T.C. Memo. 2001-150
UNITED STATES TAX COURT
BROOKSHIRE BROTHERS HOLDING, INC. AND SUBSIDIARIES, Petitioner v.
COMMISSIONER OF INTERNAL REVENUE, Respondent
Docket No. 4522-99. Filed June 22, 2001.
In the early 1990’s, P constructed, placed into
service, and began depreciating gas station properties.
P, an accrual method taxpayer, calculated its
depreciation deductions for tax purposes using the
modified accelerated cost recovery system (MACRS) of
sec. 168, I.R.C. On its returns for the years ended in
1993, 1994, and 1995, P classified and depreciated the
gas stations as nonresidential real property, with a
31.5- or 39-year recovery period. Subsequently, P filed
amended returns for those years reclassifying the gas
stations as 15-year property, based upon an Industry
Specialization Program Coordinated Issue Paper issued
by the Internal Revenue Service. R then remitted
refunds. P thereafter filed original returns for the
years ended in 1996 and 1997 which depreciated the gas
stations as 15-year property. R challenged this
treatment as an unauthorized change in accounting
method.
Held: In filing returns for the years ended in
1996 and 1997 which depreciated the gas stations as 15-
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year property, P did not violate the rules set forth in
sec. 446(e), I.R.C., regarding changes in method of
accounting.
William H. Lester, Jr., Matthew S. Parkin, and Joshua A.
Sutin, for petitioner.
David B. Mora and W. Lance Stodghill, for respondent.
MEMORANDUM OPINION
NIMS, Judge: Respondent determined Federal income tax
deficiencies for petitioner’s tax years ended April 1996 and
April 1997, in the amounts of $54,645 and $71,260, respectively.
After concessions, the sole issue for decision is whether
deductions taken by petitioner, for depreciation of gas station
properties, represent a change in accounting method made without
securing the “consent of the Secretary” as required under section
446(e). (Section 1.446-1(e)(2)(i), Income Tax Regs., substitutes
“consent of the Commissioner” for consent of the Secretary, which
practical substitution we henceforth adopt.) Additional
adjustments made in the statutory notice of deficiency are
computational in nature and will be resolved by our holding on
the foregoing issue.
Unless otherwise indicated, all section references are to
sections of the Internal Revenue Code in effect for the years at
issue, and all Rule references are to the Tax Court Rules of
Practice and Procedure.
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Background
This case was submitted fully stipulated in accordance with
Rule 122, and the facts are so found. The stipulations of the
parties, with accompanying exhibits, are incorporated herein by
this reference.
Petitioner’s Operations
Brookshire Brothers Holding, Inc., is, and was at the time
of filing the petition in this case, a Nevada corporation which
maintained its principal offices in Lake Charles, Louisiana.
Brookshire Brothers Holding, Inc., and its subsidiaries
(hereinafter collectively petitioner) are an affiliated group of
corporations which for all relevant tax years filed a
consolidated Federal income tax return.
As a significant component of its activities, petitioner is
engaged in the business of operating a chain of grocery stores.
In September of 1991, petitioner began constructing gas station
properties accessible through the parking lots of certain of its
grocery stores. These gas stations were subsequently placed into
service at grocery store locations throughout the State of Texas.
Petitioner’s Accounting
Petitioner employs the accrual method of accounting and uses
a taxable year ending on the last Saturday of April. Within this
overall method of accounting, petitioner generally computes
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depreciation for tangible assets placed in service after 1986
under the modified accelerated cost recovery system (MACRS), in
accordance with section 168.
On its U.S. Corporation Income Tax Return, Form 1120, for
the year ended April 24, 1993, petitioner began depreciating the
gas station properties.1 In doing so, petitioner characterized
the gas stations as nonresidential real property. Petitioner
likewise classified the gas stations as nonresidential real
property on its returns for the taxable years ending in April of
1994 and April of 1995. On the basis of such classification and
the prescribed treatment for nonresidential real property under
the MACRS rules, petitioner’s returns for the years ended in
1993, 1994, and 1995 reflected depreciation of the gas stations
using the straight line method and a recovery period of 31.5 or
39 years. (The Omnibus Budget Reconciliation Act of 1993, Pub.
L. 103-66, sec. 13151, 107 Stat. 448, extended the recovery
period for nonresidential real property from 31.5 to 39 years,
generally effective for property placed into service after May
12, 1993.)
1
Although the parties stipulated that petitioner began
depreciating the gas stations in the year ending in 1992, this
appears to be erroneous because petitioner’s return for the
fiscal year ending April 25, 1992, does not reflect any such
deductions on the depreciation schedule. We therefore rely on
the Form 1120 for that fiscal year. See Jasionowski v.
Commissioner, 66 T.C. 312, 316-318 (1976).
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Then, on July 15, 1996, petitioner filed with the Internal
Revenue Service an Amended U.S. Corporation Income Tax Return,
Form 1120X, for each of the tax years ended in 1993 through 1995.
On these amended returns, petitioner reclassified the gas
stations as 15-year property under the MACRS rules and,
consistent therewith, recalculated depreciation utilizing the 150
percent declining balance method and a 15-year recovery period.
Petitioner also included the following explanation with each Form
1120X: “THE DETERMINATION WAS MADE THAT GAS STATION CONVENIENCE
STORES SHOULD BE RECLASSED FROM 31.5 AND 39 YEAR PROPERTY TO 15
YEAR PROPERTY BASED ON THE ATTACHED MEMO.” The memo so
referenced and attached was a copy of an Industry Specialization
Program Coordinated Issue Paper for Petroleum and Retail
Industries (ISP paper).
The ISP paper, issued by the Internal Revenue Service with a
stated effective date of March 1, 1995, set forth the test under
which a convenience store would qualify as 15-year property,
rather than nonresidential real property, for MACRS depreciation
purposes. In general, the ISP paper required that the store be
used primarily to market petroleum products. At some time
thereafter, the Internal Revenue Service issued to petitioner
refunds of the full amount claimed in the amended returns for
years ended in 1993 and 1994 and a partial refund of the amount
claimed for the year ended in 1995.
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After filing the amended returns for prior years, petitioner
filed original Forms 1120 for the years ended in April of 1996
and April of 1997. On these returns, the gas stations were
classified and depreciated as 15-year property. Petitioner at no
time filed a Form 3115, Application for Change in Method of
Accounting, with respect to the gas station properties.
Respondent subsequently examined petitioner’s returns for
the tax years ended in 1996 and 1997 and issued a notice of
deficiency with respect to those years on December 8, 1998.
Therein, respondent determined, among other things, that
petitioner’s deductions for depreciation must be decreased
because petitioner, in treating the gas stations as 15-year
property, had engaged in a change of accounting method without
the consent of the Commissioner. Respondent computed the amount
of such decreases in depreciation expense as being $302,101 and
$257,833 for the years ended in 1996 and 1997, respectively. The
corresponding increases in taxable income resulted in
deficiencies that are the subject of this litigation.
Discussion
I. General Rules
A. Accounting Methods
As a threshold premise, section 446(a) sets forth the
general rule that “Taxable income shall be computed under the
method of accounting on the basis of which the taxpayer regularly
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computes his income in keeping his books.” Section 446(e) then
provides the particular standard governing changes in accounting
method and reads as follows:
SEC. 446(e). Requirement Respecting Change of
Accounting Method.--Except as otherwise expressly
provided in this chapter, a taxpayer who changes the
method of accounting on the basis of which he regularly
computes his income in keeping his books shall, before
computing his taxable income under the new method,
secure the consent of the Secretary.
In addition, regulations promulgated under section 446 further
clarify the operation of these statutory mandates:
Requirement respecting the adoption or change of
accounting method. (1) A taxpayer filing his first
return may adopt any permissible method of accounting
in computing taxable income for the taxable year
covered by such return. * * *
(2)(i) Except as otherwise expressly provided in
chapter 1 of the Code and the regulations thereunder, a
taxpayer who changes the method of accounting employed
in keeping his books shall, before computing his income
upon such new method for purposes of taxation, secure
the consent of the Commissioner. Consent must be
secured whether or not such method is proper or is
permitted under the Internal Revenue Code or the
regulations thereunder. [Sec. 1.446-1(e)(1) and
(2)(i), Income Tax Regs.]
For purposes of the foregoing rules, a change in accounting
method “includes a change in the overall plan of accounting for
gross income or deductions or a change in the treatment of any
material item used in such overall plan.” Sec. 1.446-
1(e)(2)(ii)(a), Income Tax Regs. A material item, in turn, “is
any item which involves the proper time for the inclusion of the
item in income or the taking of a deduction.” Id.
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However, notwithstanding the breadth of these definitions,
the regulations also offer the following caveat: “Although a
method of accounting may exist under this definition without the
necessity of a pattern of consistent treatment of an item, in
most instances a method of accounting is not established for an
item without such consistent treatment.” Id. Moreover, the
regulatory text details certain types of adjustments, with
examples thereof, that are specifically excluded from
characterization as changes in accounting method:
A change in method of accounting does not include
correction of mathematical or posting errors, or errors
in the computation of tax liability (such as errors in
computation of the foreign tax credit, net operating
loss, percentage depletion or investment credit).
Also, a change in method of accounting does not include
adjustment of any item of income or deduction which
does not involve the proper time for the inclusion of
the item of income or the taking of a deduction. For
example, corrections of items that are deducted as
interest or salary, but which are in fact payments of
dividends, and of items that are deducted as business
expenses, but which are in fact personal expenses, are
not changes in method of accounting. In addition, a
change in the method of accounting does not include an
adjustment with respect to the addition to a reserve
for bad debts or an adjustment in the useful life of a
depreciable asset. Although such adjustments may
involve the question of the proper time for the taking
of a deduction, such items are traditionally corrected
by adjustments in the current and future years. * * * A
change in the method of accounting also does not
include a change in treatment resulting from a change
in underlying facts. On the other hand, for example, a
correction to require depreciation in lieu of a
deduction for the cost of a class of depreciable assets
which had been consistently treated as an expense in
the year of purchase involves the question of the
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proper timing of an item, and is to be treated as a change
in method of accounting. [Sec. 1.446-1(e)(2)(ii)(b), Income
Tax Regs.]
Once a change in method of accounting is identified, the
procedures for securing the Commissioner’s consent are contained
in section 1.446-1(e)(3), Income Tax Regs. To secure such
consent, the taxpayer must “file an application on Form 3115 with
the Commissioner” or, alternatively, must comply with any
administrative procedures the Commissioner might prescribe for
permitting certain types of changes in accounting method. Id.
B. Depreciation Deductions
Depreciation deductions are primarily governed by sections
167 and 168. In relevant part, section 167 provides:
SEC. 167. DEPRECIATION.
(a) General Rule.--There shall be allowed as a
depreciation deduction a reasonable allowance for the
exhaustion, wear and tear (including a reasonable
allowance for obsolescence)--
(1) of property used in the trade or
business, or
(2) of property held for the production of
income.
(b) Cross Reference.--
For determination of depreciation deduction in
case of property to which section 168 applies, see
section 168.
Section 168, in turn, describes a specific depreciation
system for tangible property. Section 168 was added to the
Internal Revenue Code by the Economic Recovery Tax Act of 1981,
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Pub. L. 97-34, 95 Stat. 172, which enacted the accelerated cost
recovery system (ACRS). Then, as part of the Tax Reform Act of
1986, Pub. L. 99-514, secs. 201, 203, 100 Stat. 2122-2123, 2143,
Congress replaced ACRS with a modified accelerated cost recovery
system (MACRS), effective generally for property placed in
service after December 31, 1986, and section 168 was amended
accordingly.
Under MACRS, assets are placed into 1 of 10 classes. See
sec. 168(c), (e). Classifications are assigned either according
to class life or, for certain types of property, by the nature of
the asset. See id. The classification of an item under MACRS
determines two critical elements in calculating the allowable
depreciation: (1) The applicable depreciation method (200
percent declining balance, later switching to straight line; 150
percent declining balance, later switching to straight line; or
straight line), and (2) the applicable recovery period (the
period over which depreciation deductions are taken). See sec.
168(a), (b), and (c). As pertinent here, two of the available
MACRS classifications are 15-year property and nonresidential
real property, which differ both in the required depreciation
method and in the mandated recovery period. See id.
II. Contentions of the Parties
The parties in this matter do not dispute, and have
stipulated, that petitioner’s gas stations are assets of a nature
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which may properly be classified as 15-year property under the
MACRS rules. Rather, their disagreement lies in whether
petitioner’s treatment of the properties as such on tax returns
filed for the years at issue constitutes an unauthorized change
in method of accounting.
Petitioner’s primary contention is that depreciating the gas
stations as 15-year property does not reflect a change in
accounting method within the meaning of section 446(e).
According to petitioner, reclassification of the gas stations as
15-year property is excepted from characterization as a change in
accounting method because the new treatment does not involve a
material item, is analogous to a change in useful life, is a mere
correction, and does not deviate from an established consistent
method of treatment.
In the alternative, even if depreciating the gas stations as
15-year property is deemed a change in accounting method,
petitioner maintains that consent for such change was received
from respondent. Petitioner alleges that respondent’s acceptance
of petitioner’s amended returns for prior years and issuance of
refunds constitutes a sufficient consent for the
reclassification.
Conversely, respondent asserts that petitioner changed its
method of accounting for the gas station properties, without
respondent’s consent, in two respects. In respondent’s
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estimation, petitioner’s reclassification involved changing (1)
the recovery period over which depreciation deductions were to be
claimed from 31.5 or 39 years to 15 years and (2) the method by
which depreciation was to be calculated from straight line to
declining balance. Respondent further avers that these
alterations are not immaterial in that they implicate the timing
of deductions, are not equivalent to a change in useful life, are
not akin to the mere correction of a posting error, and do
diverge from a consistently established method.
It is also respondent’s position that the above change was
made without securing respondent’s consent. Respondent relies on
the fact that petitioner neither filed a Form 3115 nor followed
any other prescribed administrative procedures for effecting such
a change.
III. Application
The initial question raised by this matter is whether
petitioner’s treatment of the gas stations as 15-year property
constitutes a change in accounting method within the meaning of
section 446(e) and related regulations. If such inquiry is
answered in the affirmative, a second question regarding whether
petitioner obtained consent for the change will be presented.
As previously indicated, a change in accounting method for
purposes of section 446(e) is generally defined to encompass a
change in the overall plan of accounting for income or deductions
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as well as a change in the treatment of any material item. See
sec. 1.446-1(e)(2)(ii)(a), Income Tax Regs. A material item, in
turn, is explained by regulations as “any item which involves the
proper time for the inclusion of the item in income or the taking
of a deduction.” Id. This Court has also expounded that “When
an accounting practice merely postpones the reporting of income,
rather than permanently avoiding the reporting of income over the
taxpayer’s lifetime, it involves the proper time for reporting
income.” Wayne Bolt & Nut Co. v. Commissioner, 93 T.C. 500, 510
(1989).
In the case at bar, petitioner altered neither its overall
plan of accounting for income and deductions on an accrual basis
nor its basic system of accounting for depreciation using MACRS.
Petitioner is, however, seeking to switch from deducting the cost
of its gas station properties over a 31.5- or 39-year period on a
straight line basis to writing off these costs over a 15-year
term on a declining balance basis. Such involves the timing of
deductions, not the total amount of lifetime income, and would
thus appear at first blush to be a “material” difference
signaling a change in accounting method.
Yet regulations specifically provide that “a change in the
method of accounting does not include * * * an adjustment in the
useful life of a depreciable asset”, notwithstanding the fact
that “such adjustments may involve the question of the proper
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time for the taking of a deduction”. Sec. 1.446-1(e)(2)(ii)(b),
Income Tax Regs. Therefore, regardless of whether a change might
otherwise be deemed an unauthorized material alteration, the
change will not run afoul of section 446(e) if it falls within
this useful life exception.
Petitioner asks us to find that its revision of the recovery
period used in depreciating its gas stations is the equivalent of
an adjustment in useful life. Respondent, in contrast, argues
that the concept of useful life as employed under prior law
cannot be equated with the designation of a recovery period under
the current accelerated system.
Prior to the 1981 enactment of ACRS, depreciation deductions
were based on estimated useful life, meaning the period over
which an asset could reasonably be expected to be useful to the
taxpayer in his or her business or income-producing activities.
See Liddle v. Commissioner, 103 T.C. 285, 290 (1994), affd. 65
F.3d 329 (3d Cir. 1995). Then, with implementation of the
accelerated system, Congress mandated that depreciation
deductions be taken over one of a limited number of arbitrary
statutory periods. See id. at 291. Yet to the extent that
selection of a useful life under prior law or a recovery period
under current law determines the span of years over which
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property will be depreciated, there would appear to be no
meaningful difference for purposes of the exception in section
1.446-1(e)(2)(ii)(b), Income Tax Regs.
However, the foregoing analogy is complicated by the fact
that, as presently codified in section 168, MACRS inextricably
links recovery period and depreciation method. A
reclassification thus can affect not only the time over which
deductions are taken but also the methodology by which those
deductions are calculated. Such linkage generally did not exist
under earlier statutes2, and previous case law indicates that a
change in depreciation method was not excluded from the consent
requirement. See Standard Oil Co. (Indiana) v. Commissioner, 77
T.C. 349, 410-411 (1981); Casey v. Commissioner, 38 T.C. 357,
384-387 (1962).
Hence, we are faced with a choice. On one hand, to adopt
petitioner’s approach and rule that a reclassification of
property under MACRS should be treated as synonymous with an
adjustment in useful life for purposes of the regulatory
exception would broaden the exception to cover changes not only
in the period for depreciation but also potentially in the method
2
There were some exceptions, see, e.g., former sec. 167(c)
(accelerated depreciation is available only for property with a
useful life of 3 years of more); former sec. 167(j)(5) (sec. 1250
property that is used residential real property qualifies for a
125 percent declining balance method if the property has a useful
life of 20 years or more).
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for calculating depreciation. On the other hand, to accept
respondent’s position and summarily decline to equate the changes
would significantly curtail the exception’s usefulness under the
current section 168 regime.
We conclude that the former option is most consistent with
the regulatory scheme. The similarities between a change in
MACRS classification and a change in useful life are greater than
the differences. Section 1.446-1(e)(2)(ii)(b), Income Tax Regs.,
was clearly intended to permit taxpayers to alter their
depreciation schedules. The type of adjustment explicitly
permitted--a change in useful life--would have resulted both in
depreciation deductions over a longer or shorter period than
originally contemplated and in an increased or decreased amount
being deducted in any given period. A change in MACRS
classification will have precisely these same two effects.
Although a portion of the change in amount may be attributable to
calculation method, as opposed to period length alone, such
carries insufficient weight when balanced against severely
limiting the intended relief.
We therefore hold that the filing of returns for the years
ended in 1996 and 1997 which depreciated the gas stations as 15-
year property did not result in an unauthorized change in
petitioner’s method of accounting. Petitioner’s change in MACRS
classification is excluded from the definition of a change in
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accounting method by reason of analogy to the useful life
exception contained in section 1.446-1(e)(2)(ii)(b), Income Tax
Regs. Accordingly, we need not reach the parties’ other
contentions regarding the existence of a mere correction, a
consistently adopted method, or consent from the Commissioner.
As a final note, we observe that neither party has cited
section 168(e)(3)(E)(iii), enacted as part of the Small Business
Job Protection Act of 1996, Pub. L. 104-188, sec. 1120(a), 110
Stat. 1765. Nor have they asked us to address the application of
Rev. Proc. 97-10, 1997-1 C.B. 628, promulgated under such
statute, to situations similar to that presently before the
Court. We thus express no opinion as to the reach of the useful
life exception in the section 168(e)(3)(E)(iii) context or in
other circumstances where Congress or the Commissioner has
explicitly set forth procedures relating to particular
depreciation adjustments.
To reflect the foregoing and to give effect to concessions,
Decision will be entered
under Rule 155.