the annual allowance for that portion used as an office (three rooms out of eight) would be % of the cost of the house (since it was purchased after March 1, 1913) divided by the number of years of expected utility. For 1921, the allowance would be 11/12 of this annual allowance. The 1921 allowance covering the equipment of these three rooms used as an office would be 11/12 of the annual allowance. In the case of his automobile purchased in June, if it were used solely for business purposes, the 1921 allowance would be 12 of the annual allowance. As however, it was used only in part for business purposes, that allowance must be still further reduced depending upon the relative use in business compared with total use.

REFERENCE:

Sec. 214 (a) (8): (Quoted under Problem 120.)

Bul. "F" Page 6, "Automobiles.-A deduction may be claimed for depreciation of automobiles and similar equipment used in the trade or business. The rate will depend principally on the purpose for which the equipment is used and must be estimated in each case by the taxpayer according to his experience and judgment. A professional man who uses an automobile in making professional calls is entitled to an allowance for depreciation, but if the automobile is used partly for pleasure or purposes apart from the business only a proportionate part of the depreciation sustained may be deducted; if used chiefly for pleasure, no depreciation deduction is allowable."

Bul. "F" Page 7, "Depreciation of personal residence.-Depreciation of a building occupied by a taxpayer as his personal residence is not deductible for income tax purposes. If a portion of the residence is used for business purposes, as in the case of a physician or any other professional man who has his office in his home, a proportionate part of the depreciation sustained may be deducted, the amount to be based generally on the ratio of the number of rooms used for business purposes to the total number of rooms in the building...

Bul. "F" Page 11, "Professional Libraries.-A professional man is entitled to deduct a reasonable allowance covering depreciation actually sustained on that part of his library which is necessary and used wholly in the pursuit of his profession, taking as a basis for such allowance, the fair market value as of March 1, 1913, if acquired to that date, or the cost, if acquired on or subsequent to that date. The cost of professional periodicals and books purchased by a business or professional man and having a temporary value, should be deducted as an expense of doing business, but the cost of volumes which have a more permanent value to the business or

profession, should be capitalized and made the subject of depreciation allowances."

PROBLEM 124

Illustrating Deductions Allowed-Depreciation-Basis (a) Economic Life Instead of Physical Life of Property (b) Apportionment over Units of Production

FACTS:

The W. & J. Lumber Co. in 1918 secured a contract to cut and saw the timber on a certain tract of land. The company erected buildings and installed the necessary equipment to perform the contract, which was estimated to require three years to complete. The tract of land was so situated that the cost of removal of the buildings after completing the contract would be prohibitive, and the buildings and equipment would have no value to the company other than their salvage value.

QUESTION:

How should the company compute depreciation on these assets, where the period of usefulness is less than the normal physical life of such assets?

ANSWER:

Under such conditions the capital sum (cost less salvage value) to be replaced by allowances for depreciation should be charged off on the basis of either the time required to complete the contract or the units of production.

REFERENCE:

See Problem 120 for law quotation, Sec. 234 (a) (7).

Bureau of Internal Revenue Bul. "F" page 31: "The cost of the property and equipment may be charged off and deducted as depreciation allowances on the basis of the time required to complete. the contract, or in the proportion that the amount of timber cut and sawed each year bears to the total amount of timber available."

Bul. "F," page 13: "Prior to the passage of the Revenue Act of 1918, no deduction on account of obsolescence was permitted."

INDIVIDUALS:

While the above problem illustrates the principle as it applies to corporations, the same treatment as to the depreciation allowance would obtain in similar circumstances for individuals.

REFERENCE:

...

Sec. 214 (a): "That in computing net income there shall be allowed as deductions: .. (8) A reasonable allowance for the exhaustion, wear and tear of property used in the trade or business, including a reasonable allowance for obsolescence. In the case of such property acquired before March 1, 1913, this deduction shall be computed upon the basis of its fair market price or value as of March 1, 1913;"

FACTS:

PROBLEM 125

Illustrating Depreciation of Intangible Property

Henry Schmidt purchased the business and assets of the Teutonic Brewing Company in January, 1914, paying therefor the sum of $1,500,000 in cash. An appraisal of the assets acquired at the time indicated that the intangible assets, i. e., good will, trade marks, trade brands, etc., had a value of $500,000. Mr. Schmidt continued the business of his predecessor under the name of the Teutonic Brewing Company. Because of the Eighteenth Amendment to the Constitution, the brewing company had to cease business on January 16, 1920. The net income of Mr. Schmidt from January 31, 1918, to January 16, 1920, was $600,000. On the basis of the income which Mr. Schmidt expected to derive in the period from January 31, 1918, to January 16, 1920, over and above a normal return on the tangible assets the value of the intangible assets on January 31, 1918, was $300,000. Mr. Schmidt filed returns for 1918, 1919, and 1920, on the calendar-year basis. No deduction had been claimed on account of depreciation of the intangible property by reason of prohibition legislation.

QUESTION:

Is Mr. Schmidt entitled to a deduction from gross income on

account of the depreciation of the good will and other intangible assets of his brewing business, and if so, how is such depreciation to be computed?

ANSWER:

While ordinarily taxpayers are not allowed a deduction from gross income on account of depreciation of good will or other similar intangible property, by reason of the special circumstances which exist in cases of this kind the Bureau has held that taxpayers are entitled to a deduction on account of such depreciation. Because of the status of prohibition legislation on January 31, 1918, the Bureau has ruled that good will and other intangible property of distillers, brewers, etc., was on January 31, 1918 reduced to the then present value of the income to be derived between that date and January 16, 1920. The value of the good will on January 31, 1918, may be depreciated on the basis of the time elapsed between that date and the date upon which prohibition became effective, namely, January 16, 1920. The computation of the depreciation deductions on account of the intangible assets is shown in the following:

The actual value on January 31, 1918, of the net income estimated to be derived from the intangible assets was $300,000. This amount, therefore, represents the value of the intangible assets as at January 31, 1918. The difference between this amount and $500,000 represents the depreciation which had fully accrued on January 31, 1918 ($200,000).

This $200,000 is deductible in the first taxable year ending on or after January 31, 1918; in this case the taxable year ended December 31, 1918. The remaining $300,000 is deductible as follows:

11

2312

12

231/2

X $300,000 $140,425.53 for the taxable year 1918

=

X $300,000-$153,191.49 for the taxable year 1919

1/2

X $300,000 $ 6,382.98 for the period Jan. 1 to Jan. 16,

2312

1920.

Amounts to be written off in 1918: $200,000.00

It is to be noted that in the above the value of the good will on January 31, 1918, is depreciated on the basis of the portion of the interval in each taxable year between January 31, 1918, and January 16, 1920, or eleven months for 1918, twelve months for 1919, and one-half month for 1920, making a total of 232 months.

REFERENCES:

Art. 163, Reg. 62: "Depreciation of 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 the 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 allowance, provided the facts are fully shown in the return or prior thereto to the satisfaction of the Commissioner."

See also Bul. 15-19-445; T. B. R. 44. Also Bul. "F," page 15.