In 1971 the IRS audited Harrah’s Club of Reno, a casino that operated hotels and gambling casinos. To attract patrons, Harrah’s maintained a museum of about 1,000 antique automobiles. It was successful; over 200,000 people visited the museum in that year.
The casino purchased and restored these antique cars, acquired in various stages of deterioration. The museum itself was housed in a 10-acre complex, and included display areas, restoration workshops and an extensive research library. Over 150 people were employed in the museum and restoration areas.
The Tax Court arguably gave the best description of Harrah’s restoration process:
“The…restorations involve extensive showroom-or-better quality replacements and additions of body, engine, upholstery, lights and paint. Each restoration is preceded by historical research into the specifications of the original vehicle. Restoration is then carried out with meticulous attention to every detail…at great cost. Upholstery and paint are reproduced as they were originally. Entire portions of the body and engine, down to individual engine parts, are renewed, to the extent of making castings from borrowed samples of parts whose replacements cannot be found…(Their) restorations have such an excellent reputation for quality that they add a premium value to the…restored vehicle.”
The tax case[1] involved the proper tax treatment of restoration costs for 94 vehicles. Harrah maintained that these costs should be deductible in the year they were incurred.
The IRS opposed that position, and stated that the restoration costs were capital in nature because they would benefit more than one year. The government relied on a tax regulation that stated that normal repair costs can be deductible as an expense, but those costs that either added to the value or prolonged the life of the asset (the antique cars) were not deductible, but should be capitalized and added to the original cost of the asset.
In response, Harrah stated that if the restoration costs were to be added to a capital account, then they should be depreciated over a period of five to ten years.
The ball was in the IRS’s court. The government then played their ace: depreciation can only occur if the cars had a useful life that could be reasonably estimated. The cars, once restored, could last indefinitely. They pointed out that antique cars were held and displayed in the Smithsonian Museum for decades with no deterioration. Bottom line: no depreciation deduction.
Harrah then played its final card. They responded that, since many of the cars had a market value greater than a normally restored vehicle (due to Harrah’s first-class restoration techniques), the difference between the market value and the costs of restoration plus the initial cost should be deductible or depreciated.
An example of Harrah’s position might help. Recently, I saw a 1985 Firebird for sale for $1,500. The engine needed work and there was some rust on the body. If I paid the $1,500 for it, and decided to restore it to “showroom condition” and display it, I would need to spend, say $10,000. At this point, I would have $11,500 in the ‘Bird.
But maybe the market value is only $9,000, even for one in prime condition. Using Harrah’s initial logic, I’d want to deduct the $10,000 in restoration costs. IRS says no; it has to be capitalized. I now have an $11,500 asset, and the next best option for me from a tax standpoint is try and depreciate the $11,500.
Again, IRS says no, because the car now has an indefinite life. So, my last attempt to get some tax benefits from this deal is to try and depreciate the $2,500, the difference between the total costs expended ($11,500) and the market value ($9,000).
IRS again says no. The excess of the initial price and restoration costs over the market value of the car can’t be depreciated. The $2,500 is part of the $10,000 in restoration costs and can’t be separated.
Bottom line: Harrah’s Casino was unable to get any tax benefits from the restoration costs until the vehicles were sold.
Those who collect and restore cars can probably expect the same tax treatment. Recommendation: save all restoration documentation and sort it for each vehicle. It will be needed to figure the tax gain or loss when the car is finally sold. It appears that the year of sale will be the only time when tax benefits – if any – will be available for car collectors.
Footnote: Bill Harrah died in 1978 and Holiday Inn purchased the remaining shares of stock in the casino. Included in that purchase was the vehicle museum, which then had about 1,400 vehicles in its collection. Holiday Inn auctioned off the majority of the collection for about $100 million net. A small portion of that collection now forms the basis of the National Automobile Museum in Reno.
Let me know if you or your group would be interested in a presentation going into these topics or other tax and financial aspects of motor sports. I'd be interested in hearing from you.
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Until next time …
Phil Schurrer, CPA
“This posting is intended to provide general information regarding the subject matter covered. It is provided with the understanding that the author is not engaged in rendering legal, accounting, or other professional services. This information should not be used as a substitute for professional advice in specific situations. If legal advice or other expert assistance is required, the services of a professional should be sought.”
- Adopted from a Declaration of Principles jointly adopted by a Committee of the American Bar Association and a Committee of Publishers.
Attorneys and other professionals dealing with specific matters and situations should also research original sources of authority.
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