Coordinated Issue - All Industries - The Applicable Recovery Period Under I.R.S. § 168 (a) for Open-Air Parking Structures
EFFECTIVE DATE: JULY 31, 2009
Note: This issue paper is not an official pronouncement of the law or the position of the Service and can not be used, cited or relied upon as such.
For purposes of determining the appropriate recovery period under Internal Revenue Code (I.R.C.) § 168(a), whether parking structures are nonresidential real property with a cost recovery period of 39 years.
Open-air parking structures have been constructed since the mid-1950s. They typically provide multi-level parking accessed by a ramp system. These parking structures have at least two sides that are a minimum 50 percent open to the outside because they were designed to eliminate the need for heating and ventilation systems. Aside from those vehicles parked on the top level, the vehicles are protected from sun and snow. Moreover, drivers and passengers are protected from rain, ice, and to some degree, wind. In almost all parking structures, the top, exposed, level, has the fewest vehicles.
These parking structures typically have hydraulic elevators, internal stairwells (every parking structure is required by the Uniform Building Code to have a minimum of two means of egress (stairs) which are separated from each other), interior lighting (pole-mounted lighting on the top level), fire sprinklers (depending on the height and area of the structure), and signage to facilitate safe and speedy evacuations during an emergency. While fires in parking structures are generally more related to the vehicles parked within them than to the typical structural materials, the fire system (if required by code provisions) is usually comprised of the fire alarm wiring, pull stations, strobes, annunciators, and exit signage. Many parking structures have a separate area or room for electric metering and switching.
Open-air parking structures are buildings as defined in Treas. Reg. § 1.48-1(e). For depreciation purposes under I.R.C. § 168, these parking structures are nonresidential real property with a cost recovery period generally of 39 years.
I.R.C. § 168 sets forth the MACRS depreciation system. MACRS generally applies to tangible property placed in service after December 31, 1986. I.R.C. § 168(a) provides that the depreciation deduction provided by I.R.C. § 167(a) for any tangible property is determined by using the applicable depreciation method, recovery period and convention. Under MACRS the recovery period of property is generally determined by its class life.
Nonresidential real property is I.R.C. § 1250 property that is not (1) residential rental property or (2) property with a class life of less than 27.5 years. I.R.C. § 168(e)(2)(B). I.R.C. § 1250 property is any real property (other than I.R.C. § 1245 property, as defined in I.R.C. § 1245(a)(3)) which is or has been property of a character subject to the allowance for depreciation provided in I.R.C. § 167. I.R.C. §§ 168(i)(12) and 1250(c). The cost of nonresidential real property placed in service after May 12, 1993, is generally recovered over 39 years.
Taxpayers argue that “stand-alone” open-air parking structures are land improvements, with a recovery period generally of 15 years. “Land improvements” are defined in Rev. Proc. 87-56, 1987 2 C.B. 687 (Asset Class 00.3), which states:
Includes improvements directly to or added to land, whether such improvements are section 1245 property or section 1250 property, provided such improvements are depreciable. Examples of such assets include sidewalks, roads, canals, waterways, drainage facilities, sewers (not including municipal sewers in Class 51), wharves and docks, bridges, fences, landscaping, shrubbery, or radio and television transmitting towers. Does not include land improvements that are explicitly included in any other class, and buildings and structural components as defined in section 1.48-1(e) of the regulations. . . .
Therefore, if these parking structures are buildings, they are not land improvements.
For depreciation purposes, the term "building" is given its commonly accepted meaning, that is, “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.” Treas. Reg. § 1.48-1(e)(1). (Emphasis added).
In Yellow Freight System, Inc. v. Commissioner, 538 F.2d 790, 795-796 (8th Cir. 1976), the court noted:
This regulation conforms to the congressional understanding of the term "building," see The Technical Explanation of the Bill, U.S. Code Cong. & Admin. News pp. 3439, 3456 (1962), and follows Congress' intent that the term "building" be given its commonly accepted meaning. Id.
The regulation has been interpreted to include an appearance test and a function test. The appearance test generally requires a structure or edifice enclosing a space within its walls, and usually covered by a roof. The function test generally requires the structure to provide shelter or housing, or to provide working, office, parking, display, or sales space. Revenue Act of 1962, Technical Explanation of the Bill, 1962-B-3 C.B. 841, 858-859.
Both the IRS and taxpayers agree that “stand-alone” open-air parking structures are inherently permanent structures. Accordingly, the issue is whether these structures are buildings or land improvements for depreciation purposes.
Open-air parking structures (even if “stand-alone”) meet the definition of a "building" in Treas. Reg. § 1.48-1(e)(1). They satisfy both the function test and appearance test in determining whether a structure is a building under such regulation.
The function test under Treas. Reg. 1.48-1(e)(1) requires the structure or edifice to provide shelter or housing, or to provide working, office, parking, display, or sales space. The open-air parking structures clearly provide parking space. Taxpayers may argue that the open-air parking structures fail the function test because they do not provide workspace or shelter. However, Treas. Reg. § 1.48-1(e)(1) does not require a structure to meet all of the possible building functions and does clearly state that providing a parking space is a building function. Further, open-air parking structures do provide shelter for the vehicles from sun and precipitation.
The appearance test under Treas. Reg. § 1.48-1(e)(1) requires a structure or edifice enclosing a space within its walls, and usually covered by a roof. A “stand-alone” open-air parking structure clearly encloses a space within its walls. The walls of a parking structure separate the parking structure from the surrounding area and enclose vehicles within the structure. While it is not mandatory that a structure have a roof under Treas. Reg. § 1.48-1(e)(1), the top level of a “stand-alone” open-air parking structure is simply a useable roof.
However, taxpayers argue that “stand-alone open-air parking structures” are different than normal parking garages, and that these structures do not meet the definition of a building because they fail the appearance test. Specifically, taxpayers argue that the “stand-alone open-air parking structures” fail the appearance test because they: 1) do not contain walls or a roof for the specific purpose of sheltering people or vehicles; 2) are open to the elements (weather); and 3) do not have many of the structural components of a building or do not share structural supporting elements with a building. We disagree.
1. Walls or Roof
To support their “no roof” theory, taxpayers claim that each new level in the parking structure does not constitute a roof for the level below. However, the levels constitute something like a ceiling, much the same way each floor in any other building serves as a ceiling for the level below. Lighting, signage and, if required, fire systems are attached to the bottom side of each new level. The only level that does not have a ceiling is the rarely-used top level. The top level is simply a useable roof, much like a rooftop deck on an apartment building.
Even “stand-alone open-air parking structures” normally have walls, although the exterior walls do not extend to the ceiling except when required for support. The walls are necessary to prevent cars from driving off the side. A number of cases have held that walls are not necessary. See Consolidated Freightways, Inc. v. Commissioner, 708 F.2d 1385 (9th Cir. 1983), affg. in relevant part 74 T.C. 768 (1980)(loading docks without permanent walls were buildings under the appearance test; this result applies even if there were no overhead doors.), Yellow Freight System, Inc. v. Commissioner, 538 F.2d 790, 795-796 (8th Cir. 1976) (similarly; lack of clearly discernible walls was not controlling); Rev. Rul. 79-406; 1979-2 C.B. 18 (car wash is a building, despite lack of exterior walls on two sides of the structure).
Some taxpayers have cited Private Letter Ruling 8724037. In addition to the problems with citing a Private Letter Ruling as authority, this argument is particularly problematic because the Private Letter Ruling does not support their position; it describes a structure which is essentially stacked grates holding machinery, with ladders between the levels. It was not surprising that the Private Letter Ruling held that the structure was not a building.
2. Open to Elements
Even “stand-alone open-air” parking structures are not entirely open to the elements – they have a roof and partial walls. These walls may not extend to the ceiling but are high enough to shield vehicles from some wind. The properties in Consolidated Freightways and Yellow Freight System were classified as buildings despite the lack of permanent walls. These parking structures are large enough so that only those vehicles closest to the edges may get wet if it rains. It is true that these parking structures usually lack heat and air conditioning, but the lack of temperature control cannot be sufficient to establish that a structure is not a building.
3. Structural Components or Structural Supporting Components
The taxpayers sometimes argue that “stand-alone open-air” parking structures do not have many of the structural components of a building provided under Treas. Reg. § 1.48-1(e)(2) and, therefore, are not a building. Parking structures have walls, floors, elevators, stairs, sprinkler systems, fire escapes, and electric wiring and lighting fixtures. While these parking structures lack some of the structural components listed in Treas. Reg. § 1.48-1(e)(2), the regulation does not require that all listed structural components are needed in a structure to classify it as a building.
The taxpayers also sometimes state that “stand-alone open-air” parking structures do not share structural supporting elements with a building. They apparently make this statement because they are aware that property may be “other property” and not a building but still be treated as a structural component of a building. Illinois Cereal Mills, Inc. v. Commissioner, 789 F.2d 1234, 1239 (7th Cir. 1986). The IRS argues that the parking structures are themselves buildings, and does not usually argue that the parking structures are structural components of buildings.
Taxpayers have not cited any support for their position that a structure which functions as a building is not a building.
Finally, properly maintained and built open-air parking structures can be expected to perform well for 25 to more than 40 years.
Given the lack of support for the taxpayer position, an accuracy-related penalty for negligence under I.R.C. § 6662 should be considered.
I.R.C. § 6662(b)(1) imposes a twenty percent accuracy-related penalty that applies to the portion of any underpayment of tax attributable to negligence.
Negligence under § 6662 includes any failure to make a reasonable attempt to comply with the provisions of the Internal Revenue Code or to exercise ordinary and reasonable care in the preparation of a tax return. See § 6662(c) and Treas. Reg. § 1.6662-3(b)(1). Negligence also includes the failure to do what a reasonable and ordinarily prudent person would do under the same circumstances. See Marcello v. Commissioner, 380 F.2d 499, 506 (5th Cir. 1967), aff'g 43 T.C. 168 (1964); Neely v. Commissioner, 85 T.C. 934, 947 (1985). Treas. Reg. § 1.6662-3(b)(1)(ii) provides that negligence is strongly indicated where a taxpayer fails to make a reasonable attempt to ascertain the correctness of a deduction, credit or exclusion on a return that would seem to a reasonable and prudent person to be "too good to be true" under the circumstances. A return position that has a reasonable basis as defined in Treas. Reg. § 1.6662-3(b)(3) is not attributable to negligence. Treas. Reg. § 1.6662-3(b)(1). A reasonable basis is a greater standard than “merely arguable” or “merely a colorable claim.” Treas. Reg. § 1.6662-3(b)(3).
The taxpayer has the ultimate burden of overcoming the presumption that the Service’s determination of negligence is correct. Marcello, 380 F.2d at 507. With respect to examinations commencing after July 22, 1998, however, the Service must first meet the burden of production with respect to negligence. I.R.C. § 7491(c); Higbee v. Commissioner, 116 T.C. 438, 446 (2002).
The IRS is unaware of any authority that suggests a “stand-alone open-air” parking structure is not a building. While taxpayers attack the IRS’ position, they offer no affirmative justification for their position nor do they explain why a parking structure, which is an inherently permanent structure, is not a building. In fact, a parking structure is so commonly regarded as a building that to argue otherwise is frivolous.
Taxpayers attempt to distinguish the parking structures at issue to avoid classification as a building. To distinguish the parking structures, taxpayers may argue that “stand-alone open-air” parking structures lack the physical features of a building. For example, taxpayers may suggest that the walls of a parking structure do not provide enclosure. On the contrary, the walls separate the parking structure from the surrounding area, enclosing vehicles within the structure. Taxpayers may also argue that the components of a “stand-alone open-air” parking structure are not unique to buildings or that parking structures do not contain all Treas. Reg. § 1.48-1(e)(2) structural components. Arguing that components are not exclusive to buildings does not prevent a parking structure from being a building nor justify taxpayers’ position that “stand-alone open-air” parking structures are not buildings. Additionally, all structural components listed in the regulation are not required to classify a structure as a building.
Taxpayers may further argue that a “stand-alone open-air” parking structure fails the function test because it does not provide workspace or shelter. Treas. Reg. § 1.48-1(e)(1), however, does not require that a building qualify under all possible building functions and specifically designates parking as a building function. Taxpayers may further argue that the floors of a parking garage provide a similar sheltering function as a canopy over a parking lot. Having a similar function as a canopy does not mean a parking structure is not a building because a canopy is not a building. The classification of one does not affect the classification of the other. The purpose of a sundial and the purpose of a digital clock are both to tell time. The fact that a sundial is not an electric device does not mean a digital wristwatch is not an electric device.
Taxpayers can present no arguments that reasonably justify treating the “stand-alone open-air” parking structures as anything other than a building. Adopting an argument so lacking in legal foundation is negligent under § 6662.
Section 6664 Reasonable Cause Exception
I.R.C. § 6664(c) provides an exception to the imposition of any § 6662 penalty if the taxpayer shows that there was reasonable cause and the taxpayer acted in good faith. See also Treas. Reg. 1.6664-4(a). “The determination of whether the taxpayer acted with reasonable cause and in good faith is made on a case-by-case basis, taking into account all relevant facts and circumstances.” Treas. Reg. § 1.6664-4(b)(1). All relevant facts and circumstances, including the nature of the tax investment, the complexity of the tax issues, the independence of a tax advisor, the competence of a tax advisor, the sophistication of the taxpayer, and the quality of an opinion, must be developed to determine whether the taxpayer was reasonable and acted in good faith.
Generally, the most important factor in determining whether the taxpayer has reasonable cause and acted in good faith is the extent of the taxpayer's effort to assess the proper tax liability. Treas. Reg. § 1.6664-4(b)(1); see also Larson v. Commissioner, T.C. Memo. 2002-295. For example, “an isolated computational or transcription error generally is not inconsistent with reasonable cause and good faith.” Treas. Reg. § 1.6664-4(b)(1) (see regulation for additional examples).
“Circumstances that may indicate reasonable cause and good faith include an honest misunderstanding of fact or law that is reasonable in light of the facts, including the experience, knowledge, sophistication and education of the taxpayer.” Treas. Reg. § 1.6664-4(b)(1).” “The taxpayer's mental and physical condition, as well as sophistication with respect to the tax laws, at the time the return was filed, are relevant in deciding whether the taxpayer acted with reasonable cause.” Kees v. Commissioner, T.C. Memo. 1999-41. “If the taxpayer is misguided, unsophisticated in tax law, and acts in good faith, a penalty is not warranted.” See Collins v. Commissioner, 857 F.2d 1383, 1386 (9th Cir. 1988); cf. Spears v. Commissioner, T.C. Memo. 1996-341, aff'd, 98-1 USTC ¶ 50,108 (2d Cir. 1997) (Court was unconvinced by the claim of highly sophisticated, able, and successful investors that they acted reasonably in failing to inquire about their investment and simply relying on offering circulars and accountant, despite warnings in offering materials and explanations by accountant about limitations of accountant's investigation).
Reliance upon a tax opinion provided by a professional tax advisor may serve as a basis for the reasonable cause and good faith exception to the accuracy-related penalty. See Treas. Reg. § 1.6664-4(c)(1). The reliance, however, must be objectively reasonable. Id. For example, the taxpayer must supply the professional with all the necessary information to assess the tax matter, see id., and the advice “must be based upon all pertinent facts and circumstances and the law as it relates to those facts and circumstances.” Treas. Reg. § 1.6664-4(c)(1)(i).
In Long Term Capital Holdings v. United States, 330 F. Supp.2d 122, 205-11 (D. Conn. 2004), the court concluded that a legal opinion did not provide a taxpayer with reasonable cause where (1) the taxpayer did not receive the written opinion prior to filing its tax return, and the record did not establish the taxpayer's receipt of an earlier oral opinion upon which it would have been reasonable to rely; (2) the opinion was based upon unreasonable assumptions; (3) the opinion did not adequately analyze the applicable law; and (4) the taxpayer's partners did not adequately review the opinion to determine whether it could be reasonably relied upon. In addition, the court concluded that the taxpayer's lack of good faith was evidenced by its decision to attempt to conceal the losses reported from the transaction by netting them against gains on its return. Id. at 211-12.
The fact that a taxpayer consulted an independent tax advisor is not, standing alone, conclusive evidence of reasonable cause and good faith if additional facts suggest that the advice is not dependable. Spears, T.C. Memo. 1996-341. For example, a taxpayer may not rely on an independent tax adviser if the taxpayer knew or should have known that the tax adviser lacked sufficient expertise, the taxpayer did not provide the advisor with all necessary information, or the information the advisor was provided was not accurate. See Spears, T.C. Memo. 1996-341; Pessin v. Commissioner, 59 T.C. 473 (1972).