An Oily Tax Question

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By Professor James Edward Maule, Esq.  

Villanova University School of Law, Villanova, PA

Thanks to a question from a subscriber to one of the Tax Management portfolios that I wrote, I had the opportunity to review an interesting tax definition issue involving depreciation.

Section 168(e)(3)(E)(iii) permits taxpayers to elect to treat "retail motor fuels outlets" as 15-year property for purposes of the modified accelerated cost recovery system (MACRS), which for all practical purposes, is depreciation. Though it might not surprise tax professionals, it probably surprises everyone else, that the statute does not defined "retail motor fuels outlets." However, legislative history (S. Rep. No. 281, 104th Cong., 2d Sess. 14-16 (1996)) provides some guidance. According to the legislative history, a property qualifies as a "retail motor fuels outlet" if it satisfies any one of three conditions.  The first way for property to be a "retail motor fuels outlet" is for 50% or more of the gross revenues generated from the property to be derived from petroleum sales. The second way is for 50% or more of the floor space in the property to be devoted to petroleum marketing sales. The third way is for the property to be a motor fuels outlet of 1,400 square feet or less.

Two things jump to mind. First, what would a textualist who rejects legislative history do with the term "retail motor fuels outlet"? Second, does it help to define a retail motor fuels outlet by referring to a motor fuels outlet of 1,400 square feet or less. Does that not simply push the question back one notch to an inquiry into the meaning of "motor fuels outlet"?

A little history is helpful. Before section 168(e)(3)(E)(iii) was enacted, the IRS treated gas station convenience stores as 15-year property if two conditions were satisfied (IRS Industry Specialization Program Coordinated Issue Paper, Petroleum and Retail Industries Coordinated Issue: Convenience Stores (before revision)).  First, 50% of more of the gross revenues generated by the store must have been from gasoline sales. Second, 50% or more of the floor space in the building, including restrooms, counters, and areas allocable to traditional service station services, must have been devoted to petroleum marketing activity. If either condition was not satisfied, the property was treated as a convenience store and not as a petroleum product marketing station, classified as nonresidential real property.  When Congress changed the statute, the IRS issued a revised IRS Industry Specialization Program Coordinated Issue Paper, adopting the approach in the legislative history. In other words, the two-pronged test was replaced by the "any one of three" test. It also removed the reference to gasoline, as that description precluded diesel, which is no less a fuel than is gasoline.

Thereafter, in IRS Pub. 946, the IRS defined retail motor fuels outlet a bit differently. It provides:Real property is a retail motor fuels outlet if it is used to a substantial extent in the retail marketing of petroleum or petroleum products (whether or not it is also used to sell food or other convenience items) and meets any one of the following three tests.  

  •  It is not larger than 1,400 square feet.
  •  50% or more of the gross revenues generated from the property are derived from petroleum sales.
  •  50% or more of the floor space in the property is devoted to petroleum marketing sales. 

This definition shifts the focus from fuels to petroleum, and thus opens the door to the question that was posed. 

Specifically, does the building used to sell motor oil for oil changes and to perform vehicle lubrication, assuming that the motor oil sales generate 50% or more of the gross revenues, qualify for the 15-year property election?

For most people, the phrase "retail motor fuels outlets" is a fancy way of referring to a fueling station, such as a gasoline station, a gasoline/diesel station, or a convenience store that sells fuel. One would not think of a "lube and oil" establishment as a "retail motor fuels outlet" because those establishments often do not sell fuel. Yet, technically, the definition provided by the IRS in Pub. 946, if literally applied, covers that establishment, assuming its sales of motor oil and petroleum-based grease are a sufficient percentage of revenue or the square footage is sufficiently small, because the property "is used to a substantial extent in the retail marketing of petroleum or petroleum products." Motor oil is a petroleum product. From what I can figure out, most if not all synthetic motor oils are made from petroleum, or from a combination of petroleum and other ingredients.

The flaw in the reference to petroleum in the IRS definition is that not all fuels are made from petroleum, and not all petroleum products are fuels. Thus, under the IRS definition, a refueling station selling only pure ethanol would not qualify as motor fuels retail outlet property, and the "lube and oil" establishment might. At least this is an improvement from the amended IRS position, under which a refueling station selling more diesel than gasoline would fail to qualify. No one has provided a reason for the failure of the Congress to define the term it used in the statute. If it intended the everyday meaning, then the IRS definition is flawed. If it intended something else, it should have said so.  In any event, its failure to provide a definition opened the door to a rather slippery definition from the IRS.

 For more information, in the Tax Management Portfolios, see Maule, 531 T.M., Depreciation: MACRS and ACRS,  and in Tax Practice Series, see ¶2370, Depreciation of Realty and Tangible Property.

© 2012 James Edward Maule