 Income tax 2022-2023, depreciation overview. Let's do some wealth preservation with some tax preparation. Most of this information comes from publication 946, have a depreciate property tax year 2022. You can find on the IRS website IRS.gov IRS.gov looking at the income tax formula where focused on line one income remembering the first half of the income tax formula is an essence and income statement, although just an outline of scaffolding other forms and schedules flowing into it, one of them being the Schedule C. It being an income statement in and of itself having business income minus business expenses, the net business income in essence flowing into line one income of our income tax formula. This is the form 1040, noting the Schedule C would flow into Schedule 1, which would then flow into page one of form 1040 line eight. 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. We see here, this is the Schedule C profit or loss from business in essence and income statement, which has income and expenses. We're focused on the expenses here and we're focused primarily on or exclusively on we're focused in the depreciation expense. The depreciation expense is going to be an accrual type of concept. It's one of those concepts where even if you're using a cash based system, we have to deviate from that cash based system, put the asset on the books as an asset as opposed to expensing it when we purchase it. So for example, if you're on a cash based system and you buy a large piece of equipment, then generally even if paying cash for that equipment, we can't just expense it as equipment expense, but rather usually have to put it on the books as an asset and then depreciate it not according to generally accepted accounting principle depreciations, but rather in accordance to whatever the tax code says we have to do with regards to depreciation. There's two rules between normal accounting depreciation and tax depreciation being quite different, meaning depreciation from an accounting standpoint would try to allocate the cost of the thing that was purchased over the useful life that it was used in trying to accommodate the matching principle, meaning we want to be depreciating the item, expensing it and allocating the expense to the same period in which it was used consumed to generate revenue. Now if you're on a cash based system, we usually record the expense when we pay the cash, but that usually lines up pretty close to the similar concept of an accrual based system for most transactions because the cash is usually spent in an area close to when we actually consume the expense to generate revenue and it's easier to track the cash, but one reason we might have to deviate from that cash based system in this case is because it's such a big difference between when we paid for the equipment and when we actually used the equipment to generate revenue. If I bought a building that I'm going to use for 30 years into the future and I just deducted like $100,000 in the year one for the purchase of the building, then that's a substantial deviation from the general concept that we would like from an accounting standpoint, which is to match the consumption of the item to when it was used to generate revenue. Now, the tax code, that's a justification in terms of why for taxes we would have to deviate to an accrual basis method, but that's a bookkeeping kind of argument because on the tax side of things, they might have us put it on the books as an asset, but still give us in essence the full depreciation using something like an accelerated method, double declining balances, an accelerated method, as well as front loading with a 179 deduction, for example, or special depreciation. These are popular things for the lawmaker. Lawmakers went crazy because they allow us to depreciate more in the front years and the argument is that that stimulates the economy. Now, we've got this big difference between depreciation for bookkeeping, which has a different goal to try to make the books accurate to make future decision making on and taxes, which kind of uses that same concept to try to get to an accurate income to charge taxes on, but also tries to adjust our behavior by making adjustments to that general concept to try to stimulate the economy or do whatever they're trying to do. OK, so that said, let's see what's new for 2022. So what's new? Section 179 deduction dollar limit. So we'll dive into 179 in a lot more detail in future presentations. This is just what is new for 2022. Here, this is one of those front loading things where they might allow you a bigger amount of the depreciation in year one. So for tax years beginning in 2022, the maximum section 179 expense deduction is $1,080,000. This limit is reduced by the amount by which the cost of section 179 property placed in service during the tax year exceeds $2,700,000. Also, the maximum section 179 expense deduction for sport utility vehicles placed in service in tax years beginning in 2022 is $27,000. So there's a big difference in terms of the limitations. When we get to the sport utility vehicles because of the vehicle limitations, which we'll we'll dive into later. Depreciation limit on business vehicles. The total section 179 deduction and depreciation you can deduct for passenger automobile, including a truck or van you use in your business and first placed in service in 2022 is $19,200. If the special depreciation allowance applies or $11,200. If the if the special depreciation allowance does not apply, see maximum depreciation in chapter five. So we'll talk about depreciation methods, what method you have to use to depreciate and then we'll dive into 179 special depreciate and special depreciation concepts as well as limitations for certain types of property such as automobiles where the government is is skeptical of for some purposes and you know for good reason you would think. So what's new for 2023? So not tax year 2022. If we move on and think about what's going ahead in 2023, sometimes it's useful to think about the crossover between the two years so you could do some planning between the two. Section 179 deduction dollar limits for tax years beginning in 2023, the maximum section 179 expense deduction is $1,160,000. This limit is reduced by the amount by which the cost of section 179 property placed in service during the tax year exceeds $2,890,000. Also, the maximum 179 expense deductions for sport utility vehicles placed in service in tax years beginning in 2023 is $28,900. Now when you're learning the tax code, just note that certain types of things that you would expect to basically be rolling forward in the future will be adjusted due to increases in inflation would be the general idea. So you would expect the concept to be moving forward and then they might have a code in there or a law that's going to have them increasing certain dollar amounts in accordance with inflation if they're going to be items that are expected to continue on into the future. These front loaded depreciation 179 and special depreciation have been quite popular, but you might think at this point in time we've been overheating in terms of the economy. So you would think these are some things that are on the table that they might stop the 179 and stuff. You would think if they were trying to stop the economy from overheating. So we'll see what they do going forward to be interesting. So phase down of special depreciation allowance. The special depreciation allowance is 80% for certain qualified property acquired after September 27, 2017 and placed in service after December 31st, 2022 and before January 1st, 2024 other than certain property with a long production period and certain aircraft. So the special depreciation allowance is also 80% for certain specified plants bearing fruits and nuts planted or grafted after December 31st, 2022 and before January 1st, 2024 sees certain qualified property acquired after September 27, 2017 and what is qualified property later. Okay. So for more information, you can take a look at some other publications. Obviously depreciation methods kind of dovetail on a lot of other types of topics that we can dive into some of which we've talked about some of which we're not going to go into too much more detail, but a car. So a car is going to, you can look at other sources such as 463 travel gifts and car expenses because obviously that relates to like the standard message versus the mileage method and what kind of things are deductible and should you be depreciation versus taking a mileage method and so on. Residential rental property. So 527 residential rental property is a publication. You might want to take a look at there. Obviously rental property has its own huge host of issues one of which is depreciation can be involved with. Office space in your home. So you can also take a look at publication 587 business use of your home. So when we're talking about your home if you own the home then you might have depreciation as part of the office use in addition to other things like utilities and so forth. So this is just one component that kind of is part of all that stuff. If you're renting then you won't own the property so you won't have depreciation but you might still have home office expenses. Farm property. So you can see publication 225 farmers tax guide farming the whole farming industry often has differentiations between other types of industries because of the nature of the farming industry and certain needs with regards to it. So it's a whole kind of animal in and of itself. So introduction. So depreciation is an annual income tax deduction that allows you to recover the cost or other basis of certain property over the time you use the property. So in other words, you got property it's business property under normal kind of income tax deductions rules. You would expect if you consumed something you bought something for example and you're consuming it in order to generate revenue you should get that as an ordinary and necessary business expense. But if you're buying something that you didn't consume but you plan on consuming into the future it's really more of an investment. So if I bought a forklift I didn't consume the forklift today I'm gonna use it for the next five years or whatever. So I should on an accrual basis or just conceptually you would think that you wouldn't get the deduction until you consume the forklifts and allocate the cost over the useful life of the forklift. That's the standard accrual concept but there will be exceptions in the tax code with accelerated depreciation methods and 179s and special and so on. So the tax code is weird. So it is an allowance for the where and tear deterioration and obsolescence of the property. So most property you buy it goes down in value equipment, furniture, you buy it it's gonna go down in value you're gonna have to throw it away at some point in time or else revamp it, refix it, refurbish it or whatever you gotta do. The exception being usually real estate because real estate although you still have to keep it up at least the building part as opposed to the land part it could go up in value for other reasons but it just goes up in value. So real estate is the odd ball most other pieces of equipment you expect them to go down in value over time and therefore you allocate the cost as you consume those items to help you generate revenue that's the concept of depreciation. So this chapter discusses the general rules for depreciating property and answers the following questions what property can be depreciated? Obviously we wanna and we also you might rephrase that question is what property do I have to put on the books as an asset and depreciate as opposed to expensing at the point in time I purchase it from just simply a bookkeeping standpoint what property cannot be depreciated? So what property do I not have the capacity to depreciate? You also might ask what property don't I have to depreciate but possibly get an expense at the point in time I purchase it as a normal business expense, right? And then when does depreciation begin and end? So when do I start the depreciation? Seems pretty straightforward when you buy the property but oftentimes if you buy it like in the middle of January or the middle of even the middle of January you might have like a half year convention under the rules of makers rules and whatnot meaning they kinda act like you purchased it in the middle of the year which makes the calculation a little bit easier. Okay and then what method and obviously when does it end? So there's gonna be a useful life and we're gonna have to determine what the useful life is so how when does the depreciation end? We base all the depreciations on it like the straight line is the first method you wanna think about in your mind and then all these deviations makers, double declining balance half year convention, half month convention are all just variations on the standard concept of taking a piece of property and just basically dividing it on biased useful life straight line method and allocating that out, right? But now we've got all these funny things that are happening because sometimes it makes sense from a bookkeeping standpoint and sometimes it's just the tax code doing wacky stuff to try to manipulate whoever they're trying to manipulate to do whatever they're trying to make them do or whatever they're doing over there cause they're crazy. So what method can you use to depreciate your property? So which method do you have to use? So we've gotta be in accordance with the tax code. We're not using generally accepted accounting principles. We're not trying to use the method that most accurately allocates our property in accordance to an accrual accounting method for decision making purposes. We're trying to maximize our tax benefits here and therefore we use the tax method that is most appropriate which legally allows us to maximize that. That's our general goal. What is the basis of your depreciable property? So that's gonna be like the adjusted cost of the property. The basis is gonna be our key important component to calculate depreciation. And also if I sell the property it'll also be important to determine what the gain or loss on the sale of property is. Also note that I've been saying that the tax code is different than generally accepted accounting principles. That means you also have a decision from a bookkeeping standpoint. Do you want to keep your books if you're a small business on a tax basis depreciation method which is not ideal for bookkeeping but might be the easiest thing to do so that you don't have two depreciation methods or do you want to have your bookkeeping depreciation method be better for bookkeeping purposes like a straight line or something like that. And then the tax code doing whatever the wacky stuff the tax code does and that would mean that you would have different depreciation methods for the two meaning you'd have to make tax adjusting entries in essence to properly account for your books. Now most of the time no matter which method you use you're not gonna account for it in your software oftentimes as a small business. QuickBooks doesn't often automatically do like depreciation methods. You do adjusting journal entries and the depreciation schedules are usually something that could often be done in the tax software. Tax software often has the capacity to do both book and tax depreciation methods. Therefore, you might wanna make sure you coordinate with your tax professional to help them populate the depreciation in such a way that it will be beneficial for your bookkeeping as well. In other words, if you want them to give you information to help you with your bookkeeping depreciation on a straight line method or something like that you're gonna have to tell them to do that, right? Have two depreciation schedules which they should be able to do oftentimes if they have decent software. So how do you treat repairs and improvements? What about repairs versus improvements? What's the difference between the two? Do I have to put on the books improvements or repairs as generally if you are repairing something like you're repairing the roof of a building then you're restoring it to its original structure. Therefore, you could just expense it usually but if you're improving it, you're revamping the whole thing making it something different or better than it was before instead of just bringing it whole, making it whole again then you have to put it on the books possibly as a fixed asset again. There's some gray area between those two things you might say and most of the times we would like to be able to expense it. If we can instead of putting it on the books as an asset where we have to depreciate it over a long period of time. So there's a whole industries that come up trying to figure out ways that we can have shorter depreciation periods, shorter depreciation lives and be able to expense things as opposed to put them on the books as improvements and so on. So do you have to file form 4562? We'll talk about that. How do you correct depreciation deduction? So what if there's a correction involved? So useful items. So you may want to see publication, other publications you may wanna check out as you're exploring this very interesting topic. You've got 534 depreciating property placed in service before 1987, 535 business expenses. That's the, we've been talking about that in just our general business expenses, right? 538 accounting periods and methods. You've got 551 basis of assets and then you've got forms and instructions. You can take a look at the schedule C, form 1040 profit or loss from business which kind of relates to depreciation cause you might ultimately deduct depreciation on a schedule C if you have a small business for example. Form 2106, employee business expense. You've got form 3115 application for change in accounting method. If you wanna change things up on the accounting method you gotta ask permission for that. Form 4562 depreciation and amortization. So you could take a look at those forms and the related instructions for them. So terms you may need to know as we go through this whole depreciation thing. Adjusted basis. So when we talk about the basis you can kinda think about it as the cost that you're allocating over the useful life and then we've got the adjustments to the cost. So the adjusted basis is where your basis is at which is gonna be used to calculate the next year's depreciation for example and also could be useful when there's a sale or disposal of the property to help determine if there's gain or loss. Note that we usually want our adjusted basis our basis in a sense our cost that hasn't been eaten up we want that to be as high as possible usually. Why? Because if we have a high basis that means that theoretically we have more stuff that I get to depreciate in the future. So in other words, when we buy a piece of equipment if for like $60,000 or $100,000 piece of equipment we would like to depreciate as much in the first year as possible but the more we depreciate the lower the adjusted basis will be. So in a perfect world we'd like to depreciate as much as possible and still have a high basis. Because the high basis means that in the future I can usually depreciate more against it and if I was to sell the item a higher basis means the sales price minus the cost or adjusted basis the gain will be lower, gains are bad for taxes we pay taxes on it so lower gain or a greater loss. So then we have the basis so these terms are obviously somewhat related we got the basis kind of like the cost the adjusted basis being the basis that's gonna be adjusted as time passes commuting like miles, dispositions when we dispose of property planting equipment fair market value often shown as FMV how much if you were to sell something on the market would you receive at a fair market value common term that we need to conceptually use from time to time intangible property, property that you can't kick cause it's not tangible you can't touch it either you can't hit it or anything but it still has value like patents and whatnot listed property placed in service tangible property so you got intangible and tangible obviously absence term interest and useful life so we'll dive into so you can we'll dive into more of these concepts as we start to apply them in context of a discussion so what property can be depreciated you can depreciate most types of tangible property that's the kind you can kick touch whatnot except land land you can't depreciate just as buildings machinery so you can't depreciate land because the idea is that land isn't gonna deteriorate over time everything else does buildings do the equipment deteriorates over time so you can't depreciate land cause over our human lifetimes it should pretty much be the same so you can have depreciate buildings machinery vehicles furniture and equipment now you might ask how am I gonna depreciate the building when I paid for the building and the land that it's sitting on at the same time you know it's as in the one lump sum well you have to break out the portion that you paid for the land versus the building in some way and you would like to lean towards the building portion if at all possible in the appraisal process because that's the part that you get to depreciate which is good for taxes you can also depreciate certain intangible property such as patents copyrights and computer software so if you have these are things that have value but they but they're intangible things that have value due to like law for example so to depreciate the property must meet all of the following requirements it must be property you own so you have to own the property you would think that would be fairly straightforward but leases get a little bit messy because sometimes you have a lease that inform is in lease but in actuality or in structure it's a lease but in actuality you basically own it right it's a capital lease that we might deal with so it must be used in your business or income producing activity so you're not talking about your yacht that you just hang out with and just cruise around with because you're not using that for business I know you have some business clients on it sometimes but maybe it's probably might not be business related so it's gotta be business related things that's the point it must have a determinable useful life you gotta so you might not know exactly what the useful life is how long it'll last but we have to make some estimate the tax code will kind of force us to use whichever useful life they think is appropriate it must be expected to last more than a year so if you're gonna consume it in a year you would think you would get to just expense it if it wasn't a normal ordinary and necessary business expense the point is that you're gonna get usefulness out of it multiple years into the future which is why we would depreciate it as opposed to expensing it in the first year generally so property you own to claim depreciation you must usually be the owner of the property you are considered as owning property even if it is subject to a debt so other things people often say is well you hear this with people's homes that's not usually their business property unless they have a home office but with the home people say I don't own my home the bank owns 80% of the home that's not technically true it's kind of one of my little pet pee it kind of annoys me when people say that a little bit because sometimes they're joking and that's fine but sometimes it's actually serious I think people actually take this seriously now and there's a difference there's a difference between owning the property like a home for example and having a loan to the bank of 80% of it then the bank owning the home and you can tell that difference because like if the bank came to your front door and they asked you to paint your house blue or something they don't get to say that they don't have any say over what color to paint they don't get any say on what your driveway looks like what kind of plants you're gonna put in the yard or anything like that they don't own your home they don't have any rights to tell you what to do on the home what they do have is the capacity to take action if you don't fulfill your contract to pay them on time that's a different thing you don't have to have a committee with the bank to ask about whether or not you should have a garden in your backyard or anything like that so there's a difference you could have a debt on something but still own it and depreciate it if you took out a loan for business property then you're gonna be paying interest on the loan as well so example one so you made a down payment to purchase rental property and assume the previous owner's mortgage so you own the property and you can depreciate it example two you bought a new van that you will use only for your courier business you will be making payments on the van over the next five years you own the van and can depreciate it okay leased property here's where it gets messy because sometimes people they try to structure the lease as a lease even though it's actually in essence basically a purchase and why would they do that oftentimes for tax reasons or liability reasons or something like that so now you have situations where you gotta think okay it's a lease but now it's a capital lease because they structured it as a lease but it's basically a purchase because it looks pretty much like a purchase so you can depreciate lease property only if you retain the incidence of ownership in the property explained below so this means you bear the burden of exhaustion of the capital investment in the property therefore if you lease property from someone to use it in your trade or business or for the production of income generally you cannot depreciate its cost because you do not retain the incidence of ownership so if it's a normal ordinary lease you lease the equipment and it's not your equipment then you would think that you would just be able to expense the cost of the lease payments that you are making as you make the lease payments as opposed to putting it on or treating the lease as a purchase that would be the normal process but if in essence you're guaranteed to have that equipment for like 80% of the youthful life of the equipment to where the lease is structured or if you're guaranteed to pay like 100% or a large portion of the price of the equipment by the time the lease term is up or if at the end of the lease term you are gonna be able to have the option quotes option quote to buy the property for like a dollar which is a very insignificant dollar amount to be paying for a piece of property it looks a lot like a purchase in actuality and not an actual lease in those cases so if you can however depreciate any capital improvement you make to the property so you can see how you treat repairs and improvements later in this chapter and additions and improvements under which recovery period applies in chapter four if you lease property to someone if you lease property to someone you can generally depreciate its costs even if the lease E, the person leasing from you has agreed to preserve, replace, renew and maintain the property however if the lease provides that the lease is to maintain the property and return to you the same property or its equivalent in value at the expiration of the lease in as good condition and value as when leased you cannot depreciate the cost of the property so incidents of ownership incidents of ownership and property include the following so the legal title to the property the legal obligation to pay for the property so obviously when you're trying to say is it your property title it's gonna be a good indication you obligation to pay for the property you pay for it that would be a good indication cause you actually paid for the property the responsibility to pay maintenance and operating expenses the duty to pay any taxes on the property so if you're the one paying the property taxes that would be somewhat of an indication that it's your property the risk of loss if the property is destroyed condemned or diminished in value through obsolescence or exhaustion so life tenant generally if you hold business or investment property as a life tenant you can depreciate it as if you were the absolute owner of the property cause you have it basically for life however see certain term interests in property under exception property later that's somewhat of an unusual situation corporative apartments if you are a tenant stockholder in a corporative housing corporation and use your corporative apartment in your business or for the production of income you can depreciate your stock in the corporation even though the corporation owns the apartment so in that case that's a form of business structure where you're buying you're basically buying property but it's structured kinda like a corporation kind of structure so you but you still kind of own your property that you're living in in that sense it's not like you're renting it that's another kind of somewhat unusual exception situation