 Income tax 2022-2023. Maker's depreciation. Which recovery period applies? 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, where you can find it on the IRS website, irs.gov, irs.gov. 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. Income tax formula, we're focused on line one, income, first half of the income tax formula, in essence an income statement, but just an outline other forms and schedules flowing into these line items. One, that being the schedule C, having business income minus business expenses, the net business income from the schedule C flowing into line one, income of the income tax formula, form 1040, remember in the schedule C, flows into the schedule one, flowing into page one, 1040, line number eight. The schedule C's called the profit or loss from business has an income statement format, income minus expenses. We are focused on the expenses more specifically on depreciation related to depreciable property that has to be put on the books as an asset, even if using a cashed based system, this being an accrual based concept, and then we're gonna have to allocate that cost in accordance with the tax code, which may differ than bookkeeping concepts related to depreciation. So we're going into the makers, which is one of the major kind of formats of the depreciation continuing on with it here. Okay, so which recovery period applies then? The recovery period of property is the number of years over which you recover its cost or other basis. So the concept here, we have to put it on the books as an asset and then we have to allocate the cost over a number of years of recovery period, in essence, getting the benefit over those number of years. The first way you conceptualize this is usually on a straight lined type of basis, basically just dividing, in essence, the cost over the number of years and you would think that you would have an even amount of expense or deduction over that timeframe and then we'll deviate from that, going possibly to a double declining system and that's what we'll talk about in future presentations, which means you're gonna get more benefit upfront, which does make sense even from a bookkeeping standpoint because some pieces of equipment, you might have more use of them upfront than in later years and then other things don't make sense as much from a bookkeeping standpoint as we talked with the 179 deduction and the special depreciation concepts, for example. All right, it is determined based on the depreciation system, the GDS or ADS, we're using the two systems under makers, remembering that the GDS is the most common generally. So the recovery periods under GDS, the most common system for the makers GDS, under GDS property is depreciated over one of the following recovery periods. So notice we have the property classifications and within the property classifications, you'll recall that a lot of times the name of the property classification is gonna tell you the recovery period, but possibly that might not be the case in all cases, right? So the name of the property class, three year property, we talked and tried to categorize what falls into each of these categories. So the system then you would use would be, is this thing something that falls into the category of something that needs to be capitalized, put on the books as an asset and depreciated or can I expense it in the current year? If you have to depreciate it, then you're gonna find out which is the property class category and within the property class category, that will then tell you the recovery period, which kind of tells you again in the name, but this is the table that the more formal kind of table. All right, so we've got the three year property, very common property types, obviously three years. So if you were thinking about a straight line method, you would think I would just take the basis divided by three years, allocate the cost over those three years. But we'll most likely be using an accelerated depreciation method, but that conceptual concept works to always fall back on the straight line to think about the concept. Five year property, five years, of course, seven year property, seven years, 10 year property, 10 years, 15 year property, 15 years, 20 year property, 20 years, 25 year property, 25 years and residential rental property is at 27.5 years non-residential rental property. Notice these two don't give you the actual years in it. They tell you what it is in essence because it's a more restrictive category. That's the 39 years. And then we talked about what kind of things fall into these property classes in prior presentations. So the GDS recovery periods for property not listed above can be found in Appendix B table of class lives of recovery periods, residential rental property and non-residential real property are defined earlier under which property class applies under GDS. Enter the appropriate recovery period on form 4562. Obviously software helps for this categorization to help us to actual populate the form 4562, make the depreciation tables and then pull that information into the relevant form such as a schedule C. So form 4562 under column D in section B of part three, unless already shown for 25 year properties, residential rental property and non-residential real property. So office in the home. So this is like that special type of situation which dovetails on depreciation. You have an office in your home. If your home is rented, then you might be able to take the portion of the home that is an office and apply the rent to it and you wouldn't have a depreciation thing related to it. But if you own the home, then the question is, well now I should be able to depreciate part of my home that's part of the office and that's where it dovetails in with the home office situation and depreciation. So if your home is a personal use single family residence and you begin to use part or all of your home as an office, depreciate that part of your home as non-residential real property over 39 years, 31.5 years if you begin using it for business before May 13th, 1993. Yes, that's an awfully long depreciation timeframe and that's why remember that some industries when they get into like real estate, they try to say, is there certain types of things that I can categorize as real estate property that might be having to depreciate over a long frame like 39 years versus equipment or something that I might be able to depreciate sooner than that. So in other words, if you have some kind of fixture, if you have something in your office that's kind of part of the like fixed to the wall or something like that, you might have questions about, well, is that something that's part of the, part of the like the real estate or is it part, or is it something I can break out as equipment or something and possibly depreciate it over a lower or shorter timeframe, which means we might be able to get the benefit from it the expense earlier rather than later. That's always what we're trying to kind of keep in mind with these depreciation and the benefits related to them. However, if your own, if your home is an apartment in an apartment building that you own and the building is residential rental property as defined earlier under which property class applies under GDS, depreciate that part used as an office as residential rental property over 27.5 years. And then we've got C publication 587 for a discussion of the tests you must meet to claim expenses. Unforsaken expenses. Including depreciation for the business use of your home. That's a whole nother topic. We might talk about that in another course or section. So home changed to rental use. So now you have a situation it was possibly personal or something or investment and you changed it to a business use. So if you begin to rent a home that was your personal home before, so it was personal before that, 1987, you depreciate it as residential rental property over 27.5 years. Now you do have an issue with the basis to try to figure out what the cost of the home is when you do the conversion, right? So recovery periods under ADS, the less common kind of depreciation method, the recovery periods for most property are generally longer under ADS than are under GDS. The following table shows some of the ADS recovery periods. So note that if we have the choice, we usually want the shorter recovery periods because that's gonna give us a bigger benefit generally because that's the general rule we could take it earlier. Okay, but now we're on ADS property, rent to own property, recovery period, four years, automobiles and light duty trucks, five years, computers and peripheral equipment, five years, high technical telephone station equipment installed on customer premises, five years. Continuing on, we've got high technology, technology medical equipment, five years, personal property with no class life, 12 years, natural gas, gathering line, 14 years, single purpose agricultural and horticultural structures, 15 years, any tree or vine bearing fruits or nuts, 20 years, initial cleaning and grading land improvements, 20 years, I'm not reading the whole thing, initial clearing and grading land improvements, 25, electric transmission property used in the transmission of 69 or more kilovolts of electricity, 30 years, natural gas distribution, 35, non-residential real property, 40, residential rental property, 30, section 1245, real property not listed in appendix B40 and railroad grading and tunnel 50. All right, so the ADS recovery periods for property not listed above can be found in the tables in appendix B if you wanna dive into that in more detail. Rent to own property, residential rental property and non-residential real property are defined earlier. We discussed them in a little bit more detail. There are more unusual situations in a prior presentation. Tax exempt use property subject to a lease. So the ADS recovery period for any property leased under a lease agreement to a tax exempt organization, governmental unit or foreign person or entity other than partnership. So usually in a partnership, there's a partnership. It cannot be less than 125% of the lease term. Additions and improvements. An addition or improvement you make to depreciable property is treated as separate depreciable property. So now you've got your depreciable property and now you're gonna do something to it. We talked in prior presentations about whether or not whatever you do to it can be categorized as a repair, fixing it, bringing it back to wholeness or whether it's something that's gonna improve it extending its useful life or changing what it's gonna be used for. If you're gonna have an improvement, then the questions, well now you have to put it on the books as an asset again, instead of just expensing it and then you're gonna put that generally as a separate component to depreciate over the life. So see how do you treat repairs and improvements in chapter one for a definition of improvements. Its property class and recovery period are the same as those that would apply to the original property if you had placed it in service at the same time, you placed the addition or improvement in service. So it's gonna follow along with the type of property that you are improving in terms of the class of property and therefore the life of the property that you're gonna have to recover it over. And once again, that leads to the kind of question of well, if I have to put the improvement on there and depreciate it over a very long timeframe because of the class of property being used, is there anything I can do that would allow me to classify it somewhere else, which possibly I can depreciate over a shorter period of time. In other words, if I'm installing like a heating and air conditioning or something like that, I mean, do I have to depreciate that over out the life of the building like a really long timeframe or can I call it equipment or something like that? If there's any way I can recategorize it, those kind of questions come up because they could be substantial given very long recovery periods versus shorter recovery periods. So the recovery period begins on the latter of the following dates. The date you place the addition or improvement in service, the date you place and service the property to which you made the addition or improvement. Example, you own a rental home that you have been renting out since 1981. If you put an addition on the home and place the addition in service this year, you would use makers to figure your depreciation deduction for the addition. Under GDS, the property class for the addition is residential rental property and its recovery period is 27.5 years. Ouch, long time to recover that. I'd like to get it sooner if possible, but that's the way it is. So notice the issue here. Like if you were thinking through this in practice, you own a rental home that you have, if you put an addition on the home, so now it's an addition on the home. So you might think of this, if this was something that wasn't an addition, but like fixing the roof or something like that, you might try to be saying, should it be something that's gonna be increased in the value of the home or can I just expense it right now? That's what you'd like to do first. But no, it's an addition to the home, clearly improving the home and therefore you can't just expense it. You have to put it on the books as an asset. So then, and then it says it's 27.5 year property because that's an improvement. That's the depreciation method for that property. You have to use the same kind of rules. So again, ouch, it'd be nicer if I can call it. Well, if I have to capitalize it, can't I capitalize it as like equipment or something and depreciate it over seven years or something? Is there any way I can do that? Obviously not, not in this case, but that's kind of like the mindset that you might have in mind. So 27.5 years because the home to which the addition is made would be residential rental property if you had placed it in service this year.