Failure to Properly Elect Out of MACRS

In New Gaming Systems Inc. (NGS), TC Memo 2001-277, the Tax Court held that a corporation failed to properly opt out of depreciating its rental game equipment under the modified accelerated cost recovery system (MACRS).

NGS rents electronic gaming equipment. On its 1994 return, it reported depreciation on the lines for "GDS and ADS deductions for assets placed in service in tax years beginning before 1993." NGS did not report any depreciation on the line "Property subject to section 168(f)(1) election." On its 1995 and 1996 returns, NGS again reported depreciation on the GDS and ADS lines, with nothing reported on the Sec. 168(f)(1) election line. However, NGS did attach to the returns a description of the property being depreciated, the acquisition date, the basis for depreciation, and the life, rate and recovery period. NGS depreciated the rented gaming equipment using the straight-line method over a two-year recovery period.

In 1999, NGS filed amended returns for its 1994–1996 tax years, stating that it was opting to elect out of MACRS, instead depreciating its rented gaming equipment using a method "not expressed in terms of years" under Sec. 168(f)(1)(B). The IRS issued a deficiency notice based on the amended returns, stating that NGS failed to properly elect out of the MACRS depreciation method.

The Service contended that NGS failed to elect out of MACRS on its original returns under Sec. 168(f)(1)(A) and failed to make a timely election. Instead, it made the election on an amended return after audit and issuance of a deficiency notice. NGS disgreed. Although conceding that it did not comply "exactly" with the Code in making the election, NGS contended that it "substantially complied with those provisions."

The Tax Court agreed with the Service that NGS failed to make an election under Sec. 168(f)(1)(A) for 1994. It found that NGS did not substantially comply with the election requirements on its 1994 return, because it failed to provide the necessary information in its originally filed return. However, relying on ABC Rentals of San Antonio, Inc., TC Memo 1999-14, the Tax Court found that NGS, on its originally filed returns for 1995 and 1996, substantially complied with the disclosure requirements provided in the temporary regulations. In ABC Rentals, the court held that the absence of a reference to Sec. 168(f)(1) in the attachment did not prevent the taxpayer from substantially complying with the Sec. 168(f)(1)(A) requirements. In NGS, the court determined that the disclosure provided on the 1995 and 1996 returns substantially complied with the Sec. 168(f)(1)(A) election.

Despite its finding that NGS substantially complied with the disclosure requirement, the Tax Court concluded that it failed to meet Sec. 168(f)(1)'s substantive requirements for its 1995 and 1996 tax years. Specifically, it used a straight-line depreciation method with a two-year recovery period (i.e., a method expressed in terms of years). Accordingly, NGS failed to meet the second test of Sec. 168(f)(1), which requires property exempt from MACRS to be depreciated using a method "not expressed in terms of years." Therefore, the court concluded that, for all years at issue, NGS failed to properly elect out of the MACRS depreciation method.

From Jane Rohrs, Washington, DC