Chapter 9 Property Acquisition and Cost Recovery

1. Back in Boston, Steve has been busy creating and managing his new company, Teton Mountaineering (TM), which is based out of a small town in Wyoming. In the process of doing so, TM has acquired various types of assets. Below is a list of assets acquired during 2013:

Asset Cost Date Place in Service

Office furniture $10,000 02/03/2013

Machinery 560,000 07/22/2013

Used delivery truck* 15,000 08/17/2013

*Not considered a luxury automobile, thus not subject to the luxury automobile limitations

During 2013, TM had huge success (and had no §179 limitations) and Steve acquired more assets the next year to increase its production capacity. These are the assets acquired during 2014:

Asset Cost Date Place in Service

Computers & Info. System $40,000 03/31/2014

Luxury Auto^† 80,000 05/26/2014

Assembly Equipment 475,000 08/15/2014

Storage Building 400,000 11/13/2014

^†Used 100% for business purposes. .

TM generated taxable income in 2014 before any §179 expense of $732,500 (assume bonus depreciation and the 2013 §179 limitations are extended to 2014).

Required

a. Compute 2013 depreciation deductions including §179 expense (ignoring bonus depreciation).

b. Compute 2014depreciation deductions including §179 expense (ignoring bonus depreciation).

c. Compute 2014depreciation deductions including §179 expense, but now assume that Steve would like to take bonus depreciation.

d. Ignoring part c, now assume that during 2014, Steve decides to buy a competitor’s assets for a purchase price of $350,000. Compute maximum 2014 cost recovery including §179 expense (ignoring bonus depreciation). Steve purchased the following assets for the lump-sum purchase price.

Asset Cost Date Placed in Service

Inventory $20,000 09/15/2014

Office furniture 30,000 09/15/2014

Machinery 50,000 09/15/2014

Patent 98,000 09/15/2014

Goodwill 2,000 09/15/2014

Building 130,000 09/15/2014

Land 20,000 09/15/2014

e. Complete Part I of Form 4562 for part b.

72. While completing undergraduate school work in information systems, Dallin Bourne and Michael Banks decided to start a business called ISys Answers which was a technology support company. During year 1, they bought the following assets and incurred the following fees at start-up:

Year 1 Assets	Purchase Date	Basis
Computers (5-year)	October 30, Y1	$15,000
Office equipment (7-year)	October 30, Y1	$10,000
Furniture (7-year)	October 30, Y1	$3,000
Start-up costs	October 30, Y1	$17,000

In April of year 2, they decided to purchase a customer list from a company started by fellow information systems students preparing to graduate who provided virtually the same services. The customer list cost $10,000 and the sale was completed on April 30^th. During their summer break, Dallin and Michael passed on internship opportunities in an attempt to really grow their business into something they could do full time after graduation. In the summer, they purchased a small van (for transportation, not considered a luxury auto) and a pinball machine (to help attract new employees). They bought the van on June 15, Y2 for $15,000 and spent $3,000 getting it ready to put into service. The pinball machine cost $4,000 and was placed in service on July 1, Y2.

Year 2 Assets	Purchase Date	Basis
Van	June 15, Y2	$18,000
Pinball Machine (7-year)	July 1, Y2	$4,000
Customer List	April 30, Y2	$10,000

Assume that ISys Answers does not claim any §179 expense or bonus depreciation.

a. What are the maximum cost recovery deductions for ISys Answers for Y1 and Y2?

b. Complete ISys Answers’ form 4562.

c. What is ISys Answers’ basis in each of its assets at the end of Y2?

73. Diamond Mountain was originally thought to be one of the few places in North America to contain diamonds, so Diamond Mountain Inc. (DM) purchased the land for $1,000,000. Later, DM discovered that the only diamonds on the mountain had been planted there and the land was worthless for mining. DM engineers discovered a new survey technology and discovered a silver deposit estimated at 5,000 pounds on Diamond Mountain. DM immediately bought new drilling equipment and began mining the silver.

In years 1-3 following the opening of the mine, DM had net (gross) income of $200,000 ($700,000), $400,000 ($1,100,000), and $600,000 ($1,450,000), respectively. Mining amounts for each year were as follows: 750 pounds (year 1), 1,450 pounds (year 2), and 1,800 pounds (year 3). At the end of year 2, engineers used the new technology (which had been improving over time) and estimated there was still an estimated 6,000 pounds of silver deposits.

DM also began a research and experimentation project with the hopes of gaining a patent for its new survey technology. Diamond Mountain Inc. chooses to capitalize research and experimentation expenditures and amortize the costs over 60 months or until it obtains a patent on its technology. In March of year 1, DM spent $95,000 on research and experimentation. DM spent another $75,000 in February of year 2 for research and experimentation. In September of year 2, DM paid $20,000 of legal fees and was granted the patent in October of year 2 (the entire process of obtaining a patent was unusually fast).

Answer the following questions regarding DM’s activities (assume that DM tries to maximize its deductions if given a choice).

a. What is DM’s depletion expense for years 1 - 3?

b. What is DM’s research and experimentation amortization for years 1 and 2?

c. What is DM’s basis in its patent and what is its amortization for the patent in year 2?