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Gordon v. Commissioner of Internal Revenue

decided: June 24, 1985.


Appeals from the United States Tax Court.

Bauer, Cudahy, and Flaum, Circuit Judges.

Author: Cudahy

CUDAHY, Circuit Judge.

These appeals require us to determine whether the Tax Court was correct in sustaining the Commissioner's determinations of deficiencies in the taxpayers' federal income tax returns. The Tax Court held that the taxpayers were not entitled to any deduction for their flow-through share of the depreciation of a motion picture owned by a limited partnership in which the taxpayers had invested, because the partnership itself was not entitled to any depreciation on the film. Perlman v. Commissioner, T.C. Memo 1983-166, 45 T.C.M. (C.C.H.) 1100 (1983). The issue before us is whether, under the so-called "income forecast method," the partnership, a cash method taxpayer, is entitled to calculate depreciation based on revenue generated by the film and received by the distributor, but where no payments have been made to it by the distributor. We hold that the Commissioner correctly disallowed any depreciation, and affirm the decisions of the Tax Court.


These appeals together contest thirty-two decisions of the United States Tax Court sustaining the Commissioner's determinations of deficiencies in the various taxpayers' 1975, 1976 and 1977 federal income tax returns.*fn1 The decisions, which were entered on January 19, 1984, all resulted from a memorandum opinion of the Tax Court issued on March 29, 1983, which decided on summary judgment the sole issue with respect to all the taxpayers. Notices of appeal were timely filed. This court has jurisdiction pursuant to section 7482 of the Internal Revenue Code of 1954, as amended (the "Code"), 26 U.S.C. ยง 7482.

The pertinent facts are not in dispute. The taxpayers are thirteen couples who invested in an Illinois limited partnership called the Mitchell Film Company (the "Partnership") which was 'designed' to provide tax shelter through investment in a motion picture. Taxpayer Stuart D. Perlman was also the general partner of the Partnership. In May, 1975, the Partnership purchased all right, title and interest in a motion picture titled "Mitchell" (the "Film") from Essex Enterprises, Ltd. The Partnership claimed a cost basis of $1,162,500 in the Film.*fn2

Distribution rights for the Film in the United States and various other areas of the world were held by Allied Artists Picture Corporation ("Allied"). Allied distributed the Film, which was exhibited in several thousand theatres throughout the United States and shown on network television. These showings produced revenues for Allied of $701,371, $354,748 and $376,393 during 1975, 1976 and 1977, respectively. Allied never paid any portion of these revenues to the Partnership. In 1979, Allied filed for reorganization under chapter 11 of the Bankruptcy Code.

The Partnership employed the cash method of accounting during the years in issue. On its 1975, 1976 and 1977 returns, the Partnership, having received no portion of the revenues for the Film from Allied, reported no income with respect to the Film. The Partnership did, however, claim deductions for depreciation of the Film in the amounts of $543,469, $275,022, and $122,789, respectively. The depreciation deductions resulted in tax losses for the Partnership for each year. Then, in turn, each of the taxpayers involved here, as partners in the Partnership, deducted an allocable share of the losses.

The Commissioner disallowed the Partnership's deductions for depreciation of the Film for each year and, accordingly, also denied the resulting loss deductions claimed by the taxpayers. The taxpayers then filed with the Tax Court thirty-two petitions seeking redetermination of the deficiencies in their taxes for one, two or three of the years. The litigation in the Tax Court moved ahead rapidly in three of the cases. The Commissioner filed motions for summary judgment as to the depreciation issue in those cases. The taxpayers in all 32 cases and the government filed a stipulation that the depreciation issue affecting each of the cases would be disposed of according to the ruling on the summary judgment motions in the three expedited cases.

On March 29, 1983, the Tax Court issued a memorandum opinion on the summary judgment motions, resolving the depreciation issue in favor of the Commissioner. Perlman v. Commissioner, T.C. Memo 1983-166, 45 T.C.M. (C.C.H.) 1100 (1983). The court noted that the proper allowance for depreciation of motion pictures may be computed under the "income forecast method," the method that the Partnership elected. Under this method, depreciation deductible under section 167 of the Code is calculated by multiplying the property's basis for depreciation by a fraction. The numerator of the fraction is the income derived from the property during the taxable year, and the denominator is the estimated total income to be derived for the property.*fn3 In making its depreciation calculations with respect to the film involved here, the Partnership used as the numerator of this fraction for each year the revenue reported for the year by Allied; as the denominator, it used an estimate of total income of $1,500,000.

The Tax Court, however, ruled that the use of the revenues received by Allied as the numerator was incorrect. The court determined that under well-established precedent the income figure to be used by the Partnership in computing its allowable depreciation was its income, and since the Partnership received no income, the allowable depreciation would also be zero. Accordingly, the Tax Court concluded, the Commissioner correctly denied the Partnership's depreciation deductions, as well as the resulting loss deductions of the taxpayers.

Other issues in the 32 cases were settled, and pursuant to the stipulation, deficiencies in all the cases were determined in accordance with the memorandum opinion granting summary judgment. Decisions in all cases were entered by ...

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