Proposed regs. shed light on income forecast method.

• Author: Schell, Wayne M.

EXECUTIVE SUMMARY

* Under income forecast depreciation, the deduction for each year is the same proportion of basis as that year's income is to FTI.

* FTI is determined at the end of the year in which the property is placed in service; a revised computation applies when estimated total income changes.

* Under a lookback provision, the taxpayer pays or receives interest on an underpayment or overpayment due to errors in FTI.

The income forecast method allows taxpayers to depreciate property, such as movies and television films, on the basis of anticipated income. This article explains and illustrates the major elements of the proposed regulations, clarifying the application of income forecast depreciation under Sec. 167.

The income forecast method of depreciation was first allowed (1) in the early 1960s, when the IRS determined that traditional methods for recording depreciation on television films and similar property were inadequate. Currently, Sec. 167(g) authorizes use of income forecast depreciation for certain types of property. The Service issued proposed regulations (2) to provide more detailed guidance on the application of this method. This article explains and illustrates the major elements of the proposed rules.

Basic Rules

The income forecast method allows taxpayers to assign depreciation on the basis of anticipated income. In short, the depreciation deduction each year is the same proportion of a property's basis as the property's income for the year is to its forecasted total income (FTI). If it is determined in a later year that FTI was incorrectly computed in an earlier year, a lookback provision applies. Under this provision, the taxpayer must pay interest if the error caused depreciation deductions to accelerate; if it caused a delay, the taxpayer would be entitled to receive interest.

Under Prop. Regs. Sec. 1.167(n)-1(b)(1), the income forecast method is elected, for the most part, on a property-by-property basis. According to Prop. Regs. Sec. 1.167(n)-5(a), it is available for computing depreciation on copyrights, books, patents, motion picture films, videotapes, sound recordings and similar property. As a result of the wide variation in the amount and timing of income from such property, Treasury concluded that this method might better match income and expense than other depreciation methods.

Under Prop. Regs. Sec. 1.167(n)-4(a), income forecast depreciation for a year is computed by multiplying a property's depreciable or redetermined basis by a fraction, the numerator of which is current-year income and the denominator of which is FTI.

Example 1: B Corp. produced a short documentary film, spending $500,000 on the project in 2002 and $400,000 in 2003. The film was released in 2003, and generated $400,000 in income that year. Post-2003 income was estimated to be $1.6 million. The property's depreciable basis is $900,000 ($500,000 + $400,000); its FTI is $2 million ($400,000 + $1,600,000). B's 2003 income forecast depreciation deduction was $180,000 ($900,000 x ($400,000/$2,000,000)).

Example 2: The facts are the same as in Example 1, except that B's 2004 income is $500,000. As a result, its 2004 income forecast depreciation deduction is $225,000 ($900,000 x ($500,000/ $2,000,000)).

Depreciable Basis

A property's initial depreciable basis includes amounts paid or incurred as of the year it was placed in service. Prop. Regs. Sec. 1.167(n)-2(a)(2) requires basis...