Question

A taxpayer purchasing a business and seeking to minimize taxable income in the early years of the business by maximizing cost recovery deductions would seek to allocate as much of the consideration from the purchase to which type of asset:

a. real property other than land

b. goodwill

c. covenant not to compete

d. land

e. 5 year depreciable property

Answer 1

Answer: [e] 5 year depreciable property

Explanation:

A property that is used in business and depreciable, will give an advantage in the form of reduced taxes.

This arises because, depreciation, in addition to being a non cash expense, is also a tax deductible expense. The result is that, depreciation provides a tax shield to the extent of - Depreciation expense*Tax rate.

In the list of assets given, land, goodwill and covenant not to compete are not depreciable.

Real property, other than land [buildings etc] are depreciated over a longer period of time, due to which the annual depreciation expense and resultant tax shield is low.

In the case of the 5 year depreciable property, the total cost of the property is claimed as depreciation in five years, which will result in substantial tax savings in each of those years. The profits would also be low as also the taxes payable.