warrant a deduction, as the omission of such amounts operates, in itself, as a reduction of the tax.

MUST BE CHARGED OFF ON BOOKS. The law expressly provides in the case of individuals that worthless debts must have been "charged off" in the year in which they are claimed as a deduction. In the case of corporations such deduction must also be evidenced by entry on the books, as must all losses.33

WHEN DEBTS MAY BE CONSIDERED WORTHLESS. Where the debtor is an individual, it is not necessary that an unsatisfied judgment shall exist or a judicial determination be reached in order that the creditor may secure the benefit of a deduction on account of a debt which he considers worthless and uncollectible; but taking into consideration the time the debt is over-run and the financial condition of the debtor, it is required that it be shown beyond a reasonable doubt that the debt is worthless and uncollectible. If the debtor is a corporation, possessed of assets, the debt cannot be claimed as a deduction except for the year in which the debtor corporation's affairs are finally closed and its receiver in bankruptcy discharged. Where in any case a creditor to protect himself from total loss enters into a compromise agreement under the terms of which he accepts a part payment of the debt and releases the debtor from payment of the balance, the unpaid portion' may be claimed as a deduction.34 Whenever the debtor is legally discharged from his obligation either by the running of the statute of

33 Act of September 8, 1916, §§ 5 (a) and 12 (a), Reg. 33, Art. 125.

34 Letter from Treasury Department dated October 16, 1917; I. T. S. 1917, ¶ 2441.

limitation, by bankruptcy proceedings, by accord and satisfaction, by formal release, or by any other method, it seems the creditor may claim the amount of loss which he sustains as a deduction. As indicated by the ruling above it may be possible under other conditions to deduct the amount of a debt but the circumstances must be such as to indicate beyond doubt that the debt cannot be collected. A mere voluntary forgiveness of the debt would not make the amount thereof an allowable deduction since such voluntary action on the part of the creditor would be tantamount to a gift.

Unpaid Instalments. When property has been sold on the instalment plan and the total amount of notes taken for the selling price has been treated as the equivalent of cash in reporting income, if subsequently instalment payments are defaulted, there may be charged off as bad debts the amount of such unpaid instalments, less the salvage value of the property re-possessed.35

Loss Due to Adverse Judgment. In a case where a corporation was sued for infringing a trade name covering a period ending in 1912, and judgment was obtained against it in 1916, the Treasury Department held that the amount of this judgment should be prorated over the period ending in 1912 according to the income of each year. Such part as was found by this method to be applicable to the income of the corporation for the period 1909 to 1912 would be referable to those years, but no part of this sum would be deductible as a loss in the return of income for 1916. The same corporation also paid, in 1916, an additional sum, as consideration for dismissal of a pending suit for interest on the above judg35 T. D. 2090.

ment from the date of the decision of the court to the date of payment and for the unrestrained use of the trade name in question. It was held by the Treasury Department that if this amount could be segregated between interest and use, it might be prorated the same as in the other case, for the period subsequent to 1912, and such part thereof as would be found applicable to the 1916 income would be deductible under the head of business expense and interest respectively. If no segregation could be made the entire amount might be treated as business expense.36 This ruling was made, apparently, on the theory that the loss was not sustained in 1916, but in the respective years when the income was earned, but the language of the law would better support a conclusion that the entire loss was sustained in the year the adverse judgment was rendered.

36 Letter from Treasury Department dated February 9, 1917; I. T. S. 1917, ¶ 2009.

CHAPTER 32

DEDUCTION OF ALLOWANCE FOR DEPRECIATION

In the case of individuals the law permits a reasonable allowance for the exhaustion, wear and tear of property arising out of its use or employment in the business or trade of the individual. Property not used in his business may not be included in the annual allowance for depreciation. In the case of non-resident aliens, the property must be within the United States and used or employed in the business or trade of the non-resident alien. In the case of corporations, the allowance is also for the exhaustion, wear and tear of property arising out of its use or employment in the business or trade, limited in the case of a foreign corporation to the business or trade conducted by it within the United States.1 The purpose of allowing a deduction each year for depreciation is to take care of the certain loss of property which takes place from year to year, due to wear and tear. The property must be used or employed in the business or trade of the taxpayer. No depreciation is allowed on a dwelling house occupied by the owner as a private residence.2

Property Must Be Subject to Wear and Tear. Depreciation as an allowable deduction in ascertaining an

1 Act of September 8, 1916; §§ 5 (a), 6 (a), 12 (a) and 12 (b). 2 T. D. 2153.

nual net income for the purpose of the income tax is not to be confused with the deduction for loss. The depreciation permitted to be taken as a deduction is the value assigned to the deterioration of physical improvements or assets such as are susceptible of having their value lessened through wear and tear.3 Assets of any character which are not affected by use and wear and tear are not subject to the depreciation authorized by the law.

LOSS IN RENTAL VALUE OF BUILDINGS. The allowance for depreciation is to make good the wear and tear suffered by property during the tax year which, in the case of a building, means the physical deterioration thereof. It does not take into account depreciation in value due to a loss in rental value because of the construction of more modern buildings with improved facilities or due to change in the neighborhood.5

REAL ESTATE. Real estate, as such, and as distinct from the improvements thereon, is not reduced in value by reason of wear and tear and an allowance for depreciation in the case of real-estate does not apply to the grounds, but is intended to measure the decline in the value of the improvements due to wear and tear of such improvements. In determining the cost of real estate, in most cases, no segregation is made of the cost of the building as separate and distinct from the cost of the ground. In such cases the value of the ground should be appraised and deducted from the total cost of the

3 T. D. 2005.

4 T. D. 2137.

5 Cohen v. Lowe, 234 Fed. 474.