prop-erty placed in service after 1970. The asset guideline classes, asset guideline periods, and asset depreciation ranges established under the class life ADR system are stated in Revenue Procedure 72-10.
d. Revised ADR Guidelines - March 21, 1977
For assets acquired after March 21, 1977 and prior to January 1, 1981, Reve-nue Procedure 83-35 contains the revised ADR guidelines. The specified upper and lower limits of the asset depreciation range are generally 20 percent below and 20 percent above the guideline period established for each class of personal property. The taxpayer may select as the asset depreciation period any period of years, that is a whole number of years, or a whole number of years plus a half year, within these upper and lower limits. Re-alty, however, does not have asset depre-ciation ranges. Accordingly for land im-provements, buildings, and other real estate, the asset guideline period is also the asset depreciation period.
e. Taxpayer Election of ADR System The system is optional with the tax-payer, who has an annual election. Each year's election applies only to assets ac-quired during that year. A taxpayer who elects to use the class life system for a particular year must indicate such election and the class lives used in its tax return for that year. Such election is binding on both the taxpayer and the IRS and may not be modified or revoked by either party. The taxpayer must apply the system to all eligible property acquired during the year, which falls within a class for which a class life has been established, and may not arbitrarily exclude particular items.
All information relative to ADR election can be found on Form 4832 which the company is required to submit with an ADR election.
f. Asset Exclusions from ADR System The regulations provide for exclusion of certain types of property from the ADR sys-tem. The principal exclusions permissible are for assets that are (1) subject to special rapid amortization or depreciation provi-sions, (2) received from related parties in a transfer that does not trigger an investment credit recapture, (3) without an ADR class,
or (4) excludable property under the 10 per-cent used property rule (see 7-407.6).
7-405.3 Elimination of Reserve Ratio Test --- 1970
The reserve ratio test requirements are eliminated for assets placed in service after 1970, regardless of the system used for esti-mating useful lives. Thus, taxpayers may now compute depreciation under either the new class life ADR system or under the general rules using estimated lives, without the need for meeting the reserve ratio test.
7-405.4 The Economic Recovery Tax Act of 1981 --- ACRS
The Economic Recovery Tax Act of 1981 established the Accelerated Cost Recovery System (ACRS) for property placed in service after 1980 in tax years ending after 1980. All property other than ACRS property remains under the previous system of depreciation. Under ACRS, the costs of most tangible, depreciable property are recovered over predetermined periods generally unrelated to and shorter than useful lives. The recovery deduction for each year is determined by applying a percentage specified in the law to the unadjusted basis of the property. Following are some points meant to clarify the relationship between ACRS and depreciation computed under FAR 31.205-11.
a. Use of ACRS for Financial Account-ing Purposes
FAR 31.205-11(d) and (e) provide that use of a method of depreciation for finan-cial accounting purposes is a test of an acceptable depreciation method for con-tract costing. In many cases, the ACRS recovery period will not be within a rea-sonable range of the asset's useful life and contractors will be unable to use ACRS for either financial accounting or contract costing purposes.
b. Acceptability of ACRS for Contract Costing
(1) For contractors not subject to CAS 409 but to FAR 11, under FAR 31.205-11(d), ACRS is acceptable for contract cost-ing if (1) ACRS is also used for non-Government work in the same cost center, (2)
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ACRS is used for financial accounting, and (3) ACRS is used for income tax purposes.
(2) Under FAR 31.205-11(e), if contrac-tors subject to FAR 31.205-11 do not use ACRS for both financial accounting and tax purposes, ACRS can only be used for contract costing if (1) the ACRS recovery period is the same as the useful life and (2) ACRS is used for non-Government work. In any case, al-lowable depreciation cannot exceed amounts used for financial accounting.
7-406 Depreciation Methods Under the General Rules
The methods for computing depreciation described in this subparagraph apply only when the class life ADR system has not been elected. When the ADR system is used, the rules are subject to certain modifications as covered in 7-407.
7-406.1 General Principles for Deprecia-tion Methods
a. Acceptable Methods Under FAR In general, any rational and systematic method that is consistently applied may be used in computing depreciation. Regardless of the method used, deductions for depre-ciation shall not exceed such amounts as may be necessary to recover the unrecov-ered cost or other basis less salvage, during the remaining life of the property.
b. Acceptable Methods Under Internal Revenue Code
Under Section 167 of the 1986 Internal Revenue Code, the depreciation allowance on new tangible property having a useful
life of three years or more is presumed to be reasonable if it is computed by use of the straight-line method, the declining-balance method, the sum of the years digits method, or other consistently applied method, subject to the limitations below.
7-406.2 Straight-Line Method
Under this method the cost or other basis of the property less its salvage value is generally deducted in equal annual amounts over the period of its estimated useful life. The straight-line method can be used for any depreciable property, new or used. Only the straight-line method can be used if the depreciation period is less than three years.
7-406.3 Declining-Balance Method a. With the enactment of the 1954 In-ternal Revenue Code, taxpayers were per-mitted to use accelerated methods of de-preciation, including the declining-balance method, at a maximum of double the ap-propriate straight-line rate. Subsequent amendments to the Internal Revenue Code reduced the maximum permissible rate on real estate to the straight-line rate. To be able to apply the 200 percent declining-balance method (or the sum of the years digits method), the asset being depreciated must now be new, tangible personal prop-erty with a useful life of three years or more. The following table summarizes the maximum depreciation rates permitted a taxpayer for personal and real property available at the various dates.
Type of Property Maximum Depreciation Allowance
All property acquired before 1/1/54 150%
Tangible personal property:
New 200%
Used 150%
Real Property:
New - 1/1/54 to 7/24/69 200%
7/25/69 to 12/31/86 150%
1/1/87 to date straight-line
Used - 1/1/54 to 7/24/69 150%
7/25/69 to date straight-line
*During a brief “suspension period” from 10/10/66 to 3/9/67 the maximum permis-sible rate was reduced to 150 percent.
7-407 b. Special Considerations --- Salvage
Value Under Declining-Balance Method While salvage value is not deducted from the cost or other basis of the prop-erty in determining the annual deprecia-tion allowance, an asset may not be re-duced below its reasonable salvage value.
(See 7-408.2c. for the 10 percent rule regarding personal property.) Where the salvage value is large, use of the double declining-balance method may require special consideration on the part of the auditor (see 7-408).
7-406.4 Sum of the Years Digits Method The sum of the years digits method may be used only on property that meets the requirements for "twice the straight-line rate" under the declining-balance method described in 7-406.3a. above.
7-406.5 Other Methods
Any consistent method of computing depreciation may be used provided that during the first two-thirds of the useful life of the property, the depreciation deductions under any such method do not result in accumulated allowances at the end of any tax year that are greater than the total that could have been deducted under the declining-balance method.
Under appropriate circumstances, "other consistent methods" include the sinking-fund method, the unit-of-production method, and the machine-hour method.
The limitations on the use of the declining-balance and sum of the years digits methods apply to any consistent method used other than the straight-line method.
7-407 Depreciation Under the Class Life ADR System
7-407.1 Special Considerations for Con-tract Costing Under the Class Life ADR System
a. Asset lives and methods of deprecia-tion established by the contractor in conso-nance with the class life ADR system are considered to be compatible with FAR 31.205-11(d)(3). This cost principle
pro-vides that depreciation costs are reasonable where a contractor uses the same policies and procedures for income tax reporting, contract costing, and financial reporting purposes.
b. However, due to unusual circum-stances affecting defense contracts, use of the class life ADR system may result in inequitable charges to the Government. If any inequities are found, Headquarters should be advised.
7-407.2 Limits on Depreciation Method and Rates
The taxpayer may use only the straight-line, declining-balance, or sum of the years digits methods. To eliminate potential areas of dispute between taxpay-ers and the Internal Revenue Service, no other method is permitted under the class life ADR system. The various rates allow-able under accelerated depreciation for new and used property are the same as set forth in the table in 7-406.3a.
7-407.3 Establishing and Using Vintage Accounts
a. Definition of Vintage Accounts All assets for any tax year, for which the taxpayer elects to use the class life ADR system, must be accounted for in either item or multiple-asset accounts by the year placed in service. These accounts are called "vintage accounts."
b. Adjustment for Salvage Value The annual allowance for depreciation of a vintage account is determined with-out adjustment for the salvage value of the property in such account. Accord-ingly, the straight-line and sum of the years digits computations are based upon the unadjusted basis of the vintage ac-count without reduction for salvage value.
In general, the original basis of the ac-count changes only if there is an extraor-dinary retirement.
c. Change in Depreciation Method During the depreciation period for a vin-tage account the taxpayer may change from a declining-balance method of depreciation to the sum of the years digits method, and from the declining-balance method or the sum of the years digits method to the
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straight-line method without the approval of the Internal Revenue Service.
7-407.4 Asset Retirements Under the ADR System
a. Retirements in General
An asset is treated as retired when it is permanently withdrawn from use in the business. Class life ADR retirements are separated into two categories: extraordi-nary retirements and ordiextraordi-nary retirements.
b. Extraordinary Retirements
Extraordinary retirements occur when assets are destroyed by fire, storm, or other casualty, or when assets amounting to more than 20 percent of the unadjusted cost or other basis of the entire account are dis-posed of because business activities are terminated, curtailed, or disposed of. On an extraordinary retirement, gain or loss is recognized in the year of retirement.
c. Ordinary Retirements
With respect to ordinary retirements (all others), gain or loss is generally not recog-nized at the time of retirement. The sales proceeds, if any, are added to the deprecia-tion reserve of the vintage account from which the asset is retired, and the deprecia-tion deducdeprecia-tion is continued as if all the assets survived for as long as the life as-signed to the remaining assets in the group.
7-407.5 Conventions for First-Year De-preciation of Vintage Accounts a. General
The allowance for first-year depreciation of a vintage account is determined by applying the "modified half-year convention" or the "half-year convention." The same convention must be adopted for all vintage accounts of a tax year, but not necessarily for those of another tax year.
b. Modified Half-Year Convention The first-year depreciation allowance for a vintage account for which the taxpayer adopts the "modified half-year convention" is determined by treating (1) all vintage account property placed in service during the first half of the tax year as placed in service on the first day of the tax year, and (2) all vintage account property placed in service during the
second half of the tax year as placed in service on the first day of the succeeding tax year. Similarly, all extraordinary retirements from the account during the first half of the tax year are considered to have occurred on the first day of the tax year and all extraordinary retirements from the account during the second half of the tax year are considered to have occurred on the first day of the succeeding tax year.
c. Half-Year Convention
The first year depreciation allowance for a vintage account for which the tax-payer adopts the "half-year convention" is determined by treating all property in the account as placed in service on the first day of the second half of the tax year. All ex-traordinary retirements from the account are considered to have occurred on the same day.
7-407.6 Special Considerations for Ac-quisition of Used Assets
The class life ADR system applies to used assets as well as new assets. How-ever, the present ranges are geared to new property. In order to remove possible in-equities, the taxpayer may exclude used property from the system if the used property placed in service during any year amounts to more than 10 percent of the total. The 10 percent test must be applied separately to Section 1245 and Section 1250 property. If the 10 percent test is met and the taxpayer elects to use this exclusion, all the used property must be excluded from the system.
7-407.7 Transitional Rules for Lives of Buildings (1971-1974)
For real property there is also a transi-tional rule. Revenue Procedure 72-10 does not now provide a range of lives for Sec-tion 1250 assets. Instead it furnishes a sin-gle life for each class of building. In the meantime, the taxpayer is permitted to ex-clude Section 1250 property from the sys-tem on an asset-by-asset basis, provided that the particular circumstances show that a life shorter than the initially prescribed life is justified. This exclusion applies to real property placed in service on or after
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