Maly, George J., Jr.

English

Marquette University Law School

Marquette Law ReviewVolume 42Issue 4 Spring 1959 Article 12Federal Income Taxation: DepreciationDeduction: Useful Life and Salvage Value UnderThe Declining Balance MethodGeorge J. Maly Jr.Follow this and additional works at: http://scholarship.law.marquette.edu/mulrPart of the Law CommonsThis Article is brought to you for free and open access by the Journals at Marquette Law Scholarly Commons. It has been accepted for inclusion inMarquette Law Review by an authorized administrator of Marquette Law Scholarly Commons. For more information, please contactmegan.obrien@marquette.edu.Repository CitationGeorge J. Maly Jr., Federal Income Taxation: Depreciation Deduction: Useful Life and Salvage Value Under The Declining Balance Method,42 Marq. L. Rev. 568 (1959).Available at: http://scholarship.law.marquette.edu/mulr/vol42/iss4/12MARQUETTE LAW REVIEWexercised in aid of the state's administration of justice, not to defeator needlessly embarrass it.Under the particular facts of this case a strong argument can bemade in favor of affirming the action of the district court. The dissentof Judge Finnegan does just that. As the record clearly shows thepetitioner filed a notice of appeal and requested a verbatim recordimmediately after his conviction. Through no fault of his own he wasprevented from further prosecuting the appeal. The matter was beforethe State Supreme Court on at least three separate occasions" whenaction could have been taken to grant a new trial. It would seem thatduring the ten year period preceding the present case the state hadalready had a reasonable time in which to take corrective action andthat now law and justice would require the prisoner to be discharged.Aside from the final disposition of the case, there is a question ofthe propriety of the order of the district court discharging the prisonerin view of the request by the state attorney general that the prisonerbe not released pending appeal. In O'Brien v. Lindsey12 the followingcomment was made:Weighing the relevant considerations of policy, it is by nomeans clear that as a matter of right and routine a state prisonershould be set at large pending review in a court of appeals of afederal district court order discharging the prisoner on habeascorpus.Considering here the fact that the district judge certified that there ex-isted probable cause for appeal" and also the attorney general's re-quest, it would appear that the discharge should have been delayedpending the appeal.FRANK C. DEGUIREFederal Income Taxation: Depreciation Deduction-Useful Lifeand Salvage Value Under the Declining Balance Method-Taxpayercorporation is engaged in the business of renting automobiles. Onan average, during the tax years in issue, new cars were held by thetaxpayer for a period of 26 months and then sold, although, generally,such autos had a useful life to someone of four years. Taxpayer con-tended that it should be allowed to depreciate the cars on the declining11 1951-Westbrook, appearing pro se, prosecuted a writ of error to the IllinoisSupreme Court, contending the sentence imposed was improper. The Courtheld that the sentence was not for an indeterminate period and remanded thethe case for imposition of a proper sentence. He was resentenced to 30-50years imprisonment. People v. Westbrook, 411 Ill. 301, 103 N.E. 2d 494 (1952).1952-Illinois Supreme Court affirmed a denial of petition for a hearing underthe Illinois Post Conviction Hearing Act, ILL. REv. STAT. 1953, C. 38, §§26-832.1956-Petition for writ of habeas corpus dismissed. See 259 F. 2d at 217.12202. F. 2d 418, 420 (1st Cir. 1953).'3 See 28 U.S.C.A. §2253.[Vol. 42RECENT DECISIONSbalance method, using four years as the useful life of the asset. Inthis connection, it further contended that Treas. Reg. §1.167(a)-i(b)is an erroneous interpretation and expansion of Section 167(b) (2) ofthe Internal Revenue Code of 1954. This regulation holds that, forpurposes of depreciation under Section 167 of the Code, "useful life"of an asset is the useful life of that asset to a particular taxpayer andnot the inherent overall useful life of that asset to someone. If thisregulation was correct, the taxpayer in the instant case could notdepreciate its autos by the declining balance method since under Section167(c) this method can be used only with an asset which has a usefullife of 3 years or more.Held: Under Section 167 of the code "useful life" of an asset forpurposes of depreciation is the useful life of that asset to the particulartaxpayer. Examination of the reports of the Committee of both Housesof Congress indicates a congressional intent that the declining balancemethod shall be a realistic method which allows depreciation on the basisof actual economic usefulness. To achieve this result it is essentialthat useful life as well as salvage value be based upon the actual lifeand salvage value of the asset to the particular taxpayer in question.This is a much more realistic approach than using the actual life ofthe asset, computed on the basis of its economic value to someone;or salvage value based on the value of the asset when it is no longereconomically useful to someone.Thus, the taxpayer in the instant case can not depreciate its autoson the declining balance method as they have a useful life of only 26months.1 Section 167(c) was designed to prevent an unnaturally fastwriteoff of short term assets by providing assets with useful life ofless than 3 years cannot be depreciated through the declining balancemethod. This Section is not to be circumvented by placing a useful lifeof 4 years upon an asset which has an actual useful life to the taxpayerof only 26 months. Hertz Corporation v. U.S., 165 F. Supp. 261(D. Del. 1958)*.If the principal case is correct in its interpretation, an incongruousresult arises which was clearly never intended by Congress. To illus-trate, let us take the example of a corporate asset acquired by a tax-payer with a basis of $10,000.00. This asset has an overall useful lifeof 10 years but will be retained by the taxpayer for use in his businessfor only four years. Under the doctrine of the principal case, the usefullife of the asset for purposes of depreciation will be 4 years. Therate of depreciation to be applied under the declining balance methodwill be 50 percent of the unexpended balance per year (200 percentI This regulation was held inapplicable retroactively' and thus the taxpayercould use the declining balance method for years prior to the adoption of theregulation.* [Appeal authorized by Solicitor General, P-H 1959 FED. TAXES. §56,355 Ed.]19591MARQUETTE LAW REVIEWof the straight line rate which on a four year asset is 25 percent peryear). Ignoring the actual salvage value but applying the salvage valueinherent in the declining balance method, at the end of four years thetaxpayer will have deducted $19,375.00 from ordinary income for de-preciation and the asset will have a basis of $625.00. On sale of theasset the taxpayer will pay capital gains on the excess of the amountrealized over basis, thus realizing a considerable tax saving. It is thusapparent that under the doctrine of the instant case an avenue fortax avoidance is opened to the taxpayer. He can hold an asset formuch less than its actual useful life and take accelerated depreciationwhich he deducts from ordinary income otherwise taxable at a 52percent rate.2 Then, upon sale, he pays the 25 percent capital gainsrate on the amount recovered in excess of basis. This tax saving devicewill be somewhat limited, in that, if the taxpayer holds the asset forless than 3 years he will be precluded from using the declining balancemethod under Section 167(c) of the Code. In the case of assets witha useful life of 3 years or more, however, the taxayer may rely uponthis method.Clearly, Congress never intended to allow such unnaturally fastdepreciation which would result in an unnaturally low basis at thetime of sale. Thus, in discussing the declining balance method ofdepreciation, the House Ways and Means Committee states:This method concentrates deductions in the early years ofservice and results in a timing of allowances more in accord withthe actual pattern of loss of economic usefulness. With the ratelimited to twice the corresonding straight-line rate and basedon a realistic estimate of useful life, the proposed system con-forms to sound accounting principles. 3The report of the Finance Committee indicated a philosophy identi-cal to that of the House.4 Both reports indicate an intent to havedepreciation reflect actual economic decline in value and not to allowunnaturally fast write-offs with a resulting basis which is much belowactual value.This contention is further borne out by Amendment No. 50 asproposed by the Senate and adopted as Section (167(c) of the Code.Under this provision the declining balance method cannot be used withassets which have a useful life of less than 3 years. In proposing thisamendment the Finance Committee stated:The use of the 200 percent declining balance rate in the caseof short-lived properties would result in extremely fast write-offs. For example, in the case of an asset with a 2 year servicelife, the doubling of the 50 percent straight-line rate would be2 The corporate rate on the first $25,000.00 of income would be 30 per cent.3 H. R. REP. No. 1337, 83d Cong., 2d Sess. 23 (1954).4 S. REP. No. 1622, 83d Cong., 2d Sess. 25 (1954).[Vol. 42RECENT DECISIONSequivalent to expensing the cost in the year of acquisition.These properties would retain substantial value and could beresold subject to capital gain rates.To prevent unrealistic deductions and resulting tax avoid-ance, your committee has provided that the liberalized methodsbe made available only with respect to assets with useful livesof 3 or more years. 5Thus, the Committee clearly expresses an intent to' disallow un-realistic writeoffs and goes so far as to provide that the decliningbalance method cannot be used with short term assets when suchwould be the result. It seems incongruous that the Congress wouldspecifically exclude assets with a useful life of less than 3 years toprevent unrealistic writeoffs and yet intend that this result can beaccomplished with assets which have a useful life of over 3 years byapplying a concept of useful life to the taxpayer plus an artificialsalvage value. The principal case relies heavily upon the above quotedlanguage from both the House and Senate in support of its contentionthat useful life to the individual taxpayer is the useful life contemplatedin Section 167 of the Code. However, when one couples this usefullife concept with the court's opinion that actual salvage value can beignored under the declining balance method, the result achieved will bethe very type of unrealistic depreciation which Congress is seekingto avoid.Realistic depreciation plus an accurate basis at the end of depreci-ation can be achieved under the declining balance method in one oftwo ways. If useful life of an asset is defined as the inherent usefullife of the asset to someone, the taxpayer will not be able to take asgreat an amount of depreciation. If he sells the asset before its usefullife is complete his basis will thus be greater. Taking the exampleused previously of a $10,000.00 asset with overall life of 10 years,the taxpayer could depreciate the asset at the rate of 20 percent peryear. At the end of four years he would have charged off $5,904.00as depreciation and the asset would have a basis of $4,096.00. In thealternative, the useful life of the asset could be determined as theuseful life to the individual taxpayer but it could be held that, underthe declining balance system, the asset may not be depreciated belowthe reasonable salvage value of the asset at the time the taxpayernormally disposes of assets of this type. Under this system, however,when one is dealing with an asset which has a long inherent life butwhich has a useful life to the taxpayer of only limited duration, alldepreciation may be concentrated in the first year or two of the lifeof the asset with the salvage value being reached at this time. Thus,there will be no depreciation allowable during the further life of the5Id. at 29.1959lMARQUETTE LAW REVIEWasset to the taxpayer. Clearly, this result does not conform to soundaccounting principles. The instant case rejects the concept of usingactual salvage value under the declining balance method.A perusal of the reports of the House and Senate indicates thatCongress did not intend true salvage value to be a limit on the amountdeductable under the declining balance method. Thus, the SenateFinance Committee in considering the declining balance method states:The salvage value is not deducated from the basis prior toapplying the rate, since under this method at the expiration ofuseful life there remains an undepreciated balance which rep-resents salvage value.0Likewise, the Staff of the Joint Committee on Internal RevenueTaxation in referring to the declining balance system in its Summaryof the New Provisions in the Internal Revenue Code of 1954 statesat page 17:However, due to the nature of the declining balance method,some 10 to 13 percent of the cost of a property (which may beeither more or less than salvage value) remains unrecoveredat the end of its service life....In addition, the Senate clearly recognized that the amount to beused as salvage under this method was not to be actual salvage whenit proposed Amendment 51 which was adopted as Section 167(e) ofthe Code. Under this section a taxpayer is permitted to change fromthe declining balance method to the straight line method. In discussingthis amendment the Senate Finance Committee indicated that, becauseof the nature of the declining balance method, the sum left as a basisat the end of depreciation might be larger than actual salvage values.By allowing the taxpayer to switch to the straight line method hewould be allowed to depreciate the asset down to its actual salvagevalue. In referring to this conversion from declining balance to straightline the committee states:The straight-line rate would be based on the realistic estimateof remaining life of the property at the time of the switch.Moreover, the rate would thereafter be applied to the depreci-ated balance of the account at the time of the switch, less arealistic estimate of salvage value.7All of these reports indicate that under the declining balance methodactual salvage value is not a limiting factor.Thus, the only conclusion that can be reached is that Congress in-tended useful life to be the actual inherent useful life to anyone. Thisis the only interpretation which will adequately effectuate the Congres-sional intent that depreciation is to have a reasonable economic basis.OId. at 201.T Id. at 27.[VCOL 42RECENT DECISIONSThe principal case rejects this concept on the ground it is not intendedby Congress, but the alternative which is set forth is even more viola-tive of the express Congressional intent. Nowhere does Congress de-fine useful life, but the only logical inference is that it means the entireuseful life inherent in the asset. It is true that under this theory thetaxayer in the instant case could depreciate his cars on the decliningbalance method. However, this does not seem to circumvent Section167(c) as that section is directed at assets which have such a shortlife they will be totally depreciated in the year of acquisition. This isthe example that is used by the Senate Committee in discussing thissection." In the instant case the total life of the asset will be 4 yearsand thus the taxpayer will be limited to depreciation of 50 percent peryear.To effectuate the congressional intent that the declining balancemethod be a realistic system based on sound accounting principals theonly logical interpretation is that useful life is the inherent useful lifeof the asset to someone. The interpretation of the principal case wouldseem to result in a distorted system of depreciation under the decliningbalance method. GEORGE J. MALY, JR.8 Id. at 2919591

Federal Income Taxation: Depreciation Deduction: Useful Life and Salvage Value Under The Declining Balance Method

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Federal Income Taxation: Depreciation Deduction: Useful Life and Salvage Value Under The Declining Balance Method

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