internal_revenue_service national_office technical_advice_memorandum date third party communication none date of communication not applicable tam-165283-04 number release date index uil no case-mis no ---------------- --------------------------------------------------- -------------------------------- taxpayer's name taxpayer's address taxpayer's identification no period involved date of conference legend -------------------------------- ----------------------------------- ------------- ------------------------------ ---------------- ---------- no conference held ------------- -------------------------- -------------------------------- taxpayer m state x y issue charges for trailers are excludable from the taxable sale price of such trailers for purposes of the tax imposed by sec_4051 of the internal_revenue_code ----- whether under the circumstances described below transportation and delivery tam-165283-04 conclusion the transportation and delivery charges are excludable from the taxable sale price of the trailers facts for taxpayer’s first retail sales business taxpayer does not maintain an taxpayer manufactures and sells trailers taxpayer’s trailers have a gross vehicle weight rating greater than big_number pounds taxpayer sells its trailers to dealers and makes first retail sales to ultimate purchasers hereinafter referred to as first retail sales inventory of trailers available for purchase rather the trailers are custom ordered to specifications chosen by the ultimate_purchaser taxpayer does not begin manufacture of a trailer for its first retail sales business unless it has been ordered by the ultimate_purchaser taxpayer leases space in state x located in the united_states this trailer parking facility is capable of storing y trailers the trailers are completed when they pass quality control tests performed at m the transportation and delivery charges at issue are incurred after the trailers are completed the transportation and delivery charges relate to the cost of importation and to the cost of delivery from m to a place chosen by the ultimate_purchaser and agreed to by taxpayer in the sales contract taxpayer manufactures its trailers in mexico at manufacturing_facility m law and analysis sec_4052 provides that in determining the price of an article for sec_4051 imposes a percent ad valorem excise_tax on the first_retail_sale of among other articles truck trailer and semitrailer chassis and bodies including in each case parts or accessories sold on or in connection therewith or with the sale thereof purposes of the tax imposed by sec_4051 there shall be included any charge incident to placing the article in condition ready for use sec_145_4052-1 of the temporary excise_tax regulations under the highway revenue act of pub l provides that if the sale of an article is a taxable sale the tax is computed on the price as determined under sec_145_4052-1 includes the total consideration paid for the article whether the consideration is paid in money services or other forms in addition there shall be included any charge incident to placing the article in a condition ready for use similar rules to sec_4216 and the regulations thereunder relating to charges to be included in the price and excluded from sec_145_4052-1 provides that the price for which an article is sold under sec_4216 which defines the price for which an article is sold for tam-165283-04 the price shall apply for example charges for transportation delivery insurance and installation other than installation charges to which sec_4051 applies and other expenses actually incurred in connection with the delivery of an article to a purchaser pursuant to a bona_fide sale shall be excluded from the price in computing the tax purposes of the chapter manufacturers excise_taxes transportation and delivery charges are excludable from the taxable sale price sec_48_4216_a_-2 of the manufacturers and retailers excise_tax regulations provides that charges for transportation delivery and other expenses actually incurred in connection with the delivery of an article to a purchaser pursuant to a bona_fide sale shall be excluded from the sale price in computing the tax such charges include all items of transportation delivery insurance installation and similar expense incurred after shipment to a customer begins in response to the customer's order pursuant to a bona_fide sale however costs of such nature incurred by a manufacturer in transporting in the normal course of business and for its benefit and convenience articles from a factory or port of entry to a warehouse or other facility regardless of the location of such warehouse or other facility are not considered as being incurred in connection with the delivery of an article to a purchaser pursuant to a bona_fide sale and charges therefore cannot be excluded from the sale price in computing tax_liability sale price of articles it is immaterial whether the transportation delivery or other services are performed by a common carrier or independent agency for or on behalf of the manufacturer producer or importer or are performed by the manufacturer producer or importer with the use of its own vehicles or other facilities in determining whether an expense is an excludable transportation or delivery expense only those expenses_incurred by reason of the fact that the purchaser accepts delivery at some point other than the manufacturer's place of business shall be considered excludable transportation or delivery expenses the retailer m is not the manufacturer of the trailers taxpayer makes the first_retail_sale of the trailers to ultimate purchasers the trailers these charges are items of transportation delivery or similar expense actually incurred after shipment to the customer begins in response to the customer’s order pursuant to a bona_fide sale these charges are incurred only after shipment to the ultimate_purchaser begins shipment to the ultimate_purchaser begins when the trailers are completed the trailers are completed when they pass the quality control inspections at m a bona_fide sale taxpayer does not manufacture trailers for its first retail sales the transportation and delivery charges at issue are excludable from the price of for taxpayer’s first retail sales business taxpayer is both the manufacturer and the charges at issue are incurred in response to a customer’s order pursuant to sec_48_4216_a_-2 provides that for purposes of computing the taxable the charges at issue are not incident to placing the article in a condition ready for the trailer parking facility where some ultimate purchasers pick up their trailers is tam-165283-04 business except in response to the ultimate purchaser’s order the trailers are custom- manufactured to specifications required by the ultimate_purchaser the specifications are stated in a contract between taxpayer and the ultimate_purchaser the transportation and delivery charges are not incurred for taxpayer’s benefit or convenience use the trailers are in a condition ready for use when they are completed at m the additional services provided by taxpayer to the ultimate_purchaser such as importation of completed trailers and delivery of completed trailers from m to a place chosen by the ultimate_purchaser are provided only after the trailers are already in a condition ready for use see revrul_72_590 1972_2_cb_571 stating all transportation_expenses from the time shipment began at the inspection area until the vehicles were delivered to the purchaser were charges for delivery within the meaning of sec_4216 not a warehouse for the trailers the trailers have an identified customer before manufacture begins see generally 306_f2d_678 1st cir holding a dollar_figure warehouse and shipment cost was not excludable from the taxable sale price of bowling balls under sec_4216 when the product was not earmarked for a particular customer when it was sent from the factory in massachusetts to a west coast warehouse the trailer parking facility is also not a retail dealer taxpayer leases the spaces at the parking facility technical_advice_memorandum in revrul_86_68 a trucking company ordered a taxable heavy truck from a retail truck dealer and the vehicle was shipped by the manufacturer directly to the customer the ruling holds that the actual transportation and delivery charges for shipping the truck directly from the manufacturer to the retail dealer’s customer are includable in the taxable sales_price to the extent that such charges did not exceed the charges that would have been incurred to ship the truck to the retail dealer through whom the truck was ordered the balance if any of the actual transportation and delivery charges would be excludable from the taxable sales_price memorandum the revenue_ruling applies to sales from retailer dealers to ultimate purchasers here the sales are from a manufacturer to ultimate purchasers nevertheless if the analysis of revrul_86_68 were applied to the facts of this technical_advice_memorandum the holding would not change the constructive cost to transport the trailers from the manufacturer to the retailer would be zero because the retailer and the manufacturer are the same person and at the same location the balance of the actual transportation and delivery charges to transport the trailers to the ultimate_purchaser is all of the transportation costs thus the total amount of charges to transport the trailers to the customers is excludable from the taxable sales_price revrul_86_68 1986_1_cb_318 situation does not alter the holding of this revrul_86_68 is not applicable to the facts of this technical_advice tam-165283-04 taxpayer’s first retail sales business accordingly the charges at issue are excludable from the price of the trailers in caveats a copy of this technical_advice_memorandum is to be given to the taxpayer sec_6110 provides that it may not be used or cited as precedent


internal_revenue_service number release date index numbers --------------- ------------------------------------------------------------ ----------------------------- ---------------------- ------------------------------------ department of the treasury washington dc third party communication none date of communication not applicable_person to contact ----------------------- id no ------------------- --------------------------------------------------- telephone number ---------------------- refer reply to cc psi b03 plr-121517-14 date date x ------------------------------------------------------------------------------------------------------ --------------------------- legend state --------------------- d1 ---------------------- dear ---------------- this responds to a letter dated date and subsequent correspondence submitted on behalf of x requesting that the service grant x an extension of time under sec_301_9100-3 of the procedure and administration regulations to file an entity classification election the information submitted states that x was formed as a state entity on d1 eligible to be treated as a partnership for federal tax purposes however form_8832 entity classification election electing to be treated as a partnership was not filed for x sec_301_7701-2 generally provides that a business_entity is any entity recognized for federal tax purposes that is not properly classified as a_trust under sec_301_7701-4 or otherwise subject_to special treatment under the internal_revenue_code sec_301_7701-3 provides that an eligible_entity with at least two members may elect to be classified as either an association and thus a corporation under sec_301_7701-2 or as a partnership and an eligible_entity with a single owner can elect to be classified as an association or to be disregarded as an entity separate from its owner plr-121517-14 sec_301_7701-3 further provides that so long as a business_entity is not classified as a corporation under sec_301_7701-2 or an eligible_entity it may elect its classification for federal tax purposes sec_301_7701-3 provides that an entity classification election must be filed on form_8832 and can be effective up to seventy-five days prior to the date the form is filed or up to twelve months after the date on which the form is filed sec_301_9100-1 provides that the commissioner may grant a reasonable extension of time to make a regulatory election or a statutory election but no more than months except in the case of a taxpayer who is abroad under all subtitles of the internal_revenue_code except subtitles e g h and i sec_301_9100-1 defines the term regulatory election as an election whose due_date is prescribed by a regulation published in the federal_register or a revenue_ruling revenue_procedure notice or announcement published in the internal_revenue_bulletin sec_301_9100-1 through provide the standards the commissioner will use to determine whether to grant an extension of time to make the election sec_301_9100-2 provides the rules governing automatic extensions of time for making certain elections sec_301_9100-3 provides the standards the commissioner will use to determine whether to grant an extension of time for regulatory elections that do not meet the requirements of sec_301_9100-2 under sec_301_9100-3 a request for relief will be granted when the taxpayer provides evidence to establish to the satisfaction of the commissioner that the taxpayer acted reasonably and in good_faith and granting relief will not prejudice the interests of the government based solely on the information submitted and the representations made we conclude that the requirements of sec_301_9100-3 have been satisfied as a result x is granted an extension of time of days from the date of this letter to file a form_8832 with the appropriate service_center to elect to be treated as a partnership for u s income_tax purposes effective d1 a copy of this letter should be attached to the form_8832 a copy is enclosed for that purpose except as expressly provided herein we express or imply no opinion concerning the tax consequences of any aspect of any transaction or item discussed or referenced in this letter this ruling is directed only to the taxpayer requesting it sec_6110 provides that it may not be used or cited as precedent in accordance with a power_of_attorney on file with this office we are sending a copy of this letter to your authorized representative plr-121517-14 the ruling contained in this letter is based upon information and representations submitted by the taxpayer and accompanied by a penalty of perjury statement executed by an appropriate party while this office has not verified any of the material submitted in support of the ruling_request it is subject_to verification on examination sincerely associate chief_counsel passthroughs special industries by __________________________________ bradford r poston senior counsel branch office of the associate chief_counsel passthroughs special industries enclosures copy of this letter copy for sec_6110 purposes


t c memo united_states tax_court michael n and barbara j merkin petitioners v commissioner of internal revenue respondent docket no filed date neil l prupis for petitioners elizabeth s martini for respondent memorandum findings_of_fact and opinion goldberg special_trial_judge respondent determined a deficiency of dollar_figure in petitioners’ federal_income_tax for and an accuracy-related_penalty of dollar_figure under sec_6662 unless otherwise indicated all section references are to the internal_revenue_code code in effect for the taxable_year in issue and all rule references are to the tax_court rules of continued the issues for decision are whether petitioner husband was engaged in the trade_or_business of gambling during and whether petitioners are liable for an accuracy-related_penalty under sec_6662 findings_of_fact some of the facts have been stipulated and are so found the stipulation of facts and the attached exhibits are incorporated herein by this reference at the time the petition was filed petitioners resided in new york new york during the taxable_year in issue petitioner husband dr merkin was self-employed as a psychiatrist his medical practice is located on park avenue in new york city dr merkin has been engaged in private practice as a psychiatrist since petitioner wife mrs merkin is according to petitioners’ tax_return an investor petitioners’ primary residence is located on west 13th street in new york city petitioners own a secondary residence in guilford connecticut in when dr merkin wa sec_59 years old he began to ponder new ways whereby he could augment his income in retirement motivated by his preexisting interest in gambling and in particular the card game of poker dr merkin began reading up on continued practice and procedure betting games and attending card game conventions at these conventions dr merkin played poker and video slot machine games and purchased literature and other materials concerning casino games and odds-making dr merkin became particularly fascinated with video poker unlike table poker where a dealer deals a set of cards to a player or group of players in video poker a machine deals a hand of five cards to a single player and the player sees on the machine’s screen--according to the cards he or she is dealt--the odds and subsequent payout amounts for possible final card combinations such as a full house straight suit or flush suit of cards during the latter half of dr merkin decided to play video poker exclusively because he believed that it was a type of casino game where knowledge of mathematical probabilities--a knowledge he honed into his system--could improve his odds of winning video poker jackpots although dr merkin frequented several casinos and gaming establishments during the year in issue he spent most of his time playing video poker at the mohegan sun casino mohegan sun in uncasvile connecticut mohegan sun is approximately miles from the petitioners’ secondary residence in guilford connecticut dr merkin had a definitive routine when gambling at mohegan sun first upon arrival at the casino dr merkin would scout the various video poker machines located throughout the facility in order to find a machine that was paying out the highest jackpot amounts according to bets placed dr merkin would then select a video poker machine to play by inserting a mohegan sun player’s club card--similar to a credit card--into a slot on the machine dr merkin relied upon the card to record the length of time that he played the machine and his betting history the card would also record his winnings and losses when dr merkin hit a jackpot on the machine the card would record the jackpot and freeze both his card activity and the machine itself until a member of the connecticut board_of gaming could inspect the machine for signs of illegal tampering and or software irregularities each time that dr merkin would use his player’s club card in a gaming machine he would accrue player’s club points these points were awarded at the rate of one point per dollar spent and according to the length of play points were accruable and could be traded in at the casino for food beverages accommodations travel and other prizes the points had no cash_value and were not awarded in addition to winning a video poker jackpot mohegan sun issued dr merkin a form w-2g certain gambling winnings for reflecting gross winnings of dollar_figure petitioners timely filed their income_tax return they reported total income of dollar_figure consisting of the following items wage income of dollar_figure taxable interest of dollar_figure taxable state_income_tax refund of dollar_figure and business income of dollar_figure petitioners attached two schedules c profit or loss from business to their return the first pertained to dr merkin’s private medical practice and reported gross_receipts of dollar_figure and deductions of dollar_figure for a net schedule c gain of dollar_figure the second pertained to dr merkin’s activity as a professional gambler and reported gross gambling receipts of dollar_figure and claimed a deduction of dollar_figure of gambling_losses for a net schedule c loss of dollar_figure thus after combining the figures listed on both schedule c forms petitioners’ net business income reported was dollar_figure in arriving at their adjusted_gross_income petitioners deducted dollar_figure from their total income petitioners claimed itemized_deductions of dollar_figure and personal exemptions of dollar_figure resulting in taxable_income of dollar_figure and a total_tax of dollar_figure after including the alternative_minimum_tax and self- employment_tax on date respondent issued petitioners a notice_of_deficiency respondent determined that dr merkin was not engaged in the trade_or_business of gambling during and therefore could not deduct his gambling_losses on petitioners’ schedule c instead respondent determined that petitioners had to report dr merkin’s gambling winnings in total income and could deduct the gambling_losses on a schedule a itemized_deductions but only to the extent of dr merkin’s gambling winnings on the basis of the foregoing respondent determined that the amount of tax required to be shown on petitioners’ return was dollar_figure petitioners reported tax due of dollar_figure on their return resulting in a deficiency of dollar_figure respondent also determined petitioners were liable for an accuracy-related_penalty under sec_6662 of dollar_figure opinion burden_of_proof taxpayers generally bear the burden of proving that the commissioner’s determinations are incorrect rule a however sec_7491 may in specific circumstances place the burden on the commissioner with regard to any factual issue relating to the taxpayers’ liability for tax if the taxpayers produce credible_evidence with respect to that issue and meet the requirements found in sec_7491 the taxpayers bear the burden of proving that they have met the requirements of sec_7491 miner v commissioner tcmemo_2003_39 nichols v commissioner tcmemo_2003_24 affd 79_fedappx_282 9th cir although neither party has directly raised sec_7491 as an issue on our review of the entire record and for the reasons discussed infra we conclude that petitioners have neither complied with all substantiation requirements of the code nor maintained all required records see sec_6001 sec_7491 consequently the burden_of_proof respecting factual issues relevant to their liability for the deficiency in their tax remains on them tax treatment of gambling_losses sec_61 defines gross_income to mean all income from whatever source derived gambling winnings are includable in gross_income paul v commissioner tcmemo_1992_582 sec_162 allows deductions for all ordinary and necessary expenses paid_or_incurred during the taxable_year in carrying on any trade_or_business if a taxpayer is engaged in the trade_or_business of gambling his losses from gambling up to the amount of his gains from such transactions would be deductible in arriving at his adjusted_gross_income see sec_62 sec_165 thus if dr merkin’s gambling activity constituted a trade_or_business his losses from gambling as reported on schedule c up to the amount of his gambling winnings as reported on that schedule would be deductible in arriving at adjusted_gross_income if his gambling activity did not constitute a trade_or_business his gambling_losses to the extent of his winnings would be deductible as an itemized_deduction on petitioners’ schedule a in arriving at taxable_income sec_63 irrespective of whether the activity constituted a trade_or_business sec_165 provides that losses from wagering transactions shall be allowed only to the extent of the gains from such transactions see also sec_1_165-10 income_tax regs respondent determined that dr merkin was not in the trade_or_business of gambling during and thus could not claim his gambling_losses as a schedule c deduction on petitioners’ return petitioners argue that dr merkin was in the trade_or_business of gambling because he pursued the activity in good_faith with regularity and for the production_of_income to be engaged in a trade_or_business within the meaning of sec_162 an individual taxpayer must be involved in the activity with continuity regularity and with the primary purpose of deriving a profit 480_us_23 whether the taxpayer is carrying_on_a_trade_or_business requires an examination of all of the facts in each case id pincite the shift from schedule c to schedule a lowers the ceiling imposed by sec_68 on itemized_deductions other than the deduction for the gambling loss itself see calvao v commissioner tcmemo_2007_57 n although a reasonable expectation of a profit is not required the taxpayer’s profit objective must be actual and honest 78_tc_642 affd without published opinion 702_f2d_1205 d c cir sec_1_183-2 income_tax regs whether a taxpayer has an actual and honest profit objective is a question of fact to be answered from all of the relevant facts and circumstances hastings v commissioner tcmemo_2002_310 sec_1_183-2 income_tax regs the pertinent regulations set forth a nonexhaustive list of factors that may be considered in deciding whether a profit objective exists these factors include the manner in which the taxpayer carries on the activity the expertise of the taxpayer or his advisers the time and effort expended by the taxpayer in carrying on the activity the expectation that assets used in the activity may appreciate in value the success of the taxpayer in carrying on other similar or dissimilar activities the taxpayer’s history of income or losses with respect to the activity the amount of occasional profits if any which are earned the financial status of the taxpayer and the elements of personal pleasure or recreation 72_tc_411 affd without published opinion 647_f2d_170 9th cir sec_1_183-2 income_tax regs no single factor or group of factors is determinative golanty v commissioner supra pincite a final_determination is made only after a consideration of all of the relevant facts and circumstances petitioners argue that we should hold that dr merkin was engaged in the trade_or_business of gambling in and accordingly that petitioners are entitled to claim a loss attributable to this activity on their schedule c after consideration of the facts contained in the record and for the reasons discussed infra we disagree dr merkin did not carry on his gambling activity in a businesslike manner see sec_1_183-2 income_tax regs he did not maintain any receipts books_or_records but instead relied solely upon mohegan sun to track all of his playing time betting history wins and losses on his player’s club card petitioners argue that it would have been too onerous for dr merkin to have kept receipts books_or_records of his time spent at the casino and the amounts of his bets see sec_6001 pertaining to the requirement for a taxpayer to keep records dr merkin also testified that he did not maintain such records because he assumed that mohegan sun was doing that for him he also admitted however that the player’s club card did not always record his activity since the record of hours spent playing video poker shown on his player’s club statement for did not comport with his estimate of the actual amount of time he spent playing video poker during the year in issue although the court has acknowledged and accepted a taxpayer’s reliance on a player’s club card statement as a record of his winnings and losses we have not accepted the argument that where a card statement does not show all of the taxpayer’s activity ie is an incomplete statement the taxpayer is thereby excused from providing other evidence of his winnings and losses see hardwick v commissioner tcmemo_2007_359 lutz v commissioner tcmemo_2002_89 petitioners were misguided to assume that dr merkin’s players club card would keep a complete business record of his activities at a casino and that this record would absolve them of the duty to maintain business records see sec_6001 it is the taxpayer’s duty and not that of the casino to maintain such records sec_6001 in short his lack of records and accountability for his activities illustrates to us that dr merkin did not carry on his video poker playing in a businesslike manner to further illustrate this point although dr merkin testified that he spent out of weekends during playing video poker at mohegan sun for at least hours per weekend for a total of approximately big_number hours he did not provide any credible_evidence to corroborate this testimony in fact the only credible_evidence in the record with respect to dr merkin’s time spent playing video poker in was a player’s club statement generated by mohegan sun and provided by petitioners at trial this statement shows that dr merkin spent big_number minutes or hours big_number playing video poker at mohegan sun in we do not believe that dr merkin spent big_number hours at mohegan sun solely on the basis of his testimony to that effect and in the absence of any receipts or records aside from a noncontemporaneous calendar of time spent at the casino that petitioners produced in anticipation of trial moreover dr merkin admitted that it was a mistake on his part to have relied on the player’s club card to record all of his time spent playing video poker we note that if petitioners were as concerned with the amount of player’s club points that dr merkin was earning from his playing as he represented in his argument he would likely have checked the balance of points and time played on his player’s club card before the end of then if a discrepancy existed between the casino’s record and dr merkin’s estimate of hours spent playing video poker at the casino he could have resolved the issue and obtained an accurate accounting of his time spent playing video poker at the casino during the year in issue he failed to do this we infer that dr merkin’s testimony that he spent approximately big_number hours playing video poker during represented petitioners’ attempt to equate the amount of time dr merkin spent practicing medicine with the amount of time he spent playing video poker dr merkin did not testify as to the amount of time he spent engaged in his medical practice in and for the aforementioned reasons we do not find his testimony and his calendar of the time purportedly spent at mohegan sun in that year credible accordingly we cannot make a well-informed judgment as to how much time dr merkin devoted to each of these activities during the year in issue ultimately and on the basis of the one source of credible_evidence before us--the player’s club statement--we believe that dr merkin spent hours playing video poker at mohegan sun in despite dr merkin’s playing time whether it was or big_number hours he did not testify that he spent any time honing or adjusting his system when it became clear to him that he was not on track to make a profit playing video poker in see sec_1_183-2 and income_tax regs dr merkin did testify that he read video poker magazines and kept abreast of the machines and their respective payout histories at the casino but he did not prove that he used this knowledge to adjust his system in the light of his overall losses we view dr merkin’s failure to spend any time adjusting and or improving his system as a factor weighing against his gambling activity’s being a trade_or_business although dr merkin may have read video poker magazines and spent time on the casino floor scouting various machines there is nothing in the record to validate petitioners’ claim that dr merkin is a renowned poker expert see sec_1_183-2 income_tax regs aside from his explanation of how the video poker game machine works dr merkin offered no testimony as to the specifics of his system for increasing the odds of winning video poker jackpots in fact dr merkin admitted at trial that he had recently quit playing video poker because his system simply did not work petitioners maintain that dr merkin played video poker with an honest intent to make a profit and that he did in fact make a profit if not always through his gambling winnings then through the many player’s club points that he accrued while playing video poker at mohegan sun see sec_1_183-2 income_tax regs to be sure petitioners argue at length that the added element of the player’s club points distinguishes their case from other cases involving gambling_losses because the large number of player’s club points that dr merkin earned and redeemed in illustrates that his activity was not only entered into for profit but was in fact profitable we disagree petitioners filed schedules c for dr merkin’s gambling activities for all of the taxable years preceding the year in issue petitioners reported a total of dollar_figure in gambling_losses for those years and reported a gambling loss of dollar_figure for despite those losses dr merkin maintains that his activities were profitable because he redeemed hundreds of thousands of his accrued player’s club points for items such as airfare travel and automobiles throughout the years including petitioners have maintained throughout their case that dr merkin’s earning hundreds of thousands of player’s club points was in fact profit to them and that the value of the points should be included in the amount of profit generated by dr merkin’s gambling activities it is petitioners’ position that if we include the value of these points as profit we will see not only that dr merkin’s gambling activity was indeed profitable but also that dr merkin continued to engage in the gambling because of an actual profit objective as evidenced by the value of the player’s club points we disagree we fail to see how dr merkin’s earning player’s club points supports petitioners’ contention that his gambling activity was engaged in with an actual and honest profit objective dr merkin’s player’s club points were based on his dollar amounts bet and length of play while there is no accounting of the points dr merkin earned and redeemed for and there is nothing in the record showing the items for which he redeemed the points for such evidence would do nothing more than show what prizes dr merkin received in exchange for his total wagering at mohegan sun in that is if petitioners received airfare accommodations and or trips from the player’s club program they did so because of the amount of money that dr merkin was spending at the casino the items he earned through redemption of his player’s club points were items that he essentially paid for with the amounts that he bet put another way if petitioners were to have purchased all of the items they received through the redemption of their player’s club points in it is highly improbable that the value of those items would equal the amount of money wagered by dr merkin in moreover and with respect to the items for which dr merkin redeemed his player’s club points in we note that petitioners failed to report as income the value of any car airfare or travel that they acquired from the casino in in libutti v commissioner tcmemo_1996_108 we held that the value of such items awarded by a casino to a taxpayer-patron if included in his gross_income could be considered a gain from wagering against which he was allowed to offset his wagering losses however if dr merkin received any items of that type in redemption of his player’s club points we could not permit him to have it both ways that is by taking the value of those items into account to determine whether his gambling activity was engaged in with the actual intent of making a profit while not including the value of those items in income see id cf 497_us_154 petitioners also argue that dr merkin’s substantial income from his medical practice should have no effect on our determination with respect to petitioners’ profit objective see 480_us_23 we disagree the facts in the present case differ from those in groetzinger there the supreme court noted that the taxpayer following the termination of his 20-year employment in february spent the balance of that year--and most of his time--engaged in parimutuel betting and that the taxpayer looked to that activity and his winnings from it as his livelihood to the contrary dr merkin was self-employed as a psychiatrist with a longstanding practice on park avenue in new york city petitioners did not rely on dr merkin’s winnings to support themselves see sec_1_183-2 income_tax regs petitioners had ample disposable income as a result of dr merkin’s practice to cover the expenses associated with two residences as well as dr merkin’s spending while at mohegan sun finally petitioners have not persuaded us--despite dr merkin’s testimony about his system and the player’s club points- -that dr merkin when he played video poker machines programmed by the casino had as his primary objective income or profit as dr merkin candidly admitted through his testimony regarding his scouting the various machines casinos are in the business of generating revenues to be sure dr merkin’s scouting process illustrated how casinos manipulate the computer gaming machines to increase the odds that the house will usually prevail as a result his system--developed in hopes of beating video poker machines--ultimately proved ineffective dr merkin conceded this reality when he admitted at trial that his system did not work accordingly in the light of sec_1_183-2 income_tax regs and on the basis of our analysis of the facts of this case we hold that dr merkin’s gambling activity in did not constitute a trade_or_business accuracy-related_penalty under sec_6662 respondent determined that petitioners are liable for an accuracy-related_penalty under sec_6662 for of dollar_figure sec_6662 imposes a penalty in the amount of percent of the portion of the underpayment to which sec_6662 applies as relevant to this case the penalty applies to any portion of the underpayment that is attributable to any substantial_understatement_of_income_tax sec_6662 there is a substantial_understatement_of_income_tax if the amount of the understatement exceeds the greater of percent of the tax required to be shown on the return or dollar_figure sec_6662 although the commissioner bears the burden of production with respect to the penalty in this case petitioners failed to raise the penalty as an issue in their petition at trial or on brief see sec_7491 116_tc_438 the issue is thereby deemed conceded see rule b 118_tc_358 on the record before us and for the reasons previously discussed we hold that dr merkin’s gambling activity in did not rise to the level of a trade_or_business activity as contemplated by sec_162 see also sec_1_183-2 income_tax regs accordingly and because petitioners have conceded respondent’s application of the accuracy-related_penalty under sec_6662 we find for respondent to reflect our disposition of the issues decision will be entered for respondent


office_of_chief_counsel internal_revenue_service memorandum number release date cc ita b07 -------------- postf-142598-07 uilc 263a 263a 263a date date to senior counsel lmsb retailers food pharmaceuticals healthcare associate area_counsel - chicago group cc lm rfph chi from branch chief branch income_tax accounting subject postf-142598-07 definition of unit_of_property for interest capitalization this chief_counsel_advice responds to your request for assistance this advice may not be used or cited as precedent legend taxpayer z u v w t x y r s date a date b date c date d --------------------------------------------------------------------------------------- - --------------------------------------------------------------------------------------- ---------------------------------------------------------- ------------------------------------ ---------------------------- ---------------------------------- -------------------------------------------------------------------- ------------------------------- ---------------------------- ----------- -------------- ---------------------- ------------------ ------------- -------------- postf-142598-07 date e date f location p location s dollar_figureh dollar_figurei dollar_figurej dollar_figurek dollar_figurel dollar_figurem dollar_figureo issue ---------------------- ------------------ --------------- ----------------------- ----------------- --------------- --------------- ----------------- ----------------- --------------- ----------------- whether certain components of real and tangible_personal_property are functionally interdependent for purposes of sec_1_263a-10 of the income_tax regulations facts taxpayer operates several processing and manufacturing facilities across the united_states and worldwide taxpayer is principally engaged in z taxpayer’s operations are classified into three reportable business segments u v and w each segment is organized based upon the nature of products and services offered taxpayer’s remaining operations are aggregated and classified as other in its financial statements taxpayer also maintains a complex of t linking together the company and its customers and suppliers taxpayer uses an overall accrual_method of accounting for federal_income_tax purposes taxpayer historically and currently uses authorization for expenditures afes as a management tool afes are used to receive and document approval of expenditures above certain cost levels and outside of specific day-to-day activities and are categorized by type of expenditure ie expense afe or capital afe typically capital afes provide information as to why the expenditures should be made the purpose of the asset to be produced and a breakdown of the types of expenditures but not necessarily the components of the overall asset to be produced ------------------------ --------------------------------------------------------------------------------------------------------------------- --------------------------------------------------------------------------------------------------------------------- --------------------------------------- taxpayer filed a form_3115 application_for change in accounting_method requesting permission to change its method_of_accounting for interest capitalization under sec_263a of the internal_revenue_code and the income_tax regulations under that section for the taxable_year beginning date a under its present method taxpayer had determined the amount of capitalized_interest on a per-project basis taxpayer claimed that this postf-142598-07 method resulted in the inclusion of items of property that are not designated property in the accumulated production_expenditures of the project taxpayer signed a consent agreement issued by the internal_revenue_service granting taxpayer permission to change its method_of_accounting for interest capitalization for the taxable_year beginning date a the consent agreement provided that taxpayer will capitalize interest costs with respect to all property described in sec_263a and sec_1_263a-8 designated property and will perform the avoided cost calculation on the basis of units of property as defined in sec_1_263a-10 in addition taxpayer will treat interest capitalized on a unit of designated property as a cost of the unit of designated property in accordance with sec_1_263a-8 and will recover such capitalized_interest in accordance with sec_1_263a-1 interest capitalized on a unit of designated property containing one or more items of depreciable_property such as tangible_personal_property and depreciable real_property will be ratably allocated among such items of depreciable_property and will be depreciated in accordance with the code and regulations that are applicable to such property also taxpayer will cease capitalization of interest with respect to i property that are not units of designated property within the meaning of sec_1_263a-8 and ii property meeting the de_minimis_rule in sec_1 263a- b taxpayer has been involved in several capital expansion projects for which afes have been established in its form_3115 taxpayer included big_number individual assets segregated from individual afes after issuance of the consent agreement taxpayer determined that it had overcapitalized interest on property that was not designated property or had suspension periods in excess of days or on which interest was accrued after production was completed taxpayer reduced the basis of these assets in order to remove the interest it determined was erroneously capitalized this request highlights seven afes from which taxpayer identified property that was not designated property these seven projects included co-generation plant expansions a co-generation plant addition and a x plant expansion the information reviewed does not indicate that any assets included in the co-generation or r plant afes were placed_in_service with or used in support of the existing co-generation or r plants as applicable prior to the completion of the expansion or addition projects afe authorized in date b for dollar_figureh was part of a steam and power generation expansion project at the location p co-generation facility to accommodate increased processing plant expansion afe contained component assets of which are real_property components and the remaining are tangible_personal_property components taxpayer and the internal_revenue_service agree that the real_property components are functionally interdependent real_property components considered one unit of real_property among the components identified for this afe were one coal fired boiler two gas fired boilers a bagger cyclones ductwork fans gas lines heaters computer controls and instrumentation piping pumps smoke stack additions valves meters catwalks grating filters steam lines turbines and other related components postf-142598-07 afe authorized in date b for dollar_figurei also was part of the steam and power generation expansion project at the location p co-generation facility but was limited to the construction of a coal conveyor system for use at the facility afe contained component assets of which are real_property components and the remaining are tangible_personal_property components among the components identified for this afe were building additions conveyors computers insulation and special purpose structures the project descriptions for afe’s and each provide with increased grind rate of ------------bpd and expansion of bio-products plus additional bio-product processes being built steam and power generation expansion are needed ---------------- -------coal boiler ---------------turbine generator and --------------------gas boilers will be installed this will allow for down time for yearly maintenance on -------- existing coal boilers and ----- turbine generators without reductions in production it will also make --- ------- existing gas boilers available for other plants and provide needed space for future expansion the location p co-generation facility expansion was designed to produce up to an additional --- megawatts of electrical power and --------------pounds of steam per hour afe authorized in date c for dollar_figurej involved the installation of new feedwater heaters at the expanded location p co-generation facility afe contained component assets of which is a real_property component and the remaining are tangible_personal_property components taxpayer and the internal_revenue_service agree on the amount of capitalized_interest for the real_property component among the components identified for this afe were a boiler water heater piping insulation and other instrumentation the project description for afe provides due to the number of tube failures and marginal size new feedwater heaters are required for co-generation the existing units can be refurbished to be used in the location s co-generation facility which will require larger heaters to accommodate the expansion at that location afe authorized in date d for dollar_figurek was part of a steam and power generation expansion project at the location s co-generation facility afe contained component assets of which are real_property components and the remaining are tangible_personal_property components taxpayer and the internal_revenue_service agree that the real_property components are functionally interdependent real_property components considered one unit of real_property among the components identified for this afe were a coal fired boiler bag filter system control system ductwork smoke stack electrical equipment building modifications equipment foundations hoppers piping silencer platforms steam separators strainers storage bins equipment supports transformers air compressor coal and limestone conveying equipment blowers catwalks computer process control systems cyclones dust collector freight elevator elevator man-lift filling equipment fans grating postf-142598-07 instrumentation equipment supports electrical turbine generator water treatment equipment pipes valves and other related components the project description for afe provides construct --- circulating fluid bed boiler at location s capacity --------------pounds steam per hour afe authorized in date e for dollar_figurel also was part of the steam and power generation expansion project at the location s co-generation facility but was limited to the installation of boilers and turbine generators afe contained component assets of which are real_property components and the remaining are tangible_personal_property components taxpayer and the internal_revenue_service agree that the of the real_property components are functionally interdependent real_property components considered one unit of real_property and that the remaining are functionally independent among the components identified for this afe were a turbine condenser cooling tower bagger catwalk dryer electrical equipment computer processing equipment pumps tanks building structural changes man-lift elevator transformer equipment foundations grating gear reducer motor control center valves spill containment weigh feeder and other related components the project description for afe provides it is proposed to install a ------mw automatic dual extraction condensing steam turbine generator at the location s co-generation plant the machine maximizes our steam and electrical loading flexibility while producing ------------cents kw power afe authorized in date f for dollar_figurem also was part of the steam and power generation expansion project at the location s co-generation facility but was limited to the installation of an ion exchange addition afe contained component assets of which are real_property components and the remaining are tangible_personal_property components taxpayer and the internal_revenue_service agree that the real_property components are functionally interdependent real_property components considered one unit of real_property among the components identified for this afe were a crane for ion exchange addition deionization system duct work electrical equipment filters ion exchange feed system resin-ion exchanger addition valves building additions catwalk control systems piping instrumentation and other related components the project description for afe provides in order to maintain plant reliability additional water treatment capacity is needed at the co-generation plant it is proposed to add an ion-exchange carousel capable of providing --------gpm or continuous make-up water afe authorized in date c for dollar_figureo was for the expansion of x processing at the location p facility afe contained component assets of which are real_property components and the remaining are tangible_personal_property components taxpayer and the internal_revenue_service agree that the real_property components postf-142598-07 are functionally interdependent real_property components considered one unit of real_property among the components identified for this afe were an air compressor conveyor bag filter blower condenser cooling tower dryer duct work dust collector electrical ejector extractor fan filters fiber grinder heat_exchanger instrumentation insulation motors piping pumps platform cracking roll scale screw press transformer valves tanks catwalk and other related components the project description for afe provides to --------- x capacity to ----- mm lb per year will require the components listed above the service’s examination team’s meetings with taxpayer indicated that this new facility was constructed to produce three new s products the raw material for these new products is y a product already produced at the facility prior to the expansion the facility’s expansion would put the y through a -------- removal process followed by a drying process for ultimate use in the three new s products the three new products required the y be put through the -------- removal and drying processes based upon advice received from taxpayer’s representatives in implementing the change in accounting_method authorized by the consent agreement taxpayer treated each tangible_personal_property component within each afe as a discreet asset representing a separate_unit of property for purposes of sec_263a of the internal_revenue_code law and analysis sec_263a provides that in the case of any property to which sec_263a applies any costs described in sec_263a shall be included in inventory costs in the case of property which is inventory in the hands of the taxpayer or shall be capitalized in the case of property that is not inventory in the hands of the taxpayer sec_263a provides that the costs described by such paragraph with respect to any property are i the direct costs of such property and ii such property’s proper share of those indirect_costs including taxes part or all of which are allocable to such property sec_263a provides that except as otherwise provided sec_263a applies to real or tangible_personal_property produced_by_the_taxpayer sec_263a provides that sec_263a shall apply only to interest costs which i are paid_or_incurred during the production_period and ii are allocable to property which is described in sec_263a and which has a long_useful_life an estimated production_period exceeding years or an estimated production_period exceeding year and a cost exceeding dollar_figure postf-142598-07 sec_263a provides that for purposes of sec_263a property has a long_useful_life if such property is real_property or property with a class_life of years or more as determined under sec_168 sec_263a provides that for purposes of sec_263a the term production_period means when used with respect to any property the period beginning on the date on which production of the property begins and ending on the date on which the property is ready to be placed_in_service or is ready to be held_for_sale sec_1_263a-8 provides that capitalization of interest under the avoided_cost_method described in sec_1_263a-9 is required with respect to the production of designated property described in sec_1_263a-8 sec_1_263a-8 provides that except as provided in sec_1_263a-8 and sec_1_263a-8 designated property means any property that is produced and that either is i real_property or ii tangible_personal_property as defined by sec_1 263a- a which is a property with a class_life of years or more under sec_168 long- lived property but only if the property is not property described in sec_1221 in the hands of the taxpayer or a related_person b property with an estimated production_period as defined in sec_1_263a-12 exceeding years 2-year property or c property with an estimated production_period exceeding year and an estimated cost of production exceeding dollar_figure 1-year property sec_1_263a-8 provides that the thresholds described in sec_1_263a-8 are applied separately for each unit_of_property as defined in sec_1_263a-10 sec_1_263a-8 provides that produce is defined as provided in sec_263a and sec_1_263a-2 sec_263a provides that for purposes of sec_263a the term produce includes construct build install manufacture develop or improve sec_1_263a-2 provides that for purposes of sec_263a produce includes the following construct build install manufacture develop improve create raise or grow sec_1_263a-8 provides that real_property includes land unsevered natural products of land buildings and inherently permanent structures sec_1_263a-8 provides that inherently permanent structures include property that is affixed to real_property and that will ordinarily remain affixed for an indefinite period of time such as swimming pools roads bridges tunnels paved parking areas and other pavements special foundations wharves and docks fences inherently permanent advertising displays inherently permanent outdoor lighting facilities railroad tracks and signals telephone poles power generation and transmission facilities permanently installed telecommunications cables broadcasting towers oil_and_gas pipelines derricks and storage equipment grain storage bins and silos property may constitute an inherently_permanent_structure even though it is not classified as a building for purposes of former sec_48 and sec_1_48-1 any property not otherwise postf-142598-07 described in sec_1_263a-8 that constitutes other tangible_property under the principles of former sec_48 and sec_1_48-1 is treated for the purposes of sec_1_263a-8 as an inherently_permanent_structure sec_1_263a-12 provides that a separate production_period is determined for each unit_of_property defined in sec_1_263a-10 sec_1_263a-10 provides that whether property is 1-year or 2-year property under sec_1_263a-8 is also determined separately with respect to each unit_of_property as defined in sec_1_263a-10 sec_1_263a-10 provides that a unit of real_property includes any components of real_property owned by the taxpayer or a related_person that are functionally interdependent and an allocable share of any common feature owned by the taxpayer or a related_person that is real_property even though the common feature does not meet the functional_interdependence test when the production_period begins with respect to any functionally interdependent component or any common feature of the unit of real_property the production_period has begun for the entire unit of real_property sec_1_263a-12 provides that the production_period of a unit of real_property begins on the first date that any physical production activity as defined in sec_1 263a- e is performed with respect to a unit of real_property sec_1_263a-12 provides that the term physical production activities includes any physical activity that constitutes production within the meaning of sec_1_263a-8 sec_1_263a-12 provides that the production_period of a unit of tangible_personal_property begins on the first date by which the taxpayer’s accumulated production_expenditures including planning and design expenditures are at least percent of the taxpayer’s total estimated accumulated production_expenditures for the property unit thus the beginning of the production_period is determined without regard to whether physical production activity has commenced the production_period for a unit of tangible_personal_property produced under a contract begins for the customer when the customer’s accumulated production_expenditures are at least percent of the customer’s total estimated accumulated production_expenditures sec_1_263a-12 provides that the production_period for a unit_of_property produced for self use ends on the date that the unit is placed_in_service and all production activities reasonably expected to be undertaken by or for the taxpayer or a related_person are completed sec_1_263a-10 provides that components of real_property produced by or for the taxpayer for use by the taxpayer or a related_person are functionally interdependent if the placing in service of one component is dependent on the placing in service of the other component by the taxpayer or a related_person sec_1_263a-10 provides that components of tangible_personal_property are a single unit_of_property if the components are functionally interdependent components postf-142598-07 of tangible_personal_property that are produced by or for the taxpayer for use by the taxpayer or a related_person are functionally interdependent if the placing in service of one component is dependent on the placing in service of the other component by the taxpayer or a related_person sec_1_263a-8 provides that for purposes of sec_1_263a-8 through 263a- placed_in_service has the same meaning as set forth in sec_1_46-3 providing rules relating to the qualification of property investments for the investment_tax_credit sec_1_46-3 provides that property shall be considered placed_in_service in the earlier of i the taxable_year in which under the taxpayer’s depreciation practice the period for depreciation with respect to such property begins or ii the taxable_year in which the property is placed in a condition or state of readiness and availability for a specifically assigned function sec_1_46-3 provides that in the case of property acquired by the taxpayer for use in his trade_or_business or in the production_of_income the following are examples of cases where property shall be considered in a condition or state of readiness and availability for a specifically assigned function i parts are acquired and set_aside during the taxable_year for use as replacements for a particular machine or machines in order to avoid operational time loss ii operational farm equipment is acquired during the taxable_year and it is not practicable to use such equipment for its specifically assigned function in the taxpayer’s business of farming until the following year and iii equipment is acquired for a specifically assigned function and is operational but is undergoing testing to eliminate any defects however materials and parts acquired to be used in the construction of an item of equipment shall not be considered in a condition or state of readiness and availability for a specifically assigned function although courts have not addressed the issue in the context of sec_263a several cases have dealt with the definition of placed_in_service for purposes of sec_1_46-3 with respect to electrical power generation facilities courts have applied the test announced in several revenue rulings that an electrical generating plant is placed_in_service when the necessary permits and licenses have been obtained all critical tests necessary for proper operation have been performed the unit has been placed in the control of the taxpayer by the construction contractor the unit has been synchronized with the transmission grid and daily operation of the unit has begun see revrul_76_428 1976_2_cb_47 revrul_76_256 1976_2_cb_46 oglethorpe power corp v commissioner tcmemo_1990_505 46_f3d_382 5th cir nonacq 1995_2_cb_1 several cases have examined whether component assets may be regarded as individual units of property for purposes of depreciation and the investment_tax_credit in 431_f2d_980 10th cir the tenth because of the depreciation conventions under sec_168 the taxable years in i and ii are the same for property subject_to depreciation under sec_168 postf-142598-07 circuit considered whether the component assets of an electrical power plant could be placed_in_service before the entire plant was placed_in_service the component assets were a turbine-generator a steam generating unit a cooling tower a transformer and a main power plant building the court held that the various assets were placed_in_service when the entire plant became operational stating that no one of these component assets would serve any useful purpose to public service co but all of them properly fitted together by the contractor together with the building constituted a completed unit which was operational and served the purpose intended by public service co it was this complete operational unit that the contractor agreed to construct from the many components and deliver to public service co as an electrical power generating plant id pincite similarly in 697_f2d_1063 fed cir the court considered the issue of defining the applicable unit_of_property for purposes of applying the construction exception to the restoration of the investment_tax_credit in the taxpayer argued that a refinery marine terminal and product pipelines were separate properties for purposes of applying the transition rule however the trial_court reasoned that the marine terminals transport raw materials to the refinery and the pipelines connect the refinery to storage facilities so the two offsite components together with the refinery itself functionally form a single property id pincite in affirming the decision the court_of_appeals concluded that the trial court’s approach was reasonable particularly since the refinery complex was conceived designed and constructed as a unit the three components being placed in operation concurrently id in 89_tc_710 the tax_court examined the issue of whether an upper reservoir and a hydroelectric plant facility should be considered a single unit_of_property for purposes of depreciation and the investment_tax_credit for the electrical power generation facility to operate as intended water would flow down from the upper reservoir to a lower reservoir through tunnels turning hydraulic turbine generators on its way down and thereby producing electric power construction of the upper reservoir was completed in but the power facility was not operational until and the taxpayer argued that the upper reservoir should be treated as placed_in_service when it was available for use in the court concluded that both components must be viewed as one integrated unit because the physical plant and the reservoir operate simultaneously and as a unit in order to produce electrical power id pincite the tax_court addressed a similar issue in armstrong world industries inc v commissioner tcmemo_1991_326 aff’d 974_f2d_422 3rd cir in armstrong world industries the issue was the unit_of_property qualifying for investment tax_credits postf-142598-07 and depreciation_deductions under the now repealed safe-harbor leasing rules in order to qualify for accelerated deduction under the safe-harbor leasing rules property must have been placed_in_service during a specified transition_period the definition of placed_in_service for purposes of the safe-harbor leasing rules was identical to the definition provided in sec_1_46-3 the taxpayer entered into leasing agreements to acquire various railroad properties and argued that all properties acquired were interdependent component parts comprising a single unit_of_property that could not be considered placed_in_service until the final rail track project was completed the third circuit affirming the tax_court held that the various track segment projects had independent utility prior to the time all of the project components were completed after reviewing public service co hawaiian independent refinery and consumers power the court stated in sum courts appear to agree that individual components will be considered a single property for tax purposes when the component parts are functionally interdependent - when each component is essential to the operation of the project as a whole and cannot be used separately to any effect the converse thus should be equally valid in this case accordingly if a project has component parts which can function as planned in a wholly independent manner then a court may find that each component is a property placed in a condition or state of readiness and availability for a specifically assigned function id pincite emphasis in original internal citation omitted the third circuit’s approach in determining whether individual components should be considered a single unit_of_property by examining the functional independence or interdependence of the various component assets is consistent with the approach of sec_1_263a-10 as expressed in the preamble to the final interest capitalization regulations see t d 1995_1_cb_20 commentators recommended that the final regulations define a unit_of_property to include each operating_unit that performs a discrete function by referencing the definition provided in sec_1_167_a_-11 in addressing this recommendation the preamble to the final regulations states the sec_1_167_a_-11 definition of a unit may not encompass the functionally interdependent components of property this definition of a unit applied for purposes of applying the alternative depreciation adr repair_allowance provisions which were elective the provisions provided a simplification procedure for treating a taxpayer’s expenditures as either capitalized expenditures or deductible expenses taxpayers that elected the provisions and used this sec_1_167_a_-11 definition of a unit we re required to use the same standard that other taxpayers used in determining the date on which property was placed_in_service ie the standard consistent with the concept of a single property as an aggregation of functionally interdependent components accordingly the final regulations do not adopt commentators’ recommendation to modify the definition of a unit_of_property postf-142598-07 we will apply the rules set forth above to the projects identified in your submission as part of our analysis we will also examine some of the arguments offered by the taxpayer steam and power generation expansion projects at location p co-generation a facility afe and afe based on the facts presented the purpose of the steam and power generation expansion projects at the location p co-generation facility was to increase the amount of steam and electrical power generated at the facility in order to accommodate increased processing operations at that location with respect to afe relating to the installation of a new boiler at the facility each of the tangible_personal_property components identified in the afe are essential to the operation of the boiler in its role in accomplishing the project’s intended function of increasing power generation at the facility moreover each of the assets identified in the afe are essential to the intended purpose of the location p steam and power generation expansion project there is no indication that any one of the tangible_personal_property components has any utility to taxpayer apart from their combined role in fulfilling the purpose of the expansion project the facts further indicate that the tangible_personal_property components identified in afe were not used in combination with any existing assets prior to completion of the expansion project similarly with respect to afe relating to the installation of a new coal conveyor system at the facility each of the tangible_personal_property components identified in the afe are essential to the operation of the coal conveyor system in its role in accomplishing the project’s intended function of increasing power generation at the facility moreover just as the marine terminal pipelines and refinery were found functionally interdependent in hawaiian independent refinery the tangible_personal_property components of the coal conveyor system appear functionally interdependent with the other tangible_personal_property components installed as a part of the entire location p steam and power generation expansion project absent any use of the coal conveyor system in combination with existing assets there is no indication that the conveyor would have any utility to taxpayer apart from its role in fulfilling the purpose of the expansion project taxpayer has offered several arguments in support of its position that a discreet asset that can function independently of another discreet asset should be considered functionally independent of such other asset regardless of whether or not the asset is essential to the operation of the project as a whole first taxpayer suggests an equivalency between the unit_of_property for purposes of sec_263a and the unit_of_property for purposes of sec_162 and sec_263 for example taxpayer cites 291_fsupp2d_699 w d tenn aff’d 412_f3d_617 6th cir in fedex the taxpayer incurred periodic costs in servicing the engines used in its aircraft fleet and sought to deduct the expenses as incidental repairs to decide postf-142598-07 whether the expenses were currently deductible the court had to determine whether the applicable unit_of_property was the aircraft or the engine despite the taxpayer’s urging the court expressly declined to adopt the functional_interdependence test of sec_1_263a-10 as an absolute test to determine the unit_of_property for purposes of sec_162 and sec_263 fedex f_supp 2d pincite n rather the court concluded that functional_interdependence was only one factor among several factors that must be considered in resolving the unit_of_property issue for purposes of sec_162 and sec_263 since functional_interdependence is only one factor among several factors that are relevant under sec_162 and sec_263 the unit_of_property that is determined under those sections is not necessarily the unit_of_property for purposes of sec_263a taxpayer also relies upon 151_f3d_876 8th cir aff’g in part rev’g in part 952_fsupp_1346 d minn in northern states power the taxpayer argued that fuel assemblies a component of a nuclear power reactor which were acquired to replace existing fuel assemblies were placed_in_service when received and not when they were later installed in the nuclear reactor the taxpayer’s express purpose in acquiring the fuel assemblies was to maintain power output at the facility not to increase power production the court held that the replacement fuel assemblies were a distinct unit_of_property from the entire nuclear power facility thus the taxpayer was allowed investment_tax_credit and depreciation_deductions for the assemblies in the taxable_year in which they were received because taxpayer’s projects are part of an expansion of or addition to existing facilities taxpayer also relies upon 84_tc_739 aff’d 803_f2d_1572 11th cir in piggly wiggly the taxpayer claimed depreciation_deductions and investment_tax_credit in the taxable_year in which it purchased new equipment for use in the operation of new relocated and remodeled stores the equipment for the remodeled stores was installed operating and in use in these stores in the year of purchase the equipment for the new and relocated stores was placed in stores that were not open for business in the year of purchase the court held that the equipment for the remodeled stores was placed_in_service in the year of purchase but the equipment for the new and relocated stores was not placed_in_service in the year of purchase in our view taxpayer’s reliance on these cases is misplaced as the sixth circuit explicitly recognized in fedex functional_interdependence for purposes of interest capitalization is distinct from the unit_of_property test applied for purposes of sec_162 and sec_263 functional_interdependence is only one factor among several that is relevant under sec_162 and sec_263 such that the unit_of_property determined under sec_162 and sec_263 is not necessarily the unit_of_property for purposes of sec_263a in addition the fuel assemblies in northern states power were conceded to have been acquired fully assembled and ready to be placed within the reactor the only issue was whether the taxpayer actually had to use the replacement assemblies for the parts to be considered placed_in_service in contrast in the instant case there is no assertion that the expansion undertaken by taxpayer as represented in afe and afe postf-142598-07 was intended to replace any part of the existing power generation facility rather the project’s intended purpose was expansion of capacity at the existing power generation facility further unlike the equipment in the remodeled stores in piggly wiggly the expansion of the co-generation facility more closely resembles a new facility and the components that are purchased or constructed for the expansion of the co-generation facility cannot operate and be in use for the intended purpose of the project until all of the components of the expansion are complete therefore based on the foregoing analysis and the facts presented we conclude that all tangible_personal_property components essential to the operation of the location p steam and power generation expansion project as a whole for example as those identified in afe and afe are functionally interdependent for purposes of sec_263a similarly we further conclude that all real_property components essential to the operation of the location p steam and power generation expansion project as a whole for example as those identified in afe and afe are functionally interdependent for purposes of sec_263a we note however a unit_of_property that is comprised of real_property components is a distinct unit_of_property for purposes of sec_263a from the unit_of_property that is comprised of tangible_personal_property components b feedwater heater upgrade at the location p facility afe based on the facts presented the purpose of the feedwater heater upgrade project represented by afe was to replace the existing heaters because of failure of the existing units and because the old units were too small to handle the capacity required for the expanded co-generation facility each of the tangible_personal_property components identified in the afe are essential to the operation of the feedwater heaters in their role in accomplishing the intended function of the project there is no indication that any one of the tangible_personal_property components has any utility to taxpayer apart from their combined role in fulfilling the purpose of the project the facts further indicate that the tangible_personal_property components identified in afe were not used in combination with any existing assets prior to completion of the project therefore based on the foregoing analysis and the facts presented we conclude that all tangible_personal_property components identified in afe are functionally interdependent for purposes of sec_263a however the unit_of_property identified in afe may be used to replace existing feedwater heaters at the facility and thus is not functionally interdependent with the properties used in the entire location p steam and power generation expansion project for example as those identified in afe and afe steam and power generation expansion project at the location s co-generation c facility afe afe and afe postf-142598-07 based on the facts presented the purpose of the steam and power generation expansion project at the location s co-generation facility is identical to that identified for the location p steam and power generation expansion project each of afe afe and afe relate to the location s steam and power generation expansion project and each of the tangible_personal_property components identified in these afe’s are essential to taxpayer accomplishing the intended function of the expansion project to increase power generation at the facility there is no indication that any one of the tangible_personal_property components has any utility to taxpayer apart from their combined role in fulfilling the purpose of the expansion project the facts further indicate that the tangible_personal_property components identified in afe afe and afe were not used in combination with any existing assets prior to completion of the expansion project therefore based on the foregoing analysis and the facts presented we conclude that all tangible_personal_property components essential to the operation of the location s steam and power generation expansion project as a whole for example as those identified in afe afe and afe are functionally interdependent for purposes of sec_263a d expansion of x processing capacity at location p facility afe based on the facts presented the purpose of the x expansion project represented by afe was to expand the existing x processing facility to enable the ---------- removal and drying processes and ultimately produce three new s products each of the tangible_personal_property components identified in the afe are essential to the expanded operation of the facility in their role in accomplishing the intended function of the project there is no indication that any one of the tangible_personal_property components has any utility to taxpayer apart from their combined role in fulfilling the purpose of the project the facts further indicate that the tangible_personal_property components identified in afe were not used in combination with any existing assets prior to completion of the project taxpayer argues that the functionality of the drying process which follows the ---------- removal process is not dependent upon the --------removal process furthermore its preexisting grinding process which follows the drying process is not dependent upon the --------removal or drying processes in fact taxpayer represents that it could purchase r that had been through the --------removal process and then start its own_production with the drying process however the fact that each of these processes - --- -------- removal drying and grinding - could be pursued separately does not change taxpayer’s intended purpose in undertaking the expansion project taxpayer sought to produce three new s products and such production was dependent on the facility’s expansion to provide for the -------- removal and drying processes there is no factual evidence to indicate taxpayer used or intended to use the expanded facility for any purpose other than the production of the three new s products postf-142598-07 therefore based on the foregoing analysis and the facts presented we conclude that all tangible_personal_property components identified in afe are functionally interdependent for purposes of sec_263a no opinion is expressed or implied regarding whether any individual component asset is properly characterized as a real_property component or a tangible_personal_property component within the meaning of sec_1_263a-10 case development hazards and other considerations --------------------------------------------------------------------------------------------------------------------- --------------------------------------------------------------------------------------------------------------------- --------------------------------------------------------------------------------------------------------------------- --------------------------------------------------------------------------------------------------------------------- --------------------------------------------------------------------------------------------------------------------- --------------------------------------------------------------------------------------------------------------------- --------------------------------------------------------------------------------------------------------------------- ----------------------------------------------------------------- this writing may contain privileged information any unauthorized disclosure of this writing may undermine our ability to protect the privileged information if disclosure is determined to be necessary please contact this office for our views please call --------------------- if you have any further questions associate chief_counsel income_tax accounting by kathleen reed kathleen reed branch chief branch income_tax accounting