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RE: Taxation of Antique Instruments
James Figaro is a professional musician who plays the violin and operates as a self-employed individual in this industry. He also performs in an orchestra and also provides private music lessons to a small class of selected students as part of his commercial music business activities. Since his specialty is in stringed instruments particularly the violin, James has recently purchased a set of antique instruments that he intends to use in his trade. This set is comprised of a fine antique bow and a corresponding fine antique violin.
Since James is a professional music player of the violin, part of his motivation in buying the antique instruments is the corresponding sounds that they produce. Industry experts have noted that these instruments produce a higher quality of sound when compared to the modern instruments that are currently available in the market. Due to their antique nature and the specific location where they were bought, both the bow and the violin cost James an astronomical amount of money. In this regard, the bow cost him$150,000 while the violin itself cost him $250,000.
Professional appraisers of music instruments such as the bow and violin which James bought have indicated their expectation that this instrument set will appreciate significantly over time. Therefore, James would expect to make a profit if he decided to sell his instruments in the near future. As previously mentioned and due to the professional nature of his occupation, James intends to use the bow and violin for commercial purpose in the services and lessons that he offers to his clients. Consequently, he believes that the economies of purchase are ideal in regards to this particular purchase transaction.
Issue and Conclusion 1: 179 Expensing Rule
Can James Figaro apply the Section 179 rule to the purchase of his equipment?
Yes, James Figaro can apply the Section 179 Rule to the purchase of his equipment.
According to the IRS Code Section 179, the US Internal Revenue Code allows a taxpayer to choose either to deduct the total cost of the purchase of their equipment from their expected income tax in the year of purchase. This option relieves the taxpayer of the obligation of having the cost of the said equipment being capitalized and gradually depreciated over time.
However, there are certain conditions that must be met by a tax payer before the IRS can allow them to apply Section 179 of the tax code. Firstly, this code only allows a total deduction in the year of purchase of up to $500,000 (IRS 14). In the case of James Figaro, the total cost of the purchase of his equipment amounted to $400,000. In this regard, James is entitled to apply this rule since this total cost did not exceed the stipulated amount by the internal tax code of the IRS.
The second major condition which must be met as stipulated by this code is that the total deductible amount must not exceed the total net earnings from the music business of the tax payer. During the year in which James bought the equipment, his total taxable income amounted to $350,000. This amount is less by $50,000 than the total amount which he spent in purchasing the equipment. Therefore, James is incapable of applying Section 179 in this particular instance (Ozer 4).
The application of Section 179 in a practical setting such as in James`s case is best demonstrated by the case of Shirley 1, who used her home motor as a transportation and lodging facility from time to time. In this case, the court ruled that it did not have to determine whether the Section 179 code needed to be applied since the deductions were the same whether the code was applied or not.
Issue and Conclusion 2: Depreciation Related to the Instruments
Can James depreciate the value of the antique instruments that he bought for tax purposes?
Yes, James can depreciate the value of this instrument for tax purposes.
According to the Internal Revenue Service (IRS 5), musical instruments whose life exceeds one year can be depreciated for tax purposes over the entire duration of their useful life. The IRS defines the useful life of musical instruments as being equivalent to seven years. However, according to Ricker (6), the IRS views old stringed instruments such as the violin and bow which James bought as being antique items that instead appreciate in value as opposed to the standard depreciation approach. As a result, the IRS has stipulated in the tax code that such instruments must not be depreciated for tax purposes over their useful life.
As a result, several individual musicians have gone to court challenging this decision by the IRS. Consequently, the courts have ruled that the old stringed instruments must be viewed as tools just like in any other trade, and they must consequently be depreciated as is the norm. The IRS has been forced to temporary concur with the courts on this particular issue. However, the implementation this ruling by the IRS is only limited within the geographic jurisdiction in which these courts serve. Outside of these jurisdictions, the IRS continues to implement the tax code in its original form. In the case of James and his new equipment, he can choose to depreciate the cost of purchasing the equipment for tax purposes over their useful life, based on the decisions and rulings that were arrived at by the courts of law (Ozer 5).
The depreciation of antique musical instruments is best addressed in the Simon and Liddle case of 1985 in which the petitioners challenged the court to explain the extent of tax liabilities in regards to the depreciation of antique musical items. Consequently, the courts ruled that antique musical items should be depreciated in a similar manner as other tools used in different trades as they are subject to wear and tear of an equal magnitude.
Issue and Conclusion 3: Reduction of Taxable Income
Can James Figaro reduce his taxable income to the lowest possible level?
Yes, James can reduce his net taxable income from his music business to the lowest possible levels.
As previously mentioned, James Figaro can expense the cost of the purchase of his equipment and reduce his taxable income to the lowest possible levels based on the stipulations of the tax code. However, there are several factors that have been laid down by the IRS in relation to the reduction of his taxable income accruing from his music business.
According to the IRS, the first consideration which must be made in the process of deducting the cost of the music equipment is the purpose for which the equipment was purchased by the tax payer. The IRS stipulates that these costs can only be deducted if the equipment is to be used for commercial purposes and not merely as art collections. In this regard, James Figaro`s purchases do qualify for deduction under taxation law. Secondly, the IRS demands that an individual tax payer must prove that his business is operating commercially by recording profits in 3 of the last 5 years of business operations.
The specific deduction or depreciation approach which tax payers like James can adopt will ultimately determine the lowest taxable income which he will pay. In this regard, James can either opt for the straight line method of depreciation which will equally reduce the cost of equipment for the next seven years, or he can decide to use the MACRS method which applies declining depreciation rates over the seven year period. As a self-employed tax payer, it should be noted that James Figaro is entitled to a 15.3% tax rate on the net profits accruing from his business.
The reduction of the taxable income of musicians is best explained by the Case of Richard and Fiona Simon, who challenged the court to address the issue of whether they were allowed to reduce their taxable income from their music business. The court upheld the previous rulings that musician were allowed to reduce their income for tax purposes by deducting the costs of the instruments that they bought for commercial purposes and use in their trade.
Issue and Conclusion 4: Consideration of Music Instruments as Works of art
Does the IRS consider antique music instruments as works of art and not liable to depreciation?
Yes, the IRS considers antique instruments as works of art.
As previously mentioned, professional independent appraisers were of the view that the instrument set which James Figaro purchased would appreciate in value over time as opposed to the standard process of depreciation which is associated with other tools of trade in other businesses. Furthermore, the IRS recognizes these instruments as pieces of art which should appreciate and not depreciate over time. However, court rulings have been of the opinion that these instruments should be treated as any other equipment and they must be subjected to the same depreciation processes based on a seven year useful life cycle.
It should be noted that the basis of determining whether an instruments is an antique or a tool of trade by the IRS is the specific purpose for which the tax payer purchased the equipment for. In certain instances, some tax payers will purchase musical antique instruments for their aesthetic purpose and they will use them as decorations in their houses and not generate any income from them. In such instances, the IRS demands that such instruments must be viewed as pieces of art work and they cannot be depreciated for tax purposes. However, if a tax payer such as James Figaro can prove that he sustainably generates an income from such equipment, then the IRS can allow him to deduct the cost of the equipment for tax purposes.
According to the Liddle V Commissioner case of 1995, the courts ruled that antique musical items can only be viewed as works of art and appreciate in value for tax purposes if they are not used for commercial purposes by the taxpayers who purchased them. Accordingly, a taxpayer must prove that the instruments have been used to generate an income according to the ruling of the court in this particular case.
Internal Revenue Service. Topic 704 – Depreciation. IRS, 16 Dec. 2014. Web. 21 April 2015
Ozer, Martin. How to depreciate your instrument to reduce taxable income. Allegro, 3 Mar. 2014
Web. 21 April 2015
Ricker, Ramon. Tax Time–Musical Instruments and Depreciation. Polyphonic Org, 24 Mar 2011
Web. 21 April 2015
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