HOME BUILDER CANNOT DEPRECIATE HOUSES TEMPORARILY USED AS MODEL HOMES OR SALES OFFICES.

Rev. Rul. 89-25

ISSUE

The taxpayer is in the business of building and selling residential houses. To assist in its sales activity, the taxpayer used certain houses as models and/or sales offices temporarily (i.e., for a small fraction of their expected useful life). Such use generated no rental income to the taxpayer. During the period of that use, the taxpayer made no effort to sell those houses, however, the taxpayer expected to sell all houses in development D within a few years (including temporarily used as models and/or sales offices).

LAW AND ANALYSIS

Section 167 of the Internal Revenue Code provides that there shall be allowed as a depreciation deduction a reasonable allowance for the exhaustion, 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 1.167(a)-2 of the Income Tax Regulations provides that the depreciation allowance in the case of tangible property applies only to that part of the property that is subject to wear and tear, to decay or decline from natural causes, to exhaustion, and to obsolescence, and the allowance does not apply to inventories or stock in trade.

Rev. Rul. 75-538, 1975-2 C.B. 35, concerns the treatment for federal income tax purposes of motor vehicles held by a taxpayer engaged in the business of selling motor vehicles. A taxpayer engaged in the trade or business of selling motor vehicles is presumed to hold all such vehicles primarily for sale to customers in the ordinary course of the taxpayer's trade or business. To overcome this presumption, the taxpayer must show clearly that the motor vehicle was actually devoted to use in the business of the dealer and that the dealer looks to consumption through use of the vehicle in the ordinary course of business operation to recover the dealer's cost. Rev. Rul. 75-538 provides that a vehicle is not property used in the business if it is used merely for demonstration purposes, or temporarily withdrawn from stock-in-trade or inventory for business use.

Duval Motor Co. v. Commissioner, 264 F.2d 548 (5th Cir. 1959), aff'g 28 T.C. 42 (1957), concerned automobiles used as demonstrators and provided by a car dealer to company officials and salesmen for other business uses. The court found that these automobiles were held primarily for sale to customers. As a result, the dealer was not entitled to a depreciation deduction with respect to such automobiles. See also Luhring Motor Co. v. Commissioner, 42 T.C. 732 (1964); R.E. Moorhead & Son, Inc. v. Commissioner, 40 T.C. 704 (1963).

In the present situation the houses were used as models and/or sales offices for a small fraction of their expected useful lives and never generated any rental income. After this period of use, the taxpayer expected to sell the houses in the same manner as it had been selling its other houses. Moreover, the essential purpose for which the houses were built -- sale to customers -- was never altered. Thus, although the houses were used temporarily as models and/or sales offices, and although the taxpayer may have been reluctant or unwilling to sell the houses while they were being used in this way, they remained property held by the taxpayer primarily for sale to customers int he ordinary course of the taxpayer's business rather than property used in the trade or business. Thus, they may not be depreciated. See section 167(a) of the Code: DuVal Motor Co., Supra.

HOLDING

Houses that a home-builder temporarily used for models and/or sales offices were not subject to an allowance for depreciation.

DRAFTING INFORMATION

The principal author of this revenue ruling is Michael J. Hahn of the Office of Assistant Chief Counsel (Passthroughs and Special Industries). For further information regarding this revenue ruling contact Noel J. Sheehan on (202) 566-4819) (not a toll-free call).