Basis of Acquired Property (§ 1012)

At the core of property taxation lies the concept of basis. The basis of property is essentially its cost for tax purposes. It’s the amount you’ve invested in the property and is crucial for determining the taxable gain or loss when you eventually sell or dispose of it. Once the basis is established, the tax code allows for the recovery of this cost for certain types of property through deductions over time, a process known as cost recovery.  

• Initial Basis: These costs can include purchase price, sales tax, freight charges, installation fees, testing costs, excise taxes, and any other expenses directly related to acquiring the property. For real estate, basis includes the purchase price, closing costs (such as title insurance, recording fees, and attorney fees), and any other amounts paid to acquire the property.  
• Adjusted Basis (§ 1016): Over time, the initial basis of property can be adjusted. Adjusted basis reflects changes that occur after the property is acquired. It increases for improvements made to the property that have a useful life of more than one year and decreases for items such as depreciation or amortization deductions taken, casualty losses, and deferred gains. 

Cost Recovery: Depreciation – Tangible assets used in trade or business

Section 179 Deduction (§ 179): This provision allows taxpayers to elect to deduct the full cost of certain new or used tangible personal property (such as equipment and software) purchased for use in their trade or business in the year it is placed in service, rather than depreciating it over several years. There are annual limits on the amount that can be deducted under Section 179, and the deduction is phased out for taxpayers with total qualifying property exceeding a certain threshold.  

Bonus Depreciation (§ 168(k)): For certain years, the tax law has allowed for “bonus depreciation,” which permits taxpayers to deduct a significant percentage (e.g., 100% for property placed in service between September 28, 2017, and December 31, 2022, with a gradual phase-down thereafter) of the cost of qualifying new or used property in the year it is placed in service. This is in addition to any Section 179 deduction and regular MACRS depreciation.

Depreciation is the process of deducting the cost of certain property over its useful life. It applies to tangible property that is used in a trade or business or held for the production of income, wears out, decays, becomes obsolete, or loses value from natural causes. Personal use property is generally not depreciable.  Modified Accelerated Cost Recovery System (MACRS) (§ 168): For most property placed in service after 1986, the Modified Accelerated Cost Recovery System (MACRS) is used to calculate depreciation. MACRS prescribes specific recovery periods, depreciation methods, and conventions based on the type of property.

Recovery Periods: The IRS has established various recovery periods for different classes of property. Some common examples include:

• 5-year property: Includes computers, office equipment, and certain vehicles.
• 7-year property: Includes office furniture, fixtures, and equipment.
• 27.5-year property: Residential rental property. 
• 39-year property: Nonresidential real property (e.g., office buildings, retail stores).

 Depreciation Methods: MACRS uses different depreciation methods, including:

• 200% Declining Balance Method: An accelerated method where a fixed rate (double the straight-line rate) is applied to the property’s declining book value.
  150% Declining Balance Method: Another accelerated method using 1.5 times the straight-line rate.
• Straight-Line Method: The cost of the property is deducted in equal amounts over its recovery period.

Conventions: MACRS also specifies conventions that determine how much depreciation can be claimed in the year of acquisition and the year of disposition:

• Half-Year Convention: Applies to personal property and allows for one-half of the normal depreciation for the first year, regardless of when the property was placed in service. The remaining depreciation is claimed over the remaining recovery period, with the other half taken in the year of disposal.  
  Mid-Month Convention: Applies to real property and treats all property placed in service or disposed of during any month as if it were placed in service or disposed of in the middle of that month.
• Mid-Quarter Convention: Applies to personal property if more than 40% of the total basis of such property is placed in service during the last three months of the tax year.

Cost Recovery: Amortization (§ 197) – Intangible property used in trade or business

Amortization is similar to depreciation but applies to certain intangible property. Intangible assets are non-physical assets that have value because of the rights they confer.

Amortizable Property: Section 197 governs the amortization of certain acquired intangible assets, including goodwill, going concern value, covenants not to compete, franchises, trademarks, and patents.

Depletion is the process used to recover the cost of natural resources (such as oil, gas, timber, and minerals) as they are extracted or used up. The tax code provides specific rules for calculating depletion deductions, which can be based on either cost depletion or percentage depletion.