Question

Problem I:10-55 from the textbook (revised to include additional research).

The Morris Corporation is a very successful and profitable manufacturing corporation. The corporation just completed leasehold improvements of its 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 with rare collections of art. These expensive works of art were purchased by the corporation in accordance with Couch's directives. Couch justified the purchase of these works of art on the premise that (1) they are excellent investments and should increase in value in the future, (2) they provide an appropriate and impressive atmosphere when current and prospective customers visit the corporation's offices, 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 the depreciability of the leasehold improvements and the art. Prepare a research memorandum for the financial vice-president on this issue. Include a discussion on the different depreciation methods permitted and the availability of those methods of depreciation for leaseholds and the art.

A partial list of research sources includes:

• Sections 167 and 179
• Rul. 68-232, 1968-1 C.B. 70
• Shauan C. Clinger, 60 T.C.M. 598 (1990).
• Simmon v. Comr., 103 T.C. 247 (1994), aff’d 95-2 USTC ¶ 50,552 (2d Cir. 1995) nonacq. 1996-2 C.B.I.
• Liddle v. Corm., 103 T.C. 285 (1994), aff’d, 95-2 USTC ¶ 50,488 (3^rd 1995)

Answer 1

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.

Whether the items are depreciable depends on the client’s answers to further questions. It may depend on whether the decorations are considered “valuable and treasured” art pieces or just plain tangible property used in the trade or business, subject to exhaustion, wear and tear, or obsolescence. The distinction, however, may be subjective and uncertain, with little helpful guidance.

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. Obviously, the more expensive the artwork, the more likely it is that an agent will disallow a claim of depreciation expense with respect to the item.

Qualified leasehold improvements have a depreciable life of 15 years. This 15-year life can provide a significant tax benefit as Section 1250 property is typically depreciable over a 39-year period.

Qualified improvement property must be depreciated over a 39-year life.

You can generally expense qualified leasehold improvements up to $500,000 (adjusted annually for inflation) under Section 179, as opposed to depreciating them.

However, Section 179 begins to phase out when you place in service assets valued in excess of $2,000,000 in a single tax year. Currently, all qualified leasehold improvements are included in this phase-out calculation, which could eliminate Section 179 eligibility depending on the value of the assets your business places in service in a year.

Qualified improvement property cannot be expensed under Section 179 unless the property also qualifies as qualified leasehold improvement, qualified retail improvement or qualified restaurant improvement property.