 Income tax 2022-2023, depreciation, timing and method. Let's do some wealth preservation with some tax preparation. 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. Most of this information comes from publication 946, how to depreciate property tax year 2022. You can find out the IRS website, irs.gov, irs.gov. Looking at the income tax formula, we're focused on line one income. Remember in the first half of the income tax formula is in essence an income statement, but just an outline of scaffolding other forms and schedules flowing into these line items, one of those being the Schedule C. The Schedule C being an essence and income statement in and of itself. Business income minus business expenses gets to the net business income which flows in to line one income of the income tax formula we see here. Looking at the first page of the form 1040, noting that the Schedule C flows into the Schedule 1, which flows into page one of the form 1040, line number eight. Schedule C profit or loss from business has an income statement format, income minus expenses. We are focused here on the expense side of things. Looking specifically at the depreciation, depreciation being an accrual concept we're forced to deal with even if we're on a cash-based system because we have to put it on the books as an asset in essence, according to the tax code allocate the cost over the useful life, although we might have some special depreciation, some 179 depreciation that could muddy up the waters. So, given that, when does depreciation begin and end? You might think it's a straightforward type of question here because you would think it would begin when you buy the equipment or whatever it is you're purchasing that you have to depreciate, but it can be a little bit confusing in terms of when you're going to actually put that into operations and when you look at the conventions being used, you might have different conventions like a half-year convention or a mid-month convention when you purchase certain types of depreciable property. So, when does the depreciation actually start? It can be somewhat more confusing than you would think at first. So, you begin to depreciate your property when you place it in service for use in your trade or business or for the production of income. So, clearly, why are we buying the stuff? It's an ordinary and necessary type of thing for business or related to consuming it for an ordinary or necessary purpose. That's why it would be an expense. So, when we put it in place for the production of income, revenue generation being our business goal, then you would think that would be when you're going to put it on the books as a depreciable item. So, you stop depreciating property either when you have fully recovered your cost or other basis or when you retire it from service, which ever happens first. So, if we purchase something for, let's say, just $100,000 for a round number, then we're going to put it on the books when we put the piece of equipment in service, in service for use in our trade or business, meaning, for example, if you had to include shipping costs or something like that in order to get it ready and in service, then you would include it at the point in time that it's in service for business use. Then, again, you might use different methods to account for the depreciation in terms of when does the accounting calculation basically start? Are you using a mid-month or mid-year convention depending on what's required or what options we have from the tax code? And then, of course, you're trying to allocate that $100,000 over the useful life. That's the general accounting concept, meaning the cost should be allocated to the same period it was used to consume to generate revenue. But the tax code could accelerate the depreciation for reasons other than generally accepted accounting or accounting principles to try to stimulate the economy using accelerated methods. In the first years, for example, makers is a double declining balance method, and then they might use $179 deduction, special depreciation to deduct more upfront. The general idea then would be after you've allocated the full $100,000 in that example, you can't keep on depreciating after that point in time, even if you're still using the piece of equipment in business, which is likely if they allow you this big accelerated depreciation type of method because you can't depreciate more than the equipment actually costs. That would be the general idea. So you're going to fully depreciate the equipment over its useful life or whatever depreciable property you have, or you might dispose of it before that time, which means you might either sell it or you might just dispose of it, just throw it away before it's been fully depreciated, at which point you've got to calculate what's going to happen at that point in time in terms of possibly a gain or a loss at the point of sale or disposition. Okay, so retired from service. You can stop depreciating property when you retire it from service, even if you have not fully recovered its cost or other basis. You retire property from service when you permanently withdraw it from use in a trade or business or from use in the production of income because any of the following events. So note if you retire it, if you just like throw the piece of equipment away, you're not going to sell it, then you might say, well that's not good because I still had some of the adjusted basis in place that I could have depreciated it if I held on to it. But if you dispose of it, you might still get a benefit from disposing of it for the amount that had not yet been depreciated in the form of a loss when you make a disposal which is calculated similar to like if you sold it, but you had no sales price there. You just dispose of it. Sales price zero, cost, adjusted basis, loss, the difference between the two. So you sell or exchange the property. So you convert the property to personal use. That would be a similar situation. It's no longer used for business. It's personal. If you sell it, then you're not going to depreciate it anymore at that point in time. You're going to calculate your gain or loss on sale. If you abandon the property, you just leave. If it's like real estate, that's usually what comes to mind with an abandoned property. You just leave it there. Or you abandon the poor forklift into the middle of somewhere. You transfer the property to supplies or scrap account. So your accounting for it is just scrap now as opposed to like a piece of equipment. It's not a forklift anymore. It's a hunk of metal. And the property or the property is destroyed. In which case, again, that would be similar to like you sold it. You just, you lost it, right? It's gone now. So these would be similar to a sales type of transaction, but you didn't get any money for it. So you might have a loss. So you don't really lose that adjusted basis. So in other words, if you bought 100,000 piece of equipment, you've been depreciating it. There's still 30,000 that hasn't fully been depreciated at the point of time that you abandoned the property. You throw it away. You destroy it or something like that. That would be similar to like a sale happening. You'd still get a benefit possibly of that 30,000, but not in the form of depreciation rather in the form of a loss possibly from it. Okay. So what method can you use to depreciate the property? Terms you may need to know. So you may need to know the adjusted basis. We talked about a little bit before the basis. That's like the costs and the adjusted costs. Convention. What kind of convention are we using for depreciation? Exchange. Intangible property we've looked at before. Non-residential real property placed in service. When was it placed in service? The equipment. Related persons. So we often have these related person issues. Residential rental property, salvage value. How much is it still worth at the end of the life when we do our calculations? Section 145 property. Section 1250 property. So what type of property is it? The tax code charge to calculate it in these different boxes to help us determine what we need to do with it from basically an accounting and tax standpoint. Standard mileage rate when we're talking about automobiles and comparing depreciation methods or standard mileage. Straight line method. That's the baseline method you want to keep in mind as the ground basis for how depreciation works. And then we deviate from there with all this other weird stuff they do to it. Unit of production. Another depreciation method. Useful life. How long is this dang piece of equipment going to be around? How do we calculate that? Usually we're subject to the tax code telling us how to calculate that oftentimes. So you must use the modified accelerated cost recovery system, otherwise known as good old makers, MACRS. So when you think of makers, you might, if you know accounting methods for depreciation, you've got straight line, then you've got double declining balance and so on. The makers is usually a form of double declining balance, although it has like a half year convention usually, but it depends also on the type of property that we're dealing with. So that's what they're going to call it. So we have to use, as we do on normal bookkeeping, we don't get to pick the method that we're going to use that best applies to allocating the proper amount over the useful life given our best estimate. But instead, we've got to use what the tax code tells us to use. And usually we're talking makers oftentimes. So makers is discussed later in chapter four. If you want to check it out in the publication, you cannot use makers to depreciate the following properties. So property you placed in service before 1987. So we had possibly different rules and acres prior to that point in time. Certain property owned or used in 1986 and tangible property, films, videotape and recordings, certain corporate or partnership property acquired in a non-taxable transfer property you elected to exclude from makers. So generally, if we're putting something on the books like now and going forward, makers is usually the method that we're going to be putting in place. These are the exceptions.