Category: Deductions & Credits; Real
Estate Copyright 1998, The Tax Resource Group. All rights reserved. Telephone 800-578-3498. Internet: www.taxresourcegroup.com Set forth below is the body of a suggested letter to the IRS in the matter we have discussed. The government has indicated an inclination to deny the taxpayer's deductions for architectural, engineering, legal, soil testing, and other such expenses with respect to an abandoned effort to construct a commercial building on a recently purchased parcel of land adjacent to the site on which the taxpayer owns a fully operational commercial building which was placed in service in 19xx. The taxpayer respectfully takes exception to this position. It is well settled from case law stemming from the earliest days of our tax system that expenses related to the design and engineering of a building may be deducted if plans for constructing that building are scrapped. See Tom (Fayette T.) Moore, 19 B. T. A. 140 (1930); Western Wheeled Scraper Co., 14 B. T. A. 496 (1928); C. U. Connellee, 4 B. T. A. 359 (1926). As with many well settled areas of law, the cases from which this principle flow were heard many years ago; yet, despite the age of these cases, it is clear that their precedential value is as good today as it was when the cases were first decided. The government's position, as best the taxpayer can understand it, is because the abandoned project costs are part of the existing project [which characterization the taxpayer actively disputes], the costs should be capitalized as part of that original project. The taxpayer was unable to locate a case in which these precise facts were at issue. A number of cases do exist, however, in which the courts have analyzed whether costs written off by the taxpayer are a separate asset the taxpayer abandoned or an integral part of some larger asset which was not abandoned. It is the taxpayer's view that these cases are directly relevant to the issue at hand. In Robert Buedingen, 6 B. T. A. 335 (1927), the Board of Tax Appeals upheld the deduction of an architect's fee where a building as originally designed was deemed too expensive and was consequently rejected. The architect created totally new plans, and the taxpayer ultimately built a building based on those new plans. Despite the close connection between the old plans and the building that was ultimately constructed, the Board of Tax Appeals allowed a deduction for the planning costs associated with the original design. Notice that the taxpayer in Buedingen ultimately constructed a building on the exact same site as the originally planned building and as part of a single, integrated effort to produce a single building. Yet, the court allowed an abandonment loss for the cost of the original plans. In contrast, consider Driscoll v. Commissioner 45-1 USTC ¶9184],
147 F. 2d 493 (C. A. 5, 1945). The taxpayer had entered into contract
for the construction of a hotel and office building. After work
had been in progress for some time, the taxpayer determined to
make some radical changes. As a result of an ineffective air conditioning
system, it was necessary to tear out or demolish much equipment
and material and enlarge the building. In denying the taxpayer
a deduction for the abandonment of the original materials and
architectural fees, the Court of Appeals stated (at 494): Similar to the Driscoll holding is the case of R.B. Haspell v. Commr., 62 TC 59 (1974). The taxpayer wanted to erect a hotel and hired a firm of architects to design the entire building. After the foundation had been constructed, the plans for the superstructure, as designed by the original architects, were abandoned as too costly. A second firm of architects designed a different superstructure to be constructed upon the existing foundation; this second superstructure was eventually built. The court denied the taxpayer's abandonment loss since the original architects' plans for the foundation and superstructure were an integral and inseparable part of a continuous project to build a hotel. Finally, consider the case of G.R. Gorman, 33 TCM 74, Dec. 32,429(M), TC Memo 1974-18. The taxpayer owned a building which he leased out as a grocery store. The building was remodeled for a new lessee which included (pursuant to the terms of the new lease) demolition of a portion of the existing structure. Also included in the remodeling job was partial demolition of a terra cotta-covered wall plus covering the remainder of that wall with another material. The court denied the abandonment loss for partial demolition of the old structure. The regulations under Section 165 in effect at the time required the cost of demolishing a structure under the terms of a lease to be capitalized as part of the cost of the lease. However, the terra-cotta wall was found to be abandoned and sufficiently segregated from the building as a whole to merit a loss deduction. Notice the character of the factual situations presented in the cases set forth above. In all these cases, at least some portion of the abandonment losses claimed by these taxpayers related to a portion of a single structure or a single construction project. In essence, the courts were asked to decide whether a taxpayer can abandon part of a single structure or single construction project while retaining its investment in the remaining portion. In order to decide the cases the courts looked at the degree of connection between the abandoned portion and the remaining portion. In some situations the courts found that the abandoned portion was integrally connected with the remaining portion. In other cases, the courts found the abandoned portion to be sufficiently separate to warrant an abandonment loss. Here is the point: the cases actually reaching litigation present a degree of connection between the allegedly abandoned asset and some other existing asset many orders of magnitude greater than the degree of connection presented by the taxpayer now under examination. If the nature of the issue being presented to the courts is whether a taxpayer can abandon some portion of a single building or a single construction project, it seems fair to characterize as completely separate a situation involving abandonment of a new construction project, albeit a project on an adjacent tract of land, commenced some ____ years after completion of the old project and some _____ years after the old project was fully operational and leased up. Also consider the following facts. 1. When the original project was completed and placed in service in ____, the taxpayer did not even own the land connected with the abandoned costs which are the subject of this examination. 2. The plans and local permits for the original project did not contemplate an additional project on the adjacent property or any other property. 3. When the original project was planned and completed there was no assurance, e.g., through existence of an option or some other arrangement, that the adjacent property could be purchased. 4. When the original project was planned and completed there was no assurance that the necessary zoning and local permits could be obtained to build on the adjacent property. <<L: please consider whether the zoning statement is appropriate based on your knowledge or that of your client. This is a strong argument if factually supportable.>> The taxpayer respectfully submits that if the courts have allowed a loss related to the planning costs of an abandoned building design when the taxpayer actually built a redesigned structure on the same site in the same general time frame, and if the courts have allowed a loss for a demolished wall within an existing structure, surely it is permissible to write off planning and other related costs for a demonstrably separate project begun years after completion of another project owned by the same taxpayer. |
