be worth the effort. The only exemption to the rule that income cannot be accrued ratably over the period in which it is earned lies in the theory that accumulations of value, realized or unrealized, before March 1, 1913, belong to that period. And the exception strengthens the rule, especially as recently applied, for it is only that portion of the net profit or net loss which can be attributed to the period subject to income taxes that is of significance for tax purposes in the year of cash realization. Income constructively received must be reported as earned; otherwise, as has been pointed out, manipulation of the source of income over which the taxpayer has control would be possible. Income from forced conversions of the type described on page 56 is involuntary income and is not taxed if reinvested in good faith; and perhaps a somewhat similar idea lies behind the attempt of Congress not to tax certain non-cash exchanges. The seller, outside of income tax considerations, would, of course, prefer cash to property having no readily realizable market value unless the latter happened to be an equally or more preferred type of investment. But a stronger reason impels the general exemption of non-cash transactions. An income tax is based on the ability to pay, and since payment in cash may not be deferred, without penalties, to a later period, an effort has been made to eliminate the necessity of disposing of the assets received and to decrease the number of inducements to tax evasions. Considerations of income are inseparable from an analysis of deductions because it is only the net income on which the tax is based. The subsequent eight chapters, therefore, will take up the principles underlying deductions. XI DEPRECIATION AND OBSOLESCENCE Basis of depreciation. Rates of depreciation. Testing depreciation provisions. Reserve for depreciation. Intangibles. Basis for computing obsoles cence. ASSETS having a limited life are regarded as prepaid expenses from the point of view of the Revenue Act and the regulations, providing they are used for business purposes. Most deductions are confined to business expenses although income is not limited to business sources. Their cost less scrap value is recoverable through proper charges to income, following any recognized pro-rata scheme. Depreciation of capital assets of the type common to manufacturing enterprises due to new improvements and inadequacy is called "obsolescence"; while references in the regulations to "depreciation" are limited in their application to ordinary wear and tear, but sometimes include obsolescence (Art. 161-170). Extraordinary capital asset depreciation arising from the production of war facilities is found under the head of "amortization," a term not otherwise associated with depreciation. Depreciation of properties from which minerals and other products are being extracted or timber removed is "depletion." DEPRECIATION 1. Basis. Depreciation of tangible assets is based on their cost or March 1, 1913, value if purchased prior to that date, less their scrap value. The use of March 1, 1913, values has been continuous since January 1, 1916, and has been applied retroactively to March 1, 1913, but it is of interest to note that the act of 1921 is the first law to give formal sanction to such use (Sec. 214(a) (8)). The terms "cost" and "fair market price or value" are used with apparently the same meaning as in Section 202 1; that is, depreciation is to be computed on the value of the asset as arrived at in connection with the sale and transfer of property-a procedure which is in agreement with present accounting practice. Depreciation has been based on cost or March 1, 1913, value where applicable, by authority of T. D. 2754. The ascertainment of March 1, 1913, values for depreciation or other purposes was, in the past, a difficult matter, even though evidenced by appraisals or other proof of value. At one time the Department had little faith in appraisals made after 1913 for the purpose of providing March I, 1913, values.2 At present, "retrospective" appraisals are sanctioned (A. R. R. 747), and most appraisal companies are familiar with the requirements of the Bureau. Where other evidence of March 1, 1913, values is lacking, cost less depreciation should be the basis (Art. 164). The basis to be used in connection with reorganization has been subject to much speculation. In O. D. 458 (a 1920 case) it was held that the value of assets for depreciation purposes was cost at the time they were acquired in reorganization. This view is perhaps the same as that expressed in O. D. 639 where upon the dissolution of a corporation and the formation of a partnership by its principal stockholders the latter were taxed on the excess of the fair value of the assets received over the cost of their holdings, and the basis for depreciation was the fair value of the assets thus acquired. But where the assets of one corporation are transferred to another and no taxable profit accrues to the stockholders it is doubtful if the value of the assets at the time of reorganization may be regarded as a fair basis for subsequent depreciation charges, although I. T. 1701 permits such fair value in the case of a corporation formed from a sole proprietorship. It is also of in 1 See page 43. 2 For example, see A. R. R. 358, decided in early part of 1921. |