Broz v. Comm'r of Internal Revenue, 21629–06.

• Citation: 137 T.C. No. 3,137 T.C. 25
• Decision Date: 07 July 2011
• Docket Number: No. 21629–06.,21629–06.
• Parties: Robert and Kimberly BROZ, Petitioners v. COMMISSIONER of INTERNAL REVENUE, Respondent.
• Court: United States Tax Court

137 T.C. 25

137 T.C. No. 3

Robert and Kimberly BROZ, Petitioners

v.COMMISSIONER of INTERNAL REVENUE, Respondent.

No. 21629–06.

United States Tax Court.

July 7, 2011.

Ps were shareholders in a wholly owned S corporation (S) engaged in providing wireless cellular service. The parties dispute the length in years of the recovery period that S must use to calculate its annual depreciation deduction for the wireless cellular assets. Wireless cellular assets include antenna support structures, cell site equipment and leased digital equipment.

Held: We apply the plain language of sec. 168, I.R.C., in interpreting classification issues of first impression. The plain language of Rev. Proc. 87–56, 1987–2 C.B. 674, the revenue procedure in effect for the years at issue, is unambiguous as it applies to S's wireless cellular assets.

Held: The antenna support structures fall within asset class 48.14 with a recovery period of 15 years, as specified in Rev. Proc. 87–56, supra. The cell site equipment, excluding the switch, and the leased digital equipment fall within asset class 48.12 with a recovery period of 10 years. Id.

Stephen W. Feldman and Eric T. Weiss, for petitioners.

Meso T. Hammoud, Elizabeth Rebecca Edberg, and Steven G. Cappellino, for respondent.

KROUPA, Judge:

Respondent determined over $16 million of deficiencies ¹ in petitioners' Federal income tax for 1996, 1998, 1999, 2000 and 2001 (the years at issue).

In this report we decide whether RFB Cellular, Inc. (RFB), an S corporation petitioners wholly owned, is entitled to certain depreciation deductions for wireless cellular equipment. Specifically, we must determine whether petitioners properly classified antenna support structures, cell site equipment and leased digital equipment for depreciation purposes.² We find that they did not. A forthcoming report will address the remaining seven issues.

FINDINGS OF FACT

Some of the facts have been stipulated and are so found. We incorporate the stipulation of facts and the accompanying exhibits by this reference. Petitioners resided in Gaylord, Michigan at the time they filed the petition.

Overview of RFB Cellular, Inc.

Petitioner husband (petitioner) formed RFB Cellular, Inc. (RFB), a wholly owned S corporation, in 1991. RFB was engaged in providing wireless cellular service during the years at issue. Petitioner had many years of experience with the cellular industry before he formed RFB. He was president of Cellular Information Systems (CIS), a cellular company. Petitioner also served as a board member to the Cellular Telephone and Internet Association (CTIA) and was involved with lobbying efforts on behalf of the cellular industry.

Overview of the Cellular Industry

The Federal Communications Commission (FCC) administers the radio-frequency spectrum on which cellular carriers operate wireless networks. The FCC issues licenses for wireless networks to operate on specific broadcast frequencies on the spectrum. The licenses are further limited to a specific geographic area.

A cellular network is operated on a grid that divides the geographic region covered by the license into smaller cells (cell sites). The size of the cells depends on the anticipated amount of cellular traffic. In urban areas, the cells are smaller to maximize network capacity. In rural areas where capacity is less of a concern, such as those areas in Michigan where RFB operated its cellular networks, the cells are larger to provide more coverage. The cell site structure enables the cellular carrier to reuse a limited number of broadcast frequencies across the geographic region.

RFB provided cellular service to two license areas, and operated approximately 75 cell sites, on the Michigan peninsula during the years at issue. Most of RFB's revenue came from roaming charges for the use of the Michigan networks. RFB would make its networks available to customers of other carriers who were traveling within the geographic area of the licenses. RFB and other carriers sent their receivables and payables to a clearinghouse that would sort out the charges and payments and issue a bill to each carrier.

Operation of the Cellular Network

The three basic components of a cellular network are (1) the base station, which includes towers, antennas and related electronic equipment; (2) transmission facilities between the base station and the switch; and (3) the switch. Cellular carriers added onto the existing assets to update from analog to digital cellular technology.

A. The Antenna Support Structures

Signals from the cellular user travel from the cellphone to the antenna. The antenna is mounted on a free-standing tower so that it can transmit and receive signals across great distances. The height of the tower also reduces interference with radio signals from trees and tall buildings. The tower is strong enough to support the weight of the antenna and related equipment, plus accumulated ice and snow. The tower is also built to withstand high winds.

RFB constructed some of its towers on top of preexisting structures to prevent the obstruction of the antennas. RFB used the same towers for many years, and it would simply switch the antenna and related equipment when it stopped working or became obsolete.

B. The Base Station

The base station is located at or near the base of the tower. The cell phone searches for a signal from the closest base station before a call is made. The signal from the base station is what gives the cell phone service or “bars”. The cell phone then sends a radio signal to the base station identifying the user and the user's location. A radio transmitter in the cell phone converts the user's speech into strings of ones and zeroes that can be transmitted as radio signals to the antenna.

The base station contains a two-way radio that converts the radio signal from the cellphone to a form that can be transmitted over wire or optical fiber to the switch. The radio also converts the signal from the switch to a radio signal that can be transmitted to the cellular user. The radio contains some computerized parts, including a computerized component that amplifies the radio signals. The base station contains some switching software so it can route the calls if the switch no longer functions.

The base station is housed in a small equipment shelter. RFB typically leased the land beneath the equipment shelters for 25 years, with 5–year renewals. The equipment shelters were prefabricated from concrete slabs and were approximately 8 to 10 feet wide by 10 to 12 feet long. The equipment shelters were very heavy, and, like the towers, they were designed to remain in service for many years. The equipment shelters did not need to be replaced when the base station equipment was replaced. Instead, RFB would simply switch out the base station equipment when it went no longer functioned or became obsolete. The equipment shelters had air conditioning, temperature alarm systems, fire/smoke alarm systems, and intruder alarm systems.

C. The Switch

The switch, which is the technological descendant of the switchboard, is a computer system that routes the cellular calls. Wireless calls are typically transmitted to the switch from the base station over a landline or radio network. The switch is connected to the landline and other carriers. It determines how to route the call based on the number that is dialed. The switch also maintains billing records and monitors the base stations. One switch can serve as many as 200 base stations.

The Transition From Analog to Digital Technology

RFB initially provided analog cellular service. It began, however, updating its equipment to provide digital service. The digital equipment could handle approximately eight times as many calls as the analog service. The digital technology also provided customers with additional services. These additional services included the ability to text, send pictures, download ring tones and access the Internet. Moreover, the FCC eventually required that all cellular carriers phase out analog service and upgrade to newer digital technology.

RFB acquired and installed the leased digital equipment so it was ready for use in 2000. RFB decommissioned its analog equipment soon after the FCC mandated the switch to digital.

RFB's Returns for the Years at Issue

RFB claimed depreciation deductions for wireless cellular equipment during the years at issue. RFB did not specifically identify the items being depreciated but instead classified items into generic categories, such as “switch equipment” and “cellular equipment”.

RFB included all costs for towers, antennas, equipment shelters and related land improvements in the “antenna support structure” asset class. RFB depreciated the antenna support equipment over seven years under asset class 48.32. RFB classified a wide variety of equipment, including the switch and the base station, as “cell site equipment.” RFB depreciated the cell site equipment over five to seven years under asset class 48.121. RFB depreciated the leased digital equipment over five years under asset class 48.121. RFB included costs for concrete, excavating, steel, fencing and construction in the leased digital equipment category.

Respondent issued the deficiency notice disallowing the depreciation deductions. Respondent determined that the antenna structures should be depreciated over 15 years under asset class 48.14, rather than the seven years petitioners claimed. Respondent also determined that the cell site equipment and the leased digital equipment, other than the switch, should be depreciated over 10 years under asset class 48.12, rather than the five years petitioners claimed.

Petitioners timely filed a petition.

OPINION

We are asked to determine the appropriate class life for the ever-changing cellular phone industry. The parties disagree over the characterization of certain wireless cellular equipment for depreciation purposes. There are three categories of equipment at issue:...