Rev. Rul. 60-358

Advice has been requested as to the proper method for recovering the cost of leased or rented television films (including taped shows for reproduction) for Federal income tax purposes.

It has come to the attention of the Internal Revenue Service that the methods of computing depreciation described in section 167(b) of the Code are in most cases inadequate when applied to television films, resulting in a distortion of income on the returns filed by taxpayers deriving income from such films. This distortion is caused by a strikingly uneven flow of income, earned by groups of programs within the series, resulting from contract restrictions, methods of distribution and audience appeal of the programs. If the film series is a success, additional income will be forthcoming from reruns over a period of years, depending upon its popularity; whereas, unsuccessful film series may produce little or no income after the initial exhibition. Thus the usefulness of such assets in the taxpayer's trade or business is measurable over the income it produces and cannot be adequately measured by the passage of time alone. Therefore, in order to avoid distortion, depreciation must follow the `flow of income.'

Some producers of television films have used the so-called `cost recovery' method in reporting their income. By use of this method, no taxable income is reported until the income from the films exceeds the cost thereof. However, such `cost recovery' method is not acceptable for Federal income tax purposes.

After an extensive study and consideration of the matter, the Service has concluded that the so-called `income forecast' method is readily adaptable in computing depreciation of the cost of television films without producing any serious distortion of income. This method requires the application of a fraction, the numerator of which is the income from the films for the taxable year, and the denominator of which is the forecasted or estimated total income to be derived from the films during their useful life, including estimated income from foreign exhibition or other exploitation of such films. The term `income' for purposes of computing this fraction means income from the films less the expense of distributing the films, not including depreciation. This fraction is multiplied by the cost of films which produced income during the taxable year, after appropriate adjustment for estimated salvage value. The `income forecast' method may be illustrated as follows:

Example: Certain television films which produced income within the first taxable year cost 800 x dollars, after appropriate adjustment for estimated salvage value. The income therefrom for the first taxable year was 600 x dollars; second year 150 x dollars; and third year, 300 x dollars. Total estimated income to be derived from the films 1200 x dollars.

600 x dollars/1200 x dollars x 800 x dollars = 400 x dollars (first year's depreciation)

150 x dollars/1200 x dollars x 800 x dollars = 100 x dollars (second year's depreciation)

300 x dollars/1200 x dollars x 800 x dollars = 200 x dollars (third year's depreciation)

If the estimated income from the television films should be less than the cost thereof, thus resulting in a loss, the use of the `income forecast' method for computing depreciation will reflect such loss in the proper taxable years based on the amount of income from the films derived in each taxable year.

If in subsequent years it is found that the income forecast was substantially overestimated or underestimated by reason of circumstances occurring in such subsequent years, an adjustment of the income forecast for such subsequent years may be made. In such case, the formula for computing depreciation would be as follows: income for the taxable year divided by the revised estimated income (the current year's income and estimated future income), multiplied by the unrecovered depreciable film cost remaining as of the beginning of the taxable year.

The total forecast or estimated income to be derived from the films should be based on the conditions known to exist at the end of the period for which the return is made. This estimate can be revised upward or downward, as explained above, at the end of subsequent taxable periods based on additional information which became available after the last prior estimate.

Accordingly, it is the position of the Service that the `income forecast' method described above constitutes an acceptable method for computing a reasonable allowance for depreciation of the cost of television films under section 167(a) of the Code.

In applying the above methods of depreciation, television films shall not be depreciated below a reasonable salvage value, such value being the amount which it is estimated will be realizable upon sale or other disposition of such films when they are no longer useful in the taxpayer's business or in the production of his income. The time when such films are no longer useful in the taxpayer's business, etc., may vary according to his policy with respect to the use thereof. If the taxpayer's policy is to dispose of the films after the initial showing, the salvage value may represent a relatively large proportion of the original cost of such films. However, if the taxpayer customarily uses the films after the initial showing for reruns, syndication, foreign exhibition, or other exploitation thereof, the salvage value may represent a relatively small proportion of the original cost. If there is a redetermination of the `income forecast,' as explained above, salvage value may be redetermined based upon the known facts at the time of such redetermination of the `income forecast.'

The principle of `income forecast' as set forth in this Revenue Ruling is limited in its application to television films, taped shows for reproduction and other property of a similar character.