 Income tax 2022-2023, Baker's depreciation. How is the depreciation deduction figured? Part number one, 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. Looking at the income tax formula focused online, one income, remember in the first half of the income tax formula, in essence, an income statement, although just an outline, other forms and schedules flowing into these line items. One of those, the Schedule C, having business income minus business expenses, giving the business net income flowing from the Schedule C to line one of income on the income tax formula. Looking at the page one of the Form 1040, remember in the Schedule C, we'll flow into the Schedule I, flowing into page one of Form 1040, line number eight. The Schedule C is a profit or loss from business outlined in an income statement format, having income and expense sections. We're focused on the expense side of things and more precisely on the depreciation side of things, remembering that even if you're on a cash-based system, you will generally have to deviate. 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. To an accrual concept, when it comes to property, plant and equipment, depreciable assets, and now we're focusing in on those main categorizations of depreciable assets, generally those makers standards, and we have to layer on top of that the concepts of using, say, 179 deductions and the special depreciation, which we talked about in prior presentations. Okay, so how is depreciation deduction figured in any case then? To figure your depreciation deduction under makers, which is the standard depreciation kind of method, you first determine the depreciation system, property class, placed in service date, basis amount, recovery period, convention, and depreciation method to apply to your property. That sounds quite complex, but it's really, if you have some concept of depreciation, like a straight line type of method as your baseline of what you're doing, and then you alter that to comply with the tax code, it's not too bad really. So you're gonna first determine the depreciation system that you're going to be using. So normally if you're in practice or you're usually gonna be saying, okay, here's this item, can I just expense it at this point in time as supplies or something, or do I have to put it on the books as a depreciable asset? If you have to put it on the books as a depreciable asset, then you gotta think about what kind of depreciation system you're going to be using. Oftentimes most types of equipment are gonna be like a maker's depreciation system. Oftentimes the property class, because remember that you do not have as much leeway as you would under a bookkeeping kind of system or even generally accepted accounting principles from the accounting side to choose the lifespan that you're gonna depreciate over or the method that you're going to use, you have to fall into the categories of the tax code, and that in part is due to the incentives being different for taxes than financial reporting purposes. Our goal is to lower our taxes as much as possible, which means we wanna depreciate as much upfront as we can as a general rule. So we gotta find what class our property falls into. Placed in service dates, so we need to know when we put it in service, close to when we bought it oftentimes, but when we put the thing in service, the basis amount, in essence, the cost of it basically, because that's the cost that we're gonna be allocating over, that's the more simplified term for basis, but it could be a little bit more complex in certain cases, but the general idea, and then the recovery period, which is going to be determined in part by the property type, the property class, because that's gonna be dictated to us in terms of the system we used and the property class that we're gonna have, so how long, how many years, are we gonna depreciate this over? And then the convention, which also is basically gonna be dictated by the conditions in place that we've chosen before, meaning is it half year, is it mid month, is it mid quarter, and depreciation method that will apply to double declining 150% or the straight line oftentimes, we're gonna choose the default, which will be the highest depreciation method that we can take, which would be the double declining if we have access to that usually, and then there's 179 special that kinda tops on top of that. All right, so then, you are ready to figure your depreciation deduction. All right, tax software helps with this, of course. You can figure it using percentage tables provided by IRS or you can figure it yourself without using the tables. Again, software is usually gonna be necessary when we get depreciable items because they'll help us to track those depreciable items on a fixed assets worksheet depreciation schedules. So using maker's percentage table to help you figure your depreciation under makers, the IRS has established percentage tables that incorporate the applicable convention. And depreciation method, these percentage tables are in Appendix A near the end of this publication. Sometimes that's useful to project out into the future if you're trying to think about whether you're gonna use, say, double declining or whether you're gonna use a straight line if you wanna change the convention or something like that, as opposed to just picking the default of double declining and hopefully helping the software, helping you to calculate it because the tables help you to kind of see out into the future possibly a little bit more clearly than software unless you have software designed specifically for projections. All right, which table to use? Appendix A contains the maker's percentage table guide which is designed to help you locate the correct percentage table to use for depreciating your property. The percentage tables immediately follow the guide. So rules covering the use of the tables, the following rules cover the use of the percentage tables number one, you must apply the rates and the percentage tables to your property unadjusted basis. Number two, you cannot use the percentage tables for a short tax year, see figure in the deduction for a short tax year later for information on the short tax year rules. Number three, once you start using the percentage tables for any item of property, you must generally continue to use them for the entire recovery period of the property, consistency once again, being a standard rule for tax as well as accounting in general. Four, you must stop using the tables if you adjust the basis of the property for any reason other than A, depreciation allowed or allowable or B, an addition or improvement to that property that is depreciated as a separate item of property. All right, basis adjustments other than those made due to the items listed in four include an increase in basis for the recapture of a clean fuel deduction or credit and a reduction in basis for a casualty loss. So those are kind of more unusual type of situations where you might have some other benefit that is happening and you might have some interplay like we saw in prior presentations between the basis, the adjusted cost that you're allocating, the basis being something that you're gonna get a deduction for hopefully at some point in the future. And then if they give you some other benefit like a credit or something, that could adjust the basis. Otherwise you'd kind of be double dipping, getting an expense and a credit. All right, so basis adjustments due to recapture of clean fuel, vehicle deduction or credit. I'm not gonna go into that in detail because it's somewhat of an unusual situation. Depreciation methods. So you got the GDS, the methods using 200% double declining. So notice this is gonna be a maker's depreciation. The GDS under makers, 200% DB is that double declining that accelerated method, the one by default we would typically be using generally. So types of property, non-form, three, five, seven and 10 year property. So that's some of the more common ones right there. And then the form, three, five, seven and 10 year property there. Benefit provides a greater deduction during the earlier years, which is what we want. That's why we're gonna do it for the default on our side for the taxpayer. Usually that's the benefit. Changes to straight line when that method provides an equal or greater deduction. Meaning if you calculate the double declining balance, it's kind of a funny calculation because you're kind of taking the straight line method and doubling it and then using a double declining percent instead of a straight line percent, which doesn't work out to be perfect. So then you kind of at the tail end of the depreciation system, you kind of convert, you might convert back to straight line to get it to fully depreciate exactly evenly by the end point, which is a little strange, but it works. GDS using 150 double declining. So this is for form three, five, seven, 10 year, all 15 and 20 year property, non-form three, five, seven or 10 year property and form three, five, seven or 10 year. So provides a greater deduction during the earlier recovery periods, greater than straight line that is at least, and then it changes the straight line same thing. And then you got the GDS using straight line, non-residential rental property and residential rental property, those large items, real estate and essence being depreciated over long periods of time, now not getting the benefit of the double declining wanting instead that straight line method, trees or vines, bearing fruits, water, utility, all three, five, seven, 10, 15 and 20 year property. There's an appendix to that property for which you elected section 168 and it provides an equal yearly deductions. That's just kind of a recap of it. And so our general rule, we'd like to get more upfront if we can unless we have some reason other than to do that, in which case we might try to elect to go straight line if we have the option to do that. And that would only happen if we think, for example, we're gonna have more income in future years, which means we might get more tax benefit because our taxable income might be higher. And then you've got the ADS using the straight line. Okay, basis adjustments due to casualty loss. If you reduce the basis of your property because of a casualty, you cannot continue to use the percentage tables for the year of the adjustment and the remaining recovery period, you must figure the depreciation yourself using the property's adjusted basis at the end of the year, see figuring the deduction without using the tables later. Example, so on October 26, 2021, Sandra and Frank Elm, calendar year taxpayers, bought and placed in service in their business a new item of seven year property. It cost $39,000 and they elected section 179 deduction of $24,000. They also made an election under the 168K7 not to deduct the special depreciation allowance for seven year property placed in service in 2021. Their adjusted basis after the section 179 deduction was 15,000, which is the 39,000 minus the 27,000 of the 179. So they figured their maker's depreciation deduction using the percentage tables for 2021, the maker's depreciation deduction was $536. So in July, 2022, the property was vandalized and they had a deductible casualty loss of $3,000. So Sandra and Frank must adjust the property's basis for the casualty loss. So now if there was a casualty loss related to a piece of property, you would expect that if you're gonna expense it, then that you might need to decrease the basis because for the property, right? At the same time so that you don't, otherwise you'd be double dipping because you would have got the loss and you'd get the depreciation at some point in the future. So Sandra and Frank must adjust the property's basis for the casualty loss so they can no longer use the percentage. What percentage of Hayden Panatier is dwarf tables? Their adjusted basis at the end of 2022 before figuring the 2022 depreciation is 11,464. They figured that amount by subtracting the 2021 maker's depreciation of 536 and the casualty loss of 3,000. From the unadjusted basis of 15,000, they must now figure their depreciation for 2022 without the percentage tables. All right, so figuring the unadjusted basis of your property, you must apply the table rates to your property's unadjusted basis each year of the recovery period. So that's how the tables work. So the tables are gonna be set up to give you kind of an easy number to multiply times the unadjusted basis otherwise doing this double declining calculation becomes a little bit more complex because you gotta kind of figure out like the book value each period to multiply times the double declining rate and then figure if it's greater than the straight line and so on. So the tables are useful if you're trying to map out the whole depreciation for the whole timeframe. Otherwise tax software is useful for the current year and possibly the future year as well. Unadjusted basis is the same basis amount you would use to figure gain on a sale but you figure it without reducing your original basis by any maker's depreciation taken in earlier years. However, you do reduce your original basis by other amounts including the following, any amortization taken on the property, any section 179 deduction claimed, any special depreciation allowance taken on the property for business property you purchased during the year the adjusted basis is its cost minus these and other applicable adjustments. So normal depreciation now if you're using the tables you've gotta take the cost in essence times these rates on the table to figure out the proper depreciation but then you've got these funny things that happen in particular the 179 and the specials which allow you to get a lot of depreciation in essence or equivalent to depreciation write offs in the year of purchase which messes up the whole table thing. So now you gotta figure out your basis after these items and then basically use the tables if you're gonna use the tables. So if you trade property your adjusted basis is the property received in the cash paid plus the adjusted basis of the property traded minus these adjustments. In my opinion, I think the tables I would use tax software to help me calculate and then often use the tables possibly to double check that calculation and or to do projections out into the future. And then you can kind of use the two software and the tables to see if everything's lining up properly between your projections and what's been calculated in the current year. So makers worksheet. So you can use this worksheet to help you fake your depreciation deduction using the percentage tables use a separate worksheet for each item of property and then use the information from this worksheet to prepare for four, five, six, two. So obviously if you did all this by hand it would be quite complex but it gives you an idea of what is happening and you wanna be able to explain what is happening if you're using software and possibly be able to do projections into the future. So the worksheet, you've got the maker system GDS or ADS property class, date placed in service, recovery period, method and convention depreciation rate a lot of this stuff would be driven in essence by the type of property you're putting in place. And then the defaults that you would choose unless you were electing otherwise such as double declining balance unless you wanted to default to switch to straight line for whatever reason. And then you got the cost or the basis and then the basis divided by the investment use. In other words, if it's not all for business use some of it's for personal use then you'd have to multiply the times the business use percent. You multiply those lines out to get the business use that's now your basis total claimed for section 179 deduction. That's that upfront deduction that you might be able to get which we're gonna take out of the basis cause you got an expense for it when calculating normal depreciation after that 179 special depreciation. Subtract line 10 from line nine this is your tentative basis for depreciation. And then 12 multiply line 11 by the applicable percentage in the special depreciation allowance applies. This is your special depreciation allowance enter zero if this is not the year you place the property in service the property is not qualified property or you elected not to claim special depreciation. Again, special depreciation weird kind of like the 179 that upfront kind of depreciation thing. Then subtract 12 from 11 this is your basis for depreciation. So after getting past those funny depreciations upfront the adjusted basis is now to the point where you can apply the normal depreciation kind of rules which is the maker's table if you're using the tables and then you got the depreciation rate which will give you the multiply that this is your maker's depreciation deduction. Okay, example, you bought office furniture it's seven year property. So you know it's seven year property because it's office furniture and the IRS says that's seven year property. So for $10,000 and placed it in service on August 11, 2022 you use the furniture only for business. So it's a business use you don't have to multiply it times a percentage of personal use or anything like that. This is the only property you placed in service this year you did not elect the 179 deduction so we're gonna take that off the table and the property is not qualified property for purposes of claiming a special depreciation allowance so we'll take that off the table. So your property's unadjusted basis is its cost of $10,000. So we're just gonna be dealing with maker's depreciation here not all this other funny business. So you use GDS and a half year convention to figure your depreciation. You refer to the maker's percentage table guide in appendix A and find that you should use table one A multiply your property's unadjusted basis by basis each year by the percentage for seven year property given in table one A you figure your depreciation using the maker's worksheet as follows. All right, so maker's system it's the GDS system and that's the default unless we choose otherwise the property class is seven years we know that's the case because that we're using the GDS system instead of the ADS and that's what they force us to do we know the date placed in service because that's usually the date we bought it but it might not be it might be a little bit after but usually it's the date we bought it recovery period seven is seven year we know that because it's seven year property which with a GDS system and the method is gonna be 200% or double declining balance with a half year convention we know that's the case because that's the default if we're using a GDS for seven year property unless we elect to do something other than that like a straight line method half year convention is the default unless we purchased a bunch of stuff at the end of the year or something in which case they might force us to do a half quarter convention or something like that or mid quarter or whatever they wanna call it so the depreciation rate is the 0.1429 from the table so cost or other basis $10,000 business percent it's 100% business percent so $10,000 no 179 deduction so still $10,000 no special depreciation still $10,000 multiply that times the 1.1429 gives us the 1,429 for year one or for the depreciation so this is your maker's depreciation deduction so there we have that okay so if there are no adjustments to the basis of the property other than depreciation your depreciation deduction for each subsequent during a subsequent voyage Columbus found year of the recovery period will be as follows so now we've got our table $10,000 property and notice how easy it is to they just gave us these percents here now you might say how did they get these percents well you could do a double declining kind of calculation with a mid-year convention and kind of figure it out but it's a little bit messy to do it that way these tables are quite easy and note what you get here like if I add all this up by the way depreciation over the one, two, three, four, five, six, seven years we got the two, four, four, nine plus the one, seven, four, nine plus the one, two, four, nine plus the eight, nine, three plus the eight, nine, two plus the eight, nine, three plus the four, four, six is the eight, five, seven, one and then I'm gonna add plus the one, four, two, nine I believe there's the 10,000 right it adds up to the 10,000 so we've fully depreciated after that point now again the software would be quite useful to kind of try to match out it should come up pretty close to this it might be a little bit different if they're using a method other than the tables but it should be pretty close the problem with software though is that sometimes you don't have a projection software so you can't see the depreciation that's taken all the way out into the future so these tables are great for projections to see what's gonna happen if I map this out into the future for making decisions like should I take the straight line method or the double declining projecting what my income will be in future periods okay example the following examples are provided to show you how to use the percentage tables and both examples assume the following you use the property only for business so no personal use you use the calendar year as your tax year okay you use GDS for all the property so those are pretty common example pretty common conditions number one you bought a building and land for 120,000 and placed it in service on March 8th the sales contract showed that the building cost 100,000 and the land cost 20,000 so when you buy building and land you usually buy it together at one price and then you have to break out how much was building and how much was land because they have two different depreciations land is not depreciated building is therefore we would like to lean towards stuff being on the building side because we would like to expense it or depreciate it for our taxes although that's reversed for our normal bookkeeping right because everything's flipped on its head for taxes okay so it is non-residential real property the building non-adjusted basis is its original cost 100,000 you refer to the makers percentage table guide and appendix A and find that you should use table A7A March is the third month of your tax year so multiply the building's unadjusted basis 100,000 by the percentages for the third month in table A7A your depreciation deduction for each of the three years is as follows so now we've got our building now notice why they had to basically say that this was a third month because now the tables have to reflect the fact that we no longer are using a mid or half year convention because it's this property it's the real estate which usually uses a mid month convention so now you've got to determine which month it's being purchased in so you can use the proper table so it can calculate the proper amounts so the first three years they're just multiplying by the amounts found in the table again this is quite useful to be projecting out into the future I would also plug it into the software and kind of double check that that first number is accurate so I can see if I'm looking at the right table and I see the first two years at least so I see if I have the right table and if I'm plugging into the software correctly we might do that in future presentations and then use the tables to help me project out further than that into the future okay example two during the year you bought a machine seven year property for $4,000 office furniture, seven year property for $1,000 in a computer five year property for $5,000 you placed the machine in service in January the furniture in September and the computer in October you do not elect the 179 deduction so we're gonna take that off the table focus on makers and none of the items is qualified property for purposes of claiming the special depreciation allowance so we'll take that off the table just looking at makers you placed the 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 so note these kinds of property the seven year and the five year usually have a half year convention meaning we assume they were all bought in the middle of the year which makes it easy but people sometimes trying to cheat the system when they do that meaning they buy everything at the end of the year so that they can get a six month depreciation even though they bought everything in the last month of the year that's so the IRS then says well to stop that from happening if you buy everything in the end of the year we're not gonna give you the mid year convention or the half year we gonna you have to use the mid quarter convention so that you don't have to get as big a benefit so now we bought everything at the end of the year we gotta figure if we have to do the mid quarter convention so the 5,000 basis of so all prior places so the 5,000 basis of the computer which you placed in service during the last three months the fourth quarter of your tax year is more than 40% of the total basis of all property $10,000 you placed in service during the year therefore you must use the mid quarter convention instead of the half year convention bummer, bummer, but whatever you refer to the makers percentage table guide in appendix A to determine which table you should use under the mid quarter convention the machine is seven year property placed in service in the first quarter so you use table A2 the furniture is seven year property placed in service in the third quarter so you use table A4 finally because the computer is five year property placed in service in the fourth quarter you use table 5A or A5 knowing what table to use for each property you figure the depreciation so one of the major points here is that if you use the tables you would have to use a different table if you had to switch from a half year convention to a mid quarter convention because you bought more than 40% of the assets in the fourth quarter of the year so here we have the year, the property, the machine the furniture and the computer for year one and two the basis multiplied by the percentages in the tables gives us the deduction and once again if you plug this into the software the software would hopefully be able to kind of make the calculation as to whether if you do the data input properly it should be a half year convention or a mid quarter convention and then you can double check that to the results that you are getting from from your tables and then again possibly you might use the tables to project out further than two years to the life of the property you know going forward now that you have some confirmation that you have the right tables so we might do some practice problems with software in future presentations