottom line, net income flows in to the Schedule SE, which is then calculating the self-employment tax. Social Security Medicare at the 14-129, which flows into the Schedule 2. Support Accounting Instruction by clicking the link below, giving you a free month membership to all of the content on our website. Broken out by category, further broken out by course. Each course then organized in a logical, reasonable fashion, making it much more easy to find what you need than can be done on a YouTube page. We also include added resources such as Excel practice problems, PDF files and more like QuickBooks backup files when applicable. So once again, click the link below for a free month membership to our website and all the content on it. Which flows into the Form 1040 page number 2, not the income tax, but the self-employment tax. Half of that is deductible. So once again, the deductible above the line portion, Schedule C, bottom line, flows into the Schedule SE, calculating the self-employment tax. And then in essence, half of that, the 7065 in this case, flows into the Schedule 1 page number 2. There's the 7065, which flows into the Form 1040. And we've got the 100,000 minus the 7065. It's the 92935 standard deduction at the 12950. Then we are letting the software calculate the qualified business income deduction worksheet here, giving us the 63988 page number 2, calculating the tax 9692 plus the self-employment tax. 14129 gives us the 23821. We're saying that we paid 30,000 in. There it gives the bottom line of 6179. Now we're focused on the Schedule C, of course, which is flowing into the line 8. Let's go to the Schedule C. We're looking at the depreciation. So let's just put a baseline of a depreciable property first, and then we'll do an example problem related to it. So I'm going to go back on over, just noting on the data input. And your data input might be different. We're just going to do a generic machinery remembering that as we enter data in real life, we want to be as specific as possible. But we're going to be generic for the problem because we're focused on the categories and the calculation. So the category, let's say it's machinery and equipment placed in service, let's say 030122. And then the cost, I'm going to say 10,000 for a round number. And then the method that I'm going to use is five years makers. And then remember that if I was to just jump on over and let the system do the calculation, it's usually going to try to default and assume that I might be able to take the software, at least, the special depreciation deduction, which it is populating here. So we're going to talk about special depreciation a little bit later. But notice that adjusts the, in essence, basis. So now we put it on the books as an asset, but I got to expense the whole thing. Now I think the easiest way to think about depreciation is to remove the special and 179. Think about how makers works in general, the normal depreciation method, and then add the 179 kind of components on top of that, noting that the 179 special depreciations will probably change in the future. Whereas the baseline depreciation, the makers system, you would think will stay there long term. Long term memory. Because that's based on accounting concepts. So now I've removed the special depreciation. And so now you've got the 10,000 and the 10,000. And now it's using a DB, which is a decline in double declining 200 DB declining balance, half your convention. So and recall that if I was to just calculate that out, it would be something like 10,000. If it was straight line, I would divide it by five years, and there would be 2000, but it's double declining. So let's get the straight line rate taking that divided by 10,000 gives us the straight line rate of 20%. Or I can take one over the years five 20% times two, there's the double declining rate. If I multiply that times the 10,000, I get to 4000. But that would be if it was a whole year, I have a half year. So I'm going to divide that by two. And that's where I get back to the 2000 here for the current year. All right, given that recap, let's go back and take a look at another problem. So during the year you bought a machine, seven year property for 4000 office furniture, seven year property for 1000 and computer five year property for 5000. You placed the machine in service in January, the furniture in September and the computer in October. You do not elect 179 deduction and none of the items is qualified property for purposes of claiming special depreciation. You place property in service during the last three months of the year. So you must first determine if you have to use the mid quarter convention. Okay, so the issue here is, notice it's defaulting to a half year convention. Now if I put a lot of stuff in there that's going to be for the for the end of the year, the iris is skeptical that I'm trying to cheat them by by taking a six months of depreciation when I put it in at the end of the year. So we want to then that's what we're kind of testing out here because it might switch over to a mid quarter convention. So let's say that we do this we're going to say we put in machinery and they said this was seven year machinery though so this is going to be category of let's say machinery and equipment. So we'll keep it there and then I'm going to say okay 10 and that was 4,000 but it's seven year property so I'm going to say okay this is seven year property. So I'm going to say makers double declining for seven years and then we also put in a for for 4,000 office equipment so office furniture, and I'm going to say to category this is this is office furniture now that's going to be category number two. And this first one by the way was placed in service in January and the second one. So January the furniture in September so this was in September so say oh nine 15 to two and that was the furniture was for the 1000 and the method there is going to be 57 as well. And then we put a computer in place let's do another one add a computer computer and that's going to be two but this time the computer is going to be let's call it equipment. I'm going to say this is going to be equipment and this was put in place in October so let's say this was on 10 15 to two and it was for 5000 and this is five year property. So I'm going to say this is going to be five year property so we'll go with that one and then I'm going to remove any special and one 79 depreciation. So hopefully I got that correct if I jump on over here then the point is you'll note that it switched to a mid quarter convention as opposed to a mid year convention that we're using now. And that's because more of the more of the stuff that would have been in a mid year convention have now been more of it or in the end of the year. So the IRS is going to be skeptical of that and force us to kind of jump on over to a mid quarter convention. So let's just read through the rest of that the 5000 basis of the of the computer which you placed in service during the last three months. The fourth quarter of the tax year is more than 40% of the total basis of all the property 10,000 you placed in service for the year. So therefore you must use the mid quarter convention which means you're going to get less depreciation for the year. So that's the idea we want to think if you hear a half year convention you might think hey look I'm going to buy everything in the end of the year because then I can get a bigger convention but makers doesn't kind of allow you to do that. You still could think about whether or not this 179 and the special depreciation would allow you to do something like that is the general idea. In other words it allows you to do that but you have to switch from a half year to a to a mid quarter convention which means it's going to lower the depreciation. So then we can see the impact on the first year the 107-1250 if I look at 2023 the next year we're at the 255 the total is that 3012 as opposed to the current year where we are at the 10357. Now we'll talk more about like dispositions later but let's just get a quick look at that on one of these if I go back on over I'm going to delete two of these so we can just see one at a time and delete this item. And let's say that this was on the books in the prior year of 2020 let's make this two years back and it was seven year property. So if I pull that back on over then so now I'm going to see it's seven year property if I enter something into the system that was on the books in a prior year. That probably would only happen from a logistical standpoint if it was a new client otherwise I would have the depreciation schedules. So I would have to actually enter the prior year depreciation into the system which means you'd want to make sure that you get the depreciation schedules from the prior software. So I'm just going to make up a number from the prior year just to give an example number of the prior year depreciation. I'm actually going to change it to 10,000 cost prior depreciation 4200. So if I pull that back on over to my schedule here now we've got the 10,000 prior year depreciation 4200 current year depreciation 1,749. So that means the book value of this thing is 10,000 minus the 4200 minus the 1749. Now if I dispose of the property in the current year that could be by me just getting rid of it because I no longer use it anymore. Or if I sell it then the question is there could be a gain or loss on the property. And to our point here there could be some partial year basically depreciation that would happen in the year of sale which might be using the similar convention as we have here the half year convention. In other words if I dispose of it then I might use the same convention to basically calculate that last period's depreciation. So to see that more clearly let's actually use a five year. I'm going to go back on over and say let's say this was a five year property and use the straight line method. So if I use a straight line method then I'm going to go. Now I got 2,000 in the current year and the prior two years would be calculated at a straight line method of let's say 3,000. Let's say 3,000 here. Okay and so then let's say that we dispose or sell this thing. So let's say the date sold was in the current year. Let's say it's the beginning of the year. 02 somewhere 0122 that we sold it in the current year. Basis adjustment land we're going to say that that's when it was sold and the sales price is let's say the sales price is higher than what we purchased it for or higher than what the adjusted basis is. Let's make it 8,000. So I'm going to go back on over. So now our main point here is that it calculated the current depreciation of the 1,000 is the main point because it used that half year convention in the year of sale. In other words in the current year if it was straight line it would be 10,000 divided by 5,000 each year. But it assumes that we sold it in the middle of the year even though we sold it in February. So it took that and of course divided it by 2, which is easier to see with the straight line of the 1,000. So that same convention that we used on the purchase is going to be used on the disposition. Now we're almost going into a lot of detail here because we're focused on depreciation. But the accelerated methods of the depreciation make it so that when I sell the property it's more likely that I'm going to end up with a gain if I sell it for cash. Because now if I over depreciated it in the current years and then I sold it it's likely I got more deduction that I should have because if I sell it for a price greater than the book value then that would mean that I over depreciated it generally. So for example 10,000 minus the 3,000 and minus the 1,000 gives us a book value of 6,000. I sold it for 8,000 which is a $2,000 gain that would be calculated on the sale. So if I look at the 4797 we've got the 2,000 pulling in here. And so there's there we have it. If I pull that into the first page of the form 1040 we've got then the 100 and 1,000. Let's go to Schedule 2 where I've got the 99,000 here and then the other gains of the 2,000. Now there's also an issue then with regards to should that gain be capital gains because I sold machinery and equipment or should it be ordinary income gains. Now note that if I go back on down here and look at page 2 I don't see any other tax calculation happening here because in essence it put it on the books as ordinary income not having a separate tax for capital gains. Capital gains tax. Which kind of makes sense because I got the deduction of depreciation at ordinary income rates. So you would think I would have to record the income at ordinary income. Now if I sold it for more than the purchase price. So if I purchased it for 10,000 and I sold it for 11,000 which is only likely to happen if it was like a building because machinery will go down in value. So it's not likely you're going to sell it for more than you purchased it for but it might happen with a building. Now you can see that I have a tax worksheet to figure the 1,000 that's going to be taxed at possibly favorable rates capital gains rates. So that's what it gets a little bit messy with regards to the sales because of those differences in depreciations the accelerated depreciation makes it likely that you're going to end up with a game. And then you're and then the question is do you have do you have these two different rates capital gains versus versus the ordinary income. So here we have ordinary income gains and losses down here and then up top there's the 1000 up top for sale exchange of property used in business. Okay, so I'm not going to get into that more detail. Let's take a look at another one. Actually, let's look at this in a little bit more detail and play with it a little bit more in Excel over here. So just to get an idea of this, if I said, if I said for example that I purchased something at a cost of 10,000, and then we depreciated it. So I'm going to say prior year, prior year, D pre was we said 3000, I believe. And then I said the current year, let's put this over here. And then prior year depreciation is that let's put that here and then the current year current year D pre. Let's do the calculation for that. If it was straight line, the cost easiest way to do straight line is the cost is 10,000 and the straight line rate or years, years were five. So D pre per year would be equal to 10,000 divided by five 2000. But then we have the half year half year convention, which I'm going to say divided by two gives us the depreciation in the current year. So current year D pre I know I'm not spelling this great or anything. So there is that let's do this equals this divided by that. And so then the total total D pre D pre over the life of this thing equals the sum of that. Okay, so that means the book value is going to put this over here equals the sum. I'm sorry, not the sum equals 10,000 minus 4,000 equals 10,000 minus 4,000 or 6,000. Now if I sold it, let's actually put this here. If I sold it for anywhere between 6,000 and 10,000, then I would end up in a gain. And you would think I would have to record the gain is kind of like ordinary on ordinary income rates. But if I go over the 10,000, that's where you think. So if I sell it, now if I sale the sale of this thing, let's say I sold it for what did I say over here? 11,000, 11,000 minus the book value, the book value of 6,000 means I have a gain equals the 11 minus the 6, 5,000. So that's no problem. But then the question is, is it ordinary or capital? And you would think that because I got a benefit of 4,000 of deductions, I would have to eat that up. So the depri portion is going to be 4,000 at ordinary, depri at ordinary, ordinary income, and then possibly capital gain, possibly capital gain rates for the 1,000. That would kind of make sense, right? And that's what's basically happening here in essence. You've got the property, 11,000 minus the 10,000. That gives you the depreciation of the 11,000 to 10,000 depreciation is 4,000. The adjusted basis is 6,000. The total gain is 5,000. The depreciation allowed or allowable was 4,000. You've got a benefit for that, in other words, on ordinary income rates. And then if you take the 5,000 minus the 4,000, you've got the 1,000, which is going to be the amount that is over and above the ordinary income that flows into the 4,797 of the 1,000 here. Gain, if any, of the 1,000 and then the 4,000 down here. That flows into schedule one as we saw of the 4,000, which is in the other gains. And then on form 1040, you've got that included here. And then the 1,000 up top, that's also flowing through to the schedule D, which is a familiar form, which is usually often people think of where we sell. The stocks and bonds, charts and pie. It has a short term and then the long term portion on the schedule D. Now, obviously, the other thing that could happen over here is that we could sell it at a loss. This is less likely to be the case because of the accelerated depreciation, especially if we had 179 and special depreciation. But if we sold it for something under or just disposed of it, sold it for nothing in essence. Let's say we say 2,000, then I can go back on over and say, okay, now the 4,797, we've got a negative amount here. It's going to be a loss. The loss then pulling in to the schedule one of the 4,000 in this case, and then it's flowing into the form 1040. Now note that losses are going to be something the IRS is usually going to be more skeptical of because obviously if you have a loss, then you may be able to take the loss against other income generally. But if it's a business loss, then it'd be a business type of loss. And so that's going to be the general idea. By the way, you'd think that because it was a business property, notice there's no change in the tax tables. It's not using capital gains rates or anything like for the loss, for example, using different rates on basically the loss in that example.