6.5 Inherently Permanent Standard
In determining whether a structure, or component of a structure, is inherently permanent, one must consider the governing code section defining the scope and nature of the structure. Chapter 2 of this ATG discusses whether a structure is inherently permanent for cost recovery purposes under § 168. Please be aware that the analysis used for inherent permanency for cost recovery purposes under § 168 is not the same as for other code sections that use the “inherently permanent” concept. This includes the Uniform Capitalization (UNICAP) rules of § 263A (discussed in Chapter 6.1 of this ATG) and the Domestic Production Deduction (DPD) rules of § 199. The “inherently permanent” rules for each of these other code sections are markedly different from those for cost recovery. Care should be taken when evaluating a cost segregation study that the correct “inherently permanent” rules are applied. In order to assist the Examiner to recognize the differences between each code section, a brief summary of these provisions is presented below.
INHERENTLY PERMANENT UNDER § 168
The primary issue in cost segregation studies is the proper classification of assets as either § 1245 or § 1250 property. The definitions of property for purposes of §§ 1245 and 1250 are essential for determining eligibility for a number of other Code provisions (including §§ 167, 168, 179, and former § 48). Treas. Reg. § 1.1245-3 defines “tangible personal property,” “other tangible property,” “building,” and “structural component” by reference to Treas. Reg. § 1.48-1. This regulation relates to former § 48 which was enacted in 1962 along with §§ 1245 and 1250. Former § 48 allowed an investment tax credit (ITC) based on the “applicable percentage” of the investment in eligible property placed in service during the taxable year. Eligible property included tangible personal property (other than heating or air conditioning units) and other tangible property (primarily machinery and equipment used in specific business activities) that was closely integrated into the taxpayer’s trade or business. Land, buildings, structural components contained in or attached to buildings, and other inherently permanent structures generally were not eligible for ITC.
Treas. Reg. § 1.48-1(c) defines ‘tangible personal property’ as any tangible property except land and improvements thereto, such as buildings or other inherently permanent structures (including items which are structural components of such buildings or structures). Thus, buildings, swimming pools, paved parking areas, wharves and docks, bridges, and fences are not tangible personal property. Tangible personal property includes all property (other than structural components) which is contained in or attached to a building. Thus, such property as production machinery, printing presses, transportation and office equipment, refrigerators, grocery counters, testing equipment, display racks and shelves, and neon and other signs, which is contained in or attached to a building constitutes tangible personal property for purposes of the ITC. Further, all property that is in the nature of machinery (other than structural components of the building or other inherently permanent structure) is considered tangible personal property even though located outside a building. Thus, for example, a gasoline pump, hydraulic car lift or automatic vending machine, although annexed to the ground, is considered tangible personal property.
Treas. Reg. § 1.48-1(c) also provides that local law is not controlling for purposes of determining whether property is or is not “tangible” or “personal”. Thus, the fact that under local law property is held to be personal property or tangible property is not controlling. Conversely, property may be personal property for purposes of the ITC even though under local law the property is considered to be a fixture and therefore real property.
Treas. Reg. § 1.48-1(d) provides that in addition to tangible personal property, any other tangible property (but not including a building and its structural components) used as an integral part of manufacturing, production, or extraction, or as an integral part of furnishing transportation, communications, electrical energy, gas, water, or sewage disposal services by a person engaged in a trade or business of furnishing any such service, or which constitutes a research or storage facility used in connection with any of the foregoing activities, may qualify for the ITC. This regulation essentially provides that inherently permanent structures (but not a building and its structural components) used in certain business activities will be deemed eligible for the ITC.
Treas. Reg. § 1.48-1(e)(1) defines a “building” as any structure or edifice enclosing a space within its walls, and usually covered by a roof, the purpose of which is, for example, to provide shelter or housing, or to provide working, office, parking, display, or sales space. The term includes, for example, structures such as apartment houses, factory and office buildings, warehouses, barns, garages, railway or bus stations, and stores. Such term includes any such structure constructed by, or for, a lessee even if such structure must be removed, or ownership of such structure reverts to the lessor, at the termination of the lease.
Specifically excluded from the definition of the term “building” are: (i) a structure which is essentially an item of machinery or equipment, or (ii) a structure which houses property used as an integral part of an activity specified in former § 48(a)(1)(B)(i) if the use of the structure is so closely related to the use of such property that the structure clearly can be expected to be replaced when the property it initially houses is replaced. Factors which indicate that a structure is closely related to the use of the property it houses include the fact that the structure is specifically designated to provide for the stress and other demands of such property and the fact that the structure could not be economically used for other purposes. Thus, the term “building” does not include such structures as oil and gas storage tanks, grain storage bins, silos, fractionating towers, blast furnaces, basic oxygen furnaces, coke ovens, brick kilns, and coal tipples.
Treas. Reg. § 1.48-1(e)(2) provides that “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.
In Revenue Ruling 75-178, 1975-1 C.B. 9, the Service stated, “the problem of classification of property as ‘personal’ or ‘inherently permanent’ should be made on the basis of the manner of attachment to the land or the structure and how permanently the property is designed to remain in place.” Thus, the test to be used to determine whether an asset is tangible personal property is the inherently permanent test.
The seminal case involving the determination of whether an asset is inherently permanent for purposes of § 168 and former § 48 is Whiteco Industries, Inc. v. Commissioner, 65 T.C. 664 (1975). The Tax Court noted that “tangible personal property” is not intended to be defined narrowly nor to follow the rules of State law where fixation to the land is a basis for distinguishing personal property from other property. Based on an analysis of prior case law, the Tax Court put forth six questions designed to ascertain whether a particular asset qualifies as tangible personal property. These questions, also referred to as the “Whiteco factors,” are:
- Is the property capable of being moved, and has it in fact been moved?
- Is the property designed or constructed to remain permanently in place?
- 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?
- How substantial a job is removal of the property and how time-consuming is it? Is it “readily removable”?
How much damage will the property sustain upon its removal?
- What is the manner of affixation of the property to the land?
It should be noted that movability itself is not determinative in measuring permanence. The Whiteco court held that affixation to land does not per se exclude the property from the category of tangible personal property. Inversely, in L.L. Bean, Inc. v. Commissioner, T.C. Memo. 1997-175, aff’d, 145 F.3d 53 (1st Cir. 1998), the court held that the mere fact that a structure is theoretically capable of being moved does not conclusively establish that it is not inherently permanent.
Examiners should also consider the following additional factors when addressing permanency (some of which may overlap with the Whiteco factors):
- the history of the item or similar items being moved;
- the manner in which an item is attached to a building or to the land;
- the weight and size of the item;
- the function and design of the item;
- the intent of the taxpayer in installing the item;
- the time, cost, manpower, and equipment required to move the components;
- the time, cost, manpower, and equipment required to reconfigure the existing space if the item is removed;
- the effect of the item’s removal on the building; and
- the extent the item can be reused after removal.
See AmeriSouth XXXII, Ltd. V. Commissioner, T.C. Memo. 2012-67; Trentadue v. Commissioner, 128 T.C. 91 (2007); PDV America, Inc. and Subs. v. Commissioner, T.C. Memo. 2004-118; Hospital Corp. of America and Subs. v. Commissioner, 109 T.C. 21 (1997).
Further detail and updates can be obtained from the Depreciable and Capital Expenditures PN.
INHERENTLY PERMANENT UNDER § 263A
The uniform capitalization (UNICAP) rules require the capitalization of all direct costs and certain indirect costs properly allocable to real property and tangible personal property produced by the taxpayer. Included in this is the capitalization of interest expense when the taxpayer produces certain property. See § 263A(f) and Treas. Reg. § 1.263A-8.
Producers must capitalize costs (other than interest) whether incurred before, during, or after the production period of property. Pre-production costs are subject to capitalization if the property is held for future production or if it is reasonably likely that the property will be produced at a future date. Thus, costs of storing raw materials and carrying costs of realty held for development are required to be capitalized. Production period costs are costs incurred beginning on the date on which production of the property begins and ending on the date on which the property is ready to be placed in service or is ready to be held for sale. Post-production costs are costs incurred after the actual production and may include costs of storage, warehousing, insurance, materials, and handling.
In contrast, interest is only capitalized during the production period of property. Treas. Reg. §§ 1.263A-8 through 1.263A-15 provide guidance with respect to the capitalization of interest under § 263A(f). These regulations are effective for 1995 and after, or at taxpayer’s election, 1994. For years prior to the effective date of these regulations, see Notice 88-99, 1988-2 C.B. 422, as well as the prior temporary regulations, which provide guidance with respect to the capitalization of interest.
For purposes of UNICAP, interest is capitalized with respect to each unit of designated property. Designated property is defined in § 263A(f)(1) and Treas. Reg. § 1.263A-8(b)(1). Designated property is any property that is produced that constitutes: i) real property; or ii) tangible personal property which meets any of the following criteria: A) property with a class life of 20 years or more that is not inventory in the hands of the taxpayer or a related person; B) property with an estimated production period exceeding 2 years; or C) property with an estimated production period exceeding 1 year and an estimated cost of production exceeding $1,000,000. Note that all real property is subject to the rules of § 263A(f); the listed criteria only apply to tangible personal property. The criteria are applied individually to each unit of property.
Treas. Reg. § 1.263A-8(c)(1) defines real property. Real property includes land, un-severed natural products of land, buildings, and inherently permanent structures. Any interest in real property, including fee ownership, co-ownership, a leasehold, an option, or a similar interest is real property. Real property includes the structural components of both buildings and inherently permanent structures, such as walls, partitions, doors, wiring, plumbing, central air conditioning and heating systems, pipes and ducts, elevators and escalators, and other similar property. Tenant improvements to a building that are inherently permanent are real property.
Treas. Reg. § 1.263A-8(c)(3) provides that inherently permanent structures include property that is affixed to real property and that will ordinarily remain affixed for an indefinite period of time. Examples include swimming pools, roads, bridges, tunnels, paved parking areas and other pavements, special foundations, wharves and docks, fences, inherently permanent advertising displays, inherently permanent outdoor lighting facilities, railroad tracks and signals, telephone poles, power generation and transmission facilities, permanently installed telecommunications cables, broadcasting towers, oil and gas pipelines, derricks and storage equipment, grain storage bins and silos. For purposes of this section, affixation to real property may be accomplished by weight alone.
Treas. Reg. § 1.263A-8(c)(3) further provides that property may constitute an inherently permanent structure even though it is not classified as a building for purposes of Treas. Reg. § 1.48-1(e). Additionally, any property that constitutes “other tangible property” under the principles of Treas. Reg. § 1.48-1(d) is treated as an inherently permanent structure.
Treas. Reg. § 1.263A-8(c)(4) provides that a structure that is property in the nature of machinery or is essentially an item of machinery or equipment is not an inherently permanent structure and is not real property. In the case, however, of a building or inherently permanent structure that includes property in the nature of machinery as a structural component, the property in the nature of machinery is real property. A structure may be an inherently permanent structure, and not property in the nature of machinery or essentially an item of machinery, even if the structure is necessary to operate or use, supports, or is otherwise associated with, machinery. The purpose of this regulation is to prevent the definition of “property in the nature of machinery” from including inherently permanent structures that support or are otherwise necessary to the operation of that machinery such as ski lift towers and offshore oil platforms.
Treas. Reg. § 1.263A-10(b) provides that real property includes any components of real property owned by the taxpayer that are functionally interdependent. Components of real property are functionally interdependent if the placing in service of one component is dependent on the placing in service of the other component by the taxpayer or a related person.
COMPARISON OF INHERENTLY PERMANENT UNDER §§ 168 and 263A
The principles and tests used to determine whether an item of property is tangible personal property under Treas. Reg. § 1.48-1(c) (and thus to determine whether the item qualifies as § 1245 property) do not apply in determining whether such item of property is tangible personal property or real property for purposes of § 263A(f). IRS CCA 200648026. Accordingly, property classified as depreciable tangible personal property for purposes of § 168 can be either real property or tangible personal property for purposes of the “avoided cost” interest capitalization calculation under § 263A(f). A determination of whether interest is capitalized with respect to a unit of designated property is made under the principles of § 263A(f) and the regulations thereunder, and is not controlled by the characterization of property for purposes of § 168.
Similarly, the classification of the property for purposes of § 263A(f) does not control its classification for purposes of cost recovery under § 168. Id. Interest capitalized under § 263A(f) is treated as a cost of the designated property produced; cost recovery is determined by the applicable Code and regulatory provisions relating to the use, sale, or disposition of property.
There are five primary aspects how the definition of inherently permanent differs between §§ 168 and 263A.
First, whereas Treas. Reg. § 1.48-1(c) contains the principle that the classification of property under local law is irrelevant to the classification of property for purposes of the ITC (and § 1245 property), the local law characterization of an item of property can be a relevant consideration in the classification of property as either tangible personal property or real property for purposes of § 263A(f). IRS CCA 200648026.
Second, whereas the legislative intent regarding the ITC favors a broad construction of “tangible personal property,” the legislative history of § 263A(f) contains nothing to indicate that Congress intended the broad construction of tangible personal property under the ITC to apply to interest capitalization under § 263A(f). IRS CCA 201211011.
Third, an item of property that does not qualify as a structural component under the ITC scheme because it does not relate to the operation or maintenance of a building, may constitute a structural component of the building (and thus real property) for purposes of § 263A since there is no requirement under § 1.263A-8(c) that the item of property relate to the operation and maintenance of a building. The property, however, still must otherwise possess sufficient indicia of being a structural component to be classified as such. IRS CCA 200648026.
Fourth, although the definition of inherently permanent structures in Treas. Reg. § 1.263A-8(c)(3) references “other tangible property” under Treas. Reg. § 1.48-1(d) as a type of inherently permanent structure, an item of property may be an inherently permanent structure for purposes of UNICAP even though it would not have been an inherently permanent structure (and thus not “other tangible property”) for purposes of the ITC. IRS CCA 201211011.
Fifth, the specific nature of the limitations on the machinery exclusion in Treas. Reg. § 1.263A-8(c)(4) (as well as language in the preamble to the regulation) indicates that the provision was intended to reject a specific line of ITC cases and rulings that greatly expanded the definition of what constitutes property in the nature of machinery under Treas. Reg. § 1.48-1(c). Thus, inherently permanent structures that support or are otherwise necessary to the operation of that machinery are inherently permanent for purposes of UNICAP. IRS CCA 201211011.
Within the context of a cost segregation study, sometimes building systems such as electrical distribution and plumbing systems are deemed to be “dual purpose” for cost recovery purposes. Thus, for purposes of § 168, the portion of the cost of the building system corresponding to the percentage allocable to equipment constitutes tangible personal property (§ 1245 property) whereas the portion corresponding to building operation and maintenance constitutes structural components (§ 1250 property). As stated above, however, the fact that costs are characterized as tangible personal property for purposes of § 168 is not sufficient in itself to establish that these costs do not constitute real property for purposes of capitalizing interest under § 263A(f). Building systems are functionally interdependent with the building in which they are installed such that a building and its building systems are part of the same unit of real property for purposes of Treas. Reg. § 1.263A-10. Splitting a building system into two units of property for purposes of § 263A(f) would be contrary to the functional interdependence test underlying the concept of unit of property in the avoided cost regulations. Moreover, no provision is made for real property components and tangible personal property components combining into a single property unit; a unit of property under Treas. Reg. § 1.263A-10 must either be a real property unit (consisting entirely of real property components) or a tangible personal property unit (consisting entirely of tangible personal property components). Accordingly, allocating the cost of a building system such as an electrical distribution or plumbing system between real property and tangible personal property is inconsistent with § 263A(f).
Further detail and updates can be obtained from the Inventory and 263A PN.
INHERENTLY PERMANENT UNDER § 199
The Domestic Production Deduction (DPD) was enacted in 2005 and was intended to motivate domestic economic growth. The DPD is determined by applying a percentage to the lesser of a taxpayer’s qualified production activities income (QPAI) or taxable income. The applicable percentage is 3 percent for taxable years 2005 and 2006, 6 percent for taxable years 2007 through 2009, and 9 percent for taxable years beginning after 2009. § 199(a).
QPAI is determined by taking domestic production gross receipts (DPGR) less cost of goods sold (COGS) and other expenses allocable to such DPGR. DPGR consists of gross receipts derived from any lease, rental, license, sale, exchange or other disposition of qualifying production property (QPP) which was manufactured, produced, grown or extracted by the taxpayer in whole or in significant part within the United States. § 199(c)(4). QPP includes tangible personal property, computer software and sound recordings. § 199(c)(5).
Treas. Reg. § 1.199-3(j)(2) defines tangible personal property as any tangible property other than land, real property described in Treas. Reg. § 1.199-3(m)(3), and property described in other sections of the regulation (computer software, sound recordings, qualified films, electricity, natural gas, and potable water). Property such as machinery, printing presses, transportation and office equipment, refrigerators, grocery counters, testing equipment, display racks and shelves, and neon and other signs that are contained in or attached to a building constitutes tangible personal property for purposes of § 199. In determining whether property is tangible personal property, local law is not controlling.
Treas. Reg. § 1.199-3(m)(3) defines real property as buildings (including items that are structural components of such buildings), inherently permanent structures (as defined in Treas. Reg. §1.263A-8(c)(3)) other than machinery (as defined in Treas. Reg. §1.263A-8(c)(4)) (including items that are structural components of such inherently permanent structures), inherently permanent land improvements, and oil and gas wells. It also includes roads, power lines, water systems, railroad spurs, communications facilities, sewers, sidewalks, cable, wiring, and inherently permanent oil and gas platforms. For purposes of § 199, structural components of building and inherently permanent structures include property such as walls, partitions, doors, wiring, plumbing, central air conditioning and heating systems, pipes and ducts, elevators and escalators, and other similar property.
Accordingly, the definition of an inherently permanent structure is the same for § 199 as it is for § 263A(f). In other words, the same rules that determine what constitutes an inherently permanent structure for UNICAP purposes described above also apply to determine whether property qualifies as QPP. The result of using these rules is that if property is determined to be an inherently permanent structure under Treas. Reg. §1.263A-8(c)(3), it is real property for purposes of § 199 and Treas. Reg. § 1.199-3(m)(3), can constitute QPP, and the gross receipts and allocable expenses derived from the property cannot be used to determine DPGR and QPAI. Note that, per Treas. Reg. § 1.199-3(m)(6), DPGR “derived from the construction of real property performed in the United States does not include gross receipts derived for the sale, exchanged, or other disposition of real property acquired by the taxpayer even if the taxpayer originally constructed the property. In addition, DPGR derived from the construction of real property does include gross receipts from the lease or rental of real property constructed by the taxpayer.
COMPARISON OF INHERENTLY PERMANENT UNDER §§ 168 and 199
In IRS CCA 201302017, the Service considered whether a variety of outdoor advertising displays constituted inherently permanent structures and were therefore real property when determining QPP for purposes of § 199. It noted that the definition of an inherently permanent structure in Treas. Reg. § 1.263A-8(c)(3) establishes two basic criteria for an inherently permanent structure: first, it is affixed to real property; second, it will ordinarily remain affixed for an indefinite period of time.
The term “affixed to real property” under § 1.263A-8(c)(3) is understood pursuant to its ordinary and common sense meaning, that is, physically connected or attached. Affixation to real property may be accomplished by weight alone. Embedding a structure in the ground can establish attachment to real property. Mounting a structure to a foundation also can accomplish adequate connection to real property. Similarly, affixation may be achieved when the means of connection secure a structure to real property to withstand severe weather conditions. If installation of the structure involves the use of construction machinery and equipment, attachment to real property may be indicated.
The term “ordinarily remain affixed for an indefinite period of time” under § 1.263A-8(c)(3) means that the structure will typically remain affixed to real property for the period during which the structure is expected to remain in operating condition and serve a useful function, in other words, the useful life inherent in the structure. In general, the structure is attached without any fixed plan to remove it at a particular date in the future, and the exact date when the structure will be removed is neither known nor knowable when it is affixed. Additionally, the possibility or occurrence of temporary or permanent removal from real property (such as from hurricane force winds) does not transform the intrinsically permanent nature of a structure.
Practices of an industry or taxpayer also may be instructive as to whether a particular structure or type of structure is inherently permanent. Therefore, a definite lease term may be ignored if it is customary for the industry to renew the lease until the structure’s inherent useful life is exhausted or the structure is no longer profitable. Lastly, the amount of time and expense involved in affixing the structure to be able to function also should be considered.
Unlike the Whiteco factors for determining whether an item of property is an inherently permanent structure for cost recovery purposes, for purposes of § 199 it is irrelevant that the means of connection permit removal without damage to the structure. For example, a structure attached by weight alone is likely removable without damage. Similarly, a structure bolted to a cement foundation that is embedded in the ground is likely removable without damage but nevertheless is connected to real property. Note, however, that the manner of affixation should sufficiently secure the structure so that it will remain in place to be able to perform its intended function.
In short, an item is an inherently permanent structure for purposes of § 199 “when it is attached to real property and will ordinarily remain connected to real property to be able to perform its intended function.” IRS CCA 201302017.
Further detail and updates concerning using the Inherently Permanent rules within § 199 can be obtained from the Corporate Income and Losses PN.
In determining whether a structure, or component of a structure, is inherently permanent, one must consider the context and governing code section. The analysis used to determine whether an item is inherently permanent for cost recovery purposes under § 168 (or for ITC purposes under former § 48) is not the same as the analysis for UNICAP purposes under § 263A and DPD purposes under § 199. As a consequence, the “inherently permanent” rules for cost recovery are markedly different from those for the other code sections.
For cost recovery purposes, the Whiteco factors were designed in light of legislative history indicating that “tangible personal property” was intended to be broadly defined and that the rules of State law where fixation to the land is a basis for distinguishing personal property from other property were not to be followed. Thus, the standard for determining whether an item of property is inherently permanent for purposes of cost recovery is relatively narrow. In contrast, the standard for whether an item is inherently permanent for purposes of UNICAP and DPD follows its ordinary and common sense meaning, namely that fixation to the land is sufficient provided the item of property will remain in operating condition and serve a useful function over the useful life inherent in the structure. Hence, the standard for determining whether an item of property is inherently permanent for purposes of UNICAP and DPD is broader than the standard for cost recovery. Care should be taken when evaluating a cost segregation study that the correct “inherently permanent” rules are applied.