Depreciation/Amortization

[S T]

Partnership Client which is a Franchise

The franchise is implementing new software for the t/p retail store.

To participate in this upgrade, it was requested that t/p pay $3,000 in 2007 as a down payment for this software upgrade, however, the software upgrade will not take place until sometime in late 2008 at a final cost of approximately $60,000 to taxpayer.

Question, is how to treat the $3,000 down payment in 2007?

Sandy

[Gene V]

Another question along the same line; how do we treat the tax software that we buy in May at a discount, yet we don’t get the software until next year.

[Bees Knees]

Rules that apply:

Rule #1. Property eligible for depreciation must have a useful life that extends beyond the year placed in service.

This means if the useful life does not extend beyond the year placed in service, it is not depreciable property. Paper, pens, staples, and other supplies generally have a useful life of less than one year, thus they are deducted by a cash basis taxpayer when purchased, even if they are not used until the following year.

An exception to this rule applies to farmers. If pre-paid farm supplies exceed 50% of all other deductible farm expenses, the deduction for pre-paid farm supplies by a cash basis farmer may be limited to 50% of the cost of all other deductible farm expenses.

Another exception to this rule applies to costs that generally are considered inventory, even if the taxpayer qualifies to use the cash basis of accounting. Inventory is not deducted by a cash basis taxpayer until used or sold.

Rule #2. Depreciation begins for eligible property in the year the property is placed in service. Thus any costs incurred prior to the year placed in service must be capitalized as part of the cost of the property. The cost is then added to the amount eligible for depreciation once the property is placed in service.

Rule #3. Software that is not available to the general public and is acquired in connection with the purchase of a business is amortized as a Section 197 intangible over a 15-year period.

How do these two rules apply to your situation?

If the software has a useful life of more than one year, the down payment is added to the depreciable basis of the software and deducted through depreciation once it is placed in service. If that software is a Section 197 asset, the cost is amortized over 15 years, starting with the year placed in service.

For tax software, it is my opinion that the practical use of tax software is less than one year. 98% of its use is used in the year it applies, and maybe only 2% of its use is for filing amended returns and non-filers. Thus I don’t believe it needs to be depreciated or deducted under Section 179. I count it as an expense in the year I pay for it, just like any other supply or operating cost.

[Gene V]

I count it as an expense in the year I pay for it, just like any other supply or operating cost.

Thanks Bees Knees,
That’s the way I expense it, plus my software sends out an early release in November, so I can do some early tax planning, etc.

[S T]

Depreciation

Thanks Bees,

Clears up all of my questions on the down payment before the software is installed and you answered Gene's question as well.

Sandy