In Broz v. Commissioner,1 the Tax Court held that assets used to provide commercial wireless cellular service should be depreciated over 10 to 15 years under section 168 and Rev. Proc. 87-56, rejecting the taxpayer's use of shorter recovery periods during the years at issue (1996 – 2001).
Discussion
Under the facts of the case, RFB Cellular Inc. (RFB) depreciated cell towers, antennas, equipment shelters, and land improvements as seven-year property under asset class 48.32, Telegraph, Ocean Cable, and Satellite Communications – High Frequency Radio and Microwave Systems. It depreciated other assets as five- and seven-year property under asset class 48.121, Computer-based Telephone Central Office Switching Equipment. The IRS determined that such assets should have been depreciated over 10 to 15 years, under asset classes 48.12 (Telephone Central Office Equipment) and 48.14 (Telephone Distribution Plant), and proposed deficiencies of more than $16 million for the years at issue (1996 – 2001). Based on the plain language of section 168 and Rev. Proc. 87-56, the Court agreed with the IRS, and held that the assets constituted 10- to 15-year depreciable property for the years at issue.
Specifically, RFB provided wireless cellular service through its cellular network that consisted of three basic components: (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. RFB claimed depreciation deductions for this equipment during the years at issue by classifying the equipment into the following three categories:
- Antenna support structures – included costs for towers, antennas, equipment shelters and related land improvements, which were depreciated over seven years under asset class 48.32.
- Cell site equipment – included a wide variety of equipment, including the switch and the base station, which were depreciated over five to seven years under asset class 48.121.
- Leased digital equipment – included costs for concrete, excavating, steel, fencing and construction, which were depreciated over five years under asset class 48.121.
Under exam, the IRS issued a deficiency notice, disallowing the depreciation deductions and asserting that the antenna structures should have been depreciated over 15 years under asset class 48.14, Telephone Distribution Plant 2, the cell site equipment and the leased digital equipment (other than the switch) should have been depreciated over 10 years under asset class 48.12, Telephone Central Office Equipment,3 but that RFB had properly classified the switch.
Section 167 allows a reasonable depreciation deduction for the exhaustion, wear and tear, and obsolescence of property used in a trade or business. This deduction is based on the adjusted basis of the property, as determined under section 1011. Depreciation deductions are based on the Modified Accelerated Cost Recovery System. The Treasury Secretary has the authority to prescribe class lives for each class of property. These class lives can be found in a series of revenue procedures. The revenue procedure in effect for the years at issue is Rev. Proc. 87-56, which establishes two categories of depreciable assets: (1) asset classes 00.11 through 00.4, which consist of specific assets used in all business activities (asset categories), and (2) asset classes 01.1 through 80.0, which consist of assets used in specific business activities (activity categories) based on broadly defined industry classifications. The same item of depreciable property may be described in both an asset category and an activity category, in which case the item is classified in the asset category, unless specifically excluded from the asset category or specifically included in the activity category (the "priority rule").4 Rev. Proc. 87-56 includes Telephone Communications as an activity, and includes assets identified in asset classes 48.11 through 48.14 that are used to provide commercial and contract telephone services. The various classes of telephone equipment are defined by reference to the FCC's Uniform System of Accounts for Class A and Class B Telephone Companies (USOA).
As previously noted, RFB depreciated a broad range of wireless cellular equipment as "antenna supporting structures" over seven years under asset class 48.32, the Telegraph, Ocean Cable, and Satellite Communications (TOCSC) activity category, which the IRS contended should be depreciated over 15 years under asset class 48.14. The Tax Court agreed with the IRS, holding that asset class 48.32 did not apply; the TOCSC activity category involves "domestic and international radio-telegraph, wire-telegraph, ocean-cable … [or] satellite communications services." It found that the antenna support structures were more appropriately categorized in the Telephone Communications activity category. RFB disputed this classification on the grounds that the activity category is too broad to apply to the wireless equipment at issue, and that wireless network assets are more advanced than landline telephone assets. It also asserted that wireless assets have a useful life that is "demonstrably shorter" than that of landline equipment. The Tax Court noted that RFB could not depreciate its equipment "under a class life simply because they believe it better approximates the equipment's useful life." Rather, the Tax Court stated that deductions are a "matter of legislative grace," and taxpayers are "entitled to deduct only the amounts prescribed by Congress." Further, the Tax Court noted that the plain language of Rev. Proc. 87-56 is "unambiguous" - assets in the Telephone Communications activity category are used to provide commercial and contract telephonic services (which RFB provided during the years at issue). Based on this reasoning, the Tax Court concluded that the relevant asset class for the antenna support structures was asset class 48.14, with a 15-year recovery period.
RFB characterized a wide variety of cell site equipment, including the base station and the switch, under asset class 48.12 with a five-year recovery period. The IRS conceded that RFB properly classified the switch under this asset class; however, the IRS asserted that the remaining cell site equipment, including the base station, should be classified as telephone central office equipment under asset class 48.12. RFB argued that the base station should be included in asset class 48.121 because it had some of the same equipment and could perform some of the same functions as the switch. Asset classes 48.121 and 48.12 apply to telephone central office switching equipment. The main difference between the two asset classes is that asset class 48.121 "includes equipment whose functions are those of a computer or peripheral equipment." Under section 168(i)(2)(B), the term "computer" refers to a programmable electronically activated device that (1) is capable of accepting information, applying prescribed processes to the information, and supplying the results of these processes with or without human intervention, and (2) consists of a central processing unit containing extensive storage. "Related peripheral equipment" includes any equipment designed to be placed under the control of the central processing unit of a computer. In rejecting RFB's argument that the remaining cell site equipment qualified as computer equipment because it contained computerized parts, the Tax Court noted that under RFB's analysis "virtually every asset in today's increasingly computerized world would be labeled a computer." Thus, even though the remaining cell site equipment included some computerized parts, it did not constitute a computer. The Tax Court also noted that the key component of the base station and other cell site equipment was the radio, which did not employ computer processing and had functioned for many years without computerized parts. Further, the Tax Court noted that, even though the base station contained some of the same software as the switch (which was properly classified as a computer), the base station did not have the computer system or storage capacity to keep billing records. Based on this reasoning, the Tax Court found that the remaining cell site equipment, including the base station, should have been depreciated under asset class 48.12 over a 10-year recovery period. The Tax Court applied the same classification methods to various pieces of equipment that were leased by RFB.
Implications
While Broz on its face is an unfavorable decision, it is important to note that the years at issue in Broz were prior to the IRS's recent guidance on wireless class lives in Rev. Proc. 2011-22 (see Guidance for the Telecommunications Industry on Repairs and Unit of Property Issues). Specifically, the Tax Court in Broz noted that "the Internal Revenue Service has since provided updated class life guidance for the ever-changing cellular service industry. Rev. Proc. 2011-22, 2011-18 I.R.B. 737, applies for years after the years at issue." Rev. Proc. 2011-22 is effective for taxable years ending after Dec. 30, 2010, and provides that antenna support structures are personal property with no class life depreciable over seven years, and that base station controllers, base transceiver stations, and their associated enclosures or cabinets (including integrated or built-in equipment) and cables are depreciable over five years under asset class 48.121. Thus, the guidance set forth in Rev. Proc. 2011-22 is more favorable than that provided in Broz. Affected taxpayers should review their depreciation methods to ensure they are following the guidance set forth in Rev. Proc. 2011-22 to determine whether an accounting method change request may be necessary to eliminate any potential exposure under exam or change to more favorable depreciation methods for wireless telecom assets placed in service in prior years.
1 137 TC No. 3 (2011).
2 Which includes such assets as pole lines, cable, aerial wire, underground conduits, and comparable equipment, and related land improvements as defined in Federal Communications Commission Part 31 Account Nos. 241, 242.1, 242.2, 242.3, 242.4, 243, and 244.
3 Which includes central office switching and related equipment as defined in Federal Communications Commission Part 31 Account No. 221.
4 See Norwest Corp. & Subs. v. Commissioner, 111 T.C. 105, 158 (1998).
