                       T.C. Memo. 1999-14



                    UNITED STATES TAX COURT



    ABC RENTALS OF SAN ANTONIO, INC., ET AL., Petitioners v.
          COMMISSIONER OF INTERNAL REVENUE, Respondent*



    Docket Nos. 20689-91, 20690-91,         Filed January 25, 1999.
                20691-91.1



    Timothy P. O'Sullivan and John R. Gerdes, for petitioners.

    Michael J. O'Brien, for respondent.




     *This Supplemental Memorandum Findings of Fact and Opinion
supplements our prior Memorandum Opinion in the instant case, ABC
Rentals of San Antonio, Inc. v. Commissioner, T.C. Memo. 1994-
601, revd. and remanded 142 F.3d 1200 (10th Cir. 1998).
    1
      Cases of the following petitioners are consolidated
herewith: David R. Peters and Diana L. Peters, docket No. 20690-
91; and John P. Parsons and Melba R. Parsons, docket No. 20691-
91.
                                - 2 -


         SUPPLEMENTAL MEMORANDUM FINDINGS OF FACT AND OPINION

     HAMBLEN, Judge:    This case is before us on remand from the

Court of Appeals for the Tenth Circuit.    ABC Rentals of San

Antonio, Inc. v. Commissioner, 142 F.3d 1200 (10th Cir. 1998),

revg. and remanding T.C. Memo. 1994-601.

     The issues for decision concern the proper election and

proper application of the income forecast method of depreciation.

We previously determined in ABC Rentals of San Antonio, Inc. v.

Commissioner, T.C. Memo. 1994-601 (ABC Rentals I), that

petitioners failed to demonstrate that the consumer durables,

leased in their rent-to-own business, constitute property which

is properly depreciable under the income forecast method of

depreciation.    The Court of Appeals concluded that section

168(f)(1)2 does not preclude use of the income forecast method

for property like petitioners' rent-to-own inventory.    Since we

determined that petitioners' rental units could not be

depreciated using the income forecast method and did not reach

respondent's other arguments, the Court of Appeals has directed

us to determine on remand

     whether taxpayers made a proper election under
     section 168(f) and, if so, whether they improperly
     applied the income forecast method because they did not
     accurately forecast the income expected over the life


     2
      All section references are to the Internal Revenue Code in
effect for the years at issue, and all Rule references are to the
Tax Court Rules of Practice and Procedure.
                                - 3 -


       of the assets and did not make an adjustment for
       salvage value.

ABC Rentals of San Antonio, Inc. v. Commissioner, 142 F.3d at

1211.

                          FINDINGS OF FACT

       This case was submitted without a trial pursuant to Rule

122.    The findings of fact are set forth in ABC Rentals I and are

incorporated herein by this reference.      The stipulation and

exhibits are also incorporated herein by this reference.      For

convenience, we shall repeat those facts as necessary to clarify

the ensuing discussion.    We also set forth below certain

supplementary findings of fact that were not set forth in our

prior opinion but which are based on the record of the instant

case and are relevant to issues decided on remand.

       The individual petitioners petitioned this Court contesting

respondent's determinations of deficiencies in their Federal

income tax as follows:

ABC Rentals of San Antonio, Inc.--Docket No. 20689-91

       Tax Period Ended                 Deficiency

            5/31/87                     $7,404.90

David R. Peters and Diana L. Peters--Docket No. 20690-91

       Tax Period Ended                 Deficiency

            12/31/87                       $572
            12/31/88                        833
                                - 4 -


John P. Parsons and Melba R. Parsons--Docket No. 20691-91

                                         Additions to Tax
Tax Period Ended          Deficiency        Sec. 6661

     12/31/87             $11,028             $2,757
     12/31/88               8,095              2,024

     Respondent subsequently conceded the additions to tax

pursuant to section 6661 in docket No. 20691-91 for the 1987 and

1988 taxable years in the amounts of $2,757 and $2,024,

respectively.

     During the tax periods in issue, Guaranteed Rental Systems,

Inc. (Guaranteed), was an S corporation not subject to the

unified audit and litigation procedures of the Tax Equity and

Fiscal Responsibility Act of 1982 (TEFRA), Pub. L. 97-248, sec.

402(a), 96 Stat. 324, 648,3 and all of Guaranteed's adjustments

flowed directly through to the shareholders' tax returns and are

reflected in the deficiencies shown in docket Nos. 20690-91 and

20691-91.   For the fiscal year ending May 31, 1987, ABC Rentals

of San Antonio, Inc. (ABC), was a C corporation, and the notice

of deficiency in docket No. 20689-91 relates to deficiencies

during that fiscal year only.   Thereafter, ABC applied for and

     3
      Sec. 6244 provides that the TEFRA provisions relating to
the assessment and determination of partnership items are
extended to the assessment and determination of subch. S items.
Sec. 301.6241-1T(c), Temporary Proced. & Admin. Regs., 52 Fed.
Reg. 3003 (Jan. 30, 1987), exempts small S corporations, defined
as corporations with 5 or fewer shareholders, from the unified
audit and litigation procedures for taxable years the due date of
the return of which is on or after Jan. 30, 1987.
                               - 5 -


was granted S corporation status.   For the tax period ending

December 31, 1987, and the tax year ending December 31, 1988, ABC

was a non-TEFRA subchapter S corporation, and all of ABC's

adjustments flowed through to its sole shareholder, John P.

Parsons, and are reflected in the deficiencies shown in docket

No. 20691-91.

     On January 27, 1992, these cases were consolidated.    These

consolidated cases were submitted without a trial pursuant to

Rule 122.

     At the time the petitions were filed in these cases,

Guaranteed and ABC (hereinafter sometimes collectively referred

to as the Entities or individually referred to as an Entity) were

corporations incorporated in the State of Texas with their

principal offices located in Wichita, Kansas.   During the taxable

periods in controversy, Guaranteed and ABC were accrual basis

taxpayers.

     For the fiscal year ending May 31, 1987, ABC timely filed

its Federal corporate income tax return.   ABC timely filed a

valid subchapter S election, and the election was granted

effective June 1, 1987.   Guaranteed timely filed its Federal

corporate income tax return for an S corporation for the calendar

year ending 1987, and ABC timely filed its Federal corporate

income tax return for an S corporation for the short taxable
                               - 6 -


period ending December 31, 1987.    Guaranteed and ABC timely filed

their Federal corporate income tax returns for S corporations for

the calendar year 1988.

     Guaranteed and ABC operated commercial enterprises which

rented consumer durables (appliances, furniture, televisions,

stereos, and video cassette recorders) under rent-to-own leases

to individuals.   Both Entities have been in the rent-to-own

business for a number of years.    During the tax periods in

controversy, Guaranteed and ABC estimated that the total gross

rental anticipated to be received on each rental unit (except for

initial rental contracts on rental unit purchases as transfers

between companies as discussed below) would be 300 percent of its

initial cost.   This method of determining the total gross rental

anticipated to be received was consistent with the practice in

the rent-to-own industry.   In determining the weekly or monthly

rental rate, as the case may be, for each rental unit, the

Entities divided such expected total gross rental by the total

number of weeks or months, as the case may be, under the initial

rental contract for such rental units.

     Whenever a rental unit either was picked up by an Entity or

returned to that Entity prior to all payments being made under

the initial rental contract, due either to a failure of the

customer to timely pay periodic rent or the exercise by the
                              - 7 -


customer of the customer's rights to return the rental unit at

any time, normally a subsequent rental contract, having the same

provisions and weekly or monthly rental payment as the initial

rental contract, would be executed with another customer.4

During the tax years in issue, each Entity periodically sold or

purchased rental units to or from the other Entity at the selling

Entity's book value.5

     Rental units ceased to be in an Entity's depreciable rental

inventory upon the occurrence of the following events:   (1)

Customers' retaining rental units for the full term of the rental

contract; (2) customers' electing the early purchase option

thereunder; (3) selling or junking substantially damaged rental

units which were returned to an Entity by customers; (4) theft of

     4
      The term of the subsequent rental contract would be
adjusted, when so required, according to the Entity's internal
schedule. This internal schedule might require a reduction in
the term of the lease depending upon the number of days the
rental unit had been previously rented. In a small minority of
circumstances, the weekly or monthly rental payments also would
be reduced under the subsequent rental contract on returned
rental units which had sustained a diminished value beyond normal
wear and tear. Normally this procedure would continue to be
followed until a customer retained the rental unit for the full
term of the rental contract.
     5
      The Entities used the straight line method of depreciation
for book purposes with an 18-month useful life to depreciate all
of the rental units. Such transfers between Entities were not
made for tax reasons, but for the purpose of transferring rental
units to maximize their income potential. The term of the rental
contract of the rental units so purchased, which had been
previously rented by the selling Entity, was adjusted
accordingly.
                               - 8 -


the rental units; and (5) transfers between one Entity and the

other Entity.   The vast majority of rental units ceased to be in

an Entity's inventory due to customers' retaining the rental

units for the full term of the rental contract (be it the initial

rental contract or the subsequent rental contract).   If a

customer retained the rental unit for the full term of the rental

contract, title to the rental unit vested in the customer at no

additional cost, provided the customer had paid all periodic

rental payments.   When any of the units ceased to be in an

Entity's depreciable rental inventory, the remaining basis was

either "charged off" or used to determine gain or loss from the

disposition.

     On their income tax returns ending in 1987 and 1988, the

Entities continued to depreciate all rental units placed in

service during prior tax years, using the accelerated cost

recovery system (ACRS).   The recovery period used by the Entities

to calculate the depreciation under ACRS was 5 years.

     For Federal income tax purposes, the Entities calculated

depreciation on their rental units placed in service for tax

years ending after 1986 using the income forecast method.6    On


     6
      Under the income forecast method used by the Entities, a
rental unit's depreciation deduction was based on the rent
received on that rental unit. Consequently, a depreciation
deduction was not taken on a rental unit during any month in
which it did not earn rental income.
                              - 9 -


rental units initially acquired by an Entity through purchase

from third parties and rented for the first time and for rental

units rented by an entity on a subsequent rental contract, each

year's depreciation deduction was equal to the cost of the rental

units multiplied by a fraction.   The numerator of the fraction

was the current year's income from that rental unit.    The

denominator of the fraction was 300 percent of the rental unit's

initial cost, which was the amount of total gross rental that

would be received if the initial rental contract on such rental

went to term.

     Guaranteed attached Statement 2 to its tax return for the

taxable year ending December 31, 1987.   The only information

Statement 2 provided was that the type of property being

depreciated was "RENTAL UNITS".   The statement did not say that

Guaranteed made an election of the income forecast method or of

any other method of depreciation.   Rather, the Statement 2

"Method" column was left blank.   Nor did it refer to section

168(f)(1) or to any other provision of the Code.   Statement 2 did

not provide the year the rental property was placed in service--

in the "Date Acquired" column, Statement 2 says "VAR".    In

addition, Statement 2 did not provide the unadjusted basis of the

rental property--the "Cost or Basis" column is blank.
                              - 10 -


     The Form 4562 filed with Guaranteed's tax return for its

taxable year ending December 31, 1987, contains the heading on

line 9 "Property subject to section 168(f)(1) election."   The

1987 instructions for this form provide that line 9 should be

used to report property that the taxpayer elects, under section

168(f)(1), to depreciate by any method not based on a term of

years.   Furthermore, the instructions provide that the

depreciation deduction for the property should be entered in

column (f) of line 9.7   However, Guaranteed left column (f) of

line 9 blank.   Rather, it appears the depreciation deduction for

the rental property has been included in column (f) of line 10--

"Other depreciation" where a $40,616 deduction is claimed.

Guaranteed failed to indicate on its Form 4562 that it was using

the income forecast method of depreciation.   Nothing in

Guaranteed's return indicates that it was electing the income

forecast method of depreciation.

     ABC did not attach a separate statement to its return for

its taxable year ending May 31, 1987.   ABC did not include the

year the rental property was placed in service, nor did it

include the unadjusted basis of the rental property.


     7
      See infra pp. 18-19.
                              - 11 -


     The Form 4562 filed with ABC's tax return for the year

ending May 31, 1987, contains the heading on line 7 "Property

subject to section 168(e)(2) election."8   The 1986 instructions

for this form provide that line 7 should be used to report

property that the taxpayer elects, under section 168(e)(2), to

depreciate by any method not based on a term of years.

Furthermore, the instructions provide that the depreciation

deduction for the property should be entered in column (f) of

line 7.9   However, ABC left column (f) of line 7 blank.   Rather,

it appears the depreciation deduction for the rental property has

been included in column (f) of line 8--"Other depreciation" where

a $119,195 deduction is claimed.   ABC failed to indicate on its

Form 4562 or anywhere else on its return that it was using the

income forecast method of depreciation.    The only methods of

depreciation indicated on its return are "ACRS" and "DDB".




     8
      Sec. 168(e)(2) is the predecessor to sec. 168(f)(1) and
applies to property placed in service prior to Jan. 1, 1987.
ABC's tax return for the year ended May 31, 1987, contains
depreciation deductions for property placed in service from June
1 through Dec. 31, 1986, which would be governed by the former
sec. 168(e)(2) as well as property placed in service from Jan. 1
through May 31, 1987, which would be governed by sec. 168(f)(1).
     9
      See infra pp. 21-22.
                              - 12 -


Nothing in ABC's return indicates it was electing the income

forecast method of depreciation.

     ABC attached Statement 4 to its tax return for its short

taxable period ending December 31, 1987.   Statement 4 provided

that the type of property being depreciated was "RENTAL

INVENTORY" and that a method of depreciation--"INCOME

FORECASTING"--was used other than ACRS or MACRS.   The statement

did not refer to section 168(f)(1) or any other Code section.

Statement 4 provided the year the rental property was placed in

service--"6/30/87", as well as the unadjusted or cost basis of

the rental property--"624,899".

     For rental units placed in service by Guaranteed and ABC in

1988, respondent does not contest the form or timing of the

election.   The parties have stipulated that the Entities have

filed elections pursuant to section 168(f)(1) to select the

income forecast method of depreciation for the tax years ending

December 31, 1988.   Statement 10 attached to Guaranteed's 1988

income tax return contained the following:

     SECTION 168(F)(1)   ELECTION TO EXCLUDE PROPERTY FROM ACRS
     BY USE OF A METHOD OF DEPRECIATION NOT EXPRESSED IN A TERM
     OF YEARS: RENTAL INVENTORY
          1.   NAME OF TAXPAYER:   GUARANTEED RENTAL SYSTEM, INC.
          2.   TAXPAYER I.D. # : XX-XXXXXXX
          3.   YEAR RECOVERY PROPERTY PLACED IN SERVICE: VARIOUS
          4.   UNADJUSTED BASIS OF RECOVERY PROPERTY: $210,138
          5.   METHOD OF DEPRECIATION: INCOME FORECASTING
                               - 13 -


Statement 14 attached to ABC's 1988 income tax return contained

the following:

     SECTION 168(F)(1)   ELECTION TO EXCLUDE PROPERTY FROM ACRS
     BY USE OF A METHOD OF DEPRECIATION NOT EXPRESSED IN A TERM
     OF YEARS: RENTAL INVENTORY

          1.     NAME OF TAXPAYER: ABC RENTALS OF SAN ANTONIO
          2.     TAXPAYER I.D. # : XX-XXXXXXX
          3.     YEAR RECOVERY PROPERTY PLACED IN SERVICE: VARIOUS
          4.     UNADJUSTED BASIS OF THE RECOVERY PROPERTY:
                 $544,343
          5.     METHOD OF DEPRECIATION: INCOME FORECASTING

     Guaranteed and ABC compiled detailed experience data with

respect to their rental units during the 1991 and 1992 calendar

years.   Guaranteed and ABC's business operations and surrounding

market conditions have remained essentially unchanged from the

years at issue throughout the years in which such experience data

was derived.   Due to such continuity, the parties submit that

(assuming the actual data as to Guaranteed and ABC was available

for the tax years in question) the data, if delineated, would not

vary materially from the experience data delineated from 1991 and

1992.

     Each Entity's 1991 and 1992 experience data indicates that,

per category of rental units, the actual average total amount of

gross rental the Entities received under all rental contracts for

a rental unit in such category was the product of the initial

cost to an Entity of such rental unit times the following

delineated integer:
                             - 14 -


 Category                                  Integer

                                Guaranteed            ABC

Appliances                          3.1               3.2
Televisions                         2.8               3.0
Furniture                           2.9               2.6
Stereos                             2.7               3.0
Video cassette recorders            2.9               3.4

An integer of 3.0 represents a gross return of 300 percent of

initial cost.

     Each Entity's 1991 and 1992 experience data indicates that,

per category of rental units consisting of all rental units

having the same initial term, the actual average total amount of

gross rental the Entities received under all rental contracts for

a rental unit in such category was the product of the initial

cost to the Entity of such rental unit times the following

delineated integer:

Initial Term                          Integer

  Months                   Guaranteed           ABC

   12                         3.1               3.0
   15                         2.7               3.4
   18                         3.0               3.2
   19                         2.6               2.5
   20                         3.2               2.8
   21                         3.0               3.1

An integer of 3.0 represents a gross return of 300 percent of

initial cost.

     Each Entity's 1991 and 1992 experience data indicates that

its percentage of sales proceeds derived from sales of rental
                              - 15 -


units to third parties by category, such percentage being equal

to the ratio such total sales proceeds bore to the total initial

purchase price of all rental units in that category, was as

follows:

     Category                           Percentage

                               Guaranteed            ABC

Appliances                        2.0               2.7
Televisions                    Less than 1          5.5
Furniture                         2.3               2.4
Stereos                        Less than 1       Less than 1
Video Cassette Recorders       Less than 1       Less than 1

     The total initial cost of rental units acquired during the

years 1987 and 1988 and which remained in Guaranteed's rental

inventory as of the end of the years was $142,173.71 and

$117,812.45, respectively.   The total initial cost of rental

units acquired during the tax periods ending May 31, 1987,

December 31, 1987, and December 31, 1988, and which remained in

ABC's rental inventory as of the end of the periods was

$273,435.20, $137,102.89, and $328,557.04, respectively.

                              OPINION

     The U.S. Court of Appeals for the Tenth Circuit has directed

us to determine:   (1) Whether petitioners made a proper election

under section 168(f) and, (2) if a proper election was made under

section 168(f), whether petitioners improperly applied the income

forecast method because they did not accurately forecast the
                                - 16 -


income expected over the life of the assets and did not make an

adjustment for salvage value.    ABC Rentals of San Antonio, Inc.

v. Commissioner, 142 F.3d at 1211.

     We hold that Guaranteed failed to make a proper election for

its taxable year ending December 31, 1987, and that ABC failed to

make a proper election for its taxable year ending May 31, 1987.

We hold further that ABC made a proper election for its short

taxable period ending December 31, 1987, since it substantially

complied with the election requirements for this short taxable

period.   For rental units placed in service during taxable years

ending in 1988, the parties have stipulated that both Guaranteed

and ABC properly elected out of MACRS under section 168(f)(1).

     Furthermore, in this particular case, since the parties

stipulated as to the estimate of income expected over the life of

the rental property and this estimate approximated petitioners'

experience, and since they stipulated that 1991-92 data did not

vary materially from the years in question, we hold that in this

situation petitioners did accurately forecast the income expected

over the life of the rental property.    In addition, since the

salvage value is inconsequential and since the parties stipulated

that 1991 and 1992 data did not vary materially from 1987 and

1988 data, we hold that petitioners did not have to make an

adjustment to the rental units' costs for salvage value.
                                - 17 -


I.   Proper Election

     The Court of Appeals has directed us to determine whether

petitioners made a proper election under section 168(f) for the

1987 and 1988 years before us.     ABC Rentals of San Antonio, Inc.

v. Commissioner, 142 F.3d at 1211.

     Under section 168(f)(1) taxpayers must make a proper

election in the first taxable year for which a depreciation

deduction would be allowable for the rental unit.     Section

168(f)(1) provides:

          (f) Property to Which Section Does Not Apply.--This
     section shall not apply to--
               (1) Certain methods of depreciation.--Any
          property if--
                    (A) the taxpayer elects to exclude such
               property from the application of this section, and
                    (B) for the 1st taxable year for which a
               depreciation deduction would be allowable with
               respect to such property in the hands of the
               taxpayer, the property is properly depreciated
               under the unit-of-production method or any method
               of depreciation not expressed in a term of years
               (other than the retirement-replacement-betterment
               method or similar method).

     Section 2.02 of Revenue Procedure 87-57, 1987-2 C.B. 687,

688, provides that the election under section 168(f)(1) must be

made following the procedures set forth in section 2.10 of the

Revenue Procedure.     Section 2.10 of Revenue Procedure, 1987-2

C.B. at 689, provides,

          .10 Time and manner for making elections. Under
     section 5h.5(a)(2) of the temporary regulations, after April
     14, 1987, an election described in this revenue procedure
                               - 18 -


     shall be made by the due date (taking extensions into
     account) of the tax return for the first taxable year for
     which the election is to be made. The tax return must be
     accompanied by a statement identifying the election by
     reference to Code or Act section and identifying the
     property items for which the election is being made.

     Section 5h.5, Temporary Tax Reform Act of 1986 Election

Regs., 52 Fed. Reg. 3624 (Feb. 5, 1987), effective February 5,

1987, applies to section 168(f)(1) elections and sets forth the

time and manner guidelines for elections made after October 22,

1986.   The election for section 168(f)(1) is available for

property placed in service after December 31, 1986.   Section

5h.5(a)(2) of the Temporary Tax Reform Act of 1986 Election

Regs., 52 Fed. Reg. 3626 (Feb. 5, 1987), provides,

          (a)(2) Time for making elections--(i) In general.
     Except as otherwise provided in this section, the elections
     specified in paragraph (a)(1) of this section shall be made
     by the later of--
               (A) The due date (taking extensions into account)
          of the tax return for the first taxable year for which
          the election is to be effective, or
               (B) April 15, 1987 (in which case the election
          generally must be made by amended return).

Section 5h.5(a)(3) provides,

          (a)(3) Manner of making elections--(i) In general.
     Except as otherwise provided in this section, the elections
     specified in paragraph (a)(1) of this section shall be made
     by attaching a statement to the tax return for the taxable
     year for which the election is to be effective. If because
     of paragraph (a)(2)(i)(B) of this section the election may
     be filed after the due date of the tax return for the first
     taxable year for which the election is to be effective, such
     statement must be attached to a tax return or amended return
     for the taxable year to which the election relates. Except
     as otherwise provided in the return or in the instructions
                                - 19 -


     accompanying the return for the taxable year, the statement
     shall--
               (A) Contain the name, address and taxpayer
          identification number of the electing taxpayer,
               (B) Identify the election,
               (C) Indicate the section of the Code (or, if the
          provision is not codified, the section of the Act)
          under which the election is made,
               (D) Specify, as applicable, the period for which
          the election is being made and/or the property or other
          items to which the election is to apply, and
               (E) Provide any information required by the
          relevant statutory provisions and any information
          necessary to show that the taxpayer is entitled to make
          the election.

     A.   Guaranteed

     Guaranteed did not meet the requirements for the tax year

ending December 31, 1987.     Guaranteed did attach a statement--

Statement 2--to its tax return for the taxable year ending

December 31, 1987.     However, the statement did not comply with

the requirements of Revenue Procedure 87-57, supra, or section

5h.5, Temporary Tax Reform Act of 1986 Election Regs., supra.

The only item of information Statement 2 provided was that the

type of property being depreciated was "RENTAL UNITS".     The

statement did not say that Guaranteed made an election of the

income forecast method or of any other method of depreciation.

Nor did it refer to section 168(f)(1) or to any other provision

of the Code.

     Petitioners rely on section 1.168-5(e)(3), Proposed Income

Tax Regs., 49 Fed. Reg. 5968 (Feb. 16, 1984).     However, we note
                              - 20 -


that Guaranteed did not even meet the less stringent requirements

of section 1.168-5(e)(3), Proposed Income Tax Regs., supra,

assuming arguendo they were otherwise applicable.    Section 1.168-

5(e)(3) provides:

          (3) Manner of making elections. Except as provided in
     subparagraph (5), Form 4562 is provided for making an
     election under this paragraph and for submitting the
     information required. The taxpayer must specify in the
     election--
                (i) The name of the taxpayer;
                (ii) The taxpayer's identification number;
                (iii)The year the recovery property was placed in
          service (or, in the case of 15-year real property, the
          month the property was placed in service);
                (iv) The unadjusted basis of the recovery
          property; and
                (v) Such other information as may be required.

     An election will not be rendered invalid so long as there is
     substantial compliance, in good faith, with the requirements
     of subparagraph (3).

Statement 2 did not provide the year the rental property was

placed in service--in the "Date Acquired" column, Statement 2

says "VAR".   In addition, Statement 2 did not provide the

unadjusted basis of the rental property--the "Cost or Basis"

column is blank.

     Furthermore, section 1.168-5(e)(3), Proposed Income Tax

Regs., supra, states that Form 4562, Depreciation and

Amortization, is provided for making the election.   The 1987

instructions for this form provide the following guidance for

line 9 of section C, Other Depreciation:
                              - 21 -


     Line 9.--Report property that you elect, under
     section 168(f)(1), to depreciate by the units-of-
     production method or any other method not based
     on a term of years (other than the retirement-
     replacement-betterment method).
          On a separate sheet, attach: (1) a description
     of the property and what depreciation method you
     elect that excludes the property from ACRS; and
     (2) the depreciable basis (cost or other basis,
     reduced, if applicable, by salvage value, investment
     credit, and the section 179 expense).
          Enter the depreciation deduction in column (f).

     The Form 4562 filed with Guaranteed's tax return for its

taxable year ending December 31, 1987, contains the heading on

line 9 "Property subject to section 168(f)(1) election."

However, Guaranteed left column (f) of line 9 blank.   Rather, it

appears the depreciation deduction for the rental property has

been included in column (f) of line 10--"Other depreciation"

where a $40,616 deduction is claimed.   Thus, Guaranteed failed to

indicate on its tax return, or on the accompanying Statement 2

and Form 4562, that the rental property (or any other of its

property) was subject to the section 168(f)(1) election.

Moreover, Guaranteed failed to indicate on its tax return, Form

4562, or Statement 2 that it was using the income forecast method

of depreciation.   Rather, the Statement 2 "Method" column was

left blank.

     For the tax year ending December 31, 1987, Guaranteed was

not even in substantial compliance with the election

requirements.   Nothing in Guaranteed's return, or on the
                                - 22 -


accompanying form or statement, indicates that it was electing

the income forecast method of depreciation.      Knight-Ridder

Newspapers, Inc. v. United States, 743 F.2d 781, 793-99 (11th

Cir. 1984).     Thus, Guaranteed did not substantially comply with

the requirements of Revenue Procedure 87-57, supra, or section

5h.5, Temporary Tax Reform Act of 1986 Election Regs., supra, nor

did it substantially comply with section 1.168-5(e)(3), Proposed

Income Tax Regs., supra, or even with the instructions that came

with Form 4562.    Consequently, we hold that Guaranteed failed to

make a proper election of the income forecast method for its

taxable year ending December 31, 1987.

     B.   ABC

          1.      Tax Year Ending May 31, 1987

     ABC did not meet the requirements for the tax year ending

May 31, 1987.    ABC did not attach a separate statement to its

return for its taxable year ending May 31, 1987.     Petitioners'

argument that the Service did not even publish Revenue Procedure

87-57, supra, until October 19, 1987, which was subsequent to the

filing date of ABC's tax return for the tax year ending May 31,

1987, is without merit.    Section 5h.5, Temporary Tax Reform Act

of 1986 Election Regs., supra, was effective February 5, 1987,

and set forth the time and manner guidelines for elections made

after October 22, 1986.    Moreover, section 5h.5, Temporary Tax
                                - 23 -


Reform Act of 1986 Election Regs., supra, was published in the

Federal Register for February 5, 1987, which was prior to August

21, 1987, the date ABC's tax return for its taxable year ending

May 31, 1987, was signed.   Consequently, ABC should have complied

with the requirements set forth in section 5h.5, Temporary Tax

Reform Act of 1986 Election Regs., supra.   ABC did not attach to

its return a separate statement or otherwise comply with the

requirements.

     Nor did ABC comply with the requirements of section 1.168-

5(e)(3), Proposed Income Tax Regs., supra, assuming they were

applicable.   ABC did not include on its return, or on any other

form or statement accompanying the return, the year the rental

property was placed in service, nor did it include the unadjusted

basis of the rental property.

     As indicated above, section 1.168-5(e)(3), Proposed Income

Tax Regs., supra, states that Form 4562, Depreciation and

Amortization, is provided for making the election.   The 1986

instructions for this form provide the following guidance for

line 7 of section C, Depreciation of Nonrecovery Property:

     Line 7.--Report property that you elect, under
     section 168(e)(2), to depreciate by the units-of-
     production method or any other method not based
     on a term of years. If you use the retirement-
     replacement-betterment method, see section 168(f)(3).
          On a separate sheet, attach: (1) a description
     of the property and what depreciation method you
     elect that excludes the property from ACRS; and
                                - 24 -


     (2) the depreciable basis (cost or other basis,
     reduced, if applicable, by salvage value, half the
     investment credit, and the section 179 expense).
          Enter the depreciation deduction for the property in
     column (f).

     The Form 4562 filed with ABC's tax return for the year

ending May 31, 1987, contains the heading on line 7 "Property

subject to section 168(e)(2) election."10    However, ABC left

column (f) of line 7 blank.     Rather, it appears the depreciation

deduction for the rental property has been included in column (f)

of line 8--"Other depreciation" where a $119,195 deduction is

claimed.     Thus, ABC failed to indicate that any of its property

was subject to the section 168(f)(1) election.     Moreover, ABC

failed to indicate on its Form 4562 or on its return that it was

using the income forecast method of depreciation.     The only

methods of depreciation indicated on its return are "ACRS" and

"DDB".

     ABC was not even in substantial compliance with the election

requirements.     Nothing in ABC's return or on the attached Form

4562 indicates it was electing the income forecast method of

depreciation.     Knight-Ridder Newspapers, Inc. v. United States,

supra at 793-99.     Thus, ABC did not comply with the requirements

of Revenue Procedure 87-57, supra, or section 5h.5, Temporary Tax

Reform Act of 1986 Election Regs., supra, nor did it comply with


     10
          See supra note 7.
                               - 25 -


section 1.168-5(e)(3), Proposed Income Tax Regs., supra, or even

with the Instructions that came with Form 4562.    Consequently, we

hold that ABC did not make a valid election of the income

forecast method for its taxable year ending May 31, 1987.

           2.    Taxable Period Ending December 31, 1987

     ABC did not comply literally with every one of the election

requirements for its short taxable period ending December 31,

1987.   However, it did substantially comply with the election

requirements.    ABC attached Statement 4 to its tax return for its

short taxable period ending December 31, 1987.    Statement 4

substantially complied with the requirements of Revenue Procedure

87-57, supra, and section 5h.5, Temporary Tax Reform Act of 1986

Election Regs., supra.    Although it failed to identify the

applicable Code section, Statement 4 recited that the type of

property being depreciated was "RENTAL INVENTORY" and that a

method of depreciation--"INCOME FORECASTING"--was used other than

ACRS or MACRS.

     In addition, Statement 4 identified the year the rental

property was placed in service--"6/30/87", as well as the

unadjusted or cost basis of the rental property--"624,899."

     Thus, ABC's return and attached statement indicated that an

election of the income forecast method was being made.     See

Knight-Ridder Newspapers, Inc. v. United States, supra at 796.
                                - 26 -


Consequently, we hold that ABC substantially complied with the

election requirements for its short taxable period ending

December 31, 1987.

      We hold as above set forth that Guaranteed failed to make a

proper election for its taxable year ending December 31, 1987,

and that ABC failed to make a proper election for its taxable

year ending May 31, 1987.     We hold further that ABC made a proper

election for its short taxable period ending December 31, 1987,

since it substantially complied with the election requirements

for this short taxable period.     Consequently, we must determine

whether the income forecast method was properly applied to rental

units placed in service in 1988 and to ABC's rental units placed

in service during its short taxable period ending December 31,

1987.

II.   Proper Application

        The U.S. Court of Appeals for the Tenth Circuit has directed

us to determine whether petitioners improperly applied the income

forecast method because (1) they did not accurately forecast the

income expected over the life of the assets and (2) they did not

make an adjustment for salvage value.     ABC Rentals of San

Antonio, Inc. v. Commissioner, 142 F.3d at 1211.

        The income forecast method of depreciation requires the

application of a fraction, the numerator of which is the income
                                - 27 -


from the rent-to-own equipment for the taxable year, and the

denominator of which is the forecasted or estimated total income

to be derived from the rent-to-own equipment during its useful

life.     Rev. Rul. 60-358, 1960-2 C.B. 68.   This fraction is

multiplied by the cost of the rent-to-own equipment which

produced income during the taxable year, after appropriate

adjustment for estimated salvage value.       Id.

        A.   Income Forecast

        Respondent contends that in applying the income forecast

method of depreciation, petitioners failed to forecast accurately

the income to be received from the assets being depreciated.       In

fact, respondent contends that the income to be received from

equipment placed in service was never forecast.      Rather, 300

percent of the asset's cost was always used as the denominator of

the fraction.     While the latter may be true, the parties

stipulated that petitioners estimated that the total gross rental

anticipated to be received on each rental unit would be 300

percent of its initial cost, which was consistent with the

practice in the rent-to-own industry.

        Each Entity's 1991 and 1992 experience data indicates that,

per category of rental units, the actual average total amount of

gross rental the Entities received under all rental contracts for

a rental unit in such category was the product of the initial
                             - 28 -


cost to the Entity of such rental unit times the following

delineated integer:

  Category                                 Integer

                                Guaranteed           ABC

Appliances                         3.1               3.2
Televisions                        2.8               3.0
Furniture                          2.9               2.6
Stereos                            2.7               3.0
Video cassette recorders           2.9               3.4


An integer of 3.0 represents a gross return of 300 percent of

initial cost.

     In addition, each Entity's 1991 and 1992 experience data

indicates that, per category of rental units consisting of all

rental units having the same initial term, the actual average

total amount of gross rental the Entities received under all

rental contracts for a rental unit in such category was the

product of the initial cost to the Entity of such rental unit

times the following delineated integer:

Initial Term                                    Integer

   Months                             Guaranteed           ABC

    12                                    3.1              3.0
    15                                    2.7              3.4
    18                                    3.0              3.2
    19                                    2.6              2.5
    20                                    3.2              2.8
    21                                    3.0              3.1
                               - 29 -


An integer of 3.0 represents a gross return of 300 percent of

initial cost.   Thus, petitioners' experience indicates that the

total amount of gross rental received on rental units

approximated 300 percent of their initial cost, the percentage

the parties stipulated that the total gross rental anticipated to

be received on each rental unit would equal.

     Petitioners provided data only for the 1991 and 1992

calendar years.   Since such data for the years at issue was not

readily available without resorting to significant expense,

experience data derived from the 1991 and 1992 calendar years was

utilized.   The parties stipulated that petitioners' business

operations and surrounding market conditions remained essentially

unchanged from the years at issue through the years in which such

experience data was derived.   Moreover, the parties stipulated

that, due to such continuity, the parties believe that if

petitioners' actual data were available for the calendar years

1987 and 1988, the data, if delineated, would not vary materially

from the experience data delineated for 1991 and 1992.

Consequently, in this particular case, since the parties

stipulated as to the estimate of income expected over the life of

the rental property and this stipulation approximated

petitioners' experience, and since they stipulated that 1991-92

data did not vary materially from the years in question, we hold
                              - 30 -


that in this situation petitioners did accurately forecast the

income expected over the life of the rental property.

     B.   Salvage Value

     Second, the Court of Appeals has directed us to determine

whether petitioners improperly applied the income forecast method

because they did not make an adjustment for salvage value.     ABC

Rentals of San Antonio, Inc. v. Commissioner, 142 F.3d at 1211.

Under the income forecast method, the fraction--reflecting the

ratio of current income to lifetime income--is multiplied by the

cost of the rent-to-own equipment which produced income during

the taxable year, after appropriate adjustment for estimated

salvage value.   Rev. Rul. 60-358, supra.

     Section 1.167(a)-1(c)(1), Income Tax Regs., provides:

     Salvage value is the amount (determined at the
     time of acquisition) which is estimated will be
     realizable upon sale or other disposition of an
     asset when it is no longer useful in the taxpayer's
     trade or business or in the production of his
     income and is to be retired from service by the
     taxpayer. * * *

In Carland, Inc. v. Commissioner, 90 T.C. 505, 547 (1988), affd.

in part, revd. in part and remanded 909 F.2d 1101 (8th Cir.

1990), we stated:   "An important factor in the determination of

salvage value is the taxpayer's experience and the particular

circumstances of that experience.   Industry experience is also a

factor which may be given consideration."   In this case,
                              - 31 -


petitioners' experience indicates that the vast majority of

rental units ceased to be in their inventory due to customers'

retaining the rental units for the full term of the rental

contract (be it the initial rental contract or the subsequent

rental contract).   If a customer retained the rental unit for the

full term of the rental contract, title to the rental unit vested

in the customer at no additional cost, provided the customer had

paid all periodic rental payments.

     In the Carland case, we determined the salvage value of the

taxpayer's property based on a percentage of salvage proceeds to

original acquisition costs.   Id. at 547.

     In this case, each Entity's 1991 and 1992 experience data

indicates that its percentage of sales proceeds derived from

sales of rental units to third parties by category, such

percentage being equal to the ratio such total sales proceeds

bore to the total initial purchase price of all rental units in

that category, was as follows:

Category                                      Percentage

                                 Guaranteed                ABC

Appliances                          2.0                 2.7
Televisions                      Less than 1            5.5
Furniture                           2.3                 2.4
Stereos                          Less than 1         Less than 1
Video Cassette Recorders         Less than 1         Less than 1
                                - 32 -


Thus, petitioners' experience indicates that the salvage value

for their rental units was negligible--proceeds from the sales of

rental units to third parties were for most rental units less

than 3 percent of their original acquisition cost.   In such

circumstances, we conclude that petitioners were permitted to

ignore such salvage value in determining the depreciation

deduction for their property.    Sec. 167(f) (before repeal in 1990

by the Omnibus Budget Reconciliation Act of 1990, Pub. L. 101-

508, sec. 11812(a)(1) and (2), 104 Stat. 1388, 1388-534); sec.

1.167(f)-1, Income Tax Regs.    In Bailey v. Commissioner, 90 T.C.

558, 620 (1988), affd. in part, vacated in part and remanded 912

F.2d 44 (2d Cir. 1990), we stated, in discussing the application

of the income forecast method to the taxpayer's contractual

rights to films:   "During the years in issue, the values of these

contract rights at the end of their anticipated useful lives were

so negligible that salvage values need not be taken into

account."   Therefore, since petitioners' salvage values were

negligible, it was proper, under these circumstances, for

petitioners to depreciate the total cost of their rental units.

     Since the salvage value is inconsequential and since the

parties stipulated that 1991 and 1992 data did not vary

materially from 1987 and 1988 data, we hold that petitioners,
                             - 33 -


under these circumstances, did not have to make an adjustment to

the rental units' costs for salvage value.

III. Conclusion

     We hold that Guaranteed failed to make a proper election of

the income forecast method for its taxable year ending December

31, 1987, and that ABC failed to make a proper election for its

taxable year ending May 31, 1987.   We hold further that ABC made

a proper election for its short taxable period ending December

31, 1987, since it substantially complied with the election

requirements for this short taxable period.   For rental units

placed in service during taxable years ending in 1988, the

parties have stipulated that both Guaranteed and ABC properly

elected out of MACRS under section 168(f)(1).

     Furthermore, in this particular case, since the parties

stipulated as to the estimate of income expected over the life of

the rental property, and this estimate was borne out by

petitioners' experience, and since they stipulated that 1991-92

data did not vary materially from the years in question, we hold

that in this situation petitioners did accurately forecast the

income expected over the life of the rental property.   In

addition, since the salvage value is inconsequential and since

the parties stipulated that 1991 and 1992 data did not vary
                             - 34 -


materially from 1987 and 1988 data, we hold that under these

circumstances petitioners did not have to make an adjustment to

the rental units' costs for salvage value.

     To reflect the foregoing,

                                      Decisions will be entered

                                 under Rule 155.
