Video instructions and help with filling out and completing Can Form 4797 Careers

Instructions and Help about Can Form 4797 Careers

Hello in this lecture we're going to talk about depreciation recapture and how it can affect a business at the end of this we will be able to explain what depreciation recapture is discuss potential tax effects of the depreciation recapture and provide an example to illustrate depreciation recapture as always you want to seek advice from a professional when thinking about the depreciation recapture and how it can affect a business we will be looking at a scenario cure in order to see the effects of the depreciation recapture we're not going to get into specific code sections we're going to give the general idea of what depreciation recapture is how it comes about why the IRS would be justified to do it and what the potential tax effects would be in general in order to do that we're going to sell this piece of equipment here this being equipment supposed to look kind of like a dr. Seuss type of equipment where the raw material goes in here and we make widgets over here but in any case we're gonna sell this piece of equipment in order to see how this would be affected how the depreciation recapture could happen we want to go through the story of the equipment meaning we want to start with a purchase of the equipment record the life of the equipment and then to the sale of the equipment so before we sell this we're going to record the purchase of it and go through this process so when we purchase the equipment we're gonna say we purchase it for 500,000 so if we looked at our books here 500,000 would be credited when we purchased it and we put it on the books for the 500,000 of that being the fair market value price for the machines on the books at 500,000 why is it the fair market value price because it's a free market and if we purchased it for that price that's the value of it at that price so that's what we have so far we got the 500,000 on the books notice what we do not have we do not have an expense down here 500,000 we do not have an effect on net income even though we paid cash even if you're on a cash basis we do need to capitalize the Machine and then expense it over a certain time period and now we may get an accelerated depreciation method some kind of accelerated method where we get a depreciation expense related to machine in year one but this concept will remain in that we put the the books and then we depreciated so that's what we'll do next we'll talk about the depreciation we're not going to get into any specific depreciation what type of tax depreciation or special depreciation all we're gonna say is that over the time period in which we purchase the machine to the date we sold the machine we're gonna record the depreciation for that time period now what is depreciation it's gonna be the reduction of value to this machine now note that as time passes as years pass we still have the same machine the machine is not going away but the value of something will generally deteriorate us recording the depreciation is recording the reduction in value of a machine over a certain time period so we're gonna say for the purposes of this problem that depreciation over this time period is 300 thousand again I'm not specifying a year or a certain time period that it's over I'm just gonna say over the life of the machine from the time we purchased it to the time we sell it there is depreciation expense of the 300 thousand now note where depreciation expense is it's down here on the income statement that means that we have a deduction basically for taxes and that deduction is that ordinary income rates and that's where the problem is going to be here that's where the issue is what type of rates that we can have there's different tax rates between capital gains rates generally and ordinary incomes this deduction reduces the ordinary income therefore given us a benefit for the ordinary income rate the other side goes to accumulate a depreciation here so there's accumulated depreciation affecting the balance sheet side if we pulled in over the all the other accounts you might be asking well how is this related to the machine well we got the machine on the books at 500 we've got the accumulated depreciation 300,000 therefore the book value being machine - accumulated depreciation 200,000 the reason we don't put the 300,000 here and just write down the machine to 200,000 it's because we want to recognize the fact that it is just an estimate the machines still there it's not like we have reduced the amount of machine there's still one machine but we're trying to recognize the fact that it has reduced in value also note that this 300,000 like we said for tax purposes there's often accelerated depreciation and whatnot the tax code is not designed really to have this machine recorded at Book value oftentimes the depreciation rules on the tax code are designed to stimulate the economy or have accelerated methods therefore it's very possible that the machine is on the books at 200,000 is reduced or below the actual value of the machine that's the issue when we sell it now of course the main issue we're gonna have here is recognize at this point that that 300,000 benefited us by being a deduction now if we sell the machine later on let's just say we sold the machine now at a later date for two hundred and fifty thousand what would be the gain or loss related to that sell well the cash that we got is two hundred fifty thousand the Book value of the machine