Question

• The Morris Corporation is a very successful and profitable manufacturing corporation. The corporation just completed construction of new corporate offices, primarily for its top executives. The president and founder of the corporation, Mr. Timothy Couch, is an avid collector of artwork and has instructed that the lobby and selected offices be decorated in rare collection of art. These expensive works of art were purchased by the corporation in accordance with Couch's directives. Couch justified the purchase of these artworks on the premise that (1) they are excellent investments and should increase in value in the future, (2) they provide an appropriate and impressive office, and (3) the artwork is depreciable property and the corporation will be able to take sizable write-offs against income. The Financial Vice-President of the corporation has requested your advice as to whether the works of art are, in fact, depreciable property. Prepare a research memorandum for the Financial Vice-President on the issue.

• A partial list of research sources is:

Rev. Rul. 68-232, 1968-1 C.B. 70

Shauna C. Clinger, 60 T.C.M. 598 (1990)

Simon v. Comr., 103 T.C. 247 (1994), aff'd 95-2 USTC 50,552 (2d Cir. 1995)

Liddle v. Comr., 103 T.C. 285 (1994), aff'd 95-2 USTC 50,488 (3rd Cir. 1995)

Answer 1

IT DEPENDS.

Whether the art is depreciable primarily depends on the answer to the following question: “Is any of the artwork considered ‘valuable and treasured’?”

In order to understand why it boils down to this one question, it is helpful to review some history on this issue.

The Background Behind Artwork Depreciation

In 1968 the IRS issued Revenue Ruling 68-232, which states, in part: “A valuable and treasured art piece does not have a determinable useful life.   While the actual physical condition of the property may influence the value placed on the object, it will not ordinarily limit or determine the useful life. Accordingly, depreciation of works of art generally is not allowable.”

This ruling has become the standard for whether office artwork is depreciable; however, the IRS has been fairly silent since then and has provided no guidance on what constitutes a valuable and treasured work of art.

However, the depreciation rules have undergone two significant amendments since 1968. Congress has amended the law (now governed by Section 168) to establish the modified accelerated cost recovery system (MACRS). Under MACRS, an asset’s useful life is no longer the time period used for calculating the amount of depreciation, but instead established a seven-year recovery period for that do not have class lives.

Therefore, it would appear that a taxpayer no longer has to establish a class life for property to depreciate it under MACRS. Instead, the taxpayer needs to establish all four things with respect to the property:

1. It must be tangible property not subject to amortization or another method of depreciation.
2. The property must have been placed in service after 1986.
3. It must be subject to exhaustion, wear and tear, or obsolescence.
4. It must be used in a trade or business.

The third item is the one that may be difficult to prove to the IRS’ (and the courts’) satisfaction, however, as this is an “or” test, if any one of the three conditions exists, the taxpayer meets the third criterion. It is most likely that artwork will not be exhausted, which implies that the property is used up or consumed in the ordinary course of its function. Also, since beauty is in the eye of the beholder, it may be difficult to argue that artwork becomes obsolete, thus the taxpayer will need to prove that the artwork is subject to wear and tear.

Again the IRS is not much help because they have failed to set forth a standard of what constitutes wear and tear. The IRS could argue that because artwork only hangs on a wall or sits on a floor or shelf as a display, it is not subject to wear and tear; however, the curator of any museum would say that all artwork deteriorates over time.

In Simon, 103 T.C. 247 (1994),the court focused on one issue: “Were the bows property of a character subject to exhaustion, wear and tear, or obsolescence?” If they were, then the taxpayers' could depreciate them.

CONCLUSION:

It would appear that recent case laws are favorable to the proposition that all artwork, “valued and treasured” or not, is subject to the allowance for depreciation under Internal Revenue Code Section 168 if the taxpayer can meet the four requirements described above. But the taxpayer most likely will continue to be in for a fight if the IRS examines its tax return. The taxpayer should be prepared to establish the business reasons for the acquisition of the artwork to meet the “used in a trade or business” standard. The taxpayer also should be prepared to establish that the items are subject to wear and tear or obsolescence in their use.