Category: Deductions & Credits Copyright 1998, The Tax Resource Group. All rights reserved. Telephone 800-578-3498. Internet: www.taxresourcegroup.com Your memorandum of August 3, 1994 is incorporated into this document by reference. It is unclear to me whether you are specifically interested in depreciation for a given year or whether you are concerned about the gain in the year of sale. In any event, it seems to me the question of whether the IRS has the power to force the taxpayer to depreciate property in a given year may well be moot. I strongly suspect the IRS does have such power given the wording of the depreciation provisions of the Internal Revenue Code. In any event, the following is quite clear. Gain from disposition of your client's property is computed taking into account depreciation allowed or allowable. In other words, it makes no difference whether your client depreciated the property or not, gain on sale is increased by the amount of depreciation he should have taken. Gain from the sale or exchange of an asset is defined under §1001 as the difference between the amount realized from the sale or exchange and the adjusted basis of the property as defined by §1011. §1011 provides that adjusted basis means gross asset basis under §1012 (generally cost) with the adjustments provided in §1016. §1016 requires an adjustment for depreciation allowed or allowable. [Emphasis added.] The question then becomes what is allowable depreciation for your taxpayer. §1016(a)(2) provides that where no method of depreciation has been adopted for an asset, the straight line method shall be used for computing allowable depreciation. While this is interesting, it is useless information in the case of real estate which now must be written off on a straight line basis in any event. Unfortunately, this seems to be the last word on this matter. Ultimately, the question is whether straight line depreciation over 27.5 years is the allowable amount or whether the taxpayer could claim depreciation over the longer ADS life under §168(g), 40 years for real estate. The alternative longer life for real estate available under §168(g) is elective. Again, I am not completely sure whether you are dealing with the initial year of the taxpayer's ownership of the property or whether the property has been held for some time and is now being sold. If you are dealing with the initial year, then the taxpayer is free to elect the 40- year life under §168(g)(7). Otherwise, it seems to me that allowable depreciation would be computed based on 27.5 years since no special election under §168(g)(7) was made with respect to the property. This result is not free from doubt. While it seems to be a well-reasoned conclusion flowing from existing statutes, there is nothing that definitively states the conclusion set forth above regarding 27.5 year life. I was unable to find any cases or rulings on point, which is a little surprising. The closest precedent is the case of James Petroleum Corp., 24 TC 509, (Acq) in which the IRS forced the taxpayer to increase the gain on sale of an oil lease by cost depletion instead of the lower amount based on the percentage of income method. Apparently, the taxpayer was unable to claim percentage depletion due to a net income limitation, and the court forced the taxpayer to claim cost depletion instead for purposes of determining gain from disposition of the lease. While this case is is the closest thing I can find, it does not seem to affect the result here one way or the other. |
