The Tax Court held that a taxpayer’s receipts from highway construction projects were domestic production gross receipts (DPGR) permitting the taxpayer to claim a domestic production activities deduction. The court held that the taxpayer’s work substantially renovated real property, since it materially increased the property’s value, substantially prolonged its useful life or adapted the property to a new use.
IRC § 199 permits taxpayers with DPGR to take a deduction equal to 9% (3% in 2005 and 2006 and 6% in 2007 through 2009) of the lesser of qualified production activities income or taxable income before the deduction. DPGR includes receipts from the construction of real property, defined as the erection or substantial renovation of buildings, structural components and infrastructure, in the United States. Treas. Reg. § 1.199-3(m)(5) defines “substantial renovation” as “the renovation of a major component or substantial structural part of real property that materially increases the value of the property, substantially prolongs the useful life of the property, or adapts the property to a new or different use.”
Gibson and Associates Inc., an engineering and heavy construction company in Texas, builds or renovates infrastructure in Texas, Oklahoma, Arkansas and Kansas. For the tax year ended June 30, 2006, Gibson reported $26,053,570 of DPGR from 136 construction projects, claiming a domestic production activities deduction of $63,435. The IRS disallowed the entire deduction, claiming Gibson had no DPGR for the tax year. Gibson petitioned the Tax Court where, after concessions by both sides, nearly $12 million of the DPGR originally reported by Gibson remained in dispute.
Both parties presented expert witnesses to argue for or against the taxpayer’s contention that the disputed projects substantially renovated the property. William E. Gibson, the company CEO and a licensed engineer with 40 years of experience in the highway and bridge construction business, testified that the work increased the useful lives of some property by at least three years, increased the value of other property by at least 5% and adapted other property to a new use.
The court held that the substantial renovation standard had to be applied to each building, bridge or other permanent structure that Gibson worked on during the tax year. It then accepted the taxpayer’s argument that one project adapted that property to a new or different use, since after the work was performed, the property became accessible to people covered by the Americans with Disabilities Act. The court also held that 18 other projects that repaired damaged infrastructure substantially renovated those properties. These properties had been damaged by casualties rendering them completely or partially inoperative, and the court held that Gibson’s work increased their values and functionality by permitting them to function as originally intended.
The court also reviewed 80 other projects involving property (mostly bridges) that was not functioning as originally intended due to lack of proper maintenance. The court agreed with Gibson that its renovation of major structural components increased the useful life of these properties by more than three years. The court also rejected the IRS’ contention that the rehabilitation of one or more components of a property is a repair unless all of the major components were replaced.
Gibson & Associates Inc. v. Commissioner , 136 TC no. 10
By Charles J. Reichert, CPA, professor of accounting, University of Wisconsin–Superior.
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