Rev. Rul. 89-25

1989-1 C.B. 79, 1989-9 I.R.B. 6.

                       Internal Revenue Service

                                 Revenue Ruling

     DEPRECIATION; HOME-BUILDER; HOUSES USED AS MODELS AND OR SALES OFFICES

                          Published: February 27, 1989

26 CFR 1.167(a)-2: Tangible property.

  Depreciation; home-builder; houses used as models and or sales offices. Houses that a home-builder used for models and/or sales offices were not subject to an allowance for depreciation under section 167 of the Code.

  A home builder temporarily used certain houses as models and/or sales offices to assist in its sales activities. Such use, which was for a small fraction of the houses' expected useful lives, generated no rental income to the taxpayer. Although the builder made no effort to sell these model houses during this period, it did expect to sell all houses in the development within a few years, including the housing being temporarily used as models and/or sales offices.

  ISSUE. The issue is whether the houses in temporary use as models and/or sales offices are subject to an allowance for depreciation.

  HOLDING. The Service held that the houses that a home builder uses for models and/or sales offices are not depreciable under under section 167.

  ANALYSIS. An allowance for depreciation is not available for inventories or stock in trade, the Service stated, citing regulation section 1.167(a)-2. Although the home builder may have been reluctant or unwilling to sell the houses while they were being used as models and/or sales offices, the Service concluded that the houses remained property held by the builder primarily for sale to customers in the ordinary course of its business, rather than property used in the trade or business. Similarly, automobile dealers are not entitled to depreciation deductions with respect to cars used as demonstrators or to cars provided by a car dealer to company officials and salesmen for other business uses, the Service noted, citing Rev. Rul. 75-538, 1975-2 C.B. 35 and DuVal Motor Co. v. Commissioner, 264 F.2d 548 (5th Cir. 1959), aff'g 28 T.C. 42 (1957).

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).

Rev. Rul. 89-25, 1989-1 C.B. 79, 1989-9 I.R.B. 6.