                         T.C. Memo. 2001-277



                       UNITED STATES TAX COURT



             NEW GAMING SYSTEMS, INC., Petitioner v.
          COMMISSIONER OF INTERNAL REVENUE, Respondent



     Docket Nos. 11597-99, 18726-99.    Filed October 10, 2001.


     Spencer T. Malysiak, for petitioner.

     Christian A. Speck, for respondent.



                         MEMORANDUM OPINION


     VASQUEZ, Judge:    These cases are before the Court on

respondent’s motion for partial summary judgment under Rule 121.1




     1
        Unless otherwise indicated, all Rule references are to
the Tax Court Rules of Practice and Procedure, and all section
references are to the Internal Revenue Code in effect for the
years in issue.
                                 - 2 -

     The sole issue is whether petitioner properly elected to opt

out of depreciating its rental game equipment under the modified

accelerated cost recovery system (MACRS) pursuant to section

168(f)(1).

Background

     At the time of the filing of the petitions,2 petitioner was

a corporation that maintained its legal residence in Sacramento,

California.   For the periods in issue, petitioner had fiscal

years ending March 31, 1994, 1995, and 1996 (the 1994, 1995, and

1996 tax years, respectively).

     Petitioner rented electronic gaming equipment to

establishments in California.    In each of the tax years in issue,

petitioner placed gaming equipment in service.

     On its 1994 tax return, petitioner reported on Form 4562,

Depreciation and Amortization, amounts on the lines for “GDS and

ADS deductions for assets placed in service in tax years

beginning before 1993” and “ACRS and other depreciation”.

Petitioner did not report any amount on the line for “Property

subject to section 168(f)(1) election”.

     On its 1995 and 1996 tax returns, petitioner again reported

amounts on Form 4562 on the lines for “GDS and ADS deductions for


     2
        Respondent sent separate notices of deficiency to
petitioner, and petitioner filed separate petitions for: (1) The
1994 tax year and (2) the 1995 and 1996 tax years. We issued an
order consolidating the two cases for trial, briefing, and
opinion.
                                - 3 -

assets placed in service in tax years beginning before 1994” (and

“GDS and ADS deductions for assets placed in service in tax years

beginning before 1995”, respectively) and “ACRS and other

depreciation”, but not on the line for “Property subject to

section 168(f)(1) election”.   On its 1995 and 1996 tax returns,

however, petitioner attached schedules to the Forms 4562 that

included:   (1) A description of the property depreciated; (2) the

date acquired; (3) the basis for depreciation; (4) the

depreciation allowed in earlier years; (5) the method of figuring

depreciation; (6) the life, rate, or recovery period; and (7) the

deduction for that year.    On these schedules, petitioner reported

that it depreciated its gaming equipment using the straight-line

method over a 2-year recovery period.

     On July 2, 1999, petitioner filed Forms 1120X, Amended U.S.

Corporation Income Tax Return, amending its returns for the 1994,

1995, and 1996 tax years.   In each amended return, petitioner

included the following statement:

     As per IRC section 168(f)(1), the Taxpayer opted out of
     MACRS, and is instead depreciating its gaming equipment
     under an alternate method of depreciation based upon
     obsolescence due to a combination of changes in
     technology, changes in law, market competition, income
     generation from leasing the equipment, and the average
     term of the Taxpayer’s leases for such equipment.
                               - 4 -

      In the notices of deficiency,3 respondent determined

petitioner’s depreciation deductions by using the straight-line

method over a 7-year recovery period with a half-year convention.

Discussion

I.    Summary Judgment

      Respondent moved for partial summary judgment on the issue

of whether petitioner must use MACRS to calculate its

depreciation deductions on the gaming equipment.    Respondent

argues that petitioner cannot use a 2-year straight-line method

to compute its depreciation deductions because petitioner failed

to:   (1) Make proper, timely elections to exclude property from

MACRS under section 168(f)(1)(A), and (2) use a method of

depreciation not expressed in a term of years under section

168(f)(1)(B).

      Rule 121(a) provides that either party may move for summary

judgment upon all or any part of the legal issues in controversy.

Full or partial summary judgment may be granted only if it is

demonstrated that no genuine issue exists as to any material fact

and a decision may be entered as a matter of law.    See Rule

121(b); Sundstrand Corp. v. Commissioner, 98 T.C. 518, 520

(1992), affd. 17 F.3d 965 (7th Cir. 1994).


      3
        Respondent issued the notices of deficiency on Apr. 2,
1999 (for the 1994 tax year), and Sept. 17, 1999 (for the 1995
and 1996 tax years). Petitioner filed its petitions at the Tax
Court on June 28, 1999 (for the 1994 tax year), and Dec. 20, 1999
(for the 1995 and 1996 tax years).
                               - 5 -

      Petitioner argues that there is a genuine issue of material

fact as to how petitioner determined its method of depreciation.

Petitioner contends that it did not base its depreciation

deductions upon the wear and tear or physical exhaustion of the

equipment, but upon outside factors that influenced the

equipment’s income-producing ability, including the uncertainty

of whether California would change its gaming laws with respect

to this type of equipment, changes in public taste because of

advancements in technology, and petitioner’s experience with

similar equipment.

      We conclude that there is no genuine issue as to any of the

material facts regarding the method petitioner used to depreciate

its equipment.   As reflected on petitioner’s tax returns,

petitioner depreciated its equipment using a straight-line method

over a 2-year period.

II.   The Section 168(f)(1) Election

      A.   In General

      Deductions are a matter of legislative grace; petitioner has

the burden of showing that it is entitled to any deduction

claimed.   Rule 142(a); New Colonial Ice Co. v. Helvering, 292

U.S. 435, 440 (1934).

      The Internal Revenue Code provides taxpayers with a

depreciation deduction for the exhaustion, wear and tear, or

obsolescence of property used in a trade or business.   Sec.
                                - 6 -

167(a)(1).   For tangible property placed in service after

December 31, 1986, such deduction is computed under MACRS.    Sec.

168(a); Tax Reform Act of 1986, Pub. L. 99-514, secs. 201, 203,

100 Stat. 2085, 2122, 2143.    The application of MACRS is

mandatory:   “Except as otherwise provided in this section, the

depreciation deduction provided by section 167(a) for any

tangible property shall be determined using (1) the applicable

depreciation method, (2) the applicable recovery period, and (3)

the applicable convention”.    Sec. 168(a)(emphasis added).

Petitioner, therefore, must use MACRS to depreciate its equipment

unless an exception applies.

     Section 168(f) provides certain exceptions to the otherwise

mandatory provisions of section 168(a).    Specifically, property

may be excluded from using MACRS 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 * * *.

Sec. 168(f)(1).

     Respondent claims that petitioner failed to elect out of

MACRS on its original returns pursuant to section 168(f)(1)(A).

Further, on this point, respondent argues that petitioner did not

make the election timely because petitioner made the election on

amended returns after the audit, the issuance of the deficiency
                                 - 7 -

notice, and the filing of the petition disputing the 1994 tax

year.

     Petitioner argues that it did make a proper election out of

MACRS pursuant to section 168(f)(1)(A).     Petitioner concedes that

it did not comply “exactly” with the requirements of the Code to

make the election; however, petitioner contends that it

substantially complied with those provisions.     Petitioner argues

that the Court has allowed elections to be valid in such

situations, citing ABC Rentals of San Antonio, Inc. v.

Commissioner, T.C. Memo. 1999-14, Taylor v. Commissioner, 67 T.C.

1071 (1977), and Tipps v. Commissioner, 74 T.C. 458 (1980).

        The temporary regulations provide the time and manner of

making elections pursuant to section 168(f)(1).     See sec.

301.9100-7T(a)(1), Temporary Proced. & Admin. Regs., 52 Fed. Reg.

3624 (Feb.5, 1987).     The election must be made by the later of

the due date of the tax return for the first taxable year for

which the election is to be effective or April 15, 1987.       Sec.

301.9100-7T(a)(2), Temporary Proced. & Admin. Regs., 52 Fed. Reg.

3626 (Feb. 5, 1987).     In addition, the temporary regulation

provides instructions on how to make the election:     An election

is made by “attaching a statement to the tax return for the

taxable year for which the election is to be effective”.       Sec.

301.9100-7T(a)(3)(i), Temporary Proced. & Admin. Regs., 52 Fed.

Reg. 3627 (Feb. 5, 1987).     The regulation further provides that
                               - 8 -

such attachment shall include, “Except as otherwise provided in

the return or in the instructions accompanying the return”:     (1)

The name, address, and taxpayer identification number of the

electing taxpayer, (2) the identification of the election, (3)

the section of the Code under which the election is made, (4) the

period for which the election is being made and/or the property

to which the election is to apply, and (5) any other information

required by the statute and necessary to show that the taxpayer

is entitled to make the election.      Id.

     Form 4562 provides a line specifically for taxpayers to

report the amount of depreciation taken for “Property subject to

section 168(f)(1) election”.   The instructions for Form 4562

instruct the taxpayer to:

     Report property that you elect, under section
     168(f)(1), to depreciate under the unit-of-production
     method or any other method not based on a term of years
     (other than the retirement-replacement-betterment
     method). Attach a separate sheet showing (a) a
     description of the property and the depreciation method
     you elect that excludes the property from ACRS or
     MACRS; and (b) the depreciable basis.

Instructions for Form 4562, Line 17.

     If all of the requirements have not been met, an election

may still be valid if the taxpayer substantially complied with

these requirements.   ABC Rentals of San Antonio, Inc. v.

Commissioner, T.C. Memo. 1999-14.   In ABC Rentals of San Antonio,

Inc., the Court held that a taxpayer failed to make a proper

election out of MACRS for one year (year 1) when the taxpayer
                                - 9 -

failed to provide on its attached statement to its tax return the

method of depreciation elected, the applicable Code section, the

year the rental property was placed in service, and the adjusted

basis of the rental property.    Id.    In addition, for year 1, the

taxpayer did not report any amounts on the line of Form 4562 for

“Property subject to section 168(f)(1) election”; instead, the

taxpayer reported an amount on another line labeled “Other

depreciation”.   Id.   With regard to this year, the Court held

that the taxpayer did not substantially comply with the

requirements of the temporary regulations.        Id.

     For a different taxable year (year 2), another taxpayer in

ABC Rentals of San Antonio, Inc. v. Commissioner, supra, attached

a statement to its tax return that provided the type of property

being depreciated, the method of depreciation, the year the

property was placed in service, and the basis of the property.

The taxpayer, however, did not state that the election was being

taken under section 168(f)(1) of the Code.        Id.   The Court held

that the absence of the Code section alone did not prevent the

taxpayer from substantially complying with the requirements for a

section 168(f)(1) election for year 2.      Id.

     B.   The 1994 Tax Year

     For the 1994 tax year, we hold that petitioner did not make

a valid election under section 168(f)(1)(A) and did not

substantially comply with the requirements of the temporary
                              - 10 -

regulations.   As in ABC Rentals of San Antonio, Inc. v.

Commissioner, supra, for year 1, on its original tax return,

petitioner failed to provide most of the information required

under the temporary regulations, including the method of

depreciation elected, the applicable Code section, the year the

rental property was placed in service, and the adjusted basis of

the rental property.   In addition, as in ABC Rentals of San

Antonio, Inc. v. Commissioner, supra, petitioner left blank the

line on Form 4562 for “Property subject to section 168(f)(1)

election.”4

     C.   The 1995 and 1996 Tax Years

     For the 1995 and 1996 tax years, petitioner contends that it

substantially complied with the section 168(f)(1)(A) election

requirement.   Even if we assume arguendo that petitioner

substantially complied with the section 168(f)(1)(A) election

requirement, we hold, however, that petitioner did not meet the

second test of section 168(f)(1) that requires that the property

be “properly depreciated under the unit-of-production method or


     4
        As a preliminary matter, petitioner’s amended return was
untimely for sec. 168(f)(1) purposes. The temporary regulation
provides that the election must be made by the due date of the
tax return for the first taxable year for which the election is
to be effective, taking extensions into account. Sec. 301.9100-
7T(a)(2)(A), Temporary Proced. & Admin. Regs., 52 Fed. Reg. 3626
(Feb. 5, 1987). Petitioner filed its amended return on July 2,
1999, years after the due date of the original tax return.
Therefore, we do not consider petitioner’s amended return in
determining whether petitioner made an election or substantially
complied with the temporary regulation.
                                - 11 -

any method of depreciation not expressed in a term of years”.

Sec. 168(f)(1)(B).     Petitioner reported on its tax returns that

it used a straight-line depreciation method over 2 years.

Petitioner deducted 50 percent of the depreciation basis in the

year that the equipment was placed in service,5 and 50 percent in

the next year.   Respondent contends that by choosing a method of

depreciation measured by a term of years, petitioner failed the

requirement of section 168(f)(1)(B).

     Despite what its tax returns show, petitioner argues that it

did not use a depreciation method defined by a “term of years”.

Petitioner does not deny that it used a 2-year straight-line

depreciation method.    Petitioner argues that “Although

petitioner’s Form 4562 depreciates the gaming equipment as 2-year

straight-line depreciation, the factors relied upon by petitioner

in determining that useful life were other factors that had

nothing to do with the wear and tear on the machines”.

Petitioner further argues that it relied on the income forecast

method as well as a combination of other methods to determine the

depreciation deduction.    Petitioner noted that, on October 1,

1998, it provided a schedule to the Internal Revenue Service

Appeals officer that tracked the income of its machines and that




     5
        Petitioner used a half-year convention on its 1995 tax
return for the equipment placed in service after the midpoint of
that year.
                              - 12 -

demonstrated how income dropped off after the fourth or fifth

quarters of operation.

     Petitioner’s argument is unpersuasive.    The material fact is

that petitioner depreciated its equipment ratably over a 2-year

period.   This fact is undisputed.   The tax returns for the years

in issue and the record show that petitioner used a method that

was defined by a “term of years” and that petitioner did not use

the income forecast method.   The income forecast method requires

the application of a fraction, the numerator of which is the

income from the gaming equipment for the taxable year, and the

denominator is the forecasted or estimated total income to be

derived from the gaming equipment during its useful life.    See

ABC Rentals of San Antonio, Inc. v. Commissioner, T.C. Memo.

1999-14; Rev. Rul. 60-358, 1960-2 C.B. 68.    This fraction is

multiplied by the cost of the equipment that produced income

during the taxable year after an appropriate adjustment for

estimated salvage value.   Rev. Rul. 60-358, 1960-2 C.B. at 69.

     The tax returns show that petitioner calculated the

depreciation deduction using the straight-line method over 2

years, taking 50 percent in the year the equipment was placed in

service, then 50 percent the following year.    In order to use the

income forecast method, income must be forecasted.    Petitioner

prepared the income schedules submitted to the Appeals Office

long after it filed its tax returns; therefore, we conclude that
                                - 13 -

the income of the equipment was not forecasted in order to

calculate the depreciation deduction.     Petitioner’s president

stated that revenue generated by the equipment dropped off after

the fourth or fifth quarter.     Thus, under the income forecast

method of depreciation, petitioner would not have depreciated the

machines evenly over 2 years.     We conclude that petitioner did

not use the income forecast method to depreciate its equipment,

but, rather, a term of 2 years.

     In reaching all of our holdings herein, we have considered

all arguments made by the parties, and to the extent not herein

discussed, we find them to be irrelevant or without merit.

     To reflect the foregoing,

                                                An appropriate order

                                           will be issued granting

                                           respondent’s motion for

                                           partial summary judgment.
