Opinion ID: 554937
Heading Depth: 2
Heading Rank: 2

Heading: Depreciable Basis of Contract Right

Text: 31 The tax court properly recognized that although the partnership had not acquired the film, they nonetheless were entitled to a depreciation deduction on the asset they did acquire--the intangible contract right to a share of the film's proceeds. See, e.g., Tolwinsky, 86 T.C. at 1052 (right to share in proceeds of exploitation of motion picture was subject to exhaustion over time in the same way that an investment in the motion picture itself would have declined in value over time, so the interest is depreciable). This gave rise to the issue of whether the debt represented by the recourse and non-recourse notes used to finance the purchase may be included in the partnership's basis. The tax court determined that the notes did not represent bona fide debt and therefore excluded them from the partnership's basis. We agree. 32 Depreciation deductions are allowed to investors who have placed capital at risk through the purchase of an asset used in trade or business or held for the production of income. I.R.C. Sec. 167. When, however, the debt used to purchase an asset is unlikely to be paid by the taxpayer, that debt does not represent bona fide capital investment by the taxpayer and will be excluded from the depreciable basis of the asset. Durkin, 872 F.2d at 1276; Estate of Baron v. Commissioner, 83 T.C. 542, 550-53 (1984), aff'd, 798 F.2d 65 (2d Cir.1986). 33 Several factors serve to direct the inquiry of whether particular debt may be characterized as contingent: (1) whether the principal is to be paid solely out of exploitation proceeds; (2) whether the loan is non-recourse, shielding the taxpayer from personal liability; and (3) whether the purchase price of the asset unreasonably exceeds its fair market value. Durkin, 872 F.2d at 1276; Bailey, 912 F.2d at 48. Additionally, with regard to the non-recourse factor, any incentives, or lack thereof, to the debtor to pay the debt out of personal assets should be considered. Bailey, 912 F.2d at 48. 34 Applying these principles, the tax court concluded that neither of the notes represented genuine indebtedness and thus could not be included in the partnership's basis. The tax court determined that the Nonrecourse Note and the provisions for retiring it were mere paper transactions lacking economic substance, and served no 'purpose, substance or utility apart from the anticipated tax consequences.'  T.C. Memo. at 20 (citations omitted). 35 With regard to the recourse note, the tax court determined that the assumption agreement lacked economic substance because none of the partners expected Orion to enforce it. Furthermore, as a result of the multiplier clause and the additional license fee, the film's proceeds would surely satisfy the recourse note. Finally, the tax court could find no plausible business reason for the multiplier clause except to exculpate the partners from any real monetary exposure under the recourse note. 36 The record amply supports these findings and we will not disturb them on appeal. 11