CONSUMER DURABLE PROPERTY SUBJECT TO RENT-TO-OWN CONTRACTS IS 5-YEAR PROPERTY, ACCORDING TO REVENUE RULING.

Rev. Rul. 95-52

ISSUE

How is the depreciation allowance determined for consumer durable property subject to rent-to-own contracts as described in Rev. Proc. 95-38, this Bulletin?

FACTS

The taxpayer is a rent-to-own dealer engaged in transactions with the general public involving consumer durable property subject to rent-to-own contracts as described in Rev. Proc. 95-38. These rent-to-own contracts are treated as leases (not as sales) for federal income tax purposes.

LAW AND ANALYSIS

Section 167(a) of the Internal Revenue 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) 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.

For purposes of section 168, the recovery period of depreciable personal property generally is based on the property's class life. Section 168(i)(1) defines the term "class life" as meaning the class life (if any) that would be applicable with respect to any property as of January 1, 1986, under section 167(m) (determined without regard to section 167(m)(4) and as if the taxpayer had made an election under section 167(m)) as in effect on the day before the date of enactment of the Revenue Reconciliation Act of 1990. These class lives are currently set forth in Rev. Proc. 87-56, 1987-2 C.B. 674, as clarified and modified by Rev. Proc. 88-22, 1988-1 C.B. 785.

The business activity of leasing consumer durable property is described in asset class 57.0, Distributive Trades and Services, of Rev. Proc. 87-56. As a result, this property has a class life of 9 years and is treated as 5-year property pursuant to section 168(e)(1). Thus, for consumer durable property subject to rent-to- own contracts as described under Rev. Proc. 95-38, the recovery period is 5 years for purposes of section 168(c)(1) and 9 years for purposes of section 168(g).

Under certain circumstances, property is depreciated under methods not described in section 168. Section 168 does not apply to any property if: (1) a taxpayer elects under section 168(f)(1) to exclude the property from the application of section 168; and (2) for the first taxable year for which a depreciation deduction would be allowable for the property in the hands of the taxpayer, the property is properly depreciated under the unit-of-production method or any method of depreciation not expressed in a term of years (other than the retirement-replacement-betterment method or similar method). The income forecast method is a method of depreciation not expressed in a term of years.

Rev. Rul. 60-358, 1960-2 C.B. 68, as amplified by Rev. Rul. 64-273, 1964-2 C.B. 62, and Rev. Rul. 79-285, 1979-2 C.B. 91, allowed the use of the income forecast method for television and movie films, taped shows for reproduction, book manuscripts, patents, master recordings, and other property of a similar character. These assets of an artistic or creative character generate uneven flows of income and have unique income-producing potential. As a consequence, the passage of time generally is not an appropriate measure of the useful life of this property. For example, if a television film series is a success, additional income will be forthcoming from reruns over a period of years, but an unsuccessful film series may produce little or no income after the initial exhibition. Rev. Rul. 60-358, 1960-2 C.B. at 68.

The useful life of consumer durable property (whether or not subject to a rent-to-own contract) is appropriately measured by the passage of time and not by the income produced. Consumer durable property does not generate income in a manner similar to that of television and movie films and other property for which the income forecast method is allowed. See ABC Rentals of San Antonio, Inc. v. Commissioner, T.C.M. 1994-601, appeals docketed, ABC Rentals of San Antonio, Inc. v. Commissioner, No. 95-9008 (10th Cir. May 16, 1995), and El Charro TV Rental, Inc. v. Commissioner, No. 95-60301 (5th Cir. May 16, 1995) (the section 168(f)(1) election out of section 168 is not available to consumer durable property leased under rent-to-own contracts because the property is not of a character properly depreciable under the income forecast method); see also Carland, Inc. v. Commissioner, 90 T.C. 505 (1988), aff'd on this issue, 909 F.2d 1101 (8th Cir. 1990) (certain leased equipment, such as railroad rolling stock, not of a character properly depreciable under the income forecast method). Accordingly, consumer durable property is not properly depreciated under the income forecast method or any other method not expressed in a term of years, and a taxpayer may not elect under section 168(f)(1) to exclude this property from the application of section 168.

HOLDING

The depreciation allowance for consumer durable property subject to rent-to-own contracts as described under Rev. Proc. 95-38 must be determined under section 168. This property is included in asset class 57.0, Distributive Trades and Services, of Rev. Proc. 87-56 and, consequently, is treated as 5-year property under section 168(e)(1). The recovery period is 5 years for purposes of section 168(c)(1) and 9 years for purposes of section 168(g). The income forecast method of depreciation is not a permissible method of depreciation for consumer durable property subject to rent-to-own contracts as described under Rev. Proc. 95-38.

CHANGE IN ACCOUNTING METHOD

Pursuant to section 1.167(e)-1(a), any change in the method of computing the depreciation allowance for consumer durable property subject to rent-to-own contracts as described in Rev. Proc. 95-38 is a change in method of accounting, and will be permitted only with the consent of the Commissioner. This change in method of accounting is a change to which sections 446(e) and 481 apply, and must be made in accordance with Rev. Proc. 92-20, 1992-1 C.B. 685.

DRAFTING INFORMATION

The principal author of this revenue ruling is Kathleen Reed of the Office of Chief Counsel (Passthroughs & Special Industries). For further information regarding this revenue ruling, contact Ms. Reed on (202) 622-3110 (not a toll-free call).