Diamond Mountain was originally thought to be one of the few places in North America to contain diamonds, so Diamond Mountain Inc. (DM) purchased the land for $1,000,000. Later, DM discovered that the only diamonds on the mountain had been planted there and the land was worthless for mining. DM engineers discovered a new survey technology and discovered a silver deposit estimated at 5,000 pounds on Diamond Mountain. DM immediately bought new drilling equipment and began mining the silver.
In years 1-3 following the opening of the mine, DM had net (gross) income of $200,000 ($700,000), $400,000 ($1,100,000), and $600,000 ($1,450,000), respectively. Mining amounts for each year were as follows: 750 pounds (year 1), 1,450 pounds (year 2), and 1,800 pounds (year 3). At the end of year 2, engineers used the new technology (which had been improving over time) and estimated there was still an estimated 6,000 pounds of silver deposits.
DM also began a research and experimentation project with the hopes of gaining a patent for its new survey technology. Diamond Mountain Inc. chooses to capitalize research and experimentation expenditures and amortize the costs over 60 months or until it obtains a patent on its technology. In March of year 1, DM spent $95,000 on research and experimentation. DM spent another $75,000 in February of year 2 for research and experimentation. In September of year 2, DM paid $20,000 of legal fees and was granted the patent in October of year 2 (the entire process of obtaining a patent was unusually fast).
Answer the following questions regarding DM's activities (assume that DM tries to maximize its deductions if given a choice).
a.
What is DM's depletion expense for years 1-3?
Cost Depletion Method
Year 1 Year 2 Year 3
Year Begin basis
est pounds of silver in mine at beg of year 5000 4250 3800
bases depletion per pound
Pounds of silver mined in year 750 1450 1800
Year depletion
basis at end of year
% Depletion Method
Year 1 Year 2 Year 3
Net Income $200,000 $400,000 $600,000
Gross Income $700,000 $1,100,000 $1,450,000
%
% deplection expense before limit
Net Income Limitation
Allowable % depletion
Actual depletion
Org bases
Y1 deple
Y1 end
Y2 deple
Y2 end
Y3 deple
Y3 end
b What is DM's research and experimentation amortization for years 1 and 2?
Y1 straigh
Y2 straigh
c What is DM's basis in its patent and what is its amortization for the patent in year 2?
unam research & experiment exp
legal exp relate to patent
recovery period in months
monthly straight amort
DM sus mth from Oct - Dec
Y2 straigh amort of patent