Appeals court expands availability of income forecast depreciation.

• Author: Goldberg, Michael J.

The Tenth Circuit has ruled in ABC Rentals of San Antonio, Inc., 9/27/96, rev'g and rem'g TC Memo 1994-601, that the income forecast method of depreciation can be used to depreciate tangible property Although the case applies to "rent-to-own" inventory, the ruling has much broader potential application. At issue is Sec. 168(f)(1), which provides that modified accelerated cost recovery system (MACRS) depreciation does not apply to "any property" if the taxpayer timely elects out of MACRS with respect to such property and the property is "properly depreciated" under any method of depreciation not expressed in a term of years. The Tax Court held that this provision is limited to an asset of an artistic or creative nature whose useful life depends on its popularity, as Opposed to physical wear and tear. Examples of assets traditionally allowed to be depreciated under the income forecast method include films, video cassettes, books and video games.

The Tenth Circuit held, however, that Sec. 168(f)(1) applies by its terms to "any property" "properly depreciated" under a non-time-sensitive system. Contrary to the Tax Court's narrow application of Sec. 168(f)(1), the Court of Appeals stated that Sec. 168(f)(1)'s "legislative history suggests that Congress intended to permit taxpayers to exclude 'moss properly' from the ACRS and MACRS under section 168(f)(1)."

The court then interpreted the phrase "properly depreciated." It held that the taxpayer did not have to show that MACRS would not be an appropriate method; the taxpayer only needs to show that the method elected was a reasonable and consistent one. ABC Rentals kept detailed records of its fixed assets and could document projected rental income for its assets. Significantly, the IRS conceded that the income forecast method was the most economically accurate for the rent-to-own industry. (Rent-to-own companies typically rent out assets under terms giving the lessee the option to receive title at little or no cost at the end of the lease.) Accordingly, the income forecast method is an allowable method of depreciating such assets.

The appellate judges disagreed among themselves as to the proper calculation of the income forecast depreciation. The majority held that, under Sec. 167(b)(4) and (c) (as they existed prior to 1990), the income forecast method could not result in a deduction in the first year greater than that which would have been allowable under the double-declining balance method and...