How to Calculate Underappreciated Capital Cost

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An important goal of financial and tax accounting is to measure a business’s income and expenses over a fixed period of time. To avoid distortions of income and expenses during a single fiscal period, accounting rules allow the value of capital assets to be expensed over long periods. Thus, the purchase price of an expensive piece of equipment may be depreciated over a period of 10 years. Each year, a portion of the purchase price is deducted as an expense from the company’s revenues. If a company purchases capital equipment valued at \$600,000 in one year, in most cases, its net income for that period would not reflect \$600,000 in equipment expenses. Only the depreciation in value of the first year of ownership would be expensed against the year’s income. After an expense is made against the purchase price or capital cost, the remaining balance is available for further depreciation. Any portion of the capital cost that is not yet expensed is recognized as undepreciated capital cost, or UCC.

Determine the tax basis of the asset. The tax basis of a capital asset is the asset's purchase price plus any sales taxes, delivery charges and installation fees. Subtract purchase price discounts.

Select the property class that suits the capital asset in question. Business assets are categorized into classes that specify the time period over which the asset can be expensed. Office furniture and fixtures, for instance, are allowed a depreciation period of 7 years.

Determine the proportion of the asset that is used for business purposes. If a car is used for both business and family purposes, only the portion of the car’s value allocated to business use can be depreciated.

Verify that no portion of the value of the asset was previously expensed. If the asset was previously expensed, deduct the expensed amount from the tax basis.

Use the appropriate IRS table to determine the percentage of the item's tax basis that can be deducted (expensed) each year.

Use the tax basis as the UCC if the asset is used exclusively for a business purpose and the asset was not previously expensed.

Use the following formula to determine the value of the undepreciated portion of a capital asset. UCC = (tax basis) * (business use percentage) – (amounts previously expensed) – (expense deduction for current tax period).

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