Sealy Power, Ltd. v. Commissioner

IN THE UNITED STATES COURT OF APPEALS
FOR THE FIFTH CIRCUIT

No. 93-4269

SEALY POWER, LTD., DONALD E. RUTT,
Tax Matters Partner,

Petitioner-Appellant
Cross-Appellee

versus

COMMISSIONER OF INTERNAL REVENUE,

Respondent-Appellee
Cross-Appellant.

Appeal from a Decision of the United States Tax Court

February 15, 1995

Before HIGGINBOTHAM and WIENER, Circuit Judges, and KAUFMAN*,

District Judge.
WIENER, Circuit Judge:

On the procedural level, Plaintiff-Appellant Sealy Power, Ltd.

(Sealy), a Texas limited partnership, appeals the Tax Court's

determination that the notice of Final Partnership Administrative

Adjustment (FPAA) issued by the Commissioner of Internal Revenue

(Commissioner) did not shift to the Commissioner the burden of

*
District Judge of the District of Maryland, sitting by
designation.
going forward with the evidence. On the substantive level, Sealy

appeals the Tax Court's denial of its claimed depreciation

deductions and energy and investment tax credits.

With respect to the FPAA, we affirm the Tax Court's

determination that such adjustment did not shift to the

Commissioner the burden of going forward with the evidence. In

determining that Sealy's property was placed in service in 1984, we

reverse the Tax Court's ruling on Sealy's entitlement to the

depreciation deductions and credits.

The Commissioner cross-appeals the Tax Court's refusal to

address the pre-operating expense issue concerning the

deductibility of certain of Sealy's expenses. As we conclude that

the Tax Court erred in finding that the Commissioner did not

properly raise the pre-operating expense issue prior to the Rule

155 computation proceeding, we reverse and remand on this point.

FACTS AND PROCEEDINGS

The parties submitted an extensive Stipulation of Facts and

Supplemental Stipulation of Facts which the Tax Court incorporated

by reference in its opinion. The facts necessary to resolve the

disputed issues are set forth below.

In 1983, Sealy engaged the engineering firm Energy

Advancement, Inc. (EAI) to build a power production facility in

Sealy, Texas (the City) on property leased from the City and

2
located next to the City's landfill.1 Sealy's plan was to generate

electricity by incinerating the solid waste deposited in the

landfill and then sell the electricity to Houston Lighting and

Power (HL&P). The electric generating project was an attractive

way for the City to avoid the rising costs of obtaining additional

landfill space, delegate the operation of the landfill, and foster

the creation of alternative energy sources in its community.

Tor Lileng, an EAI engineer, designed and supervised the

construction of the facility. Lileng's design involved acquiring

various ready-made manufacturer components with a certain capacity

rating, constructing foundations for these components, and

connecting them through wiring and piping. Construction began

early in 1983 and the facility was substantially completed that

same year at a cost of approximately $ 3,500,000. In 1984, Sealy

completed its agreement to sell its electricity to HL&P. From the

winter of 1983 through a portion of 1988, Sealy operated the

landfill adjacent to the facility, employing two gatekeepers and

receiving small tipping fees from commercial establishments for

garbage disposal. Under the terms of Sealy's ground lease with the

City, its residents could dispose of their garbage at the landfill

at no charge.

Sealy first operated the incinerator at the facility in 1983.

1
Both general partners of Sealy Power, Jim Connatser and
Donald Rutt, owned minority interests in EAI. Further, Jack
Reber was the President and a 72% shareholder of EAI as well as a
limited partner of Sealy Power, Ltd. EAI devised the Sealy
cogeneration plant project and Sealy provided the financing for
it.

3
Two pieces of equipment in the facility, the feed mechanism and the

ash conveyor, presented minor, correctable difficulties in the

operation of the facility. The most severe problem, however, was

the incinerator, the centerpiece of the facility. The function of

the primary chamber of the incinerator was to burn the garbage into

gases which in turn would be burned in a second chamber and passed

through the vaporizer, steam superheater, and steam turbines to

create energy. The manufacturer of the incinerator had claimed it

would generate 20 million BTUs per hour, but the incinerator never

reached its rated capacity of electricity generation because the

manufacturer had delivered a primary chamber considerably smaller

than the one EAI had specified for Sealy. These equipment

deficiencies prevented the facility from generating commercial

quantities of electricity, so Sealy tried to find investors

willing to provide the additional funds required to correct the

facility's operational problems. After all such efforts failed,

Sealy filed for bankruptcy on July 1, 1988.

A few months earlier, on March 30, 1988, the Commissioner had

issued a notice of Final Partnership Administrative Adjustment

(FPAA) determining that Sealy was not entitled to several

deductions and credits.2 Donald E. Rutt, Sealy's tax matters

partner, then filed a petition for readjustment of partnership

items. The Tax Court ruled against Sealy on all tried issues.

Pursuant to Rule 155 of the Tax Court Rules of Practice and

2
Another issue before the Tax Court, but not involved in
this appeal, was whether Sealy's partners were at-risk within the
meaning of I.R.C. § 465.

4
Procedure, the court required the parties to submit proposed

decision documents consistent with the court's opinion.

Sealy timely objected to the Commissioner's proposed

computation, disallowing deductions for certain expenses incurred

in 1983 and 1984 which the Commissioner deemed to be nondeductible

pre-operating expenses. Sealy maintained that it was entitled to

a deduction for its ordinary business expenses, insisting that the

Commissioner's computation was inconsistent with the Tax Court's

ruling on that point. The Tax Court agreed with Sealy and issued

an order requiring the entry of a new computation. Both Sealy and

the Commissioner timely appealed the respective portions of the

court's decision that were adverse to them.

II

ANALYSIS

A. STANDARD OF REVIEW

Our standard of review for appeals from the United States Tax

Court is the same as for civil actions decided by the district

courts.3 Thus, we review findings of fact under a clearly

erroneous standard and legal conclusions de novo.4

B. THE FPAA NOTICE

The Tax Court held that the nature of the FPAA notice did not

3
26 U.S.C. § 7482(a)(1)(1993)("United States Courts of
Appeals . . . shall have exclusive jurisdiction to review the
decisions of the Tax Court . . . in the same manner and to the
same extent as decisions of the district courts in civil actions
tried without a jury.").
4
See Estate of Clayton v. Commissioner, 976 F.2d 1486, 1490
(5th Cir. 1992).

5
shift to the Commissioner the burden of going forward with the

evidence. Sealy appeals this ruling, arguing that the Commissioner

issued an FPAA that was arbitrary and capricious, thereby meriting

a shift of the burden. Alternatively, Sealy argues that the FPAA

is invalid because it was not a considered determination and that

the Tax Court therefore lacked jurisdiction. The Tax Court did not

make a factual finding of whether the FPAA was arbitrary, but held

instead that Sealy continued to bear the burden of going forward

with the evidence because the FPAA did not involve unreported

illegal income. This presents a question of law which we review de

novo.

The FPAA sent to Sealy noted that the Commissioner had

determined adjustments to the partnership's 1983 and 1984 returns.

The Commissioner listed the adjustments, specifying the items on

the returns which were affected for the tax years in question. In

an attachment to the schedule of adjustments, the FPAA noted that

the Commissioner was disallowing the claimed deductions and credits

because Sealy had not established that its activity had any

economic substance, was engaged in for profit, constituted a trade

or business, or involved property held for the production of

income.

As the prerequisite for litigation over disputed items on a

partnership's return, an FPAA is the functional equivalent of a

notice of deficiency.5 Both the FPAA and the notice of deficiency

serve to notify affected taxpayers that the Commissioner has made

5
See Maxwell v. Commissioner, 87 T.C. 783, 788-89 (1986).

6
a final administrative determination of their liability for

particular tax years.6 We therefore analyze the FPAA here the same

way that we would analyze a notice of deficiency.

The Internal Revenue Code does not specify the form or content

of a valid notice of deficiency. Courts have held, however, that

the notice generally must advise the taxpayer that the Commissioner

has determined a deficiency for a particular year and must specify

the amount of the deficiency or provide the information necessary

to compute the deficiency.7 A determination of deficiency issued

by the Commissioner is generally given a presumption of

correctness, which operates to place on the taxpayer the burden of

producing evidence showing that the Commissioner's determination is

incorrect.8 Several courts have recognized, however, that they

need not give effect to the presumption of correctness and may

instead shift the burden from the taxpayer to the Commissioner when

the notice of deficiency is determined to be arbitrary or

6
See Seneca, Ltd. v. Commissioner, 92 T.C. 363, 368 (1989),
aff'd without opinion, 899 F.2d 1225 (9th Cir. 1990); Clovis I v.
Commissioner, 88 T.C. 980, 982 (1987).
7
See Portillo v. Commissioner, 932 F.2d 1128, 1132 (5th Cir.
1991); Donley v. Commissioner, 791 F.2d 383, 384 (5th Cir. 1986),
cert. denied, 479 U.S. 885, 107 S.Ct. 277, 93 L.Ed.2d 253 (1986).

8
See United States v. Janis, 428 U.S. 433, 441, 96 S.Ct.
3021, 3025, 49 L.Ed.2d 1046, (1976); Helvering v. Taylor, 293
U.S. 507, 514-15, 55 S.Ct. 287, 290-91, 79 L.Ed. 623, (1935);
Welch v. Helvering, 290 U.S. 111, 115, 54 S.Ct. 8, 9, 78 L.Ed.
212, (1933); Portillo, 932 F.2d at 1133.

7
excessive.9 In these cases, the notice of deficiency involved a

determination of unreported income, whether from legal sources, as

in Portillo10, or from illegal sources, as in Jackson11.

We have previously recognized that the reason behind the

burden-shifting principle in an unreported income case is that the

taxpayer bears the difficult burden of proving the non-receipt of

income.12 The Commissioner's determination in such a case

necessarily involves reconstructing income that should have been

reported, potentially leading to questionable results.13 If the

9
See Williams v. Commissioner, 999 F.2d 760, 763-64 (4th
Cir. 1993), cert. denied 114 S.Ct. 442, 126 L.Ed.2d 376 (1993);
Portillo, 932 F.2d at 1133-34; Zuhone v. Commissioner, 883 F.2d
1317, 1325-26 (7th Cir. 1989); Anastasato v. Commissioner, 794
F.2d 884, 887 (3d Cir. 1986); Dellacroce v. Commissioner, 83 T.C.
269, 280, 287 (1984); Jackson v. Commissioner, 73 T.C. 394, 401
(1979). The Supreme Court in Janis recognized that the usual
presumption of correctness does not apply when the government's
assessment constitutes a "`naked' assessment without any
foundation whatsoever." See Janis, 428 U.S. at 441, 96 S.Ct. at
3026, 49 L.Ed.2d at .
Even while carving out this exception to the general rule of
presuming the determination correct, courts have reaffirmed their
reluctance to look behind the notice of deficiency to determine
whether the Commissioner's determination is arbitrary. See
Anastasato, 794 F.2d at 886-67; Dellacroce, 83 T.C. at 280
(1984).
10
932 F.2d at 1130-31, 1134 (subcontractor's unreported
income from contractor).
11
73 T.C. at 396-97, 402 (unreported income from drug
trafficking activities).
12
See Portillo, 932 F.2d at 1133-34; Carson v. United
States, 560 F.2d 693, 698 (5th Cir. 1977).
13
See Portillo, 932 F.2d at 1134 (notice based on unverified
"bald assertion" of third party); Weimerskirch v. Commissioner,
596 F.2d 358, 361-62 (9th Cir. 1979)(notice stemmed from IRS'
"naked assertion" that petitioner had received money from heroin
sales); Jackson, 73 T.C. at 403 ("elaborate construct set out in
the deficiency notice . . . turns out to be sheer gossamer").

8
Commissioner does not substantiate the notice's determination with

some predicate evidence, therefore, the taxpayer should be relieved

of the burden of going forward with the evidence. The issue we

must decide in the instant case is whether the same principle

applies when the notice of deficiency involves not unreported

income but a taxpayer's entitlement to deductions and credits.

In Gatlin v. Commissioner14, the Eleventh Circuit considered

whether the burden-shifting principle for unreported income cases

applies in deduction cases. It held that in a deduction case the

taxpayer at all times retains the burden of going forward with the

evidence that supports the claimed deductions and their amounts,

regardless of the nature of the Commissioner's notice of

deficiency.15 The Gatlin court observed that, unlike the taxpayer

in an unreported income case, the taxpayer with challenged

deductions has reported the full amount of income but has claimed

deductions, reducing the total tax due on the income.16 As the

taxpayer in Gatlin was "privy to the facts that substantiate a

deduction," the court ruled, the Commissioner's notice of

deficiency retained its presumption of correctness until the

taxpayer came forward with evidence to challenge its assessment.17

Several other courts have recognized the distinction between

deduction cases and unreported income cases for purposes of

14
754 F.2d 921 (11th Cir. 1985).
15
See id. at 923.
16
See id. at 924.
17
See id.

9
shifting the burden of production.18

We agree with these courts that the burden-shifting principle

for unreported income cases should not extend to cases in which the

Commissioner rejects deductions or credits claimed by a taxpayer.

The burden of overcoming the presumption of correctness in a

deduction case properly rests with the taxpayer, who is the best

source of information for determining entitlement to the claimed

deductions. In a deduction case, therefore, we apply the general

rule of not looking behind the notice of deficiency to determine

whether it is arbitrary. As the FPAA here challenged Sealy's

entitlement to deductions and credits, not Sealy's failure to

include taxable income, the Tax Court properly preserved the

presumption of correctness in requiring Sealy to continue to bear

the burden of going forward with the evidence.

Sealy also contends that the Commissioner's FPAA was void

ab initio, stripping the Tax Court of jurisdiction in the case,

because it was not a considered determination. Sections 6212(a)

and 6213(a) of the Internal Revenue Code provide that the Tax Court

only has jurisdiction when the Commissioner issues a valid

deficiency notice and the taxpayer files a petition for

18
United States v. Walton, 909 F.2d 915, 918-19 (6th Cir.
1990); LaBow v. Commissioner, 763 F.2d 125, 131-32 (2d Cir.
1985); Foster v. Commissioner, 756 F.2d 1430, 1439 (9th Cir.
1985), cert. denied, 474 U.S. 1055, 106 S.Ct. 793, 88 L.Ed.2d 770
(1986); Chaum v. Commissioner, 69 T.C. 156, 163-64 (1977). See
also Bennett Paper Corp. v. Commissioner, 699 F.2d 450, 453 (8th
Cir. 1983)(rejecting taxpayer's argument that assessment was
arbitrary, as burden of proof lies with taxpayer to show right to
claimed deduction).

10
redetermination.19 The partnership cites to Scar v. Commissioner20,

one of but a handful of cases in which a court of appeals has

invalidated a notice of deficiency upon finding that the

Commissioner had failed to make a considered determination.21

Sealy's reliance on Scar is misplaced. In Scar, the notice

referred to a tax shelter that had no connection to the taxpayers

or their return and stated that, because the taxpayers' return was

not available, the Commissioner was imposing the maximum tax rate

to the adjustment amount.22 This led the court to conclude that,

on its face, the purported notice of deficiency revealed that the

Commissioner had not examined the taxpayers' return for the year in

dispute and therefore had not made any determination of tax

deficiency.23

We have previously held that courts have interpreted the term

"determination" to mean, for purposes of Section 6212(a), a

"thoughtful and considered determination that the United States is

19
See Stamm Int'l Corp. v. Commissioner, 84 T.C. 248, 251-52
(1985).
20
814 F.2d 1363 (9th Cir. 1987).
21
The court in Scar found that the notice of deficiency did
not meet the requirement in Section 6212(a) that the Commissioner
"determine that a deficiency exists before issuing a notice of
deficiency." See Scar, 814 F.2d at 1370. As a valid notice of
deficiency is a necessary basis for Tax Court jurisdiction, the
court concluded that the Tax Court should have dismissed the
action for want of jurisdiction. See id.
22
See id. at 1365.
23
See id. at 1368-70.

11
entitled to an amount not yet paid.24" A review of the FPAA here

shows that, unlike the putative determination in Scar, the

Commissioner did consider Sealy's return in determining the

adjustments listed in the FPAA. The FPAA set out the adjustment

items for each year, enabling Sealy to determine its deficiency.

It also explained in an attachment the reasons for the

Commissioner's adjustments.25 Sealy's argument that the FPAA was

broadly drafted and that the Commissioner's review was faulty is

unavailing.26 The FPAA on its face reflects that the Commissioner

24
See Portillo v. Commissioner, 932 F.2d 1128, 1132 (5th
Cir. 1991)(quoting Scar, 814 F.2d at 1369).
25
The Commissioner later stipulated that Sealy had never
been a sham and that it had a valid business purpose during 1983
and at all times thereafter, contradicting two of its reasons
stated in the FPAA for disallowing Sealy's deductions and
credits. This does not affect our finding that the Commissioner
issued a "thoughtful and considered determination," however. The
Commissioner, in considering a taxpayer's return and
"determining" a deficiency, may challenge items for reasons that
the parties can later clarify or correct when they confer and
exchange necessary facts and documents. See Foster v.
Commissioner, 80 T.C. 34, 230
(1983)(noting usefulness of parties informally conferring to
narrow issues), aff'd and vacated on other grounds, 756 F.2d 1439
(9th Cir. 1985).
A notice of deficiency, which merely serves as a warning to
the taxpayer that the Commissioner has assessed a deficiency and
plans to hail the taxpayer into court, need not give any reasons
for the assessment of a deficiency. See Scar, 814 F.2d at 1367;
Clapp v. Commissioner, 875 F.2d 1396, 1403 (9th Cir. 1989). On
rare occasions, as in Scar, however, the reason given on the face
of the notice reveals that the Commissioner failed to make a
determination. The Commissioner's grounds for making the
adjustments in Sealy's FPAA, unlike the erroneous explanation and
imposition of an arbitrary tax rate in Scar, do not reveal that
the Commissioner failed to make a "determination" for purposes of
the Tax Court's jurisdiction.
26
See Riland v. Commissioner, 79 T.C. 185, 199-201
(1982)(notice valid despite Commissioner's violation of internal
procedures); Estate of Brimm v. Commissioner, 70 T.C. 15, 22-23

12
made a "determination" for purposes of the Tax Court's

jurisdiction.27

As the FPAA constituted a valid determination entitled to a

presumption of correctness, we conclude that the Tax Court properly

required Sealy to bear the burden of going forward with the

evidence after it challenged the Commissioner's adjustments in the

FPAA to Sealy's deductions and credits.

C. "PLACED IN SERVICE"

Sealy claimed a biomass energy tax credit and an investment

tax credit in 1983, as well as depreciation deductions in 1983 and

1984. The Commissioner disallowed these items in the FPAA and

Donald Rutt, as Sealy's tax matters partner, filed a petition in

Tax Court for readjustment of partnership items. The Tax Court

upheld the Commissioner's determination, finding that the property

(1978)(notice valid even though taxpayer argued that Commissioner
perfunctorily performed review functions and used flawed
procedures); Greenberg's Express, Inc. v. Commissioner, 62 T.C.
324, 327-30 (1974)(notice valid despite allegation that
Commissioner discriminatorily selected taxpayer for audit).
27
Sealy also refers to our decision in Pearce v.
Commissioner, No. 91-4178 (5th Cir. 1991)(unpublished opinion),
in which we held that the Tax Court lacked jurisdiction because
the notices were void ab initio. The notices reflected "gross
ineptitude" on the part of the Commissioner because they ignored
the filing status designation on the taxpayer's return, applied
an incorrect tax rate, and ignored claimed exemptions.
The facts of the instant case differ greatly. As we have
noted, the FPAA sent to Sealy did not reveal a lack of a
considered determination because it referred to disputed items in
Sealy's return and explained the Commissioner's reasons for the
adjustments. We rejected a similar argument in Portillo where,
as here, the Commissioner had considered information directly
relating to the taxpayer's income tax return and had investigated
whether a deficiency existed. See Portillo v. Commissioner, 932
F.2d 1128, 1132 (5th Cir. 1991).

13
in Sealy's facility was never "placed in service"SQnot in 1983, not

in 1984, not everSQand that, therefore, Sealy was not entitled to

its claimed depreciation deductions and investment tax credits.

Several provisions of the Internal Revenue Code are implicated

in this appeal. Section 167(a)28 provides that a depreciation

deduction is allowed for property used in the taxpayer's trade or

business or for property held for the production of income.

Section 38(a) allows for investment and energy tax credits; Section

46 outlines the calculation of the investment tax credit amount,

and Section 48 defines property eligible for the credits. The

pertinent portions of Section 48 state that the credits are

available for certain "biomass property29" and for "tangible

personal property" and "other tangible property," but only if the

"other tangible property" is used as an integral part of a

qualifying activity.30

Treasury Regulation 1.167(a)-11(e)(1)(i)31 states that property

is first placed in service for purposes of the depreciation

deduction when it is "placed in a condition or state of readiness

and availability for a specifically assigned function, whether in

a trade or business, in the production of income, in a tax-exempt

activity, or in a personal activity." For purposes of the

28
All section references are to the Internal Revenue Code of
1954 as amended and in effect during the years in issue.
29
See I.R.C. § 48(l)(15)(1984).
30
See I.R.C. §§ 48(a)(1)(A); 48(a)(1)(B)(1984).
31
(1984).

14
investment tax credit, Treasury Regulation 1.46-3(d)(1)(ii)32

defines the time that Section 38 property is "placed in service" as

the taxable year in which such property is "placed in a condition

or state of readiness and availability for a specifically assigned

function, whether in a trade or business, in the production of

income, in a tax-exempt activity, or in a personal activity."

Courts have interpreted the regulations' identically-worded "placed

in service" tests for depreciation deductions and tax credits in

the same manner.33

1. Component Parts v. Facility as a Whole

The Tax Court properly ruled that the component assets of

Sealy's facility were all tangible personal property within the

meaning of Section 48(a)(1)(A) as well as Section 38 property

qualifying for depreciation and the energy and investment tax

credits if and when placed in service.34 Sealy asserts that the

"placed in service" test should apply separately to each of these

components of the facility rather than to the facility as a whole.35

32
(1984).
33
See Armstrong World Indus., Inc. v. Commissioner, 974 F.2d
422, 431-36 (3d Cir. 1992); Oglethorpe Power Corp. v.
Commissioner, 60 T.C.M. (CCH) 850, 859 (1990); Consumers Power
Co. v. Commissioner, 89 T.C. 710, 723 (1987).
34
The Tax Court listed the facility as containing a hopper
with a screw/auger feeder, an incinerator, a tractor, a conveyor,
and various pieces of equipment such as a vaporizer, steam
superheater, separator, expander, and steam turbines. These are
all in the nature of machinery and equipment, which the
Regulation deems to be "tangible personal property." See Treas.
Reg. § 1.48-1(c).
35
Sealy argues in the alternative that it is entitled to
depreciation and investment tax credits because its tangible

15
As each of the items of machinery and equipment comprising the

facility was in a condition of being "ready and available for a

specifically assigned function" in the facility, Sealy argues, the

partnership was entitled to depreciation and investment tax credits

on these items even if the facility is deemed not to have been

operational. This approach, however, does not conform to the

analysis of Revenue Rulings and cases dealing with the "placed in

service" requirement.

In Revenue Ruling 73-51836, the Commissioner stated that a

major electrical transmission line was not placed in service, even

though it was complete, until the substations at the end of the

line were completed and the line could be energized. As the

substations were parts of the system and were necessary for the

transmission of electricity, both the transmission line and the

substations were first placed in service when the whole system was

first available for service. Revenue Ruling 76-23837 adopted a

similar approach in noting that individual units of production

machinery and equipment acquired for use in a factory were not

personal property is subject to a different "placed in service"
test than "other tangible property." The partnership refers to
the distinction between § 48(a)(1)(A), "tangible personal
property," which qualifies for the investment tax credit
"irrespective of whether it is used as an integral part" of a
qualified activity, and § 48(a)(1)(B), "other tangible property,"
which qualifies for the credit only if it used as an integral
part of a qualifying activity. See Treas. Reg. § 1.48-1(c), (d).
In view of our disposition of this case, we need not and
therefore do not reach the merits of this argument.
36
1973-2 C.B. 54.
37
1976-1 C.B. 55.

16
placed in service until they were installed in the production line

and the entire production line had been completed. This ruling

further observed that on the completion of the entire production

line, the "line was available for the production of an acceptable

product, notwithstanding later testing to eliminate defects which

prevented attainment of planned production levels or the meeting of

acceptable quality control parameters.38" Both rulings indicate

that components are not to be considered placed in service

separately from the system of which they are an essential part.

The Tax Court in several cases has embraced the Revenue

Rulings' approach of examining, for purposes of the "placed in

service" test, property in a project as a whole when a number of

interdependent components are designed to operate as a system. In

these cases, the Tax Court has found that an individual component,

incapable of contributing to the system in isolation, is not

regarded as placed in service until the entire system reaches a

condition of readiness and availability for its specifically

assigned function.39 Other circuit courts have used the same

38
See id.
39
See, e.g., Siskiyou Communications, Inc. v. Commissioner,
60 T.C.M. (CCH) 475, 478-79 (1990)(telephone switching equipment
and toll carriers not placed in service even though capable of
performing individual functions because wiring for system not
completed and employees not trained in system's use); Consumers
Power Co. v. Commissioner, 89 T.C. 710, 725-26 (1987)(upper
reservoir component of pumped storage hydroelectric plant not
placed in service until entire plant placed in service because
physical plant and reservoir operated simultaneously as one
integrated unit to produce electrical power).

17
approach as the Tax Court.40 We agree with these courts' approach

and find that the Tax Court appropriately treated the assets of

Sealy's facility as functionally forming a single property for

purposes of the "placed in service" determination.

As our focus is on Sealy's facility as a whole, it is

necessary to determine the type or kind of facility involved.

Sealy contends that in determining whether the facility has been

placed in service, it should be treated as a waste disposal

facility rather than an electric generating facility. Sealy refers

to the parties' stipulation that the partnership's stated purpose

was to "acquire, fund, and operate a unique waste disposal facility

and the adjacent landfill" and emphasizes that the stipulation does

40
See, e.g., Hawaiian Indep. Refinery, Inc. v. United
States, 697 F.2d 1063, 1069 (Fed. Cir. 1983), cert. denied 464
U.S. 816, 104 S.Ct. 73, 78 L.Ed.2d 86 (1983)(two offsite
components not considered separately from refinery in determining
applicable construction date because all were designed and
constructed as single unit and together they functionally formed
single property); Public Serv. Co. v. United States, 431 F.2d
980, 983-84 (10th Cir. 1970)(component assets of electric power
plant not considered separately for "placed in service"
determination because no one of them would serve any useful
purpose until fitted together to constitute a complete unit).
The Hawaiian and Public Service cases dealt with the date of
acquisition or construction of qualifying property under the
investment tax credit provisions and not the "placed in service"
date of qualifying property as in the instant case. We note,
however, that the concepts are sufficiently similar to serve as
an analogue for the "placed in service" determination.
The Third Circuit in Armstrong World Indus., Inc. v.
Commissioner, 974 F.2d 422, 432-35 (3d Cir. 1992), reviewed the
caselaw relevant to the "placed in service" test for a railroad
project with individual components and concluded that unlike the
component parts of the projects in Consumers, Siskiyou, Hawaiian,
and Public Serv., each completed train track segment in Armstrong
had independent utility and was placed in service prior to the
time all of the project components were completed and available
for use.

18
not mention the generation of electricity. Like the Tax Court

before us, however, we are not persuaded by this argument. Clearly

the substance of Sealy's intended business activity was to make a

profit from the sale of electricity generated from incinerating the

landfill's solid waste. Electricity generation was the feature

that made the facility "unique" as described in the stipulation.

The small tipping fees Sealy collected from commercial businesses

which were disposing of their waste were insignificant relative to

Sealy's investment in the facility. Further, Sealy's waste

disposal activitySQmaintaining a fuel sourceSQwas merely a

tangential part of the primary function of its trade or business,

producing electricity. The "placed in service" analysis,

therefore, is properly focused on the property's contribution to

Sealy's objective of generating electricity in its facility.

2. The Tax Court's Interpretation of the "Placed in
Service" Regulations

The Tax Court stated that it did not need to decide whether

the facility as a whole satisfied each of the five "placed in

service" factors outlined in various Revenue Rulings. It instead

looked to its prior decisions in Oglethorpe Power Corp. v.

Commissioner41 and Consumers Power Co. v. Commissioner42, two other

cases involving electric generating facilities, and ruled that

Sealy's facility was not placed in service because, having failed

ever to achieve its anticipated electricity output levels, it never

41
60 T.C.M. (CCH) 850 (1990).
42
89 T.C. 710 (1987).

19
operated on a regular basis.

a. Consumers Power Co. v. Commissioner

In Consumers, the Tax Court found that a unit contained in a

pumped storage hydroelectric plant was not placed in service in

1972, the year for which the taxpayer had claimed depreciation

deductions and investment tax credits.43 In that year, the unit had

not yet completed the preoperational testing phase required by the

Federal Power Commission and had not been formally accepted from

the contractor.44 The Consumers court also observed that even

though the unit had pumped water into the reservoir and generated

electrical power during the testing phase in 1972, the amount of

electrical power generated was "insufficient to establish that the

. . . [p]lant was available for full operation on a regular basis

in 1972."45 It concluded that the unit was not in a state of

readiness and availability for its specifically assigned function

until it had completed all phases of the governmentally mandated

preoperational testing.

The Tax Court in Consumers did not rest its opinion on the low

43
The court explained that a pumped storage plant provides
supplemental electrical power during periods of peak energy
demands by releasing water from an elevated reservoir to another
reservoir below. The water flows through a turbine generator on
the way down, thereby producing electrical power. See Consumers,
89 T.C. at 716-17 (quoting Stanley Works v. Commissioner, 87 T.C.
389, 391 (1986)). In Consumers, Lake Michigan served as the
lower reservoir for the plant and the unit that was the subject
of the opinion was composed of a tunnel, pumphouse, and a pump-
turbine generator. See id. at 717.
44
See id. at 717-19, 724.
45
See id. at 724.

20
amount of power generated from the unit. Rather, it held that the

unit was not placed in service until after it had successfully

completed testing. Yet in referring to the small amount of power

output as support for its conclusion, the court implicitly adopted

the Commissioner's argument that the unit was not placed in service

in 1972 because, inter alia, it did not show sustained, regular

generation of electrical power. The opinion does not reveal the

source of the Tax Court's adoption of this standard. It merely

cites to the Tax Court's previous decisions in Noell v.

Commissioner46 and Madison Newspapers, Inc. v. Commissioner47, both

of which are distinguishable and inapposite.

The Tax Court in Noell had held that a new airport runway was

not placed in service until it was paved and available for regular

use, even though some pilots occasionally took the risk and used

the rocky strip for landings prior to the runway's completion.48

Unlike the fully-constructed unit in Consumers, however, the runway

in Noell was under construction and never completed in the year for

which the taxpayer had claimed the investment credit.49

Likewise, the Consumers court's reliance on Madison Newspapers

sheds no light on the Tax Court's insistence on a facility's

46
66 T.C. 718 (1976).
47
47 T.C. 630 (1967), acq., 1975-2 C.B. 2.
48
See Noell, 66 T.C. at 729.
49
See id. The Tax Court in the instant case cited to Noell
as support for its conclusion as well, even though Sealy's
electric generating facility was completed in 1983 except for a
few minor pieces of heat-recovering equipment.

21
ability regularly to achieve its anticipated output before it may

qualify for the investment tax credit and depreciation. In Madison

Newspapers, the Tax Court held that the taxpayer was entitled to

the investment tax credit for three units of an eight-unit printing

press, even though those three units were on the taxpayer's

premises before the entitlement period for the credit began,

because the taxpayer "acquired" the units only when they were

installed and accepted by the taxpayer as ready for commercial

operation under the contract.50 The Tax Court in Consumers

mischaracterized the holding in Madison Newspapers as implying that

publishing newspapers on a regular basis had been a prerequisite

for its finding that three units of a printing press were placed in

service.51 In truth, though, installation and readiness had been

the controlling factors for the acquisition date in Madison

Newspapers.

b. Oglethorpe Power Corp. v. Commissioner

In the only other Tax Court opinion involving the "placed in

service" determination for an electric generating facility,

Oglethorpe Power Corp. v. Commissioner52, the Tax Court did look to

50
See Madison Newspapers, 47 T.C. at 637. The taxpayers in
Madison Newspapers wanted a later date of acquisition because
under the controlling statute at the time, the investment tax
credit only applied to their property if it was acquired after
December 31, 1961. See id. at 634.
51
See Consumers, 89 T.C. at 723.
52
60 T.C.M. (CCH) 850 (1990).

22
the Revenue Ruling factors for guidance.53 The Tax Court's analysis

of the factors, however, was clearly influenced by its earlier

insistence in Consumers on a facility's ability to sustain power

generation near rated capacity before it could be deemed to have

been placed in service. The Tax Court held that the taxpayer's

unit was placed in service in 1982, and not 1981 as the

Commissioner had argued, because in 1982 the unit completed the

testing required by the Georgia Public Service Commission.54 The

Commission would not consider the unit for rate-making purposes

unless it had completed testing. Further, under the terms of the

taxpayer's operating agreement with Georgia Power, which

constructed the unit, the taxpayer would not have control or the

right to income from the unit until it was declared to be in

"commercial operation" after completion of testing.55

Even though the Oglethorpe unit had been synchronized and was

producing power during test period operation in 1981, it was not in

53
The Revenue Ruling factors as cited by the Tax Court are:
1) having obtained the necessary permits and licenses for
operating; 2) having performed all critical tests necessary for
proper operation; 3) placing the unit in the control of the
taxpayer; 4) having synchronized the unit with the transmission
grid; and 5) daily operation of the unit. See id. at 860. We
discuss these factors' application to Sealy later in this
opinion.
54
See id. at 859, 864. The property of the Oglethorpe plant
was transferred in safe harbor leases, making the "placed in
service" date a crucial issue. The petitioner, Oglethorpe Power,
wanted the later date because under Section 168(f)(8) of the
Code, the property had to have been leased within three months
after such property was placed in service to be deemed "qualified
leased property." See id. at 859.
55
See id.

23
the control of the taxpayer, did not have the necessary permits,

and was still undergoing testing.56 The Tax Court did not rest its

opinion on the balance of these Revenue Ruling factors, however.

Relying on Consumers, the court in Oglethorpe stated that the unit

was not deemed to be placed in service in 1981 because it was not

available for its specifically assigned function, which the court

defined as consistently sustaining generation levels near its rated

capacity.57

Adopting and extending its prior approaches in Oglethorpe and

Consumers, the Tax Court in the instant case totally disregarded

the Revenue Ruling factors and instead placed great weight on the

purpose stated in Sealy's Certificate of Limited Partnership, i.e.,

that the facility was designed to generate 38,400 kilowatt hours of

electricity per day. The court noted that, because Sealy's

facility only generated a small amount of electricity while it was

operational, it did not fulfill its specifically assigned function

of generating the projected amount of electricity and therefore was

never placed in service. This narrow interpretation of the "placed

in service" standard contravenes the policy behind the investment

56
See id. at 855-57.
57
See id. at 861. We find interesting the fact that the
Commissioner argued in Oglethorpe that the facility should be
considered to have been placed in service in 1981, even though it
had not completed testing then, because it met its specifically
assigned function of producing electricity in that year and had
been synchronized. We agree with the Commissioner's then-
unsuccessful argument in Oglethorpe that the Treasury Regulation
would have no meaning if "operational" were defined as
"functioning perfectly or near perfectly" and that the production
of income is not necessary to find that a unit is placed in
service. See id. at 862-63.

24
tax credit and the applicable Regulation examples as well.

We conclude that the Tax Court erred in applying an unduly

restrictive "placed in service" test that requires regular

operation as measured by the amount generated. The appropriate

method for determining the year that an electric generating

facility is placed in service is to analyze a taxpayer's fact

situation, using a common-sense approach in the context of the

policy behind the investment tax credit, the Treasury Regulations

defining "placed in service," and the Revenue Ruling factors. As

we disagree with the Tax Court's interpretation of the legal

standards defining when an asset is placed in service, our review

of the "placed in service" determination for Sealy's facility is de

novo.

3. The Meaning of "Placed in Service"

The legislative history related to the investment credit

indicates that, contrary to the Tax Court's interpretation of the

"placed in service" requirement, Congress did not intend to impose

the stringent requirement of regular achievement of anticipated

production levels when it created the credit. In addition, the

Commissioner's own regulations interpreting the relevant statutory

provisions support our interpretation of the phrase "placed in

service." These regulations do not require that property entitled

to depreciation and credits must first meet expected output goals

before it may be deemed to have been placed in service58; to the

58
Treasury Regulations 1.167(a)-11(e)(1)(i) and 1.46-
3(d)(1)(ii) merely state property is placed in service when it is
"placed in a condition or state of readiness and availability for

25
contrary, these regulations reveal that defectively or

disappointingly performing property may still be considered to have

been placed in service. For these reasons, we reject the Tax

Court's narrow analyses of the "placed in service" determination in

Oglethorpe and Consumers.

Congress enacted the investment tax credit to stimulate the

economy by encouraging investment in machinery, equipment, and

certain other property.59 In the legislative history related to the

Energy Tax Act of 1978, Congress stated that the purpose of the

energy tax credit was to encourage taxpayers' expenditures towards

the use of renewable, alternative energy sources.60

These credits provide an incentive to acquire property such as

machinery and equipment by lowering the effective after-tax

acquisition cost of the qualified property, which in turn increases

the rate of return on these assets. The legislative history

dealing with the investment tax credit noted that the increased

cash flow would be particularly important for new and smaller

firms, like Sealy, which did not have ready access to the capital

a specifically assigned function, whether in a trade or business,
in the production of income, in a tax-exempt activity, or in a
personal activity."
59
See S. Rep. No. 1881, 87th Cong., 2d Sess. 11 (1962),
reprinted in 1962 U.S.C.C.A.N. 3297, 3304, 3313. See also
Comdisco, Inc. v. United States, 756 F.2d 569, 572 (7th Cir.
1985)("legislative history . . . reveals the hope of Congress
that the credit would stimulate economic growth by providing
substantial incentive to undertake capital investment projects").
60
S. Rep. No. 529, 95th Cong., 2d Sess. 1, 6-11 (1978),
reprinted in 1978 U.S.C.C.A.N. 7942, 7945-49.

26
markets.61 The credit would lower the profit risk that these firms

faced in starting out a new venture and therefore would facilitate

their investment decisions.62

Courts have often recognized the notion that the "investment

tax credit should be construed liberally in light of its

purposes."63 The Tax Court's reading of "specifically assigned

function" as achieving ideal or near ideal production levels,

however, demands a hindsight approach to the success of a

taxpayer's investment expenditures which undermines the very focus

of the credits' incentive, the initial investment decision.

Further, the Commissioner's own interpretations of the

statute in the relevant Regulations support a less restrictive

examination of the contribution of property to the business for the

"placed in service" determination. This common-sense approach

stops short of requiring a new business to achieve a certain level

of production in order to qualify for the credit. In defining

"placed in service," Treasury Regulation 1.46-3(d)(1)(ii)64 neither

states nor implies that the property must produce an anticipated or

projected amount before it may be considered ready and available

61
See S. Rep. No. 1881, reprinted in 1962 U.S.C.C.A.N. at
3314.
62
See id.
63
See Morrison, Inc. v. Commissioner, 891 F.2d 857, 864
(11th Cir. 1990); Illinois Power Co. v. Commissioner, 792 F.2d
683, 685 (7th Cir. 1986); Illinois Cereal Mills, Inc. v.
Commissioner, 789 F.2d 1234, 1239 (7th Cir. 1986), cert. den.,
479 U.S. 995, 107 S.Ct. 600, 93 L.Ed.2d 600.
64
(1984).

27
for a specifically assigned function. Neither do the examples in

Treasury Regulation § 1.46--3(d)(2)(ii) and (iii)65SQillustrating

when property acquired for use in a trade or business or for the

production of income is placed in serviceSQsupport the Tax Court's

unduly strict construction of the statute.

One Regulation example of property placed in service for a

taxable year is operational farm equipment acquired during the

taxable year but not used because it is not practicable to use such

equipment for its specifically assigned function in the taxpayer's

business of farming until the following year.66 This example does

not imply that the farming operation has to produce crops at or

near its expected level in order for the equipment to be placed in

service. To the contrary, this example contemplates that it may

not be practicable to use some assets acquired for the farming

business if the business' output does not present a need for the

additional equipment at the present time.

Another Regulation example of property placed in service is

equipment acquired for a specifically assigned function which is

operational but is undergoing testing to eliminate any defects.67

This example acknowledges that defective performanceSQpresumably

performance below that which was anticipated or projectedSQdoes not

65
(1984)
66
See Treas. Reg. §1.46-3(d)(2)(ii)(1984).
67
See Treas. Reg. § 1.46-3(d)(2)(iii)(1984).

28
bar an asset's "placed in service" designation.68

4. The Sealy Facility Was Placed in Service in 1984

Our de novo review of the "placed in service" determination

for Sealy's facility in light of the relevant legislative history,

Treasury Regulations, and Revenue Rulings leads us to conclude that

the facility was placed in service in 1984 for purposes of

depreciation and the energy and investment tax credits.

a. The Revenue Ruling Factors

The Commissioner has issued several Revenue Rulings dealing

with the "placed in service" requirement for electric generating

facilities and these have described five factors to be considered

in determining whether property has been placed in service for

purposes of depreciation and tax credits. As the factors have

evolved from examining specific facts related to each ruling's

particular facility, they are only indicative of "placed in

service" or "operational" status and are not all necessary to a

finding that a facility has been placed in service.69 Unlike

68
Rev. Rul. 76-428, 1976-2 C.B. 47, provides additional
support for this approach. The electric generating unit in this
ruling was deemed to have been placed in service in the year when
"all equipment was performing its specifically assigned function,
that is, operating as a unit even though equipment was still
undergoing testing to eliminate any defects and to demonstrate
reliability."
69
See Rev. Rul. 84-85, 1984-1 C.B. 10 (stating that although
another Revenue Ruling found taxpayer's facility had been placed
in service when it was able to operate at rated capacity without
failure, this level of operation was not prerequisite but merely
fact demonstrative of operational status). See Oglethorpe Power
Corp. v. Commissioner, 60 T.C.M. (CCH) 850, 860
(1990)(recognizing that "placed in service" determination

29
Treasury Regulations, Revenue Rulings do not have the presumptive

force and effect of law but are merely persuasive as the

Commissioner's official interpretation of statutory provisions.70

As noted earlier, the Revenue Ruling factors are: 1) whether

the necessary permits and licenses for operation have been

obtained; 2) whether critical preoperational testing has been

completed; 3) whether the taxpayer has control of the facility; 4)

whether the unit has been synchronized with the transmission grid;

and 5) whether daily or regular operation has begun.71 Considering

and balancing these factors as applied to the items of personal

property in Sealy's facility convinces us that the facility did

become "operational" and was placed in service, and that 1984 was

the year in which that occurred.

i. Permits and Licenses

A review of the pertinent documents in the record, which the

parties stipulated were authentic, reveals that by 1983 Sealy had

obtained the necessary permits and licenses for operation of its

electric generating facility. The Texas Department of Health in

1982 authorized EAI to operate the facility as an energy recovery

requires consideration and balancing of all factors).
70
See Foil v. Commissioner, 920 F.2d 1196, 1201 (5th Cir.
1990); Stubbs, Overbeck & Assocs., Inc. v. United States, 445
F.2d 1142, 1146-47 (5th Cir. 1971); Macey's Jewelry Corp. v.
United States, 387 F.2d 70, 72 (5th Cir. 1967).
71
See Rev. Rul. 84-85, 1984-1 C.B. 10; Rev. Rul. 79-203,
1979-2 C.B. 94; Rev. Rul. 79-98, 1979-1 C.B. 103; Rev. Rul. 79-
40, 1979-1 C.B. 13; Rev. Rul. 76-428, 1976-2 C.B. 47; Rev. Rul.
76-256, 1976-2 C.B.46.

30
site.72 In 1983, the Texas Air Control Board notified EAI by letter

that Sealy's facility would be exempt from its permit requirements

because of the Board's determination that the incinerator would not

make a significant contribution of air contaminants to the

atmosphere.

ii. Critical Preoperational Testing

As for the second factor, Lileng, the EAI engineer who

designed Sealy's facility, testified that no testing was necessary

because the facility's components were ready-made parts that would

function appropriately in the system if they were not defective.

Lileng's testimony was not contradicted at trial. In acquiring the

components for Sealy's facility, EAI provided the manufacturers

with the specific rating levels and capacities required for EAI's

design. Unlike the highly complex component systems in Revenue

Ruling 76-25673, therefore, the components used in the Sealy

facility did not have to pass a critical testing stage before the

facility could operate. Similarly, Sealy's facility did not need

to undergo a preoperational testing program as did the facility in

Revenue Ruling 76-428.74

iii. Control of the Facility

Sealy met the indicia of physical and legal control of the

72
EAI constructed, managed, and operated the facility on
behalf of Sealy under its management agreement with the
partnership.
73
1976-2 C.B. 46.
74
1976-2 C.B. 47.

31
electric generating facility by 1984.75 In 1982, the partnership

entered into an agreement with the City for the site property and

the lease was signed at the end of 1983. In 1983, Sealy acquired

the component parts and hired EAI to assemble them according to

EAI's design of the facility. EAI completed construction of the

facility for Sealy in the same year. Under Sealy's management

agreement with EAI, Sealy retained the risk of loss while EAI

constructed, managed and operated the facility on behalf of Sealy.

EAI was obligated to indemnify Sealy and hold it harmless from any

liabilities or obligations arising from the malfunction of the

facility due to EAI's gross negligence or willful misconduct. The

agreement also specified that EAI would contract for insurance at

Sealy's expense, insuring Sealy and EAI for any loss or damage to

the facility, for products liability, and for general liability.

Sealy had title to the facility at all times and had the legal

right to enforce the warranties that EAI obtained from the

manufacturers of the equipment for the facility. Sealy also

obtained a license for the use of EAI's patented high-pressure

75
Rev. Rul. 76-428, 1976-2 C.B. 47, stated that the taxpayer
met this "placed in service" factor because it had physical
control of the unit as well as the legal attributes of ownership
such as title, risk of loss, and liability. In Rev. Rul. 79-98,
1979-1 C.B. 103, however, a taxpayer who had not yet formally
accepted the unit from the contractor and therefore did not carry
the risk of loss nevertheless qualified for the credit. The
taxpayer had title to the material and equipment incorporated in
the unit and had agreed to obtain nuclear liability insurance,
property insurance applicable to all nonnuclear occurrences, and
an agreement of indemnification for public liability claims. The
contractor had agreed to maintain insurance for occurrences prior
to unit acceptance involving its materials and equipment and the
taxpayer's property.

32
vaporizing process.

iv. Synchronization Into the HL&P Grid

Synchronization of an electric generating facility refers to

the stage at which alternating current systems, generating units,

or a combination thereof are connected and operate at the same

frequency so that the voltages between the systems remain

constant.76 Some Revenue Rulings have used the date of a facility's

synchronization as a "placed in service" indicator.77 The Tax

Court made no factual finding as to what year Sealy's facility was

synchronized into the HL&P grid, and the trial testimony was

conflicting as to this fourth Revenue Ruling factor. Lileng

testified that Sealy's facility was connected to HL&P in 1983 to

enable HL&P to monitor the electricity output and that there was no

need for synchronization at the facility because, through the use

of induction generators, it automatically mirrored the voltage and

phase of HL&P. The "synchronization factor" would then be

irrelevant here as the Sealy facility would be distinguishable from

the facilities described in the Revenue Rulings which required

synchronization as a prerequisite to generating electricity for

another system.

Lileng's testimony was contradicted by that of IRS agent

Leanna Cantu, who testified from notes taken when she interviewed

76
See Oglethorpe Power Corp. v. Commissioner, 60 T.C.M. 850,
853 (1990).
77
See Rev. Rul. 76-256, 1976-2 C.B. 46; Rev. Rul. 76-428,
1976-2 C.B. 47; Rev. Rul. 79-98, 1979-1 C.B. 103; Rev. Rul. 79-
203, 1979-2 C.B. 94.

33
Sealy partner Donald Rutt as part of the IRS audit. Her notes

reflected that, as of the date of the interview in 1985, the

facility had not yet been synchronized into the HL&P grid. Rutt,

however, testified that he had never used the term "synchronized"

in his conversation with Agent Cantu.

As the Tax Court failed to make a factual finding on this

point, we cannot on appeal make a factual finding in the first

instance.78 Even so, as we have stated previously, neither the

presence nor absence of any one of the Revenue Ruling factors is

dispositive of the "placed in service" determination. In the

instant case, we find that the remaining Revenue Ruling factors

plus additional factual circumstances relevant to the Sealy

facility supply sufficient indicia of Sealy's operational status in

1984.

v. Daily or Regular Operation of Facility

As for this final factor, the parties do not dispute that the

electric generating operation was conducted regularly in 1984 even

though its performance was sporadic and the volume of its output

was disappointing. According to the undisputed testimony at trial,

the power facility was run on a regular basis by several EAI

employees. In addition to operating the landfill's gate and

collecting tipping fees, these employees monitored the performance

of the plant from the facility's control room, which contained a

78
See Landry v. Air Line Pilots Ass'n Int'l AFL-CIO, 901
F.2d 404, 423 (5th Cir. 1990), cert. denied, 498 U.S. 895, 111
S.Ct. 244, 112 L.Ed.2d 203 (1990); Commonwealth Mortgage Corp. v.
First Nationwide Bank, 873 F.2d 859, 869 (5th Cir. 1989), reh'g
denied, 881 F.2d 1071 (5th Cir. 1989)(en banc).

34
computer and equipment for measuring pressure and temperature

levels for the various components of the facility. The employees

took notes on the plant's performance and copied them onto the

computer printouts, creating daily reports of the facility's

generating operations. Although it is not clear from the record

whether the facility was operated on a daily basis, its operation

on a regular basis suffices to demonstrate this aspect of the

facility's "placed in service" status.79

b. Legislative History and Regulations

The legislative history and Regulations indicate that it is

sufficient for purposes of the "placed in service" test that

Section 38 property be ready and available to play its role in an

operating facility, regardless of the level of production attained.

The goal of Sealy's plan was for the facility to generate

electricity, and Sealy presented evidence that the facility did

generate electricity, starting in 1984. The Tax Court's statement

that it found no evidence to support Sealy's contention that the

facility was generating electricity in 1984 is clearly erroneous.

Lileng testified that the facility generated electricity as early

as 1984, even though the first readings from HL&P's records were in

1985. He explained that it was likely that the electricity output

79
In Rev. Rul. 76-256, 1976-2 C.B. 46, daily operation of a
generating unit was one indicator that it had been placed in
service. Rev. Rul. 79-98, 1979-1 C.B. 103, stated that a "'state
of readiness and availability for a specifically assigned
function,' such as 'daily operation'" determined when a facility
was placed in service. The more recent Rev. Rul. 84-85, 1984-1
C.B. 10, however, found that a facility operating on a regular
basis had been placed in service even though it was experiencing
operational problems.

35
in 1984 was not registered in HL&P's records because the amounts of

electricity generated in that year were small. Further, Sealy

entered into an agreement with HL&P in 1984 under which it would

sell its electricity output to the power company. That the

facility was unable to generate electricity at its rated capacity

does not obviate the fact that it met its specifically assigned

function of generating electricity.80

Moreover, the inability of Sealy's facility to achieve or

sustain anticipated levels of production stemmed from the alleged

malfeasance of the incinerator's manufacturer. The incinerator

that it fabricated and delivered to Sealy turned out to have far

less capacity than Sealy had specified in its order, crippling the

effectiveness of a key component of the facility. Albeit

unsuccessful, Sealy made a good-faith effort to correct the

facility's operational problems by seeking out new investors to

fund a replacement incinerator; and, in the end, the partnership's

misfortunes caused by the faulty incinerator ultimately forced

Sealy to declare bankruptcy. Its activities in acquiring and

operating an electric generating facility and entering into an

agreement with HL&P constituted the operation of a business even

though the facility experienced insurmountable operational problems

80
In Rev. Rul. 84-85, 1984-1 C.B. 10, the Commissioner
stated that operating at rated capacity was not a prerequisite
for a facility's operational status. This Revenue Ruling
involved an electric generating facility, similar to Sealy's,
which converted solid waste into steam energy. The facility was
deemed "placed in service" when it first became operational even
though it operated well below its rated capacity and was
experiencing operational problems.

36
that prevented its ever achieving success.

In Piggly Wiggly Southern, Inc. v. Commissioner81, the Tax

Court held that refrigeration equipment acquired for new

supermarkets was not placed in service until they were open for

business, but that equipment for remodeled stores was placed in

service when purchased. The distinction was based on the concept

that property qualifying as "placed in service" had to be acquired

for an existing trade or business.82 Using Piggly Wiggly as an

analogue, we conclude that Sealy's electric generating facility was

"open for business" in 1984: it was operating as a unit, it was

generating electricity, and Sealy had completed the sale agreement

with HL&P for its output. That Sealy's commercial enterprise made

hardly any "sales" because of substantial functional difficulties

with an essential component in the facility does not affect the

determination that the facility as a whole was placed in service.83

As discussed previously, the energy and investment tax credits

were designed to stimulate private investment in qualifying

property by allowing taxpayers with environmentally desirable

projects to implement them at a reduced cost. The partnership's

81
84 T.C. 739, 745 (1985), aff'd 803 F.2d 1572 (11th Cir.
1986).
82
See id. at 745-48.
83
As support for its "placed in service" argument, Sealy
cites to Piggly Wiggly and other "idle asset" cases in which
courts have held that property not yet in use because of
circumstances beyond the taxpayer's control may nevertheless be
considered to have been placed in service. In light of our
conclusion that the facility as a whole was operating in 1984, we
need not address the applicability of these cases to Sealy's
property.

37
attempt to create, through the purchase of various items of

tangible personal property, a unique electric generating facility

that would have the dual benefit to the community of processing and

converting its solid waste into an alternative affordable energy

source is the very type of activity Congress intended to encourage

through the energy and investment tax credit statutes. Sealy's

misfortune in acquiring an incinerator that failed to perform at

the level of Sealy's specifications and the manufacturer's

(mis?)representations does not preclude the designation of Sealy's

property as having been placed in service in 1984, the first year

in which the entire facility was operational and generating

electricity, for purposes of depreciation deductions and the energy

and investment tax credits.

D. PRE-OPERATING EXPENSE ISSUE

Having found that the property of Sealy's facility was placed

in service in 1984, we turn to the issue raised by the Commissioner

on cross-appeal. The Commissioner argues that the Tax Court erred

in not considering the challenge to the deductibility, under

Section 16284, of certain of Sealy's expenses. Based on the

procedural posture of the Commissioner's argument, we conclude that

a remand to the Tax Court is necessary for a factual determination

as to when Sealy was carrying on a trade or business for purposes

of deducting expenses under § 162.

84
Section 162(a) states that "[t]here shall be allowed as a
deduction all the ordinary and necessary expenses paid or
incurred during the taxable year in carrying on any trade or
business."

38
 The Tax Court's opinion stated that a decision would be

entered under Rule 155 of the Tax Court Rules of Practice and

Procedure.85 The Commissioner then submitted a proposed decision

document disallowing Sealy's expenses for local taxes, legal fees,

accounting fees, interest, and various other items, based on the

Commissioner's position that these expenses were nondeductible pre-

operating expenses.86 Sealy objected, arguing that the

Commissioner's computation was inconsistent with the Tax Court's

opinion and with the parties' Stipulation of Facts.

In response to the Commissioner's Motion for Entry of

Decision, the Tax Court issued a post-computation Order stating

that the Commissioner did not raise the issue of pre-opening

expenses at the trial and thus was inappropriately "bootstrapping"

the issue after the court's "placed in service" determination. It

held that the Commissioner's argument in support of its proposed

computation raised a new issue which the court would not consider

at that late date.87 Our review of the record, however, reveals

that the Tax Court clearly erred in finding that the Commissioner

85
Rule 155 provides that the Tax Court, after entering its
opinion on the issues, may withhold entry of its decision to
allow the parties to propose computations pursuant to the court's
determination of the issues. See Paccar, Inc. v. Commissioner,
849 F.2d 393, 399 (9th Cir. 1988).
86
The Commissioner, consistent with the Tax Court's opinion,
also disallowed the depreciation deductions and credits in the
proposed computation.
87
The court in a post-trial proceeding may hear arguments
regarding any disagreements between the parties as to the amount
of the deficiency, but no argument is permitted as to any new
issue. See Knowlton v. Commissioner, 791 F.2d 1506, 1511 & n.4
(11th Cir. 1986).

39
had not raised the pre-operating expense issue at trial.

In the FPAA sent to Sealy, the Commissioner listed the

itemized expenses and stated that one of the reasons for the

assessed deficiency was that Sealy had failed to substantiate that

the amounts claimed "constitute[d] ordinary and necessary business

expenses and were not capital in nature." This statement, although

broadly worded and arguably vague in the context of the

Commissioner's initial sham theory, was sufficient to have placed

the taxpayer on notice that the pre-operating expense theory would

possibly be one of the Commissioner's arguments at trial.88

The Commissioner's trial memorandum to the Tax Court further

reveals that the issue was raised at trial. The memorandum

explicitly states that one of the issues in dispute is "[w]hether,

during any of the years in issue, the Partnership was conducting

the trade or business for which it organized, or was engaged in

pre-opening activities. I.R.C. §§ 195, 709." That memorandum also

cited Richmond Television Corp. v. United States89, a case

recognized as the progenitor of the pre-operating expense doctrine

88
See Abatti v. Commissioner, 644 F.2d 1385, 1389-90 (9th
Cir. 1981)(stating that "if a deficiency notice is broadly worded
and the Commissioner later advances a theory not inconsistent
with that language, the theory does not constitute new matter");
Reese v. Commissioner, 615 F.2d 226, 233 (5th Cir. 1980)(finding
that when the determination "is made in general and indefinite
terms, the taxpayer is reasonably placed on notice that the basic
elements of a claimed deduction, including its fact, amount and
character, are in dispute").
89
345 F.2d 901 (4th Cir. 1965), vacated on other grounds,
382 U.S. 68, 86 S.Ct. 233, 15 L.Ed. 2d 143 (1965)(per curiam).

40
under Section 162.90

Moreover, Sealy acknowledged the pre-operating expense issue

in its own trial memorandum, stating that the issues included

"[w]hether petitioner was engaged in a trade or business and/or an

activity engaged in for profit during 1983 and 1984" and "[w]hether

the amounts claimed by Petitioner in 1983 and 1984 constitute

ordinary and necessary business expenses or were . . . capital in

nature." Sealy's trial memorandum also asserted that Sealy had

properly classified its expenditures as ordinary or capital.

Finally, the record reveals that the Commissioner's opening

argument at trial noted the pre-operating expense theory as an

issue.91 In light of the foregoing, we find that the court erred

in stating that the Commissioner failed to raise the expense issue

at trial and conclude that the Tax Court should have reached the

factual issue whether Sealy's expenses were incurred while engaged

in a trade or business.

Although the facts considered for both the "placed in service"

issue and the pre-operating expense issue substantially overlap,

90
See Fishman v. Commissioner, 837 F.2d 309, 312 (7th Cir.
1988), cert. denied 487 U.S. 1235, 108 S.Ct. 2902, 101 L.Ed.2d
935 (1988); Johnsen v. Commissioner, 794 F.2d 1157, 1160 (6th
Cir. 1986).
91
The Commissioner's opening argument stated that "the
operating expenses were disallowed under [a] pre-opening expense
theory" and that the second major issue, in addition to the
"placed in service" issue, was "whether during any of the years
at issue the partnership was conducting a trade or business for
which it was organized before being engaged in pre-opening
activities." The Commissioner also told the court that the
determination of this issue "mainly affect[ed] the deductibility
of claimed operating expenses."

41
the issues call for separate determinations under different

sections of the Internal Revenue Code. The Tax Court recognized

the discreteness of the two issues in its post-computation Order

when it rejected the Commissioner's proposed disallowance of

Sealy's expenses under the pre-operating expense theory. As we

cannot make such a factual finding in the first instance, and the

Tax Court failed to address whether Sealy was engaged in a trade or

business when it incurred the challenged expenses, we must remand

this issue to the Tax Court.

In doing so, however, we note that the facts available to us

in the record to date strongly militate in favor of a finding that

Sealy was engaged in a trade or business sometime in 1983.92 The

record shows that in that year, Sealy operated the landfill,

accepted tipping fees for waste disposal, leased the property on

which it built and operated the facility, obtained the necessary

permits and licenses for operating the facility, completed

construction of the facility, and operated the incinerator. In

light of cases addressing the question whether a taxpayer is

engaged in a trade or business, these facts seem sufficient to

support a finding that Sealy was not engaged in pre-opening

activity in late 1983, but instead was carrying on a trade or

92
In Commissioner v. Lincoln Savs. & Loan Assoc., 403 U.S.
345, 32, 91 S.Ct. 1893, 1898, 29 L.Ed.2d 519, (1971), the
Supreme Court stated that "[t]o qualify as an allowable deduction
under Section 162(a) . . . an item must (1) be 'paid or incurred
during the taxable year,' (2) be for 'carrying on any trade or
business,' (3) be an 'expense,' (4) be a 'necessary' expense, and
(5) be an 'ordinary' expense." The second requirement is at
issue in the instant case.

42
business.93 Further, the parties stipulated that Sealy had a valid

business purpose and had never been a sham, satisfying the

threshold "profit motive" requirement of Section 162.94 On remand

the Tax Court must determine when Sealy's start-up period ceased

and its activity of operating a trade or business began, and must

then examine each of the disallowed expenses to determine whether

any are capital in nature.95 As stated previously, we leave the

93
See Aboussie v. United States, 779 F.2d 424, 428 (8th Cir.
1985)(affirming district court's finding that partnership was not
carrying on a business until its housing project was
substantially ready for rental); Blitzer v. United States, 684
F.2d 874, 880-81, 231 Ct.Cl. 236, (Cl. Ct. 1982)(per
curiam)(corporation may be considered to be engaging in business
when it begins business operations even if income production has
not begun); Richmond Television Corp. v. United States, 345 F.2d
901, 905 (4th Cir. 1965)(television station not carrying on trade
or business because had not yet obtained license or begun
broadcasting), vacated on other grounds, 382 U.S. 68, 86 S.Ct.
233, 15 L.Ed.2d 143 (1965)(per curiam).
94
See Commissioner v. Groetzinger, 480 U.S. 23, 35, 107
S.Ct. 980, 987, 94 L.Ed.2d 25, (1987)("we accept the fact
that to be engaged in a trade or business, the taxpayer must be
involved in the activity with continuity and regularity and that
the taxpayer's primary purpose for engaging in the activity must
be for income or profit"); Hayden v. Commissioner, 889 F.2d 1548,
1552 (6th Cir. 1989); Brannen v. Commissioner, 722 F.2d 695, 704
(11th Cir. 1984); Cooper v. Commissioner, 88 T.C. 84, 108-109
(1987).
95
See Lincoln Savs. & Loan Assoc., 403 U.S. at 354, 91 S.Ct.
at 1899, 29 L.Ed.2d at (controlling feature of capital
payment is that it serves to create or enhance separate and
distinct additional asset); Fishman v. Commissioner, 837 F.2d
309, 312 (7th Cir. 1988)(expenses incurred before taxpayer's
trade or business begins to operate are not deductible); El Paso
Co. v. United States, 694 F.2d 703, 714 (Fed. Cir.
1982)(recognizing that § 162 deduction may be available to
corporation not yet carrying on revenue producing operations);
Blitzer, 684 F.2d at 880 (expenses before start of revenue
producing operations deductible under § 162 if not "in the nature
of start-up costs nor intended to provide benefits extending
beyond the year in question").

43
task of fact-finding to the Tax Court given its failure to address

the pre-operating expense issue when the Commissioner raised it at

trial.

III

CONCLUSION

For the foregoing reasons, we reverse the Tax Court's finding

regarding the "placed in service" determination and hold that, for

purposes of depreciation and the energy and investment tax credits,

the property in Sealy's electric generating facility was placed in

service in 1984. Accordingly, we remand the case to the Tax Court

for a calculation of Sealy's tax liability for 1983 and 1984 not

inconsistent with this opinion. We also remand for a finding as to

when Sealy was carrying on a trade or business for purposes of

deducting its expenses under § 162. Finally, we affirm the Tax

Court's ruling on the FPAA issue.

44