ACC 6060 Module 4 Written Assignment: Business Income, Depreciation and Property Sales Example

Expense It or Spread It? Depreciation Choices and Property Gains for a Hamilton Landscaping Business

Student Name

Master of Science in Accounting, Thomas Edison State University

ACC-6060: Federal Taxation

Mentor Name

Month Day, Year

Expense It or Spread It? Depreciation Choices and Property Gains for a Hamilton Landscaping Business

Introduction

A sole proprietor reports business income and expenses on Schedule C, pays income tax on the profit and pays self-employment tax on most of it. Depreciation is often the largest deduction a small business controls, because the Code offers several methods with very different timing: regular MACRS spreads cost over a recovery period, bonus depreciation takes a percentage at once and Section 179 lets a business expense qualifying property up to its business income (Spilker et al., 2019). When property is sold, the character of the gain depends on how it was used and how much depreciation was taken.

Facts and Schedule C Before Depreciation

In March he bought a pickup with a full-size bed for $68,000, five-year property, and in July bought mowing equipment for $24,000, seven-year property. Less than 40 percent of the year's purchases fell in the last quarter, so the half-year convention applies. He also sold the truck he bought in 2020 for $45,000 and claims a half year of 2024 depreciation on it, $2,592, under every option.

Part A: Three Depreciation Choices

Regular MACRS takes 20 percent of the truck and 14.29 percent of the equipment, $13,600 and $3,430. Bonus depreciation takes 60 percent of each first, $40,800 and $14,400, then the first-year MACRS rate on the remaining basis, $5,440 and $1,372. Section 179 expenses all $92,000, which is allowed because it is below the 2024 limit of $1,220,000 and below his business income. A pickup with a full-size bed is not subject to the lower Section 179 cap for heavy SUVs. Self-employment tax is 15.3 percent of 92.35 percent of profit.

Recommendation

Expensing everything saves the most tax now, but it leaves him with almost no income this year, wasting his standard deduction and lower brackets, and leaves no depreciation for the next six years, when his income may be higher. A smaller Section 179 election, just large enough to leave taxable income near the upper edge of the 12 percent band, saves most of the tax without wasting his cheapest brackets. Small firms respond strongly to such incentives; Zwick and Mahon (2017) found that bonus depreciation raised investment most at smaller firms, which value immediate cash flow. House and Shapiro (2008) showed that temporary incentives pull purchases forward, a reminder that the timing of a purchase is itself a tax decision.

Whichever option he chooses, the deduction reduces his basis in the assets. A larger deduction now means more Section 1245 recapture if he sells the pickup or mowers before they are fully depreciated, so expensing is most attractive for assets he expects to keep for their full working life.

Part B: Characterizing the Gains

The 2020 truck's depreciation through its sale was 88.48 percent of cost, $39,816, leaving an adjusted basis of $5,184. It sold for $16,000, a gain of $10,816. Because the gain is less than the depreciation taken, all of it is Section 1245 recapture, taxed as ordinary income, though not subject to self-employment tax.

The storage lot, held six years, had a basis of $30,000 and sold for $42,000, a $12,000 Section 1231 gain. Net Section 1231 gains are usually treated as long-term capital gains, but the lookback rule treats them as ordinary income to the extent of net Section 1231 losses in the previous five years. Marcus deducted a $5,000 net Section 1231 loss in 2021 when he sold a damaged trailer, so $5,000 of this year's gain is ordinary and $7,000 is long-term capital gain. Land is not depreciated, so no Section 1250 issue arises.

The character of the two gains changes Marcus's tax. The $10,816 of recapture is taxed at his ordinary rates, while the $7,000 of long-term capital gain is taxed at 15 percent. Had he held the old truck until it was fully depreciated and then scrapped it, there would have been no gain at all, but trading it while it still had value let him put that value toward the new pickup.

References

House, C. L., & Shapiro, M. D. (2008). Temporary investment tax incentives: Theory with evidence from bonus depreciation. American Economic Review, 98(3), 737-768. https://doi.org/10.1257/aer.98.3.737

Spilker, B. C., Ayers, B. C., Outslay, E., Weaver, C. D., Barrick, J. A., Robinson, J. R., & Worsham, R. G. (2019). Taxation of individuals and business entities. McGraw-Hill Education.

Zwick, E., & Mahon, J. (2017). Tax policy and heterogeneous investment behavior. American Economic Review, 107(1), 217-248. https://doi.org/10.1257/aer.20140855