Depreciate Your Works of Art:

Proceed at Your Peril

Introduction

The end of the year is almost upon us and calls for proper tax planning are heard near and far. For those who own personal property such as fine, decorative or collectible art, reading the IRS personal property depreciation deduction sounds like a great plan to reduce the tax bite for the coming filing. After all in the Simon v. Commissioner(1), works of art such as antique musical instruments allowed the personal property owners to depreciate their works. Yes, it took a few years and some varied courts, but the court did give the green light to works of art depreciation. Since such works are found in the office or are used in the business, even more reason to go for the depreciation deduction. The antique desk or chair or even the Remington bronze in the office is there for the business. While some personal property can be depreciated it is the exception rather than the rule. Forging ahead with such planning is to proceed with risk. Let us see why.

The Background of the Depreciation Deduction

Depreciation of property has been an IRS rule approved by the Supreme Court for over 65 years(2). It is a way to identify the yearly cost of using a particular property in a business. Tables are provided by the IRS to determine a given property's yearly depreciation. Personal property was depreciated via section 167 of the Internal Revenue Code of 1954, but then after the Economic Recovery Act of 1981 the law required that personal property possess a useful life identification by the taxpayer. In point, if a taxpayer wants to depreciate personal property the taxpayer must be able to assert that the useful life is 5, 10, 40 years, or a given quantity of years. The underlying consideration of establishing the useful life is identified in terms of wear, tear, decay or decline from natural causes. For example, a chair or desk used in an office wears and tears and as such when it is no longer usable the property has established its useful life. This concept was somewhat unworkable and subject to many taxpayer issues such that later rulings provided the defined years a particular property could be depreciated from various tables outlined in the IRS code. The various rulings(3) also noted quite clearly that works of art even if used in a business are not depreciable.

The Simon Ruling (4)

The Simon ruling held that although the bows from antique violins are customarily identified as works of art they are subject to wear and tear and decay through age. As such they are depreciable. The two bows in question generated approximately one $6000+ and one $4000 depreciation in the tax filing. This ruling took close to ten years in the making. Originally knocked down twice by the IRS, the third attempt succeeded in allowing the depreciation of the bows in Simon v. Commissioner (2nd Cir. 1998). Some have taken this case as a conceptual mandate to allow business expenses such as fine, decorative, and collectible art as being possibly depreciable. Let's look at why the concept is not a practical application of IRS regulations and possibly quite costly to the taxpayer using works of art as a depreciable write off.

Simon: A Costs/Benefits Analysis

In a costs/benefits analysis the goal is to outline the costs and benefits of a given action or decision. If the analysis demonstrates that the decision or action provides greater benefits than costs, the action or decision should be carried out. If it does not, if the action is going to cost more than the benefits accrued, such an action is deemed unreasonable and hence not actionable. There is a theoretical push and a practical one: theoretically it would be reasonable to forge ahead; practically it only makes sense if the benefit is significant. A penny benefit is a joke; a few thousand dollars is significant. In the Simon case although the benefits of $6000 and $4000 were accrued as the result, it is not clear if the taxpayers gained any benefit since no information is available as to the gross income/deductions of the taxpayer filing. If after deductions no taxes were required then the depreciation provided no tax break to the taxpayer since the income was exhausted by the first group of deductions. In point, the depreciation was without benefit to the taxpayer for the tax year.

More importantly forging ahead for years (9) against IRS rulings has many unidentified costs. The first cost is an opportunity cost of the taxpayer's time. The taxpayer will have to spend hours generating documents and repeating the process to satisfy that the IRS has received the documents. Many experts recommend using a delivery service, and not certified mail to provide documents to the IRS. This kicks in financial costs for the delivery service plus copying. More than likely there will be attorney costs and perhaps the costs of a Certified Public Accountant. Assuming that there is income left to serve as a benefit for the depreciation, the processing costs and the opportunity costs may reduce the taxable benefit. If the depreciation results in a benefit of $2000 and the financial and opportunity costs are $3000, costs outweigh benefits and therefore the process of going for the depreciation costs more than the benefits. Thus the process is unreasonable.

A Case Study

Jane is a construction consultant and operates from a rented office in a strip mall. The year prior to Jane's tax filing (2008) Jane purchased a Dali lithograph for her office. The work was appraised for $10000. Jane has all the records for the purchase and decides that since the work is being used in her office to produce income she is going to depreciate it. Jane reviewed her revenue for 2008 and found that her gross income was $50000 and her taxable income was $3000 after various deductions. By depreciating her Dali she could limit her tax payment on the $3000 of taxable income. Jane looks at IRC 168 (a) and sees that her work apparently satisfies the conditions of depreciation:

1. It is a recovery property under the Economic Recovery Tax Act of 1981.
2. It is tangible.
3. It has a useful life.
4. It was placed in service after 1980.
5. It is used in trade or business or held for the production of income.
6. It is subject to decay, wear and tear or obsolescence.(5)

Is Jane's decision to depreciate reasonable?

Analysis

With $3000 in taxable income Jane is subject to a tax hit in the area of $300. If she depreciates, the tax hit would more than likely disappear. She would have $300+ dollars in her pocket. Although it is reasonable to conclude that $300 is better in the taxpayer's hand than in the hand of the IRS, the road ahead to secure the depreciation is beset with twists and turns making the depreciation counter- productive. Here's why.

To begin with the IRS has already noted in their rulings that works of art are not usually depreciable. The tables supporting depreciation of cars, office supplies and so on are present but none are available for works of art. The first note is that depreciation of works of art amounts to challenging the IRS system. Following our earlier analysis regarding costs/benefits, it would seem that securing $300 as a benefit resulting in the costs of securing documents and financial costs of delivering the documents over many years indicate that the costs far outweigh the benefits. More importantly, since Dali works have significant authenticity issues, the IRS might argue that you cannot depreciate the $10000 since the work may not be authentic, and therefore not worth the $10000.

While it is true that the Dali litho is tangible, placed in service after 1980, subject to decay and deterioration, it fails to identify useful life and used in the production of income. Unlike the Simon bows which make music, works on paper do not make anything nor do they have an identified useful life since some works on paper are old as time. One could argue with tongue in cheek that a Brancusi sculpture might be used to drive a nail into the wall but a Dali litho serves no other use than that associated with aesthetics. More importantly, Dali works of art appreciate not depreciate. Logic demands that to depreciate that which is not depreciable is to assert a meaningless or empty statement.

Simon Says No to Depreciating Works of Art

The Simon case is demonstrative of a good win against the system. Unfortunately the win was time consuming, costly and over a period of ten years doubtful in terms of benefits. The win came down to establishing that the works - the bows - were producing income and satisfying IRS standards. The musician received income from the bows making music, and satisfied the requirements for the depreciation. Yes it is possible to depreciate your works of art, but unless your work falls into a similar category satisfying the IRS standards - works of art in general do not - the effort will not be a beneficial one. This does not mean that one should let the IRS rollover the taxpayer. There will be challenges supported by regulation and those challenging the rules. Simon says going against the rules is not an apt challenge or road to take unless you are willing to take on the tax system for a 9 year period or more.

1. SIMON v. COMMISSIONER -103 T.C. 247 (1994), aff=d 68 F.3d 41 (2d Cir. 1998)
2. United States v. Ludey, 274 U.S. 295, 301 (1927).
3. http://www.irs.gov/formspubs/article/0,,id=177054,00.html
4. SIMON v. COMMISSIONER -103 T.C. 247 (1994), aff=d 68 F.3d 41 (2d Cir. 1998)
5. http://www.irs.gov/formspubs/article/0,,id=177054,00.html

— by John Daab Ph.D.  |  November 5, 2010

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