Question

"Depreciation, Cost Recovery, and Depletion" Business owners tend to mix their business expenses with their personal expenses. Explain how business owners can take advantage of leasing a vehicle used for both business and pleasure for tax purposes. Examine the rules for claiming deductions for business vehicles and recommend one method of cost-recovery that would result in the largest tax deduction for your client. Support your recommendation. Your client owns a company that invests in a significant amount of highly technical computer equipment. Assess the appropriateness of the various depreciation methods available to your client and recommend the method that produces the greatest tax benefit. Provide a rationale for your response.

Answer 1

Cost Recovery means amount of deduction of certain portion of cost of an assets due to use in business and profession over the useful life of assets. This recovery may be in form of depreciation, amortization, and depletion. This deduction is allowed due to Doctrine of Recovery of Capital. However, entities are mixing the personal and business expenses while reporting in financial statement to reduce the profit. Therefore, it should be clearly segregated so that statement represents the true and fair view. Leasing a vehicle is an example of mixing the business and personal expenses for getting the tax advantage. Depreciation is based on ownership and no depreciation will be allowed in case of leased vehicle however leased payment will be allowed based on the percentage of use of vehicle for business purpose.

Following are some method of depreciation that may be adopted the company:

Straight-Line Method: This method is most simple and common method of depreciation in which assets is depreciated at fixed rate on cost of assets over the useful life of assets.

Declining Balance Method: In this method asset is depreciated at fixed rate of depreciation charged on the written down value of assets at the end of the year.

Sum-of-the-year’s-digits method: As per this method, depreciation is calculated by using a fraction which is computed by dividing the remaining useful life by sum of the useful years.

MACRS: This method is codified by US Tax Code that specified the useful life of asset and rate of depreciation based on the class of asset for tax purpose. Generally, this method is used by many entities in order to maintain the record as per requirement of tax authority.

Therefore, entity is free to adopt any method of depreciation while preparing the financial statements however if entity adopt the method of MACRS then the records will be maintained as per requirement of tax authority. This method will help in saving the time to comply with tax requirement still entity have an option to adopt any other method based on his specifications.