[Hospital Corp. of America, et al. v. Commissioner - 109 T.C. 21 (1997)] In a necessarily long published opinion, the Tax Court has spelled out what many tax practitioners had already concluded - that the extensive case law distinguishing personal property from real property for purposes of the investment tax credit serves as precedent for purposes of classifying property under the post 1980 Accelerated Cost Recovery System (ACRS) and MACRS.
"Component" depreciation before 1981 referred more broadly to the real property components - e.g., the outer "shell" - as well as to what may be classified as personal property. In this case, the Internal Revenue Service contended that the 1981 change enacted by Congress "...effectively operates to change the definition of tangible personal property for purposes of ACRS to eliminate ... any item which is attached to a building and that has utility beyond its relation to a particular piece of property, even if under long-standing precedent the property constitutes personal property for purposes of ... section 1245 ...". The Court disagreed.
We will look at the HCA case - but first, let's examine some IRS and practitioner reaction to it.
IRS Reaction:
"... (T)he use of cost segregation studies must be specifically applied by the taxpayer ... (a) cost segregation study may not be based on non-contemporaneous records, reconstructed data, or taxpayer's estimates or assumptions that have no supporting records ... cost segregation studies should be closely scrutinized ...". [IRS Legal Memorandum (ILM 199921045) (1999 TNT 104-65 4/1/99)]
The Treasury Department was scheduled to finalize a study on depreciation. An IRS engineer submitted comments toward production of that study, including the following observations:
"Currently the principal accounting firms and other consultants are actively promoting the use of investment tax credit provisions to continue the allocation of building construction costs to personal property accounts. The studies are called "cost segregation" studies, but they differ only in name from prohibited "component cost allocation" studies for depreciation."
"Cost segregation studies require a skill and understanding of the case law that is vested only in specialists. The studies require a significant expenditure of time in preparation, and are thus cost prohibitive for many taxpayers. Only those taxpayers with access to the professionals who can prepare a valid study may claim this tax benefit." [Ken M. Berry, IRS engineer - public comment re "Depreciation Study" (1999 TNT 219-87 10/29/99)]
Upon release of the study, the Treasury included these comments:
"Anecdotal evidence suggests that taxpayers increasingly may be undertaking cost segregation studies that provide a basis for identifying certain building components as section 1245 property. These cost segregation studies are expensive for taxpayers to undertake and for the IRS to monitor and review. The use of such studies may provide an advantage for aggressive taxpayers and may otherwise provide depreciation allowances that inappropriately vary among taxpayers." (at p. 3)
"In recent years, more sophisticated taxpayers have hired firms to conduct what are called cost segregation studies. These studies make detailed inventories of individual assets, in order to distinguish items of section 1245 property from items of section 1250 property. Following a selection of recent court decisions, these studies have been aggressive in designating property as section 1245 property." (at p. 86) [Department of the Treasury, Report to The Congress on Depreciation Recovery Periods and Methods, July 2000]
Note: The editorial discussion includes an example in which the present value of the tax savings from accelerating the deductions results in a $150K benefit on a $3M building. Although not stated to be representative of the potential savings, it may give some indication of the cost of a building required to justify the cost of a study. [McArthur, 10-01 T.T.A.. 647 (October 2001)]
The case (online) is listed as being 110 pages, and even in condensed print requires approximately 32 pages. Unfortunately, any summary of the opinion listing the various categories of property and the related tax character will be misleading to the extent that any surrounding discussion is omitted. Nonetheless, the following summary (with the categories numbered in accordance with the "opinion" section) can be useful to direct you to the portion of the opinion which discusses specific items.
1. PRIMARY AND SECONDARY ELECTRICAL DISTRIBUTION SYSTEMS:
"... the portion ... allocable to the hospitals' equipment ... constitutes (personal) property ..."
2. BRANCH ELECTRICAL WIRING AND CONNECTIONS AND SPECIAL ELECTRICAL EQUIPMENT:
"... we look to the ultimate use of the electrical power conveyed by the branch electrical systems to decide whether ... structural components or personal property ..."
3. WIRING AND RELATED PROPERTY ITEMS RELATING TO TELEVISION EQUIPMENT:
"... the ... items ... do not relate to the operation or maintenance of the buildings. Consequently ... tangible personal property ..."
4-5. CONDUIT (ETC.) RELATING TO TELEPHONE EQUIPMENT AND TO INTERNAL COMMUNICATIONS EQUIPMENT:
"... the electrical connections ... are necessary for the operation of telephones and internal communications equipment and are used directly with the equipment to which they relate, and, consequently ... constitute personal property ..."
6. CARPETING:
"... attached with adhesives that facilitate ease of removal ... constitutes tangible personal property ..."
7. VINYL WALL COVERINGS:
"... attached with adhesives that also permitted easy removal ... constitute ... tangible personal property ..."
8. VINYL FLOOR COVERINGS:
"... attached with adhesives to permit easy removal without damage to the concrete floors ... constitute tangible personal property ..."
9-10. KITCHEN WATER PIPING, KITCHEN EQUIPMENT STEAM LINES, AND SPECIAL X-RAY PLUMBING CONNECTIONS:
"... relate to the operation of specialized kitchen or hospital equipment. That equipment is related to (taxpayer's) business of providing healthcare services ... consequently, they do not constitute structural components ..."
11. KITCHEN HOODS AND EXHAUST SYSTEMS:
"... satisfy the "sole justification" test of section 1.48-1(e)(2) ... (they) were installed only to meet temperature or humidity requirements essential for the operation of (taxpayer's) kitchen equipment and they provide only incidental benefit to (taxpayer's) employees ... consequently do not constitute structural components ..."
12. PATIENT CORRIDOR HANDRAILS:
"... are placed in patient corridors to aid hospital patients ... (and are) accessory to (taxpayer's) business of providing healthcare services ... therefore constitute personal property ..."
13. OVERBED LIGHTS AND RELATED ELECTRICAL CONNECTIONS:
"... provide basic room illumination and have more than an incidental relationship to the operation or maintenance of (taxpayer's) buildings ... accordingly ... are structural components ..."
14. PARTITIONS:
"... accordion-style room dividers ... (none bear) any structural load ... not inherently permanent ... accordingly ... are personal property ..."
15. PATIENT BATHROOM ACCESSORIES AND PLASTIC MIRRORS:
"... are structural components ..."
16. ACOUSTICAL CEILINGS:
"... are structural components ..."
17. STEAM BOILERS AND RELATED ACCESSORIES:
"... are analogous to the electrical distribution system .. the (evidence presented) however, does not demonstrate the percentage ... used to operate hospital equipment ... consequently ... must be depreciated ... the same ... as the buildings ..."
"(Regarding) the position that examiners should take in light of the Tax Court's decision in (HCA) ... review (the) determination of whether an item is a structural component ... or ... 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."
Practitioners Reaction:
"Cost engineers are often better suited to perform a detailed cost-segregation analysis, as a result of their knowledge of how a facility is constructed and their cost-estimating experience. In addition, a cost engineer can perform a cost-segregation study on an existing building as well as a newly constructed one."
The HCA Case:
When evaluating this case, keep in mind that the taxpayer was in the healthcare business, with its specialized requirements in providing facilities and care to hospital patients. THE RESULT COULD VARY SUBSTANTIALLY FOR TAXPAYERS NOT IN THE SAME TRADE OR BUSINESS.
This material should be viewed only as a general summary of the tax law as of its indicated date, and not as a substitute for tax consultation in a particular case. Your questions and comments would be appreciated.
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