DEPRECIATION DEDUCTIONS ALLOWED ON ANTIQUE MUSICAL INSTRUMENTS USED IN A TRADE OR BUSINESS

By Gloria Vollmers, PhD, CPA,
assistant professor of accounting,
University of Maine, Steven C.
Colburn, PhD, CPA, associate professor of accounting, University of Maine, and Ted D. Englebrecht, PhD, CPA,
Eminent Scholar, Old Dominion
University

Taking a deduction for an asset used in a trade or business is normally not a problem for most businesses. However, in cases where the asset employed is a valuable antique musical instrument, the IRS has sought to disallow such deductions. Major areas of controversy include 1) the useful lives of such assets and 2) the fact that antique instruments often increase in value, rather than decrease in value. In Simon v. Commissioner (103 TC No. 285) and Liddle v. Commissioner (103 TC No. 247), the Tax Court addressed these issues and others in determining whether to allow depreciation deductions for antique musical instruments used by professional musicians.

A requirement complicating the calculation of depreciation deductions prior to ERTA, (the Economic Recovery Tax Act of 1981), later simplified by Congress, was that the taxpayer determine the useful life of assets employed in a trade or business. Allowances for depreciation deductions were granted under IRC section 167. IRC section 167(a) provides that "There shall be allowed as a depreciation deduction a reasonable allowance for the exhaustion, wear, and tear (including a reasonable allowance for obsolescence) of property used in the trade or business, or of property held for the production of income." The regulations developed under this section provided that such property could only be depreciated if the taxpayer could establish the property's useful life. In determining this useful life, the taxpayer was required to consider the "wear and tear and decay or decline from natural causes" that were known to affect the asset [Regs. section 1.167(a)­1(b)].

Revenue Ruling 68-232 (1968-1 C.B. 79) states that a valuable and treasured art piece does not have a determinable useful life. The ruling also distinguishes between the condition of the artwork and its life. While the actual physical condition of the artwork may influence the market value placed on it, its condition will not ordinarily limit or determine the artifact's useful life. Accordingly, works of art may not be depreciated. While a precise definition of "works of art" does not exist in the code, such assets usually fall into a category of assets that have no determinable useful life and do not predictably decline in value.

Both Simon and Liddle were similar in that the petitioners were professional musicians who had purchased antique musical instruments (Simon: two 19th century violin bows; Liddle: a late 17th century bass viol) and used them to play in symphony orchestras. Both used their instruments regularly for rehearsals and performances. The violin bows had been purchased in 1985 for more than $50,000 and insured in 1994 for $75,000. The viol had been purchased for $28,000 in 1984 and appraised at $65,000 in 1991.

The taxpayers argued that because the bows were used in their businesses, were necessary to their businesses, and had suffered wear and tear due to that use, depreciation deductions were appropriate. An expert witness testified that the bows had, indeed, suffered irreversible wear and tear.

The IRS provided two primary arguments that the taxpayers were not entitled to depreciation deductions: 1) The bows had indeterminate useful lives because they were treasured works of art for which it is impossible to determine useful lives. Their status as works of art was conditioned on their age (in excess of 100 years) and their appreciated value. 2) Referring to Revenue Ruling 68-232 (supra), the IRS maintained that the controlling issue which precluded taking a depreciation deduction was the inability of the taxpayers to assign reasonable useful lives to the instruments. The fact that the bows had existed for more than 100 years was evidence of their indeterminate lives making it impossible for the taxpayers to determine the remaining useful life of the instruments.

The court held for the taxpayers, ruling that neither the age nor the market values of the instruments were controlling. In reaching this decision, the court relied heavily on Congress' intended simplification of depreciation rules under ERTA. It interpreted this simplification as the elimination of a strict requirement that assets have a determinable useful life. As long as the asset suffered some wear and tear, as testified by an expert witness, the asset was deemed to be subject to an allowance for depreciation under IRC section 168 (ACRS).

Noting that tax accounting did not attempt to account for changes in market values of assets until such assets were sold or otherwise disposed of, the appreciation of the bows was held to be irrelevant. Depreciation was designed to allow taxpayers to recover the cost or other bases of productive assets through annual deductions.

The contention by the IRS that the violin bows were works of art was rejected by the court because of their active, regular, and routine use in the taxpayers' trade or business to produce income. Rather, it defined a work of art as a passive object, such as a painting or sculpture, that is displayed and admired for its aesthetic qualities. By way of analogy, the court noted that a computer used by a child to play games is not a depreciable asset. However, when that same computer is used by a data processor in a business, the computer becomes a depreciable asset.

The court noted that IRC section 168(a) allows a depreciation deduction for property that qualifies as "recovery property." It stated that recovery property is defined broadly under ERTA as tangible property of a character subject to the allowance for depreciation and placed in service after 1980. Thus, according to the court, property is "recovery property" if it is 1) tangible, 2) placed in service after 1980, 3) of a character subject to the allowance for depreciation, and 4) used in a trade or business. [IRC section 168(c)(1); Noyce v. Commissioner, 97 TC 670, 689 (1991); ERTA section 209(a), 95 Stat. 172.]

Applying this definition, the court further noted that the bows easily satisfied the definition of recovery property of IRC section 168. First, it was beyond dispute that the bows were tangible property and that they were placed in service after 1980. Second, the bows were used by the taxpayers on a regular basis as professional musicians in their trade or business during the year in question.

The court noted that the term "of a character subject to the allowance for depreciation" is undefined in the 1954 code. It compared the language Congress used in IRC section 167(a) of the 1954 code immediately before its amendment under ERTA, with the language used in IRC sections 168(a) and (c)(1) as added by ERTA. As a result, the court concluded the term "of a character subject to the allowance for depreciation" means that the property must suffer exhaustion, wear and tear, or obsolescence to qualify for depreciation.

The court concluded that the frequent use of the bows by the petitioners subjected them to substantial wear and tear during the tax year in question. It also noted that the IRS' expert witness acknowledged during the trial that the bows suffered wear and tear due to their use in the petitioners' business.

Noting that the petitioners had satisfied all four criteria for depreciating personal property under IRC section 168, it held that the taxpayers could depreciate the violin bows for the year at issue. The court concluded by stating that refusing to allow the taxpayers to deduct depreciation on the bows would run counter to IRC section 168 and the accounting principle of allowing taxpayers to write off income-producing assets against the income generated by those assets. The court applied similar reasoning in Liddle in determining that the taxpayer may depreciate the antique viol used to play profe ssionally in the symphony.

Editor:

Edwin B. Morris, CPA
Rosenberg, Neuwirth & Kuchner

Contributing Editor:
Richard M. Barth, CPA