Amortization Essay

1056 Words 5 Pages
Amortization, What Is It?

Amortization actually has different meanings depending on what it is being related to. Amortization is chiefly used in loan repayments, such as a mortgage loan, and in sinking funds. In this situation, amortization is the distribution of a single lump-sum cash flow into many smaller cash flow installments, as determined by an amortization schedule. Unlike other repayment models, each repayment installment consists of both principal and interest. Payments are divided into equal amounts for the length of the loan, making it the simplest repayment model. A greater amount of the payment is applied to interest at the beginning of the amortization schedule, while more money is applied to principal at the end.
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It is an effective method for recovering certain expenditures and it allows the costs incurred to be recovered over time. Prior to 1993, if you wanted to claim a deduction for the cost of an intangible asset, the taxpayer was required to establish that the intangible asset wore out over time and over the life of the asset. This caused many disputes and to eliminate them, Code Section 197 was enacted by Congress. The Section states that the cost of certain intangible assets that were purchased for use in a trade or business or for investment could be recovered ratably over 15 years beginning in the month the asset was purchased. There are a few conditions which are:
1) The intangible asset must be covered by Section 197. 2) It must be an asset that was purchased and not self-generated.
3) The asset must be connected with the operation of a trade or business or as an investment activity.
There are also a couple of exceptions. If you are just starting a business, the start-up expenditures need to be amortized under Code Section 195. And like everything else that involves the IRS, there are certain factors that need to be present:
1) The expenses must have been for:
- Investigating the creation or acquisition of an active trade or business.
- Creating an active trade or business.
- For any activity engaged in for profit and for the production of income before the day on

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