age rate on the old plant is 8 per cent, is that the proper rate on the new plant? Is $160,000 per annum for the new plant the equivalent of $80,000 for the old plant? Strictly speaking, it is equivalent because depreciation rates, when accurate, are based on the effective life of the plant, and if reserves at the rate of 8 per cent per annum will provide a fund sufficient to replace the plant as it wears out, no higher rate is permitted under a strict interpretation of the existing law.

There is, however, a sound foundation for a claim to extra depreciation on the part of those who have erected plants during this period of high prices, even when the plant will not become obsolete after the war.27 It can be assumed that anyone who built a plant under the conditions which have existed during the recent past did so because he counted upon being able, through the profits of this abnormal period, to write off that part of the cost of the plant which was clearly supernormal so that he might be on the same cost basis after the return of peace as the proprietors of other plants built before or after the period of very high prices.

The foregoing argument must not be construed to support increases in current depreciation rates where the cost of the property involved was normal although recently purchased, nor in any case in which the property was acquired prior to 1915.

Depreciation of plant or equipment acquired before April 6, 1917.-The foregoing comments refer in general to all classes of plant and equipment no matter when purchased. The 1918 law provides full relief for losses on plant and equipment acquired after April 6, 1917; but no special relief for losses arising out of the subsequent fall in value of property acquired at the high prices which prevailed after 1916 and before April 6, 1917, is found in the law. The Commissioner, however, may hold that a reasonable allowance for

"See Chapter XXX. For a discussion of the use of replacement funds in the case of losses through war hazards, see Chapter XIII.

depreciation as applied to special conditions means a higher allowance than under ordinary conditions.

It is almost safe to assume that all plants erected during 1916 and early in 1917 were operated under adverse conditions and that the actual depreciation which took place was probably double normal depreciation.

Depreciation Rates and Practice-Specific Suggestions

In the pages which follow, information2 is given which is intended to serve as a guide in deciding in what cases and at what rates depreciation shall be charged. The topics, which are arranged in alphabetical order, deal in some cases with specific objects or classes of objects and in other cases with types of enterprises. The list is not intended to be and obviously cannot be complete. The variations of the rates in some of the cases given indicate the futility of trying to set uniform rates applicable to given objects under all conditions.

Alterations and improvements.-In some cases alterations are charged as an expense, being regarded as in the nature of repairs. 29 This practice is not always correct. Many alterations are in the nature of improvements, and improvements are capital expenditures. This is the position taken by the Treasury as is shown by the following quotation:

REGULATIONS. No deduction from gross income may be made for any amounts paid out for new buildings or for permanent improvements or betterments made to increase the value of any property, or for any amounts expended in restoring property or in making good

28 The general sources are, for American practice, Auditing, Theory and Practice (2nd edition), by R. H. Montgomery, pages 401-429, and, for British practice, Income Tax Practice, by Murray and Carter.

"DECISION. "Amounts expended by a business corporation in enlarging or making improvements in its office or premises, not in the nature of permanent improvements to the property, but to facilitate the transaction of a growing business, should properly be deducted as necessary expenses of the business." (Connecticut Mutual Life Insurance Co. v. Eaton, 218 Fed. 206.)

the exhaustion thereof for which an allowance for depreciation or depletion or other allowance is or has been made. ... (Art. 581.)

. . In any case in which the cost of capital assets is being recovered through deductions for wear and tear, depletion or obsolescence any expenditure (other than ordinary repairs) made to restore the property or prolong its useful life should be charged against the property account or the appropriate reserve and not against current expenses. (Art. 24.)

The author reiterates his advice that liberal allowances should be made for repairs and depreciation, and that no expenditures should be charged to capital if there is any doubt about the items. Sometimes so-called alterations may properly be charged off as a necessary expense of the business. If so, some name other than alterations should be found for the expense.

Apartment houses.-See "Buildings" (below).

Automobiles. Under ordinary conditions the rate of depreciation on automobiles should be fixed at not less than 20 per cent per annum. This rate has been adopted by the tax commission of one of the states. The Primer states that "the estimated lifetime of automobiles used for business or farm purposes and farm tractors" is "four to five years. A rate of depreciation based on an estimated life. of three years may not be excessive if adequate provision is made for residual value.

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While five years may appear to be a high estimate for the life of the average automobile it must be remembered that the nature of the asset permits repairs to be made on so extensive a scale as to reduce materially the necessity of complete renewals. Tires are frequently renewed, motors are replaced and in some cases (e.g., the taxicab companies) bodies are entirely rebuilt. Depreciation, therefore, as distinct from repairs and renewals may be a smaller factor than would appear at first glance. Of course, full allowance must be made for "accrued" wear and tear.

30Income Tax Primer, 1918, question 99.

REGULATION.

No such allowance may be made in respect of automobiles or other vehicles used chiefly for pleasure. (Art. 162.)

31

Books-business and professional.-The Treasury rules that the cost of professional books is not a business expense but is an investment of capital against which depreciation may be charged. Roughly speaking, books in a technical library depreciate at a rate rapid enough to justify charging off the total year's purchases in the case of libraries which are being kept up to date. This obviates the necessity of an annual revaluation of the entire library.

This plan has been approved by examiners who have satisfied themselves that the deduction for new books did not exceed reasonable depreciation on the entire library.

Buildings. Obviously no general rate will apply to buildings, as methods of construction, materials used, purposes, etc., affect the wear and tear incident to use. In a case relating to depreciation of apartment houses, the government allowed 3 per cent (see below). Perhaps this was a fair rate under laws which excluded the factors of inadequacy, change in character of neighborhood and other items of obsolescence. Under the 1918 law obsolescence must be taken into consideration. Three per cent is the rate frequently used by manufacturers for slow-burning brick structures; and 2 per cent is the minimum rate for concrete, brick and steel fireproof structures. Perhaps 22 per cent is more nearly correct. Where walls are subjected to unusual strain or vibration, a rate of not less than 4 per cent should be used.

In a state where the subject has been carefully studied, a rate of 2 to 22 per cent for cement or brick buildings and 3 to 5 per cent for wooden buildings has been adopted.

The National Machine Tool Builders' Association uses

Income Tax Primer, 1918, question 59.

these rates: brick buildings, 3 per cent; frame buildings, 5 per

cent.

The Primer states: "It has been estimated that the average usable lifetime of a frame building is 25 years, a brick building 35 years, a stone building or a steel and concrete building 50 to 100 years.'

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In the case of an apartment house the jury found that 3 per cent was a proper rate of depreciation.33 This was the rate allowed by the government, while the plaintiff claimed 5 per cent. The apartment house is situated at No. 320 West 84th Street, New York, a very desirable location. The jury was, of course, influenced by the charge of the court, which was in part as follows:

There is no question that the plaintiff was entitled to a deduction for wear and tear of this building, and the government allowed him, I believe, 3 per cent-he claims 5 per cent-and the question for you to determine is whether he is entitled to any greater allowance for depreciation over and above what the government allowed him, which is 3 per cent.

The burden would be upon him reasonably to satisfy you from the evidence that he was entitled to an allowance of an amount greater than 3 per cent in order to obtain that allowance because, as I say, he is the plaintiff asserting the claim. . .

The allowance is for wear and tear when it relates to a building . . that means the physical deterioration that a building suffers during the tax year; it does not include the depreciation in value due to a loss in rental value, because of modern buildings going up with better facilities than the old building had-that is not the idea.

The Treasury takes the following general position on the question of depreciation which applies particularly to the case of buildings:

REGULATION. No modification of the method should be made on account of changes in the market value of the property from time to time, such as, on the one hand, loss in rental value of buildings due to deterioration of the neighborhood, or, on the other, appreciation due to increased demand. The conditions affecting such market values should be taken into consideration only so far as they affect the estimate of the useful life of the property. (Art. 166.)