Decision will be entered under Rule 50.
1. Held, the useful life of concrete brick buildings at a shopping center was determined to be 30 years. Held, further, that the lessor and the lessee were not "related persons" within the meaning of
2. Held, the useful lives of other equipment and improvements at the shopping center were determined.
3. Held, the heating and air-conditioning systems serving the stores in the shopping center did not qualify as "
*653 This is a case for redetermination of deficiencies in income tax of petitioner for the fiscal year ended August 31, 1964, in the amount of $ 18,815.90 and for the fiscal year ended August 31, 1965, in the amount of $ 16,759.34.
Some of the issues raised in the petition were settled by stipulation of the parties. The remaining issues are (1) the useful life for purposes of depreciation of the buildings making up *179 the Fort Walton Square shopping center at Fort Walton Beach, Fla., and if such life exceeded the term of its lease, whether petitioner was entitled to amortize the cost of the buildings over the term of the lease; (2) the useful lives for purposes of depreciation of other improvements or equipment at the Fort Walton Square shopping center; and (3) whether the heating and air-conditioning equipment installed at the Fort Walton Square shopping center qualifies as "
FINDINGS OF FACT
The evidence consisted of a stipulation of facts with exhibits attached, together with oral testimony and exhibits received at the trial. The facts as stipulated are incorporated herein by this reference.
The petitioner was incorporated under the laws of the State of Florida on July 20, 1962, with outstanding capital stock in the amount of $ 2,000. Petitioner's principal place of business during *654 the taxable years involved and at the time of the filing of the petition was Birmingham, Ala.*180 From the time the petitioner was organized until the present time 75 percent of its outstanding capital stock has been owned by J. W. Goodwin and 25 percent thereof has been owned by J. W. Goodwin's wife, Virginia M. Goodwin.
Petitioner filed its Federal income tax returns for the taxable years ended August 31, 1963, August 31, 1964, and August 31, 1965, with the district director of internal revenue, Birmingham, Ala. On January 5, 1968, petitioner executed a Form 872, Consent Fixing Period of Limitations Upon Assessment of Income and Profits Tax, for its taxable year ended August 31, 1964, extending the period of assessment to December 31, 1968.
Fort Walton Beach Mall, Inc., was a corporation organized under the laws of the State of Alabama. Neither the petitioner, J. W. Goodwin, nor any member of J. W. Goodwin's family owned any stock or had any connection with Fort Walton Beach Mall, Inc.
International Development Co., Inc., was organized in April 1961. All its outstanding capital stock, except for two qualifying shares, is owned by a trust for Joy E. Goodwin, the minor daughter of J. W. Goodwin. The trustees thereof are J. W. Goodwin and Birmingham Trust National Bank, Birmingham, *181 Ala.
On February 7, 1962, Fort Walton Beach Mall, Inc., leased certain realty located in the city of Fort Walton Beach, Fla. from James J. Tringas and Kathryn J. Tringas for a period of 99 years, beginning on March 1, 1962, and terminating on the last day of February 2061. On May 29, 1962, the said 99-year lease was amended by agreement of Fort Walton Beach Mall, Inc., and the lessors, James J. Tringas and Kathryn J. Tringas. On June 1, 1962, this 99-year lease was assigned by Fort Walton Beach Mall, Inc., to International Development Co., Inc. Although the recited consideration for this assignment was "$ 10.00 and other valuable consideration," the actual consideration for the assignment was $ 5,000.
On July 25, 1962, International Development Co., Inc., subleased the property to petitioner corporation for a term of 26 years with no option for renewal. Petitioner immediately commenced the construction of a shopping center on the said realty. The first building was completed in February of 1963 and was leased to Sears, Roebuck & Co. for a term of 20 years. Construction of the remaining shopping center store buildings was completed by October 1963. The remaining buildings were leased *182 to various tenants for terms ranging from 3 to 15 years.
Petitioner estimated the useful life of the shopping center buildings to be 40 years in its return filed for the taxable year ended *655 August 31, 1963. In its returns filed for the taxable years ended August 31, 1964 and 1965, petitioner claimed depreciation on the basis of a useful life of 25 years for its buildings. In explanation, the returns referred to the ground lease of 26 years, with 1 year required for construction. The respondent has determined that depreciation should be computed on the basis of a useful life of 40 years for the buildings.
In its returns for the taxable years ended August 31, 1964 and 1965, the petitioner computed its depreciation on the basis of an average useful life of 10 years for other items classified under the category of "Machinery and Equip." The useful lives presently claimed by the petitioner and allowed by the respondent are as follows:
| Years | ||
| Item | Petitioner | 2 Respondent |
| Heating and air conditioning | 8 | 10 |
| Electrical fixtures and wiring | 7 | 15 |
| Ceiling | 10 | 10 |
| Parking lot lighting | 6 | 15 |
| Fence and signs | 10 | 15 |
| Paving | 5 | 10 |
| Roof | 15 | 15 |
In its returns for the fiscal years *183 ended August 31, 1964 and 1965, the petitioner claimed an investment tax credit under
ULTIMATE FINDINGS OF FACT
For purposes of computing the allowance for depreciation, the useful life of petitioner's buildings at the Fort Walton Square shopping center was 30 years.
*656 For purposes of computing the allowances for depreciation, the useful lives of the other items classified under *184 the category of "Machinery and Equip." were as follows:
| Useful life | |
| Item | Years |
| Heating and air conditioning | 8 |
| Electrical fixtures and wiring | 15 |
| Ceiling | 10 |
| Parking lot lighting | 15 |
| Fence and signs | 15 |
| Paving | 10 |
| Roof | 15 |
The air-conditioning and heating equipment installed at the Fort Walton Square shopping center constituted central heating and air-conditioning systems, as distinguished from individual units, within the meaning of regulations
OPINION
Issue 1. Depreciation of BuildingsThe buildings at Fort Walton Square shopping center were constructed of concrete block. Petitioner presented the testimony of its architect, who stated that the maximum life of a concrete hollow brick building was 20 to 25 years, as distinguished from a brick masonry building which might have a physical life of 50 to 60 years. The witness predicated his estimate on the effect of changes in temperature and atmospheric conditions due to the porosity of the concrete brick. The witness could not by experience, however, relate such testimony specifically to the conditions prevailing at the Fort Walton Square shopping center. In addition, it is not clear that the witness took into account the extent to which *185 the life of the buildings might be extended by the use of a sealant which was applied to the concrete hollow brick.
While the Court is convinced that the useful life of 40 years proposed by the respondent is not the proper basis for depreciation of shopping center store buildings constructed of concrete hollow brick, the testimony of petitioner's expert witness cannot be accepted at face value. The buildings were constructed in accordance with specifications provided by Sears, Roebuck & Co. It would hardly seem reasonable that Sears, Roebuck & Co. would provide specifications for a building which could be expected to deteriorate at or about the time of the expiration of its lease. The specifications may well have provided for a building that would meet Sears' needs at the lowest possible cost. Sears would want to be equally certain, *657 however, that the building was standing and in good shape at the end of its term. For Sears to specify a building having a useful life of from 20 to 25 years, when it was entering into a 20-year lease, would be "cutting it too thin." Accordingly, the Court finds the useful life of the building to be 30 years.
The Court must still consider whether, notwithstanding *186 our finding of a useful life of 30 years for the buildings, the petitioner is entitled to amortize the cost of the buildings over a shorter period measured by the term of its ground lease from International Development Co., Inc. The respondent argues to the contrary on the grounds that the lessor and the lessee were "related persons" as defined in
In arguing that the lessor and lessee are "related persons" within the meaning of
(b) Related Lessee and Lessor. --
(1) General Rule. -- If a lessee and lessor are related persons (as determined under paragraph (2)) at any time during the taxable year then, in determining the amount allowable to the lessee as a deduction for such taxable year for exhaustion, wear and tear, obsolescence, or amortization in respect of any building erected (or other *187 improvement made) on the leased property, the lease shall be treated as including a period of not less duration than the remaining useful life of such improvement.
(2) Related persons defined. -- For purposes of paragraph (1), a lessor and lessee shall be considered to be related persons if --
(A) the lessor and the lessee are members of an affiliated group (as defined in
(B) the relationship between the lessor and lessee is one described in subsection (b) of
It is not claimed that the lessor and the lessee are members of an "affiliated group" as defined in
(b) *188 Relationships. -- The persons referred to in subsection (a) are:
(1) Members of a family, as defined in subsection (c)(4);
*658 (2) An individual and a corporation more than 50 percent in value of the outstanding stock of which is owned, directly or indirectly, by or for such individual;
(3) Two corporations more than 50 percent in value of the outstanding stock of each of which is owned, directly or indirectly, by or for the same individual, if either one of such corporations, with respect to the taxable year of the corporation preceding the date of the sale or exchange was, under the law applicable to such taxable year, a personal holding company or a foreign personal holding company;
(4) A grantor and a fiduciary of any trust;
(5) A fiduciary of a trust and a fiduciary of another trust, if the same person is a grantor of both trusts;
(6) A fiduciary of a trust and a beneficiary of such trust;
(7) A fiduciary of a trust and a beneficiary of another trust, if the same person is a grantor of both trusts;
(8) A fiduciary of a trust and a corporation more than 50 percent in value of the outstanding stock of which is owned, directly or indirectly, by or for the trust or by or for a person who is *189 a grantor of the trust; or
(9) A person and an organization to which
It will be noted that the only situation in which two corporations are deemed to be "related persons" within the meaning of
Apparently *190 as an afterthought, in his reply brief the respondent argues that the lease should be disregarded for purposes of depreciation of the buildings because it was not entered into in an "arm's length" transaction. In support of this, respondent cites the relationship of the stockholders of the lessor and the stockholders of the lessee. Respondent concludes:
Petitioner has offered no sound business reason for the creation of the twenty-six year sublease. The principal reason for such a transaction appears to be to effect a shorter useful life of the shopping center buildings.
The fallacy of this argument rests on the fact that, as the respondent notes elsewhere, the petitioner did not in its first return *659 for the fiscal year ended August 31, 1963, rely upon the term of the lease for purposes of computing the deduction for amortization of depreciation of the buildings. In the absence of evidence to the contrary, therefore, it must be assumed that whatever reasons there might have been in fixing the term of the petitioner's lease, the question of depreciation was not controlling.
In view of our holding that the petitioner and the lessee were not "related persons" as defined in
Heating and Air Conditioning. -- Considerable testimony was directed to the problems encountered with respect to the heating and air-conditioning equipment. Unquestionably climatic conditions in the Fort Walton area caused the more rapid deterioration of those units. Respondent acknowledges this in his brief and is willing to allow a useful life of 10 years. In the opinion of the Court, however, this would not be adequate in light of number of units which had been replaced. Accordingly, it is our opinion that the petitioner's claim of a useful life of 8 years for purposes of depreciation of the heating and air-conditioning equipment is reasonable and should be sustained.
Electrical Fixtures and Wiring. -- In its returns, the petitioner placed a useful life of 10 years on this equipment. The evidence adduced by the petitioner related only to the fluorescent lighting fixtures as distinguished from the fuse or junction boxes and the wiring and circuitry leading to the fixtures. It must be assumed that except for the fluorescent fixtures, the remainder *192 of the electrical wiring and equipment would have a useful life at least equal to the term of the lease with Sears, Roebuck & Co. Since no evidence was submitted with respect to the relative cost of the fluorescent light fixtures and of the other electrical equipment and wiring under this classification, the Court finds that the respondent's proposed useful life of 15 years for purposes of depreciation of the electrical fixtures and wiring is reasonable and should be sustained.
Ceiling. -- The parties have agreed that for purposes of depreciation the useful life of the ceiling was 10 years and the Court so holds.
Parking Lot Lighting. -- The petitioner presented evidence to show that due to climatic conditions some of the lighting fixtures had deteriorated and had been replaced. It was not clear, however, whether it was also necessary to replace the stanchions, wiring, and other elements making up the cost of the parking lot lighting. On this record, the respondent's determination of a useful life of 15 years *660 for purposes of depreciation of the parking lot lights is reasonable and should be sustained.
Fence and Signs. -- Petitioner submitted no evidence concerning the useful life *193 of the fence and signs claimed on the returns as part of the machinery and equipment account. Accordingly, respondent's determination of a useful life of 15 years for purposes of depreciation of the fence and signs is reasonable and should be sustained.
Paving. -- The petitioner presented evidence to show that during the first 6 years approximately one third of the paving in the parking lot had been "replaced." To what extent such replacement was the equivalent in cost of laying the original surface was not made clear. In any event, since the remaining two-thirds presumably was still in use, the allowance by the respondent of a useful life of 10 years for purposes of depreciation of the parking lot is reasonable and should be sustained.
Roof. -- The parties have agreed that for purposes of depreciation the useful life of the roof was 15 years and the Court so holds.
Issue 3. Investment Tax Credit for Heating and Air-Conditioning EquipmentThe question whether the heating and air-conditioning systems installed by the petitioner at the Fort Walton Square shopping center qualified as "
(2) The term "structural components" includes such parts of a building as walls, partitions, floors, and ceilings, as well as any permanent coverings therefor such as paneling or tiling; windows and doors; all components (whether in, on, or adjacent to the building) of a central air conditioning or heating system, including motors, compressors, pipes and ducts; plumbing and plumbing fixtures, such as sinks and bathtubs; electric wiring and lighting fixtures; chimneys; stairs, escalators, and elevators, including all components thereof; sprinkler systems; fire escapes; and other components relating to the operation or maintenance of a building. However, the term "structural components" does not include machinery the sole justification for the installation of which is the fact that such machinery is required to meet temperature or humidity requirements which are essential for the operation of other machinery or the processing of materials or foodstuffs. Machinery may meet the "sole justification" test provided by the preceding sentence even though it incidentally provides for the comfort of employees, or serves, to an insubstantial *195 degree, areas where such temperature or humidity requirements are not essential. For example, an air conditioning and humidification system installed in a textile plant in order to maintain the temperature or humidity within a narrow optimum range which is critical in processing particular types of yarn or cloth is not included within the term "structural components". For special rules with respect to an elevator or escalator, the construction, reconstruction, or erection of which is completed by the taxpayer after June 30, 1963, or which is acquired *661 after June 30, 1963, and the original use of which commences with the taxpayer and commences after such date, see
The analogy between heating and air-conditioning equipment on the one hand and elevators and escalators on the other is particularly significant. In section 203(c) of the Revenue Act of 1964 (Pub. L. 88-272) the Congress amended
A third problem arises *196 with respect to the treatment of escalators and elevators in the case of the investment credit. Among the categories of property not eligible for the investment credit are buildings and their structural components. The House committee report indicated that the term "structural components" of a building included such parts of a building as central air conditioning and heating systems, plumbing, and electrical wiring and lighting fixtures relating to the operation and maintenance of the building. The proposed regulations issued by the Treasury Department with respect to the term "structural components" provide an extensive list of the type of items considered to be structural components and therefore not eligible for the investment credit. Among these items are escalators and elevators. While these regulations are an accurate interpretation of the intention of Congress last year in this respect, nevertheless your committee believes that it is appropriate to reconsider the treatment of escalators and elevators for purposes of the investment credit. Escalators and elevators are closely akin to assets "accessory to the operation" of a business which presently are eligible for the investment *197 credit. These assets include machinery, printing presses, transportation or office equipment, refrigerators, individual air-conditioning units, grocery counters, etc. Your committee further believes that new elevator and escalator equipment represents an important aspect of modernization of plant and facilities. [Emphasis added.]
What was said with respect to elevators and escalators would apply with equal force to heating and air-conditioning equipment if the Congress had so elected. The fact that the Congress did not do so is strong evidence of an intent to apply a stricter rule with respect to heating and air-conditioning equipment. In the face of this intent, regulations
There are two commonly accepted methods of providing heating and air conditioning for commercial areas. Under one method, a heating or *198 cooling liquid is piped from the heating and compressor *662 unit to the areas to be served and air forced over radiation coils in units located within that area. Under the alternative method, the blower and coils are located at and are a part of the heating and compressor unit, and the heated or cooled air is carried by ducts to the area to be served.
The heating and air-conditioning systems installed by the petitioner were of the latter type. A complete unit consisted of equipment for heating by gas, a compressor for cooling, the radiation coils, and a forced air blower. The unit was placed on the roof of the building and connected to the ducts with canvas flashing. One or more units were installed for each tenant and the gas and electrical consumption was metered separately.
The petitioner argues that such systems are not a "central heating and air conditioning system," as referred to in regulations
We find nothing to indicate that the Congress intended thus to limit the definition of a "central heating and air-conditioning system." It is wholly unrealistic to argue, in effect, that whether a unit is a central system or an individual system depends on whether the coolant is piped to the area or the cooled air is carried to the area by ducts. In either case, there is a "central unit" capable of serving more than a single room or a single area. The fact that one or more of such units may be connected and metered separately for each tenant does not convert them into "individual" units.
In
Decision will be entered under Rule 50.