Sam Johnson started a small machine shop, Machines, Inc., in his garage and incorporated it in March of 2002 as a calendar-year corporation. At that time, he began using his personal computer and tools solely for the business as part of his contribution to the corporation. The computer cost $2,700 but had a fair market value of $900 only at conversion, and the tools, which had cost $1,500, were valued at $1,100. During 2002, Machines, Inc. purchased two machines, Machine A purchased on May 2 cost $24,000 and Machine B, purchased on June 5, cost $40,000.

The corporation expensed Machine A under Section 179. The computer, tools, and Machine B were depreciated using accelerated MACRS, but no bonus depreciation was included. The corporation did not include any depreciation on the garage nor did Sam charge the business rent because the business moved to another building the corporation purchased for $125,000 on January 5, 2003. On January 20, 2003, Machines, Inc. purchased $4,000 worth of office furniture and on July 7, it purchased Machine C for $48,000. It depreciated these assets under MACRS but did not use either Section 179 expensing or bonus depreciation. Machines, Inc. acquired no new assets in 2004.

On February 4, 2005, Machines, Inc., bought a new computer system for $5,100. It sold the old computer the same day for $300. On March 15, it sold Machine A for $6,000 and purchased a more versatile machine for $58,000. On August 15, Machines, Inc., sold bonds it had purchased with $9,800 of the cash Sam originally contributed to the corporation for $10,400 to pay creditors. The business takes the maximum allowable depreciation deduction on assets purchased in 2005 but does not use Section 179 expensing.

Task:
a. Determine Machines, Inc.'s depreciation expense deductions from 2002 through 2005.
b. Determine the realized and recognized gains or losses on the property transactions in 2005.
Provide rationales to justify your answer.

To determine Machines, Inc.'s depreciation expense deductions from 2002 through 2005, we need to calculate the depreciation for each asset based on the given information.

a. Depreciation Expense Deductions:

1. Computer:
The computer was purchased in 2002 for $2,700 and had a fair market value of $900 at conversion. We will use the fair market value of $900 for depreciation calculations.

Depreciation Method: MACRS
Recovery Period: 5 years

Depreciation for 2002:
$900 * (1/5) = $180

Depreciation for 2003:
$900 * (2/5) = $360

Depreciation for 2004:
$900 * (3/5) = $540

Depreciation for 2005:
$900 * (4/5) = $720

2. Tools:
The tools were purchased in 2002 for $1,500 and were valued at $1,100.

Depreciation Method: MACRS
Recovery Period: 7 years

Depreciation for 2002:
$1,100 * (1/7) = $157.14

Depreciation for 2003:
$1,100 * (2/7) = $314.29

Depreciation for 2004:
$1,100 * (3/7) = $471.43

3. Machine A:
The machine was purchased on May 2, 2002, for $24,000 and expensed under Section 179.

Depreciation Method: Section 179
Recovery Period: N/A (expensed)

No depreciation deductions are taken for future years since the machine was expensed in 2002.

4. Machine B:
The machine was purchased on June 5, 2002, for $40,000.

Depreciation Method: MACRS
Recovery Period: 7 years

Depreciation for 2002:
$40,000 * (1/7) = $5,714.29

Depreciation for 2003:
$40,000 * (2/7) = $11,428.57

Depreciation for 2004:
$40,000 * (3/7) = $17,142.86

5. Office Furniture:
The office furniture was purchased on January 20, 2003, for $4,000.

Depreciation Method: MACRS
Recovery Period: 7 years

Depreciation for 2003:
$4,000 * (1/7) = $571.43

Depreciation for 2004:
$4,000 * (2/7) = $1,142.86

6. Machine C:
The machine was purchased on July 7, 2003, for $48,000.

Depreciation Method: MACRS
Recovery Period: 7 years

Depreciation for 2003:
$48,000 * (1/7) = $6,857.14

Depreciation for 2004:
$48,000 * (2/7) = $13,714.29

7. New Computer System (2005):
The new computer system was purchased on February 4, 2005, for $5,100, and the old computer was sold for $300.

Depreciation Method: MACRS
Recovery Period: 5 years

Depreciation for 2005 (new computer system):
$5,100 * (1/5) = $1,020

Realized and Recognized Gains or Losses on Property Transactions in 2005:

1. Sale of Machine A:
Machine A was sold on March 15, 2005, for $6,000.

Realized Gain/Loss:
Sale Price - Original Cost = $6,000 - $24,000 = -$18,000 (loss)

Since Machine A was expensed under Section 179, there is no recognized gain/loss for tax purposes.

2. Purchase of More Versatile Machine:
A more versatile machine was purchased on March 15, 2005, for $58,000.

No realized or recognized gains/losses are applicable for this transaction as it only involves a purchase.

3. Sale of Bonds:
Bonds purchased for $9,800 were sold for $10,400 on August 15, 2005.

Realized Gain:
Sale Price - Purchase Price = $10,400 - $9,800 = $600

The realized gain of $600 needs to be recognized for tax purposes.

Rationales:

- The depreciation expense is calculated using the appropriate depreciation methods (MACRS or Section 179) and the recovery period specified for each asset category.

- The realized gain or loss is determined by subtracting the original cost from the selling price of the asset.

- The recognized gain or loss for tax purposes may differ from the realized gain or loss due to specific rules regarding depreciation, expensing, and other applicable tax regulations. In some cases, the realized gain or loss may not be recognized for tax purposes.