Adjusting depreciation allowable - for depreciation allowed

National Public Accountant, The, Oct, 1997

When adjustments must be made to reflect depreciation taken *(Allowed) for depreciation which will be allowable in the future, the method for making that calculation is logical, but not necessarily obvious.

Let's assume the taxpayer bought the property in May 1985 for $750,000 and 18-year ACRS is applicable. The client claimed the land represented only 20% or $150,000 of the purchase price, so the depreciable basis of the improvements was $600,000. The yearly depreciation deduction is shown in the "Per Client" column of the attached table.

In 1994, an IRS audit claimed county tax records showed the value of the property was 50% land and 50% improvements. The auditor elected not to disallow any depreciation prior to 1994, but adjusted the 1994 depreciation deduction from $30,000 to $2,561. Disregarding the appropriateness of the IRS' action, the method for correctly calculating the allowable depreciation is as follows.

The depreciation taken through 1993 was $354,000, and the IRS chose to allow this. Since their position was that the depreciable improvements were worth only $375,00, the depreciation remaining to be taken was $21,000. Referring to the Depreciation Percentage column of the table, 59% of the depreciation had been taken and 41% remained. Thus, the allowable depreciation for 1994 is calculated by multiplying $21,000 by the 5% set for 1994, dividing by the 41% remaining. $21,000 x 5 +41 = $2,561. Similarly, for 1997, the calculation is $21,000 x 4 + 41 = $2,049. Referring to the table, it can be seen that this method distributes the remaining allowable depreciation of $21,000 correctly.

From a more pragmatic point of view, the tax practitioner should probably take the position that 1994 tax assessments may not accurately reflect the facts in 1985, and attempt to prove a higher percentage of the property's value is due to improvements.

                     Per Client      Per IRS

Initial basis:       $750,000        $750,000
Land                 $150,000        $375,000
Depreciable Basis:   $600,000        $375,00

Depreciation calendar

             Depreciation               Depreciation
     Year     Percentage                   Yearly

1    1985         6         $36,000
2    1986         9         $54,000
3    1987         8         $48,000
4    1988         7         $42,000
5    1989         7         $42,000
6    1990         6         $36,000
7    1991         6         $36,000
8    1992         5         $30,000
9    1993         5         $30,000
10   1994         5         $30,000        $2,561
11   1995         5         $30,000        $2,561
12   1996         5         $30,000        $2,561
13   1997         4         $24,000        $2,049
14   1998         4         $24,000        $2,049
15   1999         4         $24,000        $2,049
16   2000         4         $24,000        $2,049
17   2001         4         $24,000        $2,049
18   2002         4         $24,000        $2,049
19   2003         2         $12,000        $1,024

Checksum:        100        $600,000       $21,000

Dep. Taken through 1993: $354,000 - 59%
Depreciable Remaining: $21,000 - 41%