Restoration and recapture: The auditor's responsibility;

              Restoration
and Recapture:
The Auditor's Responsibility
I N THE FUTURE, the preparation of federal income tax
returns for audit clients will require additional work to
insure that transactions involving restoration of the invest­ment
credit and recapture of depreciation are properly
reflected in the returns. Audit engagements in which the
responsibility for the preparation of the federal income
tax return has been retained by the client will require
consideration of restoration and recapture because of the
effect which the operation of these new rules will have on
a client's tax liability.
Although the tax department ultimately may have to be
consulted regarding various possible applications of the
rules, the audit staff will have responsibility for recogniz­ing
transactions which may be subject to restoration and
recapture. Close client relationships of the audit staff will
require a degree of familiarity with restoration and recap­ture
in order fully to understand the problems incident to
significant acquisitions or disposals of operating assets
which may be undertaken by clients.
Restoration and recapture are required by Sections 47
and 1245 of the Internal Revenue Code. Both sections
were added to the Code by the Revenue Act of 1962.
Section 47 provides for the restoration of an investment
credit previously derived from the acquisition of property
included within the definition of Section 38 property.1
Restoration is required if Section 38 property is disposed
of, ceases to be Section 38 property, or is converted to
public utility property. Section 1245 provides for the re­capture,
as ordinary income, of depreciation taken after
December 31, 1961, on property included within the
definition of Section 1245 property.2 The recapture pro­vision
pertains only to dispositions occurring in years
be ginning after December 31, 1962.
Section 47 was enacted to complement the basic invest­ment
credit provision of the Code.3 The purpose of the
Section is to prevent taxpayers from deriving multiple
investment credits merely by turning over a fixed invest­ment
in Section 38 property.4
The purpose of Section 1245 is to prevent the conver­sion
of ordinary income into capital gain upon the dispo­sition
of property in those instances in which depreciation
has been taken at a faster rate than the actual decline in
value of the property.5 This approach is clearly in conflict
with the basic accounting concept of depreciation as a
method of allocating the cost of property over its expected
useful life without regard to its value. The enactment of
Section 1245 was spurred by the advent of the liberalized
depreciation rules0 which would have increased the
amount of capital gain to be realized upon the sale of
depreciable property and the investment credit incentive
which was designed to encourage the acquisition of depre­ciable
property.7
The principle of recapture expressed in Section 1245 is
not unique in the Code. Section 1238, which was enacted
as part of the Revenue Act of 1950, requires ordinary
income treatment of amortization in excess of deprecia­tion
taken on an emergency facility which is subsequently
recovered as gain on disposition of the facility.
Restoration of the investment credit is required upon
disposition or cessation of status as Section 38 property.8
24 THE QUARTERLY