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CCA 199921045
IRC Sec. 1245- Gain From Dispositions of Certain Depreciable Property
DEPARTMENT OF THE TREASURY
INTERNAL REVENUE SERVICE
WASHINGTON, D.C. 20224
CC:DOM:FS:P&SI
April 1, 1999
UILC: 9999.9800
Number: 199921045
Release Date: 5/28/1999
MEMORANDUM FOR JOSEPH M. ABELE
CC:NER:PEN:PHI
ASSISTANT DISTRICT COUNSEL
FROM: HARVE M. LEWIS
CHIEF, PASSTHROUGHS & SPECIAL INDUSTRIES
(FIELD SERVICE DIVISION)
SUBJECT: DEPRECIATION/HCA-SPR-122705-98
You have asked for our response as to the position that examiners should take in light of the Tax Court's decision in
Health Corp. of America, Inc. v. Commissioner, 109 T.C. 21 (1997) ("HCA"). In the following discussion we review the
factors relevant to a determination of whether an item is a structural component of a building or tangible personal
property, as well as what facts and circumstances may be of special concern to examiners. The determination is still
a highly factual one, with no bright line tests.
In HCA petitioners argued that several disputed items associated with facilities built in the 1980's constituted
Internal Revenue Code § 1245 property and therefore were appropriately depreciated using a 5-year recovery period
(pursuant to petitioner's business asset guideline class under ACRS and MACRS). The Commissioner countered that
allowing these items to be depreciated over a different recovery period than the buildings to which they related
resulted in component depreciation, which is no longer allowed under ACRS and MACRS. Further, the Commissioner
argued that investment tax credit ("ITC") cases involving years prior to 1981, when the cost recovery system was
adopted and component depreciation was disallowed, are of limited application in determining what constitutes a
structural component. Finally, the Commissioner took the position that these items were structural components
and thus section 1250 property and should be depreciated over the same recovery period as the building to which
they relate.
The Tax Court rejected the Commissioner's primary argument stating that in prohibiting component depreciation,
Congress did not intend to redefine section 1250 property to include property which prior to the enactment of ACRS
had been section 1245 property for the purposes of the ITC. The court looked at the statutory and regulatory
language of ACRS and MACRS, as well as its legislative history and determined that to the extent disputed property
would qualify as tangible personal property for ITC purposes under pre-1981 law, it will also qualify as tangible
personal property for ACRS and MACRS.
The court then turned to the Commissioner's contention that the disputed items were structural components under
an ITC analysis. The court examined each category of disputed items to determine whether the assets should be
characterized as section 1250 property, a structural component of the facility, or section 1245 property, tangible
personal property under Treas. Reg. § 1.48-1(c). In making this determination the court employed the factors set
forth in Whiteco Indus., Inc. v. Commissioner, 65 T.C. 664, 672-673 (1975) to ascertain whether the items were
inherently permanent and thus not tangible personal property within the meaning of Treas. Reg. § 1.48-1(c). These
factors include: 1) Is the property capable of being moved, and has it in fact been moved?; 2) Is the property
designed or constructed to remain permanently in place?; 3) Are there circumstances which tend to show the expected
or intended length of affixation, i.e., are there circumstances which show that the property may or will have to
be moved?; 4) How substantial a job is removal of the property and how time-consuming is it? Is it "readily
removable?"; 5) How much damage will the property sustain upon its removal?; and 6) What is the manner of
affixation of the property to the land? HCA, 109 T.C. at 57 (citing Whiteco, 65 T.C. at 672. The presence of one
factor is not the sole determinant of what is tangible personal property. Id.
HCA went on to define structural components by way of example as set forth in §1.48-1(e)(2):
The term "structural components" includes such parts of a building as walls, partitions, floors, and ceilings, as
well as any permanent coverings therefor such as paneling or tiling; windows and doors; all components (whether in,
on, or adjacent to the building) of a central air conditioning or heating system, including motors, compressors,
pipes and ducts; plumbing and plumbing fixtures; such as sinks and bathtubs; electric wiring and lighting fixtures;
chimneys; stairs; escalators, and elevators, including all components thereof; sprinkler systems; fire escapes;
and other components relating to the operation or maintenance of a building .... the term "structural
components" does not include machinery the sole justification for the installation of which is the fact
that such machinery is required to meet temperature or humidity requirements which are essential for the
operation of other machinery or the processing of materials or foodstuffs.
The court summarized the regulation saying, "an item constitutes a structural component of a building if the item
relates to the operation and maintenance of the building .... "HCA, 109 T.C. at 58. Be aware, however, that the
list may be misleading. The HCA court followed Scott Paper Co. v. Commissioner, 74 T.C. 137, 182-3 (1980) in
determining that even though wiring is an example under Treas. Reg. § 1.48-1(e)(2), it is not a structural
component unless it relates to the operation or maintenance of a building. HCA, 109 T.C. at 66. The focus, the
court found, should be on ultimate use. Id. at 68. In addition, the Service has stated that it will not challenge
the Scott Paper approach. Illinois Cereal Mills, Inc. v. Commissioner, T.C. Memo. 1983-469, action on decision,
1991-019 (Oct. 22, 1991).
Again, the determination of whether an asset is a structural component or tangible personal property is a facts
and circumstances assessment. As noted above, pre-1981 case law and factors set forth therein are still relevant
to the assessment. In view of the factual nature of the inquiry, no bright line test exists.
As a practical matter, it should be noted that the use of cost segregation studies must be specifically applied
by the taxpayer. The HCA court sustained the Service's position that certain "allocated" equipment must be
depreciated over the same period as the buildings to which they relate because the record did not provide any
"logical and objective measure" of the portion of the equipment that would constitute § 1245 property. HCA,
109 T.C. at 92. An accurate cost segregation study may not be based on non-contemporaneous records, reconstructed
data, or taxpayer's estimates or assumptions that have no supporting records. See Boddie-Noell Enterprises,
Inc. v. United States, 36 Fed. CI. 722, 746 (1996), aff'd without op. 132 F.2d 54 (Fed. Cir. 1997). Thus, cost
segregation studies should be closely scrutinized by the field.
Treas. Reg. § 1.167(e)-1(a) provides that any change in the method of computing the depreciation allowances with
respect to a particular account is a change in method of accounting. Further, the legislative history underlying
the statutory language of section 446(e) and former section 167(e) clearly indicates that a change in depreciation
method is a change in method of accounting. The legislative history of section 446(e) provides that a change in
method of accounting includes "a change in the treatment of a material item such as... a change in the method of
depreciating any property." S. Rep. No. 1622, 83d Cong., 2d Sess. (1954). The legislative history of former
section 167(e) provides that "[alii changes in depreciation method are changes in accounting method under section
446(e) and, therefore, will require the consent of the Secretary or his delegate." S. Rep. No. 1622, 83d Cong.,
2d Sess. (1954). Also, in Standard Oil Co. v. Commissioner, 77 T.C. 349 (1981), which concerned a taxpayer that
reclassified certain assets from section 1250 property to section 1245 property and then sought to use different
depreciation methods, the Tax Court stated that it "is unquestioned that a change in the method of computing
depreciation is a change in the method of accounting." 77 T.C. at 410. Thus, a change in depreciation method is
a change in method of accounting.
With respect to a change in recovery period or convention, Treas. Reg. § 1.446-l(e)(2)(ii)(a) indicates that such
a change is a change in method of accounting. This section provides that a change in method of accounting includes
a change in the treatment of any material item, and that a material item is any item that involves the proper time
for the inclusion of the item in income or the taking of the item as a deduction. The recovery period determines
the period of time over which the basis of depreciable property is recovered. The convention determines the portion
of the taxable year for which depreciation is allowable and determines how much of the applicable recovery period
remains as of the beginning of the taxable year following the placed-in-service year. A change in recovery period
or convention affects when, not whether, the cost of depreciable property will be recovered. Consequently, a
change in recovery period or convention affects the timing of deductions and is a change in method of accounting.
Treas. Reg. § 1.446-1(e)(2)(i) provides that a taxpayer who changes the method of accounting employed in keeping
his books shall, before computing his income using a new method for tax purposes, secure the consent of the
Commissioner, whether or not such method is proper or is permitted under the Internal Revenue Code or the
regulations thereunder.
Sincerely,
HARVE M. LEWIS
CHIEF
PASSTHROUGHS & SPECIAL
INDUSTRIES BRANCH
(FIELD SERVICE)
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