Question

Assume that Ernesto purchased a digital camera on July 10 of year 1 for $3,000. In year 1, 80 percent of his camera usage was for his business and 20 percent was for personal photography activities. This was the only asset he placed in service during year 1. Ignoring any potential §179 expense and bonus depreciation, answer the questions for each of the following alternative scenarios: (Use MACRS Table 1, Table 2.)

a. What is Ernesto’s depreciation deduction for the camera in year 1?

b. What would be Ernesto’s depreciation deduction for the camera in year 2 if his year 2 usage was 75 percent business and 25 percent for personal use?

c. What would be Ernesto’s depreciation deduction for the camera in year 2 if his year 2 usage was 45 percent business and 55 percent for personal use?

d. What would be Ernesto’s depreciation deduction for the camera in year 2 if his year 2 usage was 30 percent business and 70 percent for personal use?

Answer 1

a)

The depreciation expense will be $480 in year 1, calculated as follows:

Description	Amount	Explanation
(1) Original basis of camera	$3,000	Assumed in problem
(2) MACRS depreciation rate	20%	5-yr prop, yr. 1, ½ yr. convention.
(3) Full MACRS depreciation expense	$600	(1) x (2)
(4) Business use percentage	80%	Assumed in the problem
Depreciation deduction for year	$480	(3) x (4)

b)

The depreciation expense will be $720 in year 2, calculated as follows:

Description	Amount	Explanation
(1) Original basis of camera	$3,000	Assumed in problem
(2) MACRS depreciation rate	32%	5-yr prop, yr. 1, ½ yr. convention.
(3) Full MACRS depreciation expense	$960	(1) x (2)
(4) Business use percentage	75%	Assumed in the problem
Depreciation deduction for year	$720	(3) x (4)

c)   

$30. Because his business usage is below 50%, Ernesto must use the straight-line method to determine depreciation. Using this method, his depreciation expense for year 2 is $270. However, because his business usage dropped from above to below 50%, he must also recalculate prior year depreciation using the straight line method. Any accelerated depreciation that he claimed in the prior year in excess of the straight-line amount for that prior year reduces the $270 of depreciation expense for year 2. In this case, the excess $240 depreciation reduces the $270, leaving $30 of depreciation expense as computed below.

Description	Amount	Explanation
(1) Straight-line depreciation in current year	$270	$3,000/5 years x 45% business
(2) Prior year straight-line depreciation	$240	$3,000/5 x ½ year convention x 80% business use percentage
(3) Prior year accelerated depreciation	$480	From part “a” above
(4) Excess accelerated depreciation	$240	(3) – (2)
Current year depreciation deduction	$30	(1) – (4).

d)   

Income of $60 (no depreciation deduction). Because his business usage in year 2 is below 50%, Ernesto must use the straight-line method to determine depreciation. Using this method, his depreciation expense is$180 in year 2 because his business use is 30%. Moreover, because the camera is listed property and fell below 50% business use, depreciation for year 1 must be recalculated using the straight-line method and any excess depreciation reduces the year 2 depreciation amount. In this case, the excess depreciation of $240 is $60 greater than the $180 straight line depreciation so Ernesto does not get to deduct depreciation expense in year 2, but instead he must recognize ordinary income of $60. The $60 of income is computed as follows:

Description	Amount	Explanation
(1) Straight-line depreciation in current year	$180	$3,000/5 years x 30% business
(2) Prior year straight-line depreciation	$240	$3,000/5 x ½ year convention x 80% business use percentage
(3) Prior year accelerated depreciation	$480	From part “a” above
(4) Excess accelerated depreciation	$240	(3) – (2)
Current year income	($60)	(1) – (4).