By Philip D. Morrison, Esq.
Deloitte Tax LLP, Washington, DC
Real property for purposes of the Foreign Investment in Real Property Tax Act (FIRPTA)1 includes three general categories: (1) land and unsevered natural products of the land; (2) improvements; and (3) personal property associated with the use of real property.2 The second category, improvements, itself includes three categories: (1) buildings; (2) inherently permanent structures; and (3) structural components of buildings and structures.3
The FIRPTA regulations' authors4 understood that the definition of each of these terms would provide significant potential for controversy. They also understood that many of these controversies had already arisen in other contexts, particularly depreciation and investment credit cases, and wished to take advantage of the resolutions of such prior controversies.
Regs. §1.897-1(b)(3)(iii) attempts to do this in what, at the time it was promulgated in 1984, was a fairly straightforward fashion:
(B) Use of precedents under section 48.—Any property not otherwise described in this paragraph (b)(3) that constitutes "other tangible property" under the principles of section 48(a)(1)(B) and §1.48-1(c) and (d) shall be treated for purposes of this section as an inherently permanent structure. Thus, for example, the term includes swimming pools, paved parking areas and other pavements, special foundations for heavy equipment, wharves and docks, bridges, fences, inherently permanent advertising displays, inherently permanent outdoor lighting facilities, railroad tracks and signals, telephone poles, permanently installed telephone and television cables, broadcasting towers, oil derricks, oil and gas pipelines, oil and gas storage tanks, grain storage bins, and silos.
As most readers know, however, §48 was repealed by the Tax Reform Act of 1986 and the regulations thereunder have become essentially obsolete as cases under §48 have long ago wended their way through the court system. Depending on one's view of the breadth of the concept of "principles," however, the "principles of" those provisions and the cases decided thereunder arguably live on in the various iterations of §168 (dealing with the accelerated cost recovery system) and authority developed thereunder.
The question arises, therefore, whether the regulations' language quoted above provides a dynamic, ambulatory rule, still allowing new (i.e., post-repeal of §48) guidance with respect to accelerated depreciation to be used for §897 purposes. Or whether it is frozen in time, static as of the repeal of §48 (or perhaps even earlier, as of the date of the regulations' promulgation, with respect to this list in the second sentence quoted above). As is so often the case, there are arguments supporting either interpretation. The better answer for the more efficient operation of the tax system ought to be that the rule is dynamic. The answer based on the authorities, the recorded intent of the regulations' authors, and the case law is not altogether clear.
The statute is not terribly prolix in describing what should constitute real property for §897 purposes. Section 897(c)(1)(A) provides that an interest in real property includes an interest in a mine, well, or other natural deposit. Section 897(c)(6)(A) makes clear that real property includes improvements on land. Section 897(c)(6)(B) provides that real property includes associated personal property such as moveable walls and furnishings. Otherwise, there is no definition or cross-reference to a definition elsewhere.
The legislative history is also sparse. There is little relevant guidance regarding what constitutes real property and what does not.
The first version of the temporary and proposed regulations5 elaborated somewhat on the Code's limited specificity regarding what would constitute real property for §897 purposes. It made clear that "improvements" included buildings and structural components of buildings such as wiring. Importantly, it stated that "improvements" also included "inherently permanent structures." It also provided some more specificity regarding "personal property associated with the use of real property," defining it generally as personal property the use of which is an ordinary and necessary corollary of the use to which real property is put. This version, however, provided no explicit cross-references to other Code or regulation sections.
The second Notice of Proposed Rulemaking,6 which left the temporary regulations intact but replaced the proposed regulations that were based thereon, expanded the definition of real property "improvements" to address commenters' requests for more detailed guidance. The Preamble described the change:
In response to several requests for a definite rule, paragraph (b)(3) [of Regs. §1.897-1] now defines an improvement to land as a building or any other inherently permanent structure that constitutes "other tangible property" under the principles of §1.48-1(d) (relating to the investment tax credit). Thus, the well-developed body of law under that provision will apply to determine what constitutes an improvement.
The proposed regulation itself looked very similar to current Regs. §1.897-1(b)(3)(iii)(B). The cross-reference to §48(a)(1)(B) was there, although the regulation's cross-reference did not mention Regs. §1.48-1(c); it only referenced -1(d). Another difference with the final regulations was that the proposed regulations made explicit that the cross-reference to §48 and the regulations thereunder was not meant to require the referenced property to actually qualify for the investment credit. Also, the structure of the provision in the proposed version was slightly different than that in the final, since the cross-reference was for purposes of defining "improvements" rather than the subset of improvements called "inherently permanent structures." Critically, the proposed regulation included the list in the second sentence of current Regs. §1.897-1(b)(3)(iii) — the "Thus, …" sentence — providing a laundry list of examples that were included in the definition of "real property."
When the regulations were finalized,7 even greater clarification was provided. The §48 cross-reference (and the "Thus, …" sentence that follows it) was retained (though now made specific to the definition of "inherently permanent structure"). In addition, the so-called Whiteco8 factors were added to deal with cases for which the §48 cross-reference did not provide an answer. Again, the Preamble explains:
[G]eneral standards drawn from the case law have been added to the definition of an inherently permanent structure, in response to comments pointing out that precedents thus far developed under section 48 may fail to provide adequate guidance with respect to the classification of a particular type of property.
None of this lengthy regulatory history answers the dynamic versus static question, however. If the reason for the cross-reference was to fix the status of certain types of property based on the case law as of 1984, as the "Thus, …" sentence may imply, then the cross-reference would be a static one; reference to cases or other guidance after 1984 would be irrelevant. If, on the other hand, the cross-reference meant that one should continue using "the principles of section 48" as those principles evolved to continue to define types of property not dealt with before 1984 (or to revise the definition of property previously dealt with as technology changed), as the "thus far developed" language from the Preamble implies, then the dynamic view ought to prevail.
This commentator believes that the dynamic view ought to be the view adopted. If, as seems to be the case, the current authority is unclear, a revenue ruling or notice could be promulgated to make it clear that the dynamic view is appropriate.
First, the statute directs us to the principlesof §48, not to the results of §48's actual application. Those principles for determining what constitutes an inherently permanent structure continue to exist and to be applied in §168 cases and other guidance. There is no difference in the "principles" that apply for deciding whether a structure is "inherently permanent" when one is applying §168 versus applying §48.
Second, it is difficult to find a clear rationale for those principles to be frozen in time for §897 purposes while they continue to develop and expand (i.e., cover more items of property in more circumstances) under §168.9 While the static approach may provide some certainty for §897 purposes, it will fail to take technological advances into account and will disengage the §897 analysis from the §§48 and 168 analysis. The static approach raises the clear specter of the same property being "inherently permanent" for one purpose but not for another. The efficient administration of the tax law would seem to dictate that both analyses move in tandem.
The treatment of oil storage tanks provides an example of how case law under the principles of §§48 and 168 has changed over the last 40 years. In Northville Dock Corp. v. Comr..,10 oil storage tanks were found to qualify as §38 property under §48(a)(1)(B), the provision cross-referenced in Regs. §1.897-1(b)(3)(iii)(B). While the case did not discuss the issue, in order to reach its conclusion the court appears to have assumed that the tanks were "other tangible property" since that is the only way the tanks could have potentially qualified as §38 property within the scope of Regs. §1.48-1(d). This §48 case is likely part of the "the well-developed body of law under that provision" referenced in the Preamble quoted above. It is also likely the reason for the inclusion of oil storage tanks in the "Thus, …" sentence in the regulations.
The Siler v. Comr.11 case, decided in 1985, essentially affirmed what appears to have been assumed in Northville, explicitly holding that larger oil storage tanks at a dock facility were "other tangible property" for §48 purposes and thus, by cross-reference under the §897 regulations, "inherently permanent structures." Smaller oil storage tanks, termed "customer service tanks," however, were held notto be inherently permanent structures. "The well-developed body of law" that gave rise to the "Thus, …" sentence in the final regulations as of 1984, became, within only a year, a little less clear as it became even more developed. As most cases under §§48 and 168 did after 1975, Siler applied the Whiteco factors, those that apply for FIRPTA purposes (as provided by Regs. §1.897-1(b)(3)(iii)(C)) in the absence of precedents under §48, to make the determination of whether a structure is inherently permanent or not.
The PDV America v. Comr.12 case, decided in 2004, turned Siler and Northville on their heads. While decided under §168, it applies the same principles applied under §48 to determine whether property constitutes an "inherently permanent structure." Just like Siler, it applied the Whiteco factors. Unlike Siler, however, the PDV America court determined, based on those factors, that the oil storage tanks at issue were not "inherently permanent structures." One of the chief reasons for the different conclusion in 2004 than that reached in 1985 and 1969 appears to be that technology had advanced in the interim to make even moderately large oil storage tanks moveable.13
PDV America demonstrates the importance of interpreting the cross-reference to §48 principles in the FIRPTA regulations as being dynamic, rather than static. If the cross-reference is frozen in time as of 1984 (or even 1986, when §48 was repealed), then technological change that leads to a completely different conclusion under the principles of §48 as interpreted in a recent §168 case must be ignored. The result will be conclusions regarding the definition of the same words that are 180 degrees opposed to each other depending on what section is at issue — oil storage tanks will be inherently permanent for §897 purposes but not for §168 purposes. There seems to this commentator to be no policy reason for such disparate results. A dynamic approach to following the principles of §48 also appears justifiable in implementing the intent of the FIRPTA regulations. Because it is not clear that a dynamic approach is correct, the IRS should publish guidance so providing.
This commentary also will appear in the June 2011 issue of the Tax Management International Journal. For more information, in the Tax Management Portfolios, see Caballero, Feese, and Plowgian, 912 T.M., U.S. Taxation of Foreign Investment in U.S. Real Estate, and in Tax Practice Series, see ¶7140, Foreign Persons — FIRPTA.
4 Including a now-retired former partner of mine with whom I very much enjoyed working (and from whom I learned what little I know about FIRPTA, though she bears no responsibility for the views expressed herein).
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