Broz, (2011) 137 TC No. 3
In a case of first impression, the Tax Court has determined the appropriate asset class and depreciation periods for various wireless cellular assets including antenna support structures, cell site equipment, and leased digital equipment. In general, the Court sided with IRS and found that the wireless company misclassified its assets.
Background. Code Sec. 167(a) permits as a depreciation deduction a reasonable allowance for the exhaustion, wear and tear, and obsolescence of property used in a trade or business. For tangible property, Code Sec. 168(a) provides that under the MACRS rules, the depreciation deduction of Code Sec. 167(a) is determined by using the applicable depreciation method, recovery period, and convention. The assignment of MACRS property to a recovery class is generally made by reference to that property's class life as of Jan. 1,’86. (Code Sec. 168(i)(1)) The class life of many types of assets is carried in Rev Proc 87-56, 1987-2 CB 674.
Asset class 48.14 of Rev Proc 87-56 is titled telephone distribution plant. It includes assets such as pole lines, cable, aerial wire, underground conduits, and comparable equipment, as well as certain related land improvements. Assets that are in class 48.14 have a 15-year recovery period under MACRS.
Asset class 48.12 of Rev Proc 87-56 is titled computer-based telephone central office switching equipment, and includes central office switching and certain related equipment, but does not include computer-based telephone central office switching equipment included in class 48.121 or private branch exchange equipment. Property in class 48.12 has a MACRS recovery period of ten years.
Facts. Robert Broz formed RFB Cellular, Inc. (RFB), a wholly owned S corporation, in’91. RFB was engaged in providing wireless cellular service during the years at issue. RFB provided cellular service to two license areas, and operated approximately 75 cell sites, during the years at issue ('96,’98–2001). Most of RFB's revenue came from roaming charges for the use of the Michigan networks.
The three basic components of a cellular network are: (1) the base station, which includes towers, antennas and related electronic equipment; (2) transmission facilities between the base station and the switch; and (3) the switch. Cellular carriers added onto the existing assets to update from analog to digital cellular technology.
RFB initially provided analog cellular service. It began, however, updating its equipment to provide digital service. It acquired and installed the leased digital equipment so it was ready for use in 2000, and decommissioned its analog equipment soon after the FCC mandated the switch to digital.
On its returns for the years at issue, RFB claimed depreciation deductions for its wireless cellular equipment, but did not specifically identify the items being depreciated. Instead, it classified items into generic categories, such as “switch equipment” and “cellular equipment.” RFB included all costs for towers, antennas, equipment shelters and related land improvements in the “antenna support structure” asset class, which it depreciated over seven years under asset class 48.32. Similarly, it classified a wide variety of equipment, including the switch and the base station, as “cell site equipment” depreciable over five years under asset class 48.121. Finally, RFB depreciated the leased digital equipment over five years under asset class 48.121, including costs for concrete, excavating, steel, fencing and construction.
IRS determined that the antenna structures should be depreciated over 15 years under asset class 48.14, rather than the seven years RFB claimed. It also determined that the cell site equipment and the leased digital equipment, other than the switch, should be depreciated over ten years under asset class 48.12, rather than the five years RFB claimed.
Tax Court sides with IRS. The Tax Court agreed with IRS that the antenna support structures fell within asset class 48.14 with a 15-year recovery period, and the cell site equipment, excluding the switch, and leased digital equipment fell within asset class 48.12 with a ten-year recovery period.
The Court began by examining the “antenna supporting structures,” which RFB classified under asset class 48.32 and depreciated over seven years. However, the Court noted that asset class 48.32 covered telegraph, ocean cable, and satellite communication services—not cellular phone services. The Court agreed with IRS that the equipment was more appropriately categorized within “Telephone Communications.” In so holding, the Court rejected RFB's argument that its wireless cellular equipment didn't belong in the same category as land line equipment. Even if RFB believed that the useful life of another asset class more closely approximated that of its equipment, the Court said that was an insufficient basis to depreciate their equipment under another asset class. Additionally, the Court found that the plain language of Rev Proc 87-56 unambiguously included RHB's antenna structures within the telephone communications category, and that this interpretation was further supported by the FCC's Uniform System of Accounts for Class A and Class B Telephone Companies (USOA) classifications in effect for the years at issue.
The Court then turned to the cell site equipment, including the base station and the switch, which RFB classified as asset class 48.121 computer-based telephone central office switching equipment with a five-year life. IRS conceded that the switch was properly classified, but argued that the remaining cell site equipment was telephone central office equipment under asset class 48.12. The Court examined these asset classes, noting that the primary distinction is that 48.121 “includes equipment whose functions are those of a computer or peripheral equipment,” and found that if RFB's argument were accepted, “virtually every asset in today's increasingly computerized world would be labeled a computer.” The Court ultimately agreed with IRS that, even though some of the equipment included computerized parts, the equipment itself was not a computer or computer-based. Additionally, the Court found that the plain language of Rev Proc 87-56 placed the remaining cell site equipment in asset class 48.12.
Finally, with regard to the leased digital equipment, which RFB also classified as computer-based switching equipment under 48.121, the Court found based on its prior analysis that although the switch was properly considered within asset class 48.121, the other digital equipment was not. Rather, the remaining cell site equipment was properly within asset class 48.12 with a ten-year class life, and the towers and related land improvement have a 15-year class life under asset class 48.14. Further, since depreciation doesn't begin until an asset is placed in service under Code Sec. 168(d), RFB wasn't entitled to claim any deductions for the leased digital equipment until 2000 (i.e., the year it converted to digital service).
Observation: A recent revenue procedure (Rev Proc 2011-22, 2011-18 IRB 737) provides a safe harbor method of accounting for determining the recovery periods for depreciation of certain tangible assets used by wireless telecommunications carriers, effective for tax years ending on or after Dec. 31, 2010. Sec. 5 of Rev Proc 2011-22 prescribes recovery periods for a number of different, highly technical types of assets located at a mobile telephone switching office and cell sites, which have functions comparable to those of a wireline telephone central office and the associated land line cables. Among other things, Sec. 5 of Rev Proc 2011-22 provides that the recovery period for an antenna support tower is seven years.
The Court stated that “additional issues are being addressed in a forthcoming opinion.”
References: For depreciation recovery periods, see FTC 2d/FIN ¶L-8202; United States Tax Reporter ¶1684.01; TaxDesk ¶267,003; TG ¶14103.