Question

While completing undergraduate school work in information systems, Dallin Bourne and Michael Banks decided to start a technology support company called eSys Answers. During year 1, they bought the following assets and incurred the following start-up fees:

Year 1 Assets	Purchase Date	Basis
Computers (5-year)	October 30, Y1	$	15,000
Office equipment (7-year)	October 30, Y1		10,000
Furniture (7-year)	October 30, Y1		3,000
Start-up costs	October 30, Y1		17,000

In April of year 2, they decided to purchase a customer list from a company providing virtually the same services, started by fellow information systems students preparing to graduate. The customer list cost $10,000 and the sale was completed on April 30. During their summer break, Dallin and Michael passed on internship opportunities in an attempt to really grow their business into something they could do full-time after graduation. In the summer, they purchased a small van (for transportation, not considered a luxury auto) and a pinball machine (to help attract new employees). They bought the van on June 15, Y2, for $15,000 and spent $3,000 getting it ready to put into service. The pinball machine cost $4,000 and was placed in service on July 1, Y2.

Year 2 Assets	Purchase Date	Basis
Van	June 15, Y2	$	18,000
Pinball machine (7-year)	July 1, Y2		4,000
Customer list	April 30, Y2		10,000

Assume that eSys Answers does not claim any §179 expense or bonus depreciation. (Use MACRS Table 1, Table 2, Table 3, Table 4 and Table 5.) (Do not round intermediate calculations. Round your answers to the nearest whole dollar amount.)

Required:

1. a. What are the maximum cost recovery deductions for eSys Answers for Y1 and Y2?
2. c. What is eSys Answer’s basis in each of its assets at the end of Y2?

Answer 1

ANSWER

a)

eSys Answer Y1 cost recovery deductions are $6,414 including the expensing of the start -up costs.

eSys Answers Y2 cost recovery deductions are $14,754.

Y1 Cost Recovery Remaining Asset Original Basis Expense Depreciation Expense Basis Quarter Rate Computer Equipment $15,000 $15,000 4th 5.00% $750 Office Equipment $10,000 $10,000 3.57% $357 Furniture $3,000 $3,000 4th 3.57% $107 Start-up costs $17,000 $5,000 $12,000 See below $200 Start-up immediate expense $5,000 Total Cost Recovery Expense $6,414

Start-up costs Y1 Description Amount Explanation (1) Maximum immediate expense $5,000 $195 (2) Total start-up costs $17,000 Given in problem (3) Phase-out threshold 50,000 $195 (4) Immediate expense phase-out S02) – (3) (5) Allowable immediate expense $5,000 (1)-(4)

(6) Remaining start- up costs $12,000 (2) - (5) (7) Recovery period in months 180 15 years $195 (8) Monthly straight- line amortization 66.67(6)/(7) (9) Sys' business months during year 1 X 3 October through December Year 1 straight-line amortization for start-up costs $200 (8) X (9)

Y2 Cost Recovery Asset Original Basis Expense Remaining Basis Depreciation Expense Quarter Rate Computer Equipment $15,000 $15,000 4th 38.00% 55,700 Office Equipment $10,000 $10,000 4th 27.55% $2,755 Furniture $3,000 $3,000 4th 27.55% $827 Start-up costs $17,000 $5,000 $12,000 NA $66.67 X 12 $800 Delivery van $18,000 HY 20.00% $3,600 Pinball machine $4,000 HY 14.29% $572 Customer List $10,000 NA See below $500 Total Cost Recovery Expense $14,754

Description Amount Explanation (1) Customer list (section 197 intangible) $10,000 Given in problem (2) Recovery period in months 180 Section 197 (3) Monthly straight- line amortization R RC, 55.56 (1)/(2) (4) April through December Year 1 straight-line amortization for customer list $500 (3) (4)

c)

eSys Answers basis is follows

Adjusted Basis Asset Original Basis Expense Year 1 Cost Recovery Year 2 Cost Recovery 2012 Ending Basis Computer Equipment $750 $5,700 $15,000 $8,550 Office Equipment $10,000 357 $2,755 $ 6,888 Furniture $3,000 S107 $827 $ 2,066 Start-up costs $17,000 $5,000 5200 5800 11,000 Delivery van $18,000 $3,600 $14,400 Pinball machine $4,000 5572 $3,428 Customer List $10,000 5500 $9,500 $77,000 $11,331 $14,421 S55,832 Totals

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