 Income tax 2022-2023, depreciation, election to exclude property from makers use of standard mileage rate and basis. Let's do some wealth preservation with some tax preparation. Most of this information comes from publication 946 how to depreciate property tax year 2022 you can find on the IRS website IRS.gov IRS.gov. We're 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. 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 although just an outline of scaffolding other forms and schedules flowing into it one of those being the Schedule C in essence an income statement in and of itself with business income minus business expenses the net business income flowing into line one here income of our income tax formula first page of the form 1040 we're focused online number eight noting the schedule C would flow into the schedule one which would flow into line eight of page one of form 1040 the schedule C profit or loss from business has an income and expense section we're focused here on the expense side of things thinking about depreciation which is an accrual concept that we have to deal with even if we're a cash based tax payer because the tax code forces us to do so noting that means that we put something on the books as generally an asset and allocate the cost of that asset over the useful life and doing so one of the standard methods we could use is the makers method which is usually going to be a form of double declining balance with like a half year type of convention it's like an accelerated straight line type of method and then we would have to determine what the life is which is often dictated by the code as well so given that now we're thinking about the election to exclude property from makers so you might say I've got property and putting it on the books it might be machinery or something like that equipment furniture you're putting it on the books usually you would be using the makers depreciation which usually is a type of accelerated depreciation a double declining balance type of system if you're familiar with the depreciation methods in other words it's similar to a straight line but we're taking more of the depreciation upfront in the early years with it now you might say I don't want to do that you might say I still want a straight line depreciation or something like that now normally if you can get an accelerated depreciation that's what you would want you wouldn't want the straight line from a tax standpoint because our goal usually is to depreciate more early because then we get the benefit faster that's the general rule but there might be exceptions to that rule for example if we think that depreciated more in the current year would be less beneficial because we have less income in the current year and we expect our income to be going up in future years resulting in higher tax brackets in future years we might have a situation where we would like to depreciate at least evenly or possibly more in the in the tail end because that's where we would have higher tax rates possibly all right given that so if you can properly depreciate any property under a method not based on a term of years such as the unit of production method you can elect to exclude that property from makers so unit of production method is another kind of depreciation format a way to calculate the depreciation that's tied to your production so if you have a piece of machinery and you're making things with a piece of machinery you can tie the depreciation not to years but rather to the things being produced for example a printer try to tie out the depreciation not to how old the printer is but how many pieces of paper it has printed for example so you make the election by reporting your depreciation for the property online 15 in part two of form 4562 and attaching a statement as described in the instructions for form 4562 so that's more of an unusual type of situation but could come up in certain uncertain circumstances so you must make this election by a return due date including extensions for the tax year you place your property in service however if you timely filed your return for the year without making the election you can still make the election by filing an amended return within six months of the due date of the return excluding an extensions so you would think you would need in essence moon mostly to pick the depreciation that's going to stick in the first year or close to it possibly with that amended return you know within six months because after that point in time you you would need consistency you would think in depreciation method going forward so attach the election to the amended return and write a quote filed pursuant to section 301.9100-2 end quote on the election statement file the amended return at the same address you filed the original return use of standard mileage rate so this might be another reason where we might deviate from the depreciation method of say a maker's depreciation method because we have an automobile where we might have a choice or option between taking the mileage method or taking the actual which would include depreciation as well as fuel and so on and so forth the mileage method is typically thought to be an easier method oftentimes especially for sole proprietors small businesses because then you don't have to track all the individual items as easily and even when you do track the individual items such as gas and whatnot it can be difficult to allocate how much is going to be business related versus non-business related and sometimes to determine the amount that is business versus non-business you still need to track the miles to use a percentage a ratio kind of system to figure that out so the easier method of course would be then to try to figure out the miles driven and just used then the base rate that they give you to calculate your your expense in which case you're not really doing the depreciation thing on the car but using an alternative method which includes both the cost of depreciation or is designed to as well as other costs related to the car like the gas and the maintenance so if you use the standard mileage rate to figure your tax deduction for your business automobile you are treated as having made an election to exclude the automobile from makers so you could see publication 463 for a discussion of the standard mileage rate if you want to dive into that more detail we touched on it a little bit in some prior section of course so what is the basis of your depreciable property to figure your depreciation deduction you must determine the basis in essence like the cost kind of similar to the cost of your property to determine the basis you need to know the cost or other basis of your property so cost as basis the basis of property you buy is its costs plus amounts you paid for items such as sales tax it's the exception below freight charges and installation so let's say you bought a big freezer or something like that for your ice cream shop then the cost of the freezer is clearly going to be a cost that will be included you know something that you would be depreciating but also the shipping of the freezer to get it to the place you need it in the store to store the ice cream is also something that would be included in the amount that's going to be depreciated as well as the installation to get the freezer in place so it's ready to rock and or roll right so in other words you might think that i should be able to take the freight charges and the installation fees and just record them as expenses and only record the cost of the refrigerator for the depreciable item but generally to get the refrigerator or freezer ready to roll you had to not only buy it you also had to ship it and you had to install it before it was ready to be in service so all of those things would be part of the basis which is why you might think of it as a little bit different than cost but quite similar to cost also you would think of that thing being put on the books generally at the point in time it was it was kind of like put into into service okay so the cost includes the amount you pay in cash debt obligations other property or services so clearly if you paid cash for these items purchasing the fridge paying the freight and so on that would be included in the cost debt obligations so so you might take on debt in order to pay it so if you financed the freezer you didn't pay cash for it that's the same situation we talked about in prior presentation where it's similar to your home where people make the mistake that because i've alone on it i don't own the home for example you do own the home the phrase saying that the bank owns my home it was started out to be a joke that's a joke the bank doesn't own your home even though you owe the bank 80 percent on the loan of the home because again the bank can't come in and tell you what to do with the home they can't tell you to landscape the home they can't tell you to paint your home they're not sitting at the kitchen table telling you what color the living room should be right they can't do those types of things so so the the loan then is this is like a separate a separate thing so if you if you finance the same kind of idea here if you finance the equipment you still own the equipment you're going to put it on the books at the cost of including the amount that you financed and then you're going to have to deal with the financing which of course means that you're going to pay back the loan in the future and the interest on the financing which is the rent in essence on the purchasing power that you used to buy the the freezer in this case so that you can make revenue selling ice cream the rent on that the interest may also be deductible as well as a business expense right so other property so obviously if you if you traded in an old freezer for the new freezer or something like that then that that's kind of part of what you paid for it there could you might think of that if you traded anything if you gave them a car for the freezer or something like that you're still paying them and you'd have to then figure out how much it costs given the fact that you kind of bartered in a situation or services if you gave them free ice cream for life for whatever you have to value the value that or something so exception you can elect to deduct state and local general sales tax instead of state and local income taxes as an itemized deduction on schedule a form 1040 if you make that choice you cannot include those sales tax as part of your cost basis now this gets a little bit messy because remember for just normal taxes for schedule a you might be able to deduct sales tax now the sale the sales tax would only be deductible if you had greater if you had greater itemized deductions than the standard deductions and usually if you're in a state that has income tax like california or new york you're more likely to then take the incomes tax as opposed to the sales tax but if you live in a state that has sales tax as their private new primary revenue generation source then then you might be able to deduct the sales tax now when you make a big purchase of something like a freezer then that could substantially increase the sales tax so then the question should i be able to get the sales tax like on a schedule a or what would i be able to take it on the schedule c now there's a kind of a question of which one would be most beneficial if you have to depreciate the freezer over a long period of time and you had to include the the sales tax on the schedule c if you had to depreciate the sales tax then you might not get a benefit until the useful life of the freezers is taken up over five years if for some if somehow some way you could separate the sales tax from the cost of the freezer and deduct it get the tax benefit in the current year then in some cases that might be beneficial it's more of an unusual situation assumed debt i mean so in general you would think normally though the sales tax would be part of the cost of the freezer that you'd have to include in the cost and depreciate over the life okay so assume debt if you buy property and assume or buy subject to an existing mortgage or other debt on the property your basis includes the amount you pay for the property plus the amount of the assumed debt example you make twenty thousand dollar down payment on property and assume the seller's mortgage of one hundred and twenty thousand so your total cost is one hundred and forty thousand the cash you paid plus the mortgage you assumed so settlement costs the costs of real property also includes certain fees and charges you pay in addition to the purchase price these are generally shown on your settlement statement and include the following so oftentimes when you buy like real estate for example if you're buying a business building or something like that then you've got all the costs related to the purchasing process which you would think would also need to be included in the cost of the building that you purchased or the property that you purchased which you might then have to to kind of deviate or allocate between land and building so you got legal and recording fees you got abstract fees service charges owners title insurance amounts the seller owes that you agree to pay such as back taxes or interest recording recording or mortgage fees charges for improvements or repairs and sales and commissions so for fees and charges you cannot include in the basis of property see real property publication five five one real property of real estate obviously is a is a more complex situation oftentimes due to the dollar amount and the complexity with the purchasing of real estate so other basis other basis usually refers to basis that is determined by the way you receive the property so for example your basis is other than cost if you acquire the property in exchange for other property as payment for services you performed as a gift or as an inheritance so if you acquired property in this or some other way see publication five five one to determine your basis so notice that the basis if it was an arms length transaction if you went out and bought a forklift or something like that it's a pretty straightforward type of situation to determine the basis but what if you what if you had a had a basis like you bought something from like like a related person or something like that then the transaction might not be an arms length transaction what if you were gifted the property from a parent or something like that then you might be using it in the business and whatnot but what it's going to be the basis at that point in time what if you inherited the property so once again you didn't buy the property so you don't really have the price that you need for the basis so so you're going to have to think about well what's going to be the basis going to be so like if it was gifted to you for example you might assume then that the basis might be kind of related to the basis of the person who gave you the gift or something like that could be the case you want to dive into that do more research publication 551 if you inherited the property then you have a kind of a weird situation because like if the property was part of the estate of the person that died then it could be subject if they're wealthy enough to an estate tax the death tax meaning they already pay taxes on it not as an income tax but as an estate tax or death tax and therefore when you get it you would think you would get a step up in basis which is usually a good thing right we would like to like if someone gave gave us property or we inherited property I would like that like they gave me let's say they gave me a business building I would like the business building to if I had a choice between the business building having a hundred thousand dollar basis or a thirty thousand dollar basis the one hundred thousand dollar basis would be better and I didn't have to pay for it I just got it for free but I would still like to have the basis that I can then allocate and depreciate over time or at least if I sold it in some future point the gain would be less or the loss would be greater if I had a higher basis so the higher basis is usually good so if it was an inheritance do you get a step up in basis at the point in time that the death happened if it's a gift do you have to take on the basis of the prior person which might be lower than the current fair market value those questions kind of come up so property charge from personal use if you held property for personal use and later use it for your business or income producing activity your depreciation basis is the lesser of the following so now you have something let's say you had you know a home or something or whatever something that you're using for personal use and then you converted it to business property well you're left in the same problem here I don't know what the cost is anymore because when I bought it it cost something different than the current fair market value when I transformed it from personal to business property so one the fair market value of the property so it's the lesser of one the fair market value of the property on the date of the change in use meaning when you converted it to business or two your original cost or other basis adjustments as follows a increase by the cost of any permanent improvement or additions and other costs that must be added be decreased by any deductions you you uh claimed for casualty and theft losses and other items that reduced your basis so in other words you're you're transforming something that was personal into business property it's a it's a something you're going to depreciate you would think it would make sense from a tax standpoint they would want you to put it on the lesser of the fair market value meaning the cost at this point in time which usually you would expect to be lower than what you paid for it because most things go down in value except real estate which could go up in value that's why it's the lesser of the fair market value or your original cost or other basis adjusted by a and b below okay so example several years ago nia paid 160 000 to have a home built on a lot that cost 25 000 before changing the property to rental use last year nia paid 20 000 for permanent approved improvements to the home and claimed a two thousand dollar casualty loss deduction for damage to the house so land is not depreciable so nia includes only the cost of the house when figuring the basis for depreciation purposes so the adjusted basis in the house when nia changed its use was 178 000 which is the 160 000 plus that's the what she paid for it 160 plus the 20 000 so 20 000 for for the improvements minus the 2000 casualty loss that she had so on the same date the property the property had a fair market value of 180 000 so 180 000 is greater than the 178 000 and we're taking the lesser of in this case so of which but then 15 000 was for land and 165 was for the house so now we have to break it out between the land and the house so the basis the basis for depreciation on the house is the fair market value because now we took the 180 000 for both the building and the land and 15 000 was for the land so now that reduces down to the 165 000 so now the lesser of the two the 165 000 or the 178 000 is of course the 165 000 and that's the one that be used so because it is less than nia's adjusted basis okay property acquired in a non-taxable transaction generally if you receive property in a non-taxable exchange the basis of the property you receive is the same as the adjusted basis of the property you gave up special rules applies to determining the basis and figuring the maker's depreciation deduction and special depreciation allowance for property acquired in like kind exchange or involuntary conversion so those are two kind of special situations that you can dive into in a lot more detail like kind exchange type of situation or involuntary conversion for example the government coming in and saying we need this property for a particular freeway or something and telling you telling you that is what it is so see like kind exchange and involuntary conversions under how much can you deduct in chapter three and figuring the deduction for property acquired in non-taxable exchange so you can take a look at the publications here on chapter three and chapter four if you want to dive into that in more detail find that on the iris website so there are also special rules for determining the basis of maker's property involved in a like kind exchange or involuntary conversion when the property is contained in a general asset account so you can see how to use general asset accounts in chapter four of the publication if you want to dive into that in more detail adjusted basis to find your property's basis for depreciation you may have to make certain adjustments increases or decreases to the basis of the property for events occurring between the time you acquired the property and the time you placed it in service these events could include the following installing utility lines so paying legal fees for perfecting the title so settling zoning issues you can see most of these of course are on real estate type of type of property and the question is are these types of things that need to be included in you know the basis or not as you get the property set up and ready for business use receiving rebates incurring a casualty or theft loss for a discussion of adjustments to the basis of your property you could see adjusted basis in publication 551 if you depreciate your property under makers you may also have to reduce your basis by certain deductions and credits with respect to the property for more information see what is the basis for depreciation chapter four of the publication basis adjustments for depreciation allowed or allowable you must reduce the basis of property by the depreciation allow or allowable whichever is greater so notice when we're depreciating the asset depreciation is good we want that we want to be able to take the depreciation because that's an expense unforeseeable expenses and as we take the depreciation we decrease the adjusted basis which is like the adjusted cost we want the adjusted cost to be as high as we can right so we're but we're reducing the asset in essence the basis the property that we have and we're expensing the cost so so again we like the expense but it also reduces the asset right so depreciation allowed is depreciation you actually deduct from which you've received a tax benefit depreciation allowable is depreciation you are entitled to deduct so you want to make sure to not give up your capacity to deduct the depreciation so if you do not claim depreciation you are entitled to deduct you must still reduce the basis of the property by the full amount of depreciation allowable that would be not good because that would mean you could have depreciated it you didn't get the benefit of depreciation and you had to reduce the basis the adjusted cost which means you don't get the depreciation in the future and when you sell it you're going to have more of a gain or less of a loss at the point of sale so if you deduct more depreciation than you should you must reduce your basis by any amount deducted from which you received a tax benefit the depreciation allowed so how do you treat repairs and improvements if you improve depreciable property you must treat the improvement as a separate depreciable property so now you didn't just repair it because if you've repaired it you would bring it back to its normal state like if you just repaired the roof but if you put on a full new roof you improved it you've extended the useful life then you might have to depreciate that should you just increase the cost of the building or the adjusted basis of the building no you put it on the books generally as another asset that has another you know useful life for an improvement so improvement means in addition to or partial replacement of property that is better meant to the property restores the property or adopts it to a new or different use and note we do use the term they have the the term restore the property here so you can get into messy situations in terms of is this something that it's a repair or is this something an improvement as a general rule you would like to be able to record something as a repair easily repaired because then you would get the depreciation in the year of the repair as opposed to having to record it as an improvement which means you have to depreciate it over a long period of time and if you're talking about real estate that could be quite a long period of time so it's a quite significant difference and worth looking into when you're doing the substantial improvement to see whether or or repair to see whether it can be qualified as a repair or improvement so c-section 1.263 a-3 of the regulations for more information you generally deduct the cost of repairing business property in the same way as any other business expense however if the cost is for a betterment to the property to restore the property or to adopt the property to a new or different use you must treat it as an improvement and depreciate it so example you repair a small section of section on one corner of the roof of a rental house you deduct the cost of the repair as rental expense so now you're not repairing the whole roof if this is a common example right the roof is always an issue so you're just trying to plug up the hole and and bring it back to restore it that's just a repair not an improvement however if you completely replace the roof the new roof is an improvement because it it is a restoration of the building so in other words you've kind of extended the useful life of the building beyond what it was before is one way you might think of it and therefore it could be an improvement that's much worse because you don't get to deduct the whole cost of the roof in the first year but you might have to appreciate it over a long period of time because it's real estate so you depreciate the cost of the roof now so do you have to file form 4562 use form 4562 to figure your depreciation for depreciation and amortization attach form 4562 to your tax return for the current tax year if you are claiming any of the following items so you got section 179 deduction which we'll talk about in future presentations for the current year or a section 179 carry over from a prior year c chapter 2 for information on section 179 depreciation for property placed in service during the current year depreciation on any vehicle or other listed property regardless of when it was placed in service c chapter 5 for more information on listed property we might talk about that more in the future a deduction for any vehicle if the deduction is reported on a form other than schedule c that's the normal small business schedule that's the form schedule c form 1040 amortization of cost if the current year is the first year of the amortization period depreciation or amortization on any asset on a corporate income tax return other than form 1120 s us income tax return for an s corporation regardless of when it was placed in service