CCA 200033002: five year depreciation for a raised computer floor

Plain-English summary

A company built a data center with a raised floor that allowed access to wiring, plumbing, and ventilation for computer equipment. The IRS advised that, on the facts provided, the floor was personal property rather than a structural part of the building under an earlier revenue ruling. If further fact finding did not show that it was a structural component, the floor belonged in Asset Class 57.0 and had a five year depreciation recovery period. The IRS did not plan to revisit the earlier ruling and noted that additional facts about the floor's permanence and removal could change the classification.

Ruling snapshot

• Question: Is the raised floor personal property or a building component, and what recovery period applies?
• Outcome: Advice given. Treat it as personal property in Asset Class 57.0 with a five year recovery period on the current facts.
• Key authorities: IRC §§ 167, 168, 1245, and 1250; Rev. Rul. 74-391; Rev. Proc. 87-56.

Full text (IRS public release)

                             DEPARTMENT OF THE TREASURY
                                 I N T E R N AL R E V E N U E S E R V I C E
                                      WASHINGTON, D.C. 20224
                                         April 17, 2000


Number: 200033002
Release Date: 8/18/2000
CC:DOM:FS:P&SI
TL-N-5722-99
UILC: 167.00-00, 167.13-05, 167.13-08, 167.13-11


  INTERNAL REVENUE SERVICE NATIONAL OFFICE FIELD SERVICE ADVICE


MEMORANDUM FOR JEFFREY P. EHRLICH
               DISTRICT COUNSEL, DELAWARE - MARYLAND
               CC:SER:DEM:BAL

FROM:                  DEBORAH A. BUTLER
                       ASSISTANT CHIEF COUNSEL (FIELD SERVICE)
                       CC:DOM:FS:P&SI

SUBJECT:               Depreciation of Raised Floor Installed in an Office Building
                       TL-N-5722-99

This Field Service Advice responds to your memorandum dated February 16, 2000.
Field Service Advice is not binding on Examination or Appeals and is not a final
case determination. This document is not to be cited as precedent.

LEGEND

Taxpayer                                                        .
Tax Year
Amount-1

ISSUES

1. Whether a raised floor installed during the initial construction of an office
building to facilitate the installation of computer systems is personal property under
I.R.C. § 168 or a structural component of a building?

2. If the raised floor is personal property under I.R.C. § 168, what is the
appropriate recovery period?

3. Should Rev. Rul. 74-391, 1974-2 C.B. 9 be reconsidered in light of changes in
the business environment since its issuance?
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CONCLUSIONS

Issue 1: Based on the facts submitted, we believe the raised floor in this case
would be considered personal property under Rev. Rul. 74-391. If additional fact
finding reveals any additional information supporting a determination that it is a
structural component of the building, this issue may be revisited.

Issue 2: The raised floor is appropriately classified in Asset Class 57.0 and has a
5-year recovery period.

Issue 3: There are no plans to revisit Rev. Rul. 74-391.

FACTS

TAXPAYER is in the business of providing various computer-related services to
banks. During TAX YEAR, the taxpayers constructed and placed in service a
AMOUNT-1 square foot data center which consists of a three story building. Two
floors are devoted to offices and computer equipment and one floor is a parking
garage.

The first floor of the building was constructed with a raised floor to facilitate the
installation of wiring, plumbing, and ventilation for computers and other equipment.
The raised floor includes removable panels that provide access to the space
between the raised floor and the sub-floor. There is no finished floor below the
raised floor. The raised floor is installed in most of the first floor of the building
including a computer room, printer room, storage rooms, mail room, conference
rooms, offices, customer service areas, mechanical and electrical rooms, and
telecommunications rooms. The only areas without the raised floor are the main
lobby, restrooms, stairwells, and the corridors connecting the stairwells to
emergency exits.

The raised floor is installed in approximately 90 percent of the total square footage
available on the floor. The interior spaces of the building are designed around the
raised floor. Doors and ceilings are full height from the top of the floor. Walls
reach from the top of the raised floor to the ceiling. Removal of the raised floor,
while possible would necessitate a major renovation of the interior of the building.

The taxpayer identified the raised floor as personal property under I.R.C. § 1245.
The taxpayer engaged an outside firm to conduct a "cost segregation study" in
support of its position on the raised floor. The taxpayer claims that the raised floor
is 5-year property for purposes of I.R.C. § 168.

LAW AND ANALYSIS
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Section 167(a) permits the taxpayer to take depreciation deductions for the
exhaustion, wear and tear of property used in its trade or business, or of property
held for the production of income. For tangible property placed in service after
1986, section 168 provides that the depreciation deduction is determined by using
the applicable depreciation method, the applicable recovery period and the
applicable convention.

The only issue here is the applicable recovery period. The mechanics of
determining the applicable recovery period are somewhat complicated. First,
recovery periods correspond to different classes of property (the depreciable
asset). Section 168(c). Four of the classes bear somewhat descriptive titles, such
as the class of "nonresidential real property" which had a recovery period of 31.5
years for the tax years at issue. However, the six remaining classes do not have
descriptive titles, and are labeled only in number terms corresponding to their
recovery periods: i.e. "three year property", "five year property", etc. These six
classes are further described at section 168(e), which defines each of these
classes in terms of the "class life" of the property belonging to it. Thus for example,
if a depreciable asset has a class life of sixteen to twenty years, it is "10-year
property" under section 168(e)(1), and has a recovery period of ten years under
section 168(c). (A special recovery period is assigned to property with no class
life.) Next, the term "class life" is defined by section 168(i)(1). That definition
incorporates former section 167(m), which specifically authorized the Commissioner
to promulgate regulations regarding class lives of depreciable assets.

The Commissioner did issue regulations, and two rules deriving from them are most
pertinent here. First, property is to be classified according to its primary use, even
though that use may be insubstantial in relation to all the taxpayer’s other activities.
Treas. Reg. section 1.167(a)-11(b)(4)(iii)(b). Second, while the regulations did not
themselves set out class lives, they left it to the Commissioner to make those
determinations in issued revenue procedures. Treas. Reg. section 1.167(a)-
11(b)(ii). Thus, we come to Rev. Proc. 87-56, 1987-2 C.B. 674 (Rev. Proc. 87-56),
the revenue procedure in effect for the years at issue.

Rev. Proc. 87-56 sets out the current class lives and recovery periods of property
subject to section 168 of the Internal Revenue Code. It divides assets into two
broad categories: (1) Asset guideline classes 00.11 through 00.4, consisting of
specific depreciable assets used in all business activities (the asset category);
and (2) asset guideline classes 01.1 through 80.0, consisting of depreciable assets
used in specific business activities (the activity category). The same item of
depreciable property can be described in both an asset category and an activity
category. See for example Norwest Corporation & Subsidiaries v. Commissioner,
111 T.C. 105 (1998), where the court decided whether an item described in both an
asset and an activity category (furniture and fixtures) should be placed in the
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activity category or the specific asset category. The court determined that the asset
category took priority.

The taxpayer contends that the raised floor is properly classified as tangible
personal property and should be considered 5-year recovery property. The
examiner presumes the 5-year recovery period results from the taxpayer
characterizing the raised floor as part of asset class 00.12 "Information Systems" as
defined in Rev. Proc. 87-56. The examining agent believes the raised floor is a
structural component of the building, nonresidential real property. The recovery
period of nonresidential real property is established by statute.

Nonresidential real property is defined as section 1250 property which is not
residential rental property or property with a class life of less than 27.5 years.
Section 168(e)(2)(B). Section 168(i)(12) provides that section 1250 property has
the same meaning as given in section 1250(c). Section 1250 property is any real
property, other than section 1245 property, which is or has been of a character
subject to the allowance for depreciation provided in section 167. Section 1250(c).

Section 1245 property is any property of a character subject to the allowance for
depreciation under section 167 and is either (a) personal property, (b) other
tangible property (not including a building or its structural components) used in
connection with a qualified activity or a research or storage facility used with a
qualified activity, (c) a single purpose agricultural or horticultural structure or, (d) a
storage facility used in connection with the distribution of petroleum). Section
1245(a)(3). The terms "buildings" and "structural components" have the meanings
assigned to those terms in Treas. Reg. § 1.48-1(e). Treas. Reg. § 1.1245-3(c)(2).

A building is defined in Treas. Reg. § 1.48-1(e)(1) 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.
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 ducks; 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 or a building.
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Rev. Rul. 74-391, 1974-2 C.B. 9 ("Rev. Rul. 74-391"), considered a raised floor built
over an existing floor to permit wiring, air-conditioning ducts, and other services for
the computer to be installed. The ruling stated that the raised false floor built on
the existing floor was a necessary part of the installation and operation of the
computer equipment, an accessory of such equipment and not a "structural
component" of the building. The ruling differentiated wood block flooring attached
to the existing floor with mastic, holding that the wood block flooring that is a
permanent covering of the concrete floor does not qualify as "section 38 property"
for investment credit purposes.

Based on the facts developed so far, the taxpayer’s situation appears to fall
squarely within that ruling. Substantial additional factual development would be
required for any attempt at recharacterizing the raised floor as a structural
component of the building. Suggestions relating to further factual development are
made below.

If additional fact finding does not clearly indicate that the raised floor should be
considered a structural component of the building, we believe the raised floor is
appropriately placed within Asset Class 57.0 (an activity category). That asset
class includes "assets used in wholesale and retail trade, and personal and
professional services", which describes Taxpayer’s business. The class has a
recovery period of 5 years.

We do not concur in your belief that the "unique" test used in Norwest Corporation
& Subsidiaries v. Commissioner, T.C. Memo 1995-390, should apply and would
cause the raised floor to fall under the "Specific Depreciable Assets Used In All
Business Activities" class 00.11, Office Furniture, Fixtures and Equipment (an asset
category). We believe the Court in the second Norwest case, Norwest Corporation
& Subsidiaries v. Commissioner, 111 T.C. 105 (1998) moved away from the
"unique" test and instead held that the priority rule in Rev. Proc. 62-21 is implicit in
Rev. Rul. 87-56. This priority is stated in Question 50 of Rev. Proc. 62-21, which
states that assets falling withing group 1 should first be classified in the appropriate
class contained in group 1 (now asset classes 00.11 through 00.4 of Rev. Proc. 87-
56). Then the remaining assets are be classified according to the taxpayer’s
activity.

In this case, if the raised floor is "Office Furniture, Fixtures and Equipment" it
would fall in asset class 00.11, a specific depreciable assets category. We do not
believe the raised floor is properly classified as office furniture, fixtures and
equipment. Fitting no other specific depreciable asset category, the asset must
then be placed in an activity category. We believe the appropriate classification is
in Asset Class 57.0 - Distributive Trades and Services (includes assets used in
wholesale and retail trade, and personal and professional services), which
corresponds to Taxpayer’s business.
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CASE DEVELOPMENT, HAZARDS AND OTHER CONSIDERATIONS:

If the examining agent wishes to pursue this issue, further factual development is
essential. The court in Whiteco Industries, Inc. v. Commissioner, 65 T.C. 664
(1975) cited various factors to consider in analyzing whether particular property is a
structural component of a building or depreciable personal property. The include:
Whether the property is capable of being moved, and has it in fact been moved?;
Whether the property is designed or constructed to remain permanently in place?;
Whether there are 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 movable?; How much damage will the property
sustain upon its removal?; and What is the manner of affixation of the property to
the land?

To summarize, the factors are whether the property is / was:
CAPABLE OF BEING MOVED - HAS BEEN MOVED
DESIGNED / CONSTRUCTED TO REMAIN IN PLACE
EXPECTED / INTENDED LENGTH OF AFFIXATION
TIME / COSTS REQUIRED FOR REMOVAL
DAMAGE CAUSED BY REMOVAL
MANNER OF AFFIXATION
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               WILLIAM C. SABIN, JR.
               Senior Technician Reviewer
               Passthroughs & Special Industries Branch
               Field Service Division