Tonawanda Coke Corp. v. Comm'r of Internal Revenue, Docket No. 2894-88.

• Decision Date: 08 August 1990
• Docket Number: Docket No. 2894-88.
• Citation: 95 T.C. No. 10,95 T.C. 124
• Parties: TONAWANDA COKE CORPORATION, Petitioner v. COMMISSIONER OF INTERNAL REVENUE, Respondent
• Court: U.S. Tax Court

95 T.C. 124

95 T.C. No. 10

TONAWANDA COKE CORPORATION, Petitioner

v.COMMISSIONER OF INTERNAL REVENUE, Respondent

Docket No. 2894-88.

United States Tax Court

Filed August 8, 1990.

T purchased a coke-producing plant shortly after the plant had suffered a devastating fire. T made certain expenditures to remove debris from the fire and to repair the plant. The expenditures included the removal of ice and tar, the replacement of destroyed piping, and the shoring up of the plant's steel structure. Respondent determined that the expenditures were for ‘demolition‘ for purposes of sec. 1.165- 3(a)(1), Income Tax Regs., and that therefore the expenditures must be allocated to T's basis in the underlying land, rather than to its basis in the coke plant. Held, because no demolition occurred, sec. 1.165-3(a)(1), Income Tax Regs., is inapplicable, and T therefore correctly allocated the cost of the expenditures to its basis in the coke plant. E.W. Dann Stevens, for the petitioner.

Gary Borek and Gary Bluestein, for the respondent.

WRIGHT, JUDGE:

Respondent determined a deficiency in petitioner's Federal income tax for taxable year 1983 in the amount of $358,074. After concessions by both parties, the sole issue remaining for decision is whether a portion of the cost of repairing a fire-damaged coke plant is attributable to a demolition for purposes of section 1.165-3(a)(1), Income Tax Regs, and therefore is properly chargeable to capital account with respect to the underlying land, rather than with respect to the coke plant.

FINDINGS OF FACT

Some of the facts have been stipulated. The stipulation of facts, supplemental stipulation of facts, and accompanying exhibits are incorporated herein.

Petitioner Tonawanda Coke Corporation (hereinafter referred to as petitioner) has its principal place of business in Tonawanda, New York. In June 1977, a coke plant (hereinafter referred to as the plant) owned and operated by Allied Chemical Corporation was offered for sale. The plant employed 60 coke ovens in producing coke. Each oven holds 19 tons of coal, which is heated to 22,000 degrees to produce coke. The coke ovens are made of brick and mortar. The ovens must be kept hot at all times, or the mortar will contract, and the ovens will collapse. The minimum temperature at which the ovens can be maintained is 12,000 degrees. Each of the 60 ovens has a value in excess of $1,000,000. The gases which are produced in the coking process, which are captured and transported by pipeline, are purified and then recycled to heat the ovens. The plant occupied 160 acres.

The Donner-Hanna Coke Corporation (Donner-Hanna) was interested in purchasing the plant. Donner-Hanna was represented during negotiations by J.D. Crane, its vice president and general manager. Crane inspected the plant and became familiar with its operations. Crane had 30 years' experience in managing coke plants with Donner- Hanna, and was familiar with all aspects of coke-making operations. As a representative of Donner-Hanna, he went so far as to sign a letter of intent to purchase the plant. However, the board of directors of Donner-Hanna ultimately declined to make the purchase.

On December 23, 1977, there was an explosion, and resulting fire, at the plant. The cause of the fire was the rupture of a large, steel tar storage tank. The rupture allowed more than 300,000 gallons of molten tar to inundate part of the plant. Approximately 100 firemen battled the fire with water hoses.

Only a small area of the plant was destroyed by the fire. However, the area which was destroyed was critical to the plant's operation. Among the damages caused by the fire were the losses of the gas delivery system, the liquid flushing system, and the tar containment systems. The two buildings most affected by the fire were the byproducts pump house and the exhauster building. The byproducts pump house contained several large pumps and motors which were later reconditioned and put back into service. The exhauster building contained an exhaust mechanism (a large pump which circulates gases) which was destroyed and had to be replaced. The plant could not operate without repairs to these areas. Areas of the plant which were not critical to its operation, such as the roofs of several buildings, were also damaged.

As a result of the rupture of the tar storage tank, a large area of the plant was covered with burning tar, which solidified due to the winter temperatures. The tar covered 40 acres of the plant site to a depth of 18 inches. The water which was used to combat the fire turned to ice, with a thickness of up to two feet, atop the hardened tar.

Upon learning of the fire, Crane, acting in his individual capacity rather than as an officer of Donner-Hanna, immediately visited and inspected the plant. Though Allied Chemical Corporation was doubtful the plant would ever operate again, Crane believed he could get the plant back into operation within 10 days. Crane formed and incorporated petitioner in January of 1978. On January 10, 1978, petitioner offered to purchase the plant. After completing negotiations with Allied Chemical, petitioner purchased the coke plant on January 27, 1978, a Friday. Crane, as chief executive officer of petitioner, planned to immediately restore the damaged portion of the coke plant and resume production of coke.

On Saturday, January 28, 1978, Crane and approximately 150 workers started putting the plant back into operation. Among the contractors hired by petitioner to repair the plant were John W. Danforth Company, Rupp Rigging, and Great Lakes Wrecking.

The work performed by John W. Danforth, a pipe-fitting company, involved replacement of piping from the by-products pump house into the primary and secondary coolers, replacement of gas piping into new exhausters and replacement of other gas, liquid, and steam piping. Most of the existing piping was rebuilt and reused. John W. Danforth's invoice totalled $240,226.

The work performed by Rupp Rigging involved repair of the secondary gas cooler (part of the exhauster mechanism) and installation of a new flushing liquid collecting tank. The secondary gas cooler had been left standing at a 45-degree angle after the fire due to damage to a portion of its base. Rupp Rigging lifted the tank, which has a diameter of 10 feet, removed the damaged portion of the base of the tank, and welded the new portion of the base. Rupp Rigging also shored up portions of buildings damaged in the fire, and strengthened the existing structural steel frame work to provide a measure of safety to the workers. Rupp Rigging does not perform demolition work. Rupp Rigging's invoice totalled $135,199 and described the work performed, in part, as ‘for services to dismantle fire damaged equipment, to transport to offload areas.‘

The work performed by Great Lakes Wrecking consisted primarily of breaking up tar and ice in the area. Great Lakes Wrecking moved the broken tar to a coal field adjacent to the coke plant. Great Lakes Wrecking also removed damaged piping and equipment in preparation for the installation of new piping by John W. Danforth. However, they did not remove the framework which supported the piping.

Finally, Great Lakes Wrecking cleaned fallen roofing, insulation, and any bent steel or piping which was in the way of the repair work. Any parts or equipment that were salvageable were used or set aside during cleanup and rebuilding. In addition, approximately one-half of the spilled tar was recycled by the plant for the production of coke. Great Lakes Wrecking's invoice totalled $62,039. The invoice describes the nature of the work done as being ‘for clean-up and building dismantlement.‘

From the date of the fire, and throughout the rehabilitation period, the 60-oven battery was kept at ‘idle-hot‘ by burning natural gas. The cost of heating the ovens was $5,000 to $10,000 per day. Thus, each day the plant was out of operation cost petitioner at least $5,000. Following completion of the rehabilitation work, coke production resumed at the coke plant on February 17, 1978. As of the date of trial, the plant was operating in the same buildings it utilized prior to the fire.

None of the buildings or equipment essential to the operation of the plant were torn down. The tar tank which had exploded was not replaced or discarded for a period of one year after the fire. None of the expenses at issue are attributable to the tar tank. None of the major structural damage to the plant, such as the loss of roofs, was repaired as of the date of trial.

In preparing its Federal income tax return for taxable year 1978, petitioner capitalized the cost of the work done to rehabilitate the plant, including the cost of the work performed by John W. Danforth, Rupp Rigging, and Great Lakes Wrecking, pursuant to section 1016(a)(1) ¹, and added the cost to its basis in the plant. Petitioner then depreciated the cost on the basis of a 15-year useful life.

Respondent determined that petitioner was not allowed depreciation in the amount of $75,956 on the total capital expenditures of $1,086,600 made in 1978 for rehabilitation of the coke plant because the expenditures were ‘demolition costs.‘ Respondent later conceded that all but $437,464 of the total expenses were properly capitalized and depreciated. However, respondent determined that the amounts paid to John W. Danforth, Rupp Rigging, and Great Lake Wrecking, totaling $437,464, were attributable to demolition costs, the need for which petitioner was aware when it purchased the plant, and that therefore, under section 165 and the regulations thereunder, such costs must be added to petitioner's basis in the underlying land, rather than to its basis in the plant itself.

OPINION

Section 165(a) provides that there shall be allowed as a deduction any loss sustained during the taxable year and not compensated for by insurance or otherwise. The regulations provide that the loss incurred in a trade or...