Walgreen Co. & Subsidiaries v. Comm'r of Internal Revenue
| Decision Date | 10 November 1994 |
| Docket Number | No. 6634–92.,6634–92. |
| Parties | WALGREEN CO. & SUBSIDIARIES, Petitioner, v. COMMISSIONER OF INTERNAL REVENUE, Respondent. |
| Court | U.S. Tax Court |
OPINION TEXT STARTS HERE
David J. Duez, Lydia R.B. Kelley, Chicago, IL, and Gregory F. Jenner, Washington, DC, for petitioner.
James S. Stanis, Patricia Pierce Davis, and James M. Cascino, Chicago, IL, for respondent.
During P's taxable years 1980 through 1984, P made substantial improvements to leased premises for the purpose of operating its pharmacies and Wags restaurants. The leasehold improvements constitute section 1250 property as defined in sec. 1250(c), I.R.C. During P's taxable years ending in 1983 and 1984, P claimed depreciation deductions pertaining to the leasehold improvements pursuant to secs. 167(m) and 168, I.R.C. In calculating its depreciation deductions, P used a recovery period based on its belief that some of the leasehold improvements did not constitute the structural shell of a building or an integral part thereof. As such, P concluded that the leasehold improvements were classified in Asset Depreciation Range Class 57.0, “Distributive Trades and Services”, prescribed in Rev.Proc. 83–35, 1983–1 C.B. 745, 762. Held: pursuant to sec. 5 of Act of Jan. 3, 1975, Pub.L. 93–625, 88 Stat. 2108, 2112, Congress removed all section 1250 property from the ADR system until such time as the Treasury Department prescribed class lives explicitly containing section 1250 property; Held, further, ADR Class 57.0 did not contain any section 1250 property.
Respondent determined deficiencies in petitioner's Federal income taxes for petitioner's taxable years ending August 31, 1983, and August 31, 1984, in the amounts of $408,711 and $529,445, respectively. After concessions by petitioner, the issues for decision are: (1) Whether Asset Depreciation Range (ADR) Class 57.0 (ADR Class 57.0), prescribed in Rev.Proc. 83–35, 1983–1 C.B. 745, 762, includes section 1250 property; and (2) if ADR Class 57.0 does include section 1250 property, whether that class differentiates between items of section 1250 property that are structural and nonstructural components of a building.
Unless otherwise indicated, all section references are to sections of the Internal Revenue Code in effect for the years in issue.
At the time petitioner filed its petition its principal place of business was located in Deerfield, Illinois.
Some of the facts have been stipulated and are so found.
During the years in question, petitioner operated retail drugstores throughout 30 States. Petitioner also operated a chain of Wags restaurants. Through its drugstores, petitioner provides retail pharmacy services and sells health and beauty aids, proprietary drugs, liquor, tobacco, general merchandise, and food items. The buildings in which petitioner operates its drugstores and restaurants are either: (1) Owned by petitioner; (2) built by petitioner, sold to a third party, and leased-back to petitioner; or (3) leased by petitioner from a third party.
The present dispute pertains to depreciation deductions claimed by petitioner with respect to certain real property leasehold improvements (section 1250 leasehold improvements) made by petitioner between September 1, 1980, and August 31, 1984. These improvements were utilized by petitioner in the operation of the leased buildings as either drugstores or restaurants. Among other items, the section 1250 leasehold improvements in dispute consist of the following items:
(1) Interior partitions made up of drywall, glass, and metal;
(2) miscellaneous millwork, carpentry, lumber, metals, steel, and paint;
(3) acoustic, drywall, and plaster ceilings;
(4) restroom accessories;
(5) electric lighting fixtures; (6) interior floor finishings, including carpet, vinyl, rubber tile, ceramic tile, quarry tile, and terrazzo tile; and
(7) decor finishes, including wood trim, decorative steel work, and simulated structures.
Because of the large number of leasehold improvements involved in this case, the parties agreed to survey petitioner's drugstores and restaurants on a sample basis. Experts for both petitioner and respondent surveyed a sample group consisting of 10 drugstores and two restaurants. Based on this survey and prior to the issuance of the notice of deficiency, the parties reached an agreement that five percent of the leasehold improvements to petitioner's drugstores and 10 percent of the leasehold improvements to the restaurants consisted of personal property (section 1245 property) that was properly depreciated by petitioner. The parties also stipulated that the remaining 95 percent of the leasehold improvements pertaining to the drugstores and 90 percent of the leasehold improvements pertaining to the restaurants, which are the subject of the present dispute, consisted of section 1250 property as defined by section 1250(c). The total cost to petitioner of the section 1250 leasehold improvements in dispute is summarized in the following table:
+-----------------------------------------------------+
¦Period Placed ¦ ¦ ¦ ¦
+----------------+-----------+-----------+------------¦
¦In Service ¦Drugstores ¦Restaurants¦Total ¦
+----------------+-----------+-----------+------------¦
¦Sept. 1, 1980 to¦ ¦ ¦ ¦
+----------------+-----------+-----------+------------¦
¦Dec. 31, 1980 ¦$ 2,815,586¦$139,009 ¦$ 2,954,595 ¦
+----------------+-----------+-----------+------------¦
¦Jan. 1, 1981 to ¦ ¦ ¦ ¦
+----------------+-----------+-----------+------------¦
¦Aug. 31, 1981 ¦7,241,184 ¦204,989 ¦7,446,173* ¦
+----------------+-----------+-----------+------------¦
¦Sept. 1, 1981 to¦ ¦ ¦ ¦
+----------------+-----------+-----------+------------¦
¦Aug. 31, 1982 ¦9,069,580 ¦337,003 ¦9,406,583 ¦
+----------------+-----------+-----------+------------¦
¦Sept. 1, 1982 to¦ ¦ ¦ ¦
+----------------+-----------+-----------+------------¦
¦Aug. 31, 1983 ¦9,238,328 ¦384,818 ¦9,623,146 ¦
+----------------+-----------+-----------+------------¦
¦Sept. 1, 1983 to¦ ¦ ¦ ¦
+----------------+-----------+-----------+------------¦
¦Aug. 31, 1984 ¦16,191,156 ¦683,296 ¦16,874,452 ¦
+----------------+-----------+-----------+------------¦
¦ ¦ ¦ ¦46,304,949 ¦
+-----------------------------------------------------+
With respect to the section 1250 leasehold improvements placed in service before January 1, 1981, petitioner claimed depreciation deductions under section 167, under the ADR class life system, using a seven-year useful life for the property. With respect to the section 1250 leasehold improvements placed in service on or after January 1, 1981, petitioner claimed depreciation deductions under section 168, the Accelerated Cost Recovery System (ACRS), using a useful life of 10 years pursuant to section 168(c)(2)(C)(ii). Petitioner calculated the forgoing useful lives of the section 1250 leasehold improvements based on its belief that the improvements were classified under ADR Class 57.0.
For the years in question, ADR Class 57.0: . Rev.Proc. 83–35, 1983–1 C.B. 745, 762. Rev.Proc. 83–35 assigned the ADR Class 57.0 assets an asset guideline period of 9 years, with a lower limit of 7 years and an upper limit of 11 years. Id.
During the trial of this case, each party presented expert witnesses for the purpose of establishing the structural nature of the section 1250 leasehold improvements at issue. This testimony raises questions of fact that only become necessary to resolve if, as a matter of law, we determine that ADR Class 57.0 includes any section 1250 property, as urged by petitioner.
OPINIONInitially, we must determine whether ADR Class 57.0 includes section 1250 property. If we decide this issue in the affirmative, we must further determine whether ADR Class 57.0 differentiates between section 1250 property that constitutes structural components of a building, and section 1250 property that constitutes nonstructural components of a building.
Essentially, petitioner's argument is as follows: (1) ADR Class 57.0 includes certain items of section 1250 property that do not constitute the structural shell of a building or an integral part thereof; and (2) approximately 25 percent of petitioner's section 1250 leasehold improvements do not constitute the structural shell of a building or an integral part thereof. On the other hand, respondent contends that the legislative intent behind the applicable depreciation sections prevents section 1250 property from being included in any ADR class unless such class prescribed by the Treasury Department (Treasury) explicitly contains section 1250 property. Respondent argues that because ADR Class 57.0 does not explicitly include section 1250 property, the section 1250 leasehold improvements at issue in this case may not be included in such class.
Section 1250 property is any real property (other than section 1245 property (personal property), as defined in section 1245(a)(3)) which is or has been subject to the depreciation allowance under section 167. Sec. 1250(c). Real property, as used in section 1250(c), includes both “a building or its structural components” and other real property except that which is defined in sections 1245(a)(3)(B) and (D). Sec. 1.1250–1(e)(3)(i), Income Tax Regs. The parties agree that the leasehold improvements at issue constitute section 1250 property.
Proper resolution and understanding of this case require a detailed consideration of the statutory and regulatory scheme behind the relevant depreciation sections, as well as the relevant legislative history of...
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