VIDEOCASSETTE LESSOR MAY NOT DEPRECIATE TAPES UNDER ACRS, BUT MAY USE STRAIGHT-LINE OR INCOME-FORECAST METHODS.

Rev. Rul. 89-62

ISSUE

What is the proper method of depreciating videocassettes under the Internal Revenue Code?

FACTS

In 1988 the taxpayer established a videocassette rental business. A video-cassette consists of a cartridge mechanism containing a designated length of magnetic video tape. Videocassettes are used in videocassette recorders or players. The taxpayer purchases, mass-produced copies of master versions of movies in the videocassette format and rents them to the public.

LAW AND ANALYSIS

Section 167(a) of the Code provides that there shall be allowed as a depreciation deduction a reasonable allowance for the exhaustion and wear and tear (including a reasonable allowance for obsolescence) of property used in the trade or business or held for the production of income.

Section 168(a) of the Code provides that, except as otherwise provided in this section, the depreciation deduction provided by section 167(a) for any tangible property shall be determined by using the applicable depreciation method, recovery period, and convention.

Section 168(f)(3) of the Code provides that section 168 does not apply to "any motion picture film or video tape". If videocassettes are encompassed within the phrase "any motion picture film or video tape", they are not subject to section 168(a). The language of section 168(f)(3) is broadly inclusive. Similarly inclusive language was used in section 168(e)(5) of the Internal Revenue Code of 1954, the predecessor of section 168(f)(3). There is nothing in the legislative history of these sections to suggest that they were to be narrowly applied. H.R. Conf. Rep. No. 861, 98th Cong., 2d Sess. 1009 (1984), 1984-3 (Vol. 2) C.B. 263.

A videocassete is a video tape adapted for use in a videocassette recorder or player. Accordingly, videocassettes are among the motion picture films and video tapes excluded from the scope of section 168.

If property is excluded from section 168 of the Code, the provisions of section 167 apply in determining the allowable depreciation deduction with respect to such property.

Section 167(b) of the Code provides that a reasonable allowance for depreciation shall include an allowance computed under the straight line method and certain accelerated methods.

Section 167(c) of the Code provides that the accelerated methods of depreciation described in section 167(b) do not apply to any motion picture film, video tape, or sound recording. This broadly inclusive language encompasses videocassettes. Accordingly, the taxpayer may depreciate the videocassettes utilizing the straight line method over their useful life in the taxpayer's business, but may not utilize the methods of depreciation described in paragraphs (2), (3), and (4) of section 167(b).

A taxpayer's videocassettes may be depreciated in a group account consistent with the rules set forth in section 1.167(a)(7) of the Income Tax Regulations. In addition, taxpayers may be able to demonstrate that some of their videocassettes will not have a useful life in excess of 1 year. The cost of such videocassettes may be deducted under section 162 of the Code.

The legislative history of section 167(c) states that the income forecast method of depreciation is available with respect to motion picture films, video tapes, and sound recordings. H.R. Rep. No. 426, 99th Cong., 2d Sess. 914-15 (1985), 1986-3 (Vol. 2) C.B. 914-15. For a description of the income forecast method, see Rev. Rul. 60-358, 1960-2 C.B. 68 (income forecast method applied to films). The income forecast method recognizes that certain assets generate uneven flows of income and have unique income producing potential. To properly apply the income forecast method, taxpayers must make income projections for each asset subject to the method. Taxpayers may group their videocassettes by videocassette title for purposes of making the required income projections. Broader groupings of videocassettes for projection purposes are not permissible under the income forecast method.

HOLDING

Videocassettes are subject to section 167 of the Code and may be depreciated in accordance with the straight line method over the useful life of the videocassettes in the particular taxpayer's business. Alternatively, the income forecast method may be used.

DRAFTING INFORMATION

The principal author of this revenue ruling is Mark Pitzer of the Office of Assistant Chief Counsel (Passthroughs and Special Industries). For further information regarding this revenue ruling contact Mark Pitzer on (202) 566-3381 (not a toll-free call).