## Facts

- James L. Rose and Judy S. Rose invested in three “reproduction master” packages marketed by Jackie Fine Arts involving photographic transparencies of Pablo Picasso works and related exploitation rights (e.g., prints, posters, calendars).
- The investment was marketed as producing substantial tax benefits, including accelerated depreciation and a 10% investment tax credit based on the stated purchase price.
- Each package came with appraisals valuing the masters around $600,000–$800,000; the appraisals were largely boilerplate and relied on Picasso’s reputation and markets for original prints rather than the market for mass-produced reproductions.
- The stated purchase prices were financed with a mix of cash/short-term notes and long-term partial recourse promissory notes secured by the masters and related rights and proceeds.
- On joint returns for 1979 and 1980, the Roses reported high incomes and claimed large depreciation deductions, investment tax credits, and related expense and interest deductions from an “art print activity.”
- The IRS issued deficiency notices disallowing the depreciation, deductions, and credits and asserted increased interest under I.R.C. § 6621(d) for a tax-motivated transaction.

## Issues

1. Whether the art master transactions had economic substance such that the Roses could claim depreciation, other deductions, and investment tax credits arising from the packages.
2. Whether the Roses could deduct interest that was accrued and/or actually paid on the financing notes used to acquire the packages.
3. Whether increased interest under I.R.C. § 6621(d) applied because the underpayments were attributable to tax-motivated transactions.

## Decision

- The Tax Court held the transactions lacked economic substance apart from anticipated tax benefits and disallowed depreciation, miscellaneous deductions, and investment tax credits arising from the art masters.
- The court allowed a deduction under I.R.C. § 163 only for interest actually paid on genuine recourse indebtedness; it disallowed interest that was merely accrued or tied to sham/non-substantive debt features.
- The court sustained increased interest under I.R.C. § 6621(d) because the underpayments were attributable to tax-motivated transactions.

## Legal Principles

- Deductions and credits may be denied where a transaction lacks economic substance and functions primarily to generate tax benefits rather than economic profit.
- In evaluating economic substance, courts consider objective indicators including realistic profit potential, credible valuation evidence, financing terms, and the presence or absence of bona fide business activity.
- Boilerplate or inflated appraisals and financing structures designed to inflate basis and tax benefits support disregarding the transaction for depreciation and investment credit purposes.
- Interest under I.R.C. § 163 may be deductible when actually paid on genuine recourse debt, even if other tax benefits from the associated transaction are disallowed for lack of economic substance.
- Increased interest under I.R.C. § 6621(d) applies to substantial underpayments attributable to tax-motivated transactions, including transactions lacking economic substance.

## Conclusion

The Tax Court treated the art master program as a tax shelter lacking economic substance, denied depreciation and investment tax credits connected to the packages, allowed only interest actually paid on genuine recourse debt, and imposed increased interest for tax-motivated underpayments under § 6621(d).


Rose v. Commissioner, 88 T.C. 386 (1987)