Is Office Artwork Depreciable Property?
23 August 2012 / Uncategorized / Comments Off on Is Office Artwork Depreciable Property?
Is Office Artwork Depreciable Property?
Many offices contain artwork to make customers feel comfortable and to give the business an air of success. Or they could be there just because the decorator said they were necessary. Whatever the reason, our clients often ask whether their art is depreciable for tax purposes. The answer, similar to the answer to most tax deduction questions, is the ever-popular, “It depends.”
Let’s assume that a taxpayer remodeled their offices, purchasing new furniture, computer and telephone equipment, and artwork. Further assume that the taxpayer spent a significant sum on the artwork, some from local galleries, some directly from freelance artists, and others from the furniture store and Wal*Mart, with the prices of these pieces of art ranging from $50 to $5,000. All items were hung up on the wall by the taxpayer.
Whether the art is depreciable primarily depends on the taxpayer’s answer to the following question: “Is any of the artwork considered ‘valuable and treasured’?”
In order to understand why it boils down to this one question, it is helpful to review some history on this issue:
The Background Behind Artwork Depreciation
In 1968 the IRS issued Revenue Ruling 68-232, which states, in part: “A valuable and treasured art piece does not have a determinable useful life. While the actual physical condition of the property may influence the value placed on the object, it will not ordinarily limit or determine the useful life. Accordingly, depreciation of works of art generally is not allowable.”
This ruling has become the standard for whether office artwork is depreciable; however, the IRS has been fairly silent since then and has provided no guidance on what constitutes a valuable and treasured work of art.
In 1968, when the IRS issued Revenue Ruling 68-232, depreciation was determined under IRS Code Section 167, which required taxpayers’ to establish the property’s cost basis, useful life, and salvage value in order to calculate depreciation for property used in a taxpayer’s trade or business. Based on the law in 1968, the IRS’s position with respect to valued and treasured artwork made perfect sense. It would be difficult to establish a useful life for valued and treasured pieces of art that were already hundreds of years old. Especially because valued and treasured artwork would be expected to appreciate in value.
However, the depreciation rules have undergone two significant amendments since 1968. Congress has amended the law (now governed by Section 168) to establish the modified accelerated cost recovery system (MACRS). Under MACRS, an asset’s useful life is no longer the time period used for calculating the amount of depreciation, but instead established a seven-year recovery period for that do not have class lives.
Therefore, it would appear that a taxpayer no longer has to establish a class life for property to depreciate it under MACRS. Instead, the taxpayer needs to establish all four things with respect to the property:
- It must be tangible property not subject to amortization or another method of depreciation.
- The property must have been placed in service after 1986.
- It must be subject to exhaustion, wear and tear, or obsolescence.
- It must be used in a trade or business.
The third item is the one that may be difficult to prove to the IRS’ (and the courts’) satisfaction, however, as this is an “or” test, if any one of the three conditions exists, the taxpayer meets the third criterion. It is most likely that artwork will not be exhausted, which implies that the property is used up or consumed in the ordinary course of its function. Also, since beauty is in the eye of the beholder, it may be difficult to argue that artwork becomes obsolete, thus the taxpayer will need to prove that the artwork is subject to wear and tear.
Again the IRS is not much help because they have failed to set forth a standard of what constitutes wear and tear. The IRS could argue that because artwork only hangs on a wall or sits on a floor or shelf as a display, it is not subject to wear and tear; however, the curator of any museum would say that all artwork deteriorates over time.
What do the courts say?
A Tax Court case often cited by the IRS to defend disallowing depreciation deductions is Associated Obstetricians and Gynecologists P.C., T.C. Memo. 1983-380. In this case the taxpayer, a doctors’ office, displayed various pieces of art in its offices, claimed depreciation on said artwork, which the IRS disallowed. At trial the IRS argued that the works of art did not have a useful life, based on Revenue Ruling 68-232. The court held in favor of the IRS, but noted that Revenue Ruling 68-232 was not applicable because the paintings in question “were more wall decorations than works of art.” (Note that the cost of the objects ranged in price from $40 to $7,000, and the years at issue were 1976 and 1977.) The court also stated, “The paintings could be depreciated if petitioner established their economic useful life and salvage value.” As noted, the tax years at issue were prior to the amendment of the depreciation rules.
In Simon, 103 T.C. 247 (1994), the IRS argued that violin bows used by the taxpayers in their trade or business of being orchestra musicians could be depreciated only if the taxpayers could establish a useful life for the property. The IRS argued that the bows were treasured works of art that appreciated in value and for which it was impossible to determine useful lives. In its opinion, the Tax Court got around Revenue Ruling 68-232 by concluding that the bows were not works of art, but assets used actively, regularly, and routinely to produce income in the taxpayers’ business. The court focused on one issue: “Were the bows property of a character subject to exhaustion, wear and tear, or obsolescence?” If they were, then the taxpayers' could depreciate them.
Therefore, if artwork is not “valuable and treasured” (as specified in Revenue Ruling 68-232), and the taxpayer can establish that the artwork is subject to wear and tear, depreciation should be allowed on the assets.
In Selig, T.C. Memo. 1995-519, the Tax Court addressed whether the taxpayer could depreciate certain high-technology “exotic cars” the taxpayer had placed in service in its trade or business by exhibiting them to the public for an admission fee. The taxpayer maintained the cars were subject to obsolescence and therefore were depreciable. Again, the IRS sought to disallow the deduction on the basis that the taxpayer could not establish a useful life for the vehicles. The Tax Court said the cars’ state-of-the-art character supported the taxpayer’s argument they were subject to obsolescence and stated, “The fact that petitioners have failed to show the useful lives of the exotic automobiles is irrelevant.”
This case is significant for holding that establishing a useful life was not a determining factor for claiming depreciation, and it dealt with tax years under current Section 168 (MACRS). The court stated that although Congress extensively revised Section 168, “there is no indication . . . that Congress intended...that a taxpayer must show the useful life of property if the taxpayer is to determine the section 167 depreciation deduction under section 168.”
With respect to Simon and other cases, the IRS has indicated its non-acquiescence to those decisions.
Conclusion
It would appear that recent case law is favorable to the proposition that all artwork, “valued and treasured” or not, is subject to the allowance for depreciation under Internal Revenue Code Section 168 if the taxpayer can meet the four requirements described above. But the taxpayer most likely will continue to be in for a fight if the IRS examines its tax return. The taxpayer should be prepared to establish the business reasons for the acquisition of the artwork to meet the “used in a trade or business” standard. The taxpayer also should be prepared to establish that the items are subject to wear and tear or obsolescence in their use. Obviously, the more expensive the artwork, the more likely it is that an agent will disallow a claim of depreciation expense with respect to the item.
We at Widget hope you have found this article informative and interesting. If you have questions on the depreciation of artwork, or any other issues, please feel free to give Widget a call. We are here to help!!