the United States, offered as security, had to be, in par value not less than the amount of the penal sum of the bond executed on Form 1124a, which had to be in double the amount of the tax covered by the abatement claim. The bonds so offered as security were delivered to the Commissioner at the obligor's risk and expense. Registered bonds so offered as security were registered in the name of the obligor and duly assigned to the Commissioner at or before the date of deposit with the Commissioner. The Commissioner issued a receipt in duplicate for United States Bonds so deposited with him as security, the original of the receipt being given to the obligor, and the duplicate retained by the Commissioner for his files. Bonds of the United States will be returned to the obligor as soon as the security for the performance of such penal bond is no longer necessary. Registered bonds will be re assigned to the owner when the liability is cancelled.86

86 T. D. 2925.

CHAPTER 26

DEDUCTION OF ALLOWANCE FOR DEPRECIATION, OBSOLESCENCE AND

AMORTIZATION

In the case of individuals the Revenue Act of 1918 permits a reasonable allowance for the exhaustion, wear and tear of property used in the trade or business of an individual, including a reasonable allowance for obsolescence.1 In the case of nonresident aliens, the deduction for depreciation or obsolescence is permitted if and to the extent that it is connected with income arising from a source within the United States; and the proper apportionment and allocation of the deduction with respect to sources of income within and without the United States is determined under rules and regulations prescribed by the Commissioner with the approval of the Secretary. In the case of corporations, the allowance is also for the exhaustion, wear and tear of property used in the trade or business, including a reasonable allowance for obsolescence, limited in the case of a foreign corporation as above indicated in the case of non-resident aliens. It must be borne in mind that the allowance for depreciation or obsolescence does not include any element of a mere reduction in market value not resulting from exhaustion, wear and tear or obsolescence. The proper allowance for such depreciation of any property used in the trade or business is that amount which should be set aside for the taxable year in accordance with a consistent plan by which the aggregate of such amounts for the useful life of the property in the business will suffice, with the salvage value, at the end of such useful life to provide in place of the property, its cost, or its value as of March 1, 1913, if acquired by the taxpayer before that date.5

The new provisions of the Revenue Act of 1918 for the deduction of a reasonable allowance for obsolescence and amortization are treated in this chapter in addition to the subject of depreciation of property used in the trade or business of a taxpayer. Depreciation in the case of farmers is discussed elsewhere in this book.

9

Depreciation Under Preceding Income Tax Laws. The 1909 Law allowed the deduction of all losses including a reasonable allowance for depreciation of property, if any. The 1913 Law allowed as a deduction in the case of individuals " a reasonable allowance for the exhaustion, wear and tear of property arising out of its use or employment in the business," and in the case of corporations all losses "including a reasonable allowance for depreciation by use, wear and tear of property, if any." The 1916 Law allowed to individuals 10 a deduction of “a reasonable allowance for the exhaustion, wear and tear of property arising out of its use or employment in the business or trade," and to corporations 11 a deduction of all losses "including a reasonable allowance for the exhaustion, wear and tear of property arising out of its use or employment in the business or trade." It is important to note the difference in phraseology between these various provisions in consulting any case decided under preceding laws as an authority under the present law.

Depreciable Property. The necessity for a depreciation allowance arises from the fact that certain property used in the business gradually approaches a point where its usefulness is exhausted. The allowance should be confined to property of this nature. In the case of tangible property, it applies to that which is subject to wear and tear, to decay or decline from natural causes, to exhaustion, and to obsolescence due to the normal progress of the art or to becoming inadequate to the growing needs of the business. It does not apply to inventories or to stock in trade; nor to land apart from the improvements or

6 See Chapter 7.

7 Act of August 5, 1909, § 38.

8 Act of October 3, 1913, § B.

9 Act of October 3, 1913, § G (b).

10 Revenue Act of 1916, §§ 5 (a), 6 (a).

11 Revenue Act of 1916, § 12.

physical development added to it.12 It does not apply to bodies of minerals which through the process of removal suffer depletion, other provision for this being made in the statute by way of an allowance for depletion.13 Property kept in repair may, nevertheless, be the subject of a depreciation allowance.14 The deduction of an allowance for depreciation is limited to property used in the taxpayer's trade or business. No such allowance may be made in respect of automobiles or other vehicles used chiefly for pleasure, a building used by the taxpayer solely as his residence, nor in respect of furniture or furnishings therein, personal effects, or clothing; but properties and costumes used exclusively in a business, such as a theatrical business,15 may be the subject of a depreciation allowance.16

LOSS IN RENTAL VALUE OF BUILDINGS. Under the former laws the deduction on account of depreciation could not include any allowance for an estimated loss due to lessening of rental value, nor could the computation of the deduction be influenced by the changed environment after a period of years, nor by its lack of adaptability to the use originally intended, nor to any other outside influence affecting its value. But under the present law it would seem that these factors of obsolescence may be given weight in calculating the depreciation of office buildings, apartment houses and other structures. However, the regulations appear still to hold to the old rule.17

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 ground. The allowance is intended. to measure the decline in the value of the improvements due to the wear and tear thereof.18 In determining the cost of real estate upon which depreciable property is located, it frequently occurs that no segregation is made of the cost of buildings as

12 See paragraph on real estate, below.

13 See Chapter 28.

14 See p. 408.

15 See p. 404.

16 Reg. 45, Art. 162; Reg. 33 Rev., Art. 159; T. D. 2153; T. D. 2005. Depreciation as an allowable deduction in ascertaining net income for the purpose of the income tax is not to be confused with the deduction for loss.

17 Cohen v. Lowe, 234 Fed. 474; Reg. 33 Rev., Art. 162; Reg. 45, Art. 166. 18 Reg. 45, Art. 162; Reg. 33 Rev., Art. 162; T. D. 2152; T. D. 2137.

separate and distinct from the cost of the ground upon which such buildings stand. In such cases where the actual cost of the buildings or improvements at the time they were taken over by the taxpayer can not be definitely determined, it will be sufficient, for the purpose of determining the rate of depreciation to be used in computing the amount deductible from gross income, to estimate the actual value at the time acquired, of buildings or improvements if acquired after March 1, 1913, or the fair market price or value as of that date, if the property was acquired prior to March 1, 1913.19

WEARING APPAREL. If costumes purchased by actors and actresses are used exclusively in the production of a play and are not adapted for occasional personal use, and are not so used, deduction may be claimed on account of such depreciation in their value as occurs during the year on account of wear and tear arising from their use in the production of a play, or a loss may be claimed if they become obsolete at the close of the production.20

MERCHANDISE. Depreciation does not apply to inventories or to stock in trade.21

Intangible Property. Intangibles, the use of which in the trade or business is definitely limited in duration, may be the subject of a depreciation allowance. Examples are patents and copyrights, licenses, and franchises. Intangibles, the use of which in business or trade is not so limited, will not usually be a proper subject of such an allowance. If, however, an intangible asset acquired through capital outlay is known from experience. to be of value in the business for only a limited period, the length of which can be estimated from experience with reasonable certainty, such intangible asset may be the subject of a depreciation

19 Reg. 33 Rev., Art. 163; T. D. 2137; T. D. 2152.

20 Reg. 45, Art. 162; Reg. 33 Rev., Art. 8; T. D. 2090. See Reg. 45, Art. 143, if loss is claimed.

21 Reg. 45, Art. 162. It has been held under previous laws that depreciation computed on total invoice cost of merchandise in stock is not an allowable deduction, except that if any portion of the merchandise in stock is unsalable by reason of obsolescence or damage, a depreciation deduction not in excess of the decline in value during the taxable year will be allowed. (Reg. 33 Rev., Art. 169.)