Ft. Walton Square, Inc. v. Commissioner , 54 T.C. 653 ( 1970 )

Fort Walton Square, Inc., Petitioner v. Commissioner of Internal Revenue, Respondent

Ft. Walton Square, Inc. v. Commissioner

Docket No. 5329-68

United States Tax Court

54 T.C. 653; 1970 U.S. Tax Ct. LEXIS 178;

March 26, 1970, Filed

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Decision will be entered under Rule 50.

1. Held, the useful life of concrete brick buildings at a shopping center was determined to be 30 years. Held, further, that the lessor and the lessee were not "related persons" within the meaning of sec. 178(b) and the cost of the buildings could be amortized over the term of petitioner's lease.

2. Held, the useful lives of other equipment and improvements at the shopping center were determined.

3. Held, the heating and air-conditioning systems serving the stores in the shopping center did not qualify as "section 38 property" with respect to which petitioner was entitled to an investment tax credit. Sec. 1.48-1(e)(2), Income Tax Regs.

D. P. Wingo, for the petitioner.

Robert G. Faircloth, for the respondent.

Quealy, Judge.

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QUEALY

This is a case for redetermination of deficiencies in income tax of petitioner for the fiscal year ended August 31, 1964, in the amount of $ 18,815.90 and for the fiscal year ended August 31, 1965, in the amount of $ 16,759.34.

Some of the issues raised in the petition were settled by stipulation of the parties. The remaining issues are (1) the useful life for purposes of depreciation of the buildings making up the Fort Walton Square shopping center at Fort Walton Beach, Fla., and if such life exceeded the term of its lease, whether petitioner was entitled to amortize the cost of the buildings over the term of the lease; (2) the useful lives for purposes of depreciation of other improvements or equipment at the Fort Walton Square shopping center; and (3) whether the heating and air-conditioning equipment installed at the Fort Walton Square shopping center qualifies as "section 38 property" on account of which petitioner would be entitled to an investment tax credit under section 38 of the Internal Revenue Code. ¹

FINDINGS OF FACT

The evidence consisted of a stipulation of facts with exhibits attached, together with oral testimony and exhibits received at the trial. The facts as stipulated are incorporated herein by this reference.

The petitioner was incorporated under the laws of the State of Florida on July 20, 1962, with outstanding capital stock in the amount of $ 2,000. Petitioner's principal place of business during the taxable years involved and at the time of the filing of the petition was Birmingham, Ala. From the time the petitioner was organized until the present time 75 percent of its outstanding capital stock has been owned by J. W. Goodwin and 25 percent thereof has been owned by J. W. Goodwin's wife, Virginia M. Goodwin.

Petitioner filed its Federal income tax returns for the taxable years ended August 31, 1963, August 31, 1964, and August 31, 1965, with the district director of internal revenue, Birmingham, Ala. On January 5, 1968, petitioner executed a Form 872, Consent Fixing Period of Limitations Upon Assessment of Income and Profits Tax, for its taxable year ended August 31, 1964, extending the period of assessment to December 31, 1968.

Fort Walton Beach Mall, Inc., was a corporation organized under the laws of the State of Alabama. Neither the petitioner, J. W. Goodwin, nor any member of J. W. Goodwin's family owned any stock or had any connection with Fort Walton Beach Mall, Inc.

International Development Co., Inc., was organized in April 1961. All its outstanding capital stock, except for two qualifying shares, is owned by a trust for Joy E. Goodwin, the minor daughter of J. W. Goodwin. The trustees thereof are J. W. Goodwin and Birmingham Trust National Bank, Birmingham, Ala.

On February 7, 1962, Fort Walton Beach Mall, Inc., leased certain realty located in the city of Fort Walton Beach, Fla. from James J. Tringas and Kathryn J. Tringas for a period of 99 years, beginning on March 1, 1962, and terminating on the last day of February 2061. On May 29, 1962, the said 99-year lease was amended by agreement of Fort Walton Beach Mall, Inc., and the lessors, James J. Tringas and Kathryn J. Tringas. On June 1, 1962, this 99-year lease was assigned by Fort Walton Beach Mall, Inc., to International Development Co., Inc. Although the recited consideration for this assignment was "$ 10.00 and other valuable consideration," the actual consideration for the assignment was $ 5,000.

On July 25, 1962, International Development Co., Inc., subleased the property to petitioner corporation for a term of 26 years with no option for renewal. Petitioner immediately commenced the construction of a shopping center on the said realty. The first building was completed in February of 1963 and was leased to Sears, Roebuck & Co. for a term of 20 years. Construction of the remaining shopping center store buildings was completed by October 1963. The remaining buildings were leased to various tenants for terms ranging from 3 to 15 years.

Petitioner estimated the useful life of the shopping center buildings to be 40 years in its return filed for the taxable year ended August 31, 1963. In its returns filed for the taxable years ended August 31, 1964 and 1965, petitioner claimed depreciation on the basis of a useful life of 25 years for its buildings. In explanation, the returns referred to the ground lease of 26 years, with 1 year required for construction. The respondent has determined that depreciation should be computed on the basis of a useful life of 40 years for the buildings.

In its returns for the taxable years ended August 31, 1964 and 1965, the petitioner computed its depreciation on the basis of an average useful life of 10 years for other items classified under the category of "Machinery and Equip." The useful lives presently claimed by the petitioner and allowed by the respondent are as follows:

	Years
Item	Petitioner	2 Respondent
Heating and air conditioning	8	10
Electrical fixtures and wiring	7	15
Ceiling	10	10
Parking lot lighting	6	15
Fence and signs	10	15
Paving	5	10
Roof	15	15

In its returns for the fiscal years ended August 31, 1964 and 1965, the petitioner claimed an investment tax credit under section 38 of the Internal Revenue Code for the cost of the airconditioning and heating systems installed at the Fort Walton Square shopping center. The air-conditioning and heating systems consisted of what was described as a "pre-packaged" unit containing a heating element, a cooling unit or a compressor and blower. Some 30 of such systems were located on the roof of the buildings and connected by permanent ducts to the areas to be served. The compressor varied in size from 2- to 60-ton capacity. More than one unit was required to serve the area leased by Sears, Roebuck & Co. Separate units served each of the other leased areas. The units rested upon framing attached to the roof and were connected to the ductwork with canvas flashing so that the vibration of the unit would not be transmitted to the ductwork.

ULTIMATE FINDINGS OF FACT

For purposes of computing the allowance for depreciation, the useful life of petitioner's buildings at the Fort Walton Square shopping center was 30 years.

For purposes of computing the allowances for depreciation, the useful lives of the other items classified under the category of "Machinery and Equip." were as follows:

	Useful life
Item	Years
Heating and air conditioning	8
Electrical fixtures and wiring	15
Ceiling	10
Parking lot lighting	15
Fence and signs	15
Paving	10
Roof	15

The air-conditioning and heating equipment installed at the Fort Walton Square shopping center constituted central heating and air-conditioning systems, as distinguished from individual units, within the meaning of regulations section 1.48-1(e)(2).

OPINION

Issue 1. Depreciation of Buildings

The buildings at Fort Walton Square shopping center were constructed of concrete block. Petitioner presented the testimony of its architect, who stated that the maximum life of a concrete hollow brick building was 20 to 25 years, as distinguished from a brick masonry building which might have a physical life of 50 to 60 years. The witness predicated his estimate on the effect of changes in temperature and atmospheric conditions due to the porosity of the concrete brick. The witness could not by experience, however, relate such testimony specifically to the conditions prevailing at the Fort Walton Square shopping center. In addition, it is not clear that the witness took into account the extent to which the life of the buildings might be extended by the use of a sealant which was applied to the concrete hollow brick.

While the Court is convinced that the useful life of 40 years proposed by the respondent is not the proper basis for depreciation of shopping center store buildings constructed of concrete hollow brick, the testimony of petitioner's expert witness cannot be accepted at face value. The buildings were constructed in accordance with specifications provided by Sears, Roebuck & Co. It would hardly seem reasonable that Sears, Roebuck & Co. would provide specifications for a building which could be expected to deteriorate at or about the time of the expiration of its lease. The specifications may well have provided for a building that would meet Sears' needs at the lowest possible cost. Sears would want to be equally certain, however, that the building was standing and in good shape at the end of its term. For Sears to specify a building having a useful life of from 20 to 25 years, when it was entering into a 20-year lease, would be "cutting it too thin." Accordingly, the Court finds the useful life of the building to be 30 years.

The Court must still consider whether, notwithstanding our finding of a useful life of 30 years for the buildings, the petitioner is entitled to amortize the cost of the buildings over a shorter period measured by the term of its ground lease from International Development Co., Inc. The respondent argues to the contrary on the grounds that the lessor and the lessee were "related persons" as defined in section 178(b) of the Code and, in the alternative, that the term of the lease was not predicated on an "arm's length" transaction.

In arguing that the lessor and lessee are "related persons" within the meaning of section 178(b), the respondent apparently recognizes that the relationship between the lessor and the lessee in this case does not come within any of the statutory definitions of "related persons." A reading of the statute makes this clear. Section 178(b) provides:

(b) Related Lessee and Lessor. --

(1) General Rule. -- If a lessee and lessor are related persons (as determined under paragraph (2)) at any time during the taxable year then, in determining the amount allowable to the lessee as a deduction for such taxable year for exhaustion, wear and tear, obsolescence, or amortization in respect of any building erected (or other improvement made) on the leased property, the lease shall be treated as including a period of not less duration than the remaining useful life of such improvement.

(2) Related persons defined. -- For purposes of paragraph (1), a lessor and lessee shall be considered to be related persons if --

(A) the lessor and the lessee are members of an affiliated group (as defined in section 1504), or

(B) the relationship between the lessor and lessee is one described in subsection (b) of section 267, except that, for purposes of this subparagraph, the phrase "80 percent or more" shall be substituted for the phrase "more than 50 percent" each place it appears in such subsection.

For purposes of determining the ownership of stock in applying subparagraph (B), the rules of subsection (c) of section 267 shall apply, except that the family of an individual shall include only his spouse, ancestors, and lineal descendants.

It is not claimed that the lessor and the lessee are members of an "affiliated group" as defined in section 1504. It then becomes necessary to determine whether the relationship between the lessor and the lessee is one described in subsection (b) of section 267. That section provides:

(b) Relationships. -- The persons referred to in subsection (a) are:

(1) Members of a family, as defined in subsection (c)(4);

(2) An individual and a corporation more than 50 percent in value of the outstanding stock of which is owned, directly or indirectly, by or for such individual;

(3) Two corporations more than 50 percent in value of the outstanding stock of each of which is owned, directly or indirectly, by or for the same individual, if either one of such corporations, with respect to the taxable year of the corporation preceding the date of the sale or exchange was, under the law applicable to such taxable year, a personal holding company or a foreign personal holding company;

(4) A grantor and a fiduciary of any trust;

(5) A fiduciary of a trust and a fiduciary of another trust, if the same person is a grantor of both trusts;

(6) A fiduciary of a trust and a beneficiary of such trust;

(7) A fiduciary of a trust and a beneficiary of another trust, if the same person is a grantor of both trusts;

(8) A fiduciary of a trust and a corporation more than 50 percent in value of the outstanding stock of which is owned, directly or indirectly, by or for the trust or by or for a person who is a grantor of the trust; or

(9) A person and an organization to which section 501 (relating to certain educational and charitable organizations which are exempt from tax) applies and which is controlled directly or indirectly by such person or (if such person is an individual) by members of the family of such individual.

It will be noted that the only situation in which two corporations are deemed to be "related persons" within the meaning of section 267(b) is set forth in paragraph (3) wherein one corporation must be a personal holding company or a foreign personal holding company. Respondent does not contend that either the lessor or the lessee in this case was a "personal holding company." Faced with substantially the same circumstances in a case involving a sale between two corporations, the stock of one being owned by the members of a family and the stock of the other by a trust for two members of that family, it was held that the corporations were not otherwise "related persons." Shelden Land Co., 42 B.T.A. 498">42 B.T.A. 498 (1940). That decision is determinative of the issue. Fort Walton Square, Inc., and International Development Co. were not "related persons" as defined in section 178(b).

Apparently as an afterthought, in his reply brief the respondent argues that the lease should be disregarded for purposes of depreciation of the buildings because it was not entered into in an "arm's length" transaction. In support of this, respondent cites the relationship of the stockholders of the lessor and the stockholders of the lessee. Respondent concludes:

Petitioner has offered no sound business reason for the creation of the twenty-six year sublease. The principal reason for such a transaction appears to be to effect a shorter useful life of the shopping center buildings.

The fallacy of this argument rests on the fact that, as the respondent notes elsewhere, the petitioner did not in its first return for the fiscal year ended August 31, 1963, rely upon the term of the lease for purposes of computing the deduction for amortization of depreciation of the buildings. In the absence of evidence to the contrary, therefore, it must be assumed that whatever reasons there might have been in fixing the term of the petitioner's lease, the question of depreciation was not controlling.

In view of our holding that the petitioner and the lessee were not "related persons" as defined in section 178(b), the petitioner was entitled to amortize the cost of the buildings over the term of its lease.

Issue 2. Depreciation of Other Property

Heating and Air Conditioning. -- Considerable testimony was directed to the problems encountered with respect to the heating and air-conditioning equipment. Unquestionably climatic conditions in the Fort Walton area caused the more rapid deterioration of those units. Respondent acknowledges this in his brief and is willing to allow a useful life of 10 years. In the opinion of the Court, however, this would not be adequate in light of number of units which had been replaced. Accordingly, it is our opinion that the petitioner's claim of a useful life of 8 years for purposes of depreciation of the heating and air-conditioning equipment is reasonable and should be sustained.

Electrical Fixtures and Wiring. -- In its returns, the petitioner placed a useful life of 10 years on this equipment. The evidence adduced by the petitioner related only to the fluorescent lighting fixtures as distinguished from the fuse or junction boxes and the wiring and circuitry leading to the fixtures. It must be assumed that except for the fluorescent fixtures, the remainder of the electrical wiring and equipment would have a useful life at least equal to the term of the lease with Sears, Roebuck & Co. Since no evidence was submitted with respect to the relative cost of the fluorescent light fixtures and of the other electrical equipment and wiring under this classification, the Court finds that the respondent's proposed useful life of 15 years for purposes of depreciation of the electrical fixtures and wiring is reasonable and should be sustained.

Ceiling. -- The parties have agreed that for purposes of depreciation the useful life of the ceiling was 10 years and the Court so holds.

Parking Lot Lighting. -- The petitioner presented evidence to show that due to climatic conditions some of the lighting fixtures had deteriorated and had been replaced. It was not clear, however, whether it was also necessary to replace the stanchions, wiring, and other elements making up the cost of the parking lot lighting. On this record, the respondent's determination of a useful life of 15 years for purposes of depreciation of the parking lot lights is reasonable and should be sustained.

Fence and Signs. -- Petitioner submitted no evidence concerning the useful life of the fence and signs claimed on the returns as part of the machinery and equipment account. Accordingly, respondent's determination of a useful life of 15 years for purposes of depreciation of the fence and signs is reasonable and should be sustained.

Paving. -- The petitioner presented evidence to show that during the first 6 years approximately one third of the paving in the parking lot had been "replaced." To what extent such replacement was the equivalent in cost of laying the original surface was not made clear. In any event, since the remaining two-thirds presumably was still in use, the allowance by the respondent of a useful life of 10 years for purposes of depreciation of the parking lot is reasonable and should be sustained.

Roof. -- The parties have agreed that for purposes of depreciation the useful life of the roof was 15 years and the Court so holds.

Issue 3. Investment Tax Credit for Heating and Air-Conditioning Equipment

The question whether the heating and air-conditioning systems installed by the petitioner at the Fort Walton Square shopping center qualified as "section 38 property" for purposes of the investment tax credit is governed by section 48 as interpreted by regulations section 1.48-1(e)(2). That regulation provides:

(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. However, 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. Machinery may meet the "sole justification" test provided by the preceding sentence even though it incidentally provides for the comfort of employees, or serves, to an insubstantial degree, areas where such temperature or humidity requirements are not essential. For example, an air conditioning and humidification system installed in a textile plant in order to maintain the temperature or humidity within a narrow optimum range which is critical in processing particular types of yarn or cloth is not included within the term "structural components". For special rules with respect to an elevator or escalator, the construction, reconstruction, or erection of which is completed by the taxpayer after June 30, 1963, or which is acquired after June 30, 1963, and the original use of which commences with the taxpayer and commences after such date, see section 48(a)(1)(C) and paragraph (m) of this section.

The analogy between heating and air-conditioning equipment on the one hand and elevators and escalators on the other is particularly significant. In section 203(c) of the Revenue Act of 1964 (Pub. L. 88-272) the Congress amended section 48(a)(1) by the addition of subparagraph (C) in order to bring elevators and escalators within the definition of section 38 property. In its report accompanying that amendment the Committee on Ways and Means said:

A third problem arises with respect to the treatment of escalators and elevators in the case of the investment credit. Among the categories of property not eligible for the investment credit are buildings and their structural components. The House committee report indicated that the term "structural components" of a building included such parts of a building as central air conditioning and heating systems, plumbing, and electrical wiring and lighting fixtures relating to the operation and maintenance of the building. The proposed regulations issued by the Treasury Department with respect to the term "structural components" provide an extensive list of the type of items considered to be structural components and therefore not eligible for the investment credit. Among these items are escalators and elevators. While these regulations are an accurate interpretation of the intention of Congress last year in this respect, nevertheless your committee believes that it is appropriate to reconsider the treatment of escalators and elevators for purposes of the investment credit. Escalators and elevators are closely akin to assets "accessory to the operation" of a business which presently are eligible for the investment credit. These assets include machinery, printing presses, transportation or office equipment, refrigerators, individual air-conditioning units, grocery counters, etc. Your committee further believes that new elevator and escalator equipment represents an important aspect of modernization of plant and facilities. [Emphasis added.]

What was said with respect to elevators and escalators would apply with equal force to heating and air-conditioning equipment if the Congress had so elected. The fact that the Congress did not do so is strong evidence of an intent to apply a stricter rule with respect to heating and air-conditioning equipment. In the face of this intent, regulations section 1.48-1(e)(2) must be accepted as having the full force and effect of law. In fact, in light of this legislative history, the accompanying rulings by the respondent dealing specifically with heating and air-conditioning equipment should be presumed to be in conformity with the legislative intent. See Rev. Rul. 67-359, 2 C.B. 9">1967-2 C.B. 9; Rev. Rul. 67-417, 2 C.B. 49">1967-2 C.B. 49.

There are two commonly accepted methods of providing heating and air conditioning for commercial areas. Under one method, a heating or cooling liquid is piped from the heating and compressor unit to the areas to be served and air forced over radiation coils in units located within that area. Under the alternative method, the blower and coils are located at and are a part of the heating and compressor unit, and the heated or cooled air is carried by ducts to the area to be served.

The heating and air-conditioning systems installed by the petitioner were of the latter type. A complete unit consisted of equipment for heating by gas, a compressor for cooling, the radiation coils, and a forced air blower. The unit was placed on the roof of the building and connected to the ducts with canvas flashing. One or more units were installed for each tenant and the gas and electrical consumption was metered separately.

The petitioner argues that such systems are not a "central heating and air conditioning system," as referred to in regulations section 1.48-1(e)(2). In effect, the petitioner argues that any complete unit, regardless of size or the area to be served, is not a "central heating and air conditioning system" if the system operates by first cooling or heating the air and delivering that air to the area to be served rather than by heating or cooling the liquid for delivery to separate forced-air radiators within the area to be served.

We find nothing to indicate that the Congress intended thus to limit the definition of a "central heating and air-conditioning system." It is wholly unrealistic to argue, in effect, that whether a unit is a central system or an individual system depends on whether the coolant is piped to the area or the cooled air is carried to the area by ducts. In either case, there is a "central unit" capable of serving more than a single room or a single area. The fact that one or more of such units may be connected and metered separately for each tenant does not convert them into "individual" units.

In Rev. Rul. 67-417 the respondent has ruled that the term "central heating and air conditioning system" is not restricted to mean that an entire building must be served by one unit of equipment. In Rev. Rul. 67-359 the respondent also ruled that roof-type air-conditioning units such as those installed by the petitioner at the shopping center were "structural components of the building" within the meaning of regulations section 1.48-1(e)(2). The respondent's rulings with respect to such air conditioning equipment are reasonable, clearly within the intent of the Congress, and should be followed. The respondent's determination that the heating and air-conditioning systems involved in the instant case do not constitute "section 38 property" should be sustained.

Decision will be entered under Rule 50.

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Footnotes

• 1. All statutory references are to the Internal Revenue Code of 1954, as amended.↩

• 2. Including concessions made by respondent in his brief.↩