La Petite Academy
A summary of facts along with key considerations
This case is about 12 categories of property within a childcare facility that were claimed by the plaintiff as investment tax credit eligible but ultimately some were denied by the IRS.
Revised: October 26, 2015
Originally Issued: October 26, 2015
Prepared by the ASCSP Education Committee
Table of Contents
- Alliance Wall Panels. 3
- Mansard Roofing. 4
- Playground Fencing. 6
- Exterior Lighting. 7
- Fire Protection System, Heat and Smoke Detectors, Emergency Lighting, Exit Signs. 8
- Children’s Restroom Accessories and Handicap Toilet Cabinet. 9
- Grease Trap and Electrical Service to Counter. 11
- Dumpster Enclosure. 12
- Thermal Recovery System… 13
- Kitchen Pass-Through Door, Bypass Door, and Dutch Door. 14
La Petite Academy is an operator of approximately 460 child care centers in 34 states. In tax years 1984 and 1985 placed in service 137 newly constructed and 3 remodeled facilities. The facilities were all very similar other than square footage. La Petite Academy claimed the investment tax credit (ITC) for various components of the facilities. Under audit in 1990, the IRS denied the eligibility of these components and asserted deficiencies for 1984 and 1985. La Petite disagreed with the IRS but paid the deficiencies and interest as required by law.
The taxpayer was a publicly held C corporation in tax return years 1984 and 1985 in which the property was placed in service.
The tax return years were 1984 and 1985. In 1990 the IRS asserted deficiencies. It appears that the ITC was claimed in those years. There was no discussion of amended returns or accounting method changes.
The taxpayer paid the deficiencies in full as required by law with interest.
Are the following items personal property and ultimately eligible for the investment tax credit (since expired):
- Alliance wall panels
- Mansard roof
- Playground fencing
- Exterior lighting
- Fire protection systems, heat and smoke detectors, emergency lighting, exit signs
- Children’s restroom accessories and handicap toilet cabinet
- Grease trap and electrical service to counter
- Dumpster enclosure
- Thermal recovery system
- Kitchen pass-through door, bypass door, and dutch door
All of the above assets were deemed structural components, not personal property, and ineligible for the investment tax credit.
The tax return with claimed depreciation and the ITC was filed by La Petite Academy.
The tax return was reviewed by the IRS which determined that the 12 categories of property were not eligible for the investment credit.
La Petite Academy and the IRS desired a summary judgment from the Court.
The case went to trial in US District Court, Western District of MO.
The judge granted summary judgment for the IRS.
Summary Judgment: In law, a summary judgment is a judgment entered by a court for one party against another party without a full trial. Such a judgment may be issued on the merits of an entire case or on discrete issues in that case.
- Internal Revenue Code section 167(a)
- Internal Revenue Code section 38(b)
- Reg. section 1.48-1(e)(2)
- Reg. section 1.48-1(c)
- Revenue Ruling 75-178
- R. Rep. No. 1447, 87th Cong., 2d Sess. 11-12 (1962);
- Rep. No. 1881, 87th Cong., 2nd Sess. 11-12, 16 (1962)
- Yellow Freight System, Inc. v. United States, 538 F.2d 790, 796 [38 AFTR 2d 76-5232](8th Cir. 1976)
- Chevron, U.S.A. v. Natural Resources Defense Council, Inc., 467 U.S. 837, 844 (1984)
- Nat’l Muffler Dealers Ass’n v. United States, 440 U.S. 472, 476-77 [43 AFTR 2d 79-828](1979).
- Tax Reform Act of 1984
- Senate Finance Committee’s Report issued in connection with the Revenue Act of 1978
- (quoting H.R. Rep. [pg. 95-1624] No. 1447, 87th Cong., 2d Sess. (1962), reprinted in 1962-3 C.B. 405, 415-16
- Rep. No. 1881, 87th Cong., 2d Sess. (1962), reprinted in 1962 U.S.C.C.A.N. 3297, 3318, and in 1962-3 C.B.-707, 722).
This case was very unfavorable to the taxpayer. The judge provided a discussion section in the write up that summarized the plaintiff’s and defendant’s points but then ultimately discussed the assets in question in each of the separate ten sections.
Note that in the judge’s write-up of the case, 12 categories of property were mentioned. In the write-up only 10 categories were included. There is no discussion of the missing two categories or if they were included in the 10 categories. The write-up from the judge only focused on the 10 items that were denied the ITC. There is no discussion of which items were eligible for the ITC.
See below for further discussion and analysis of the ten categories.
Alliance wall panel systems were considered easily removable by La Petite Academy and therefore eligible for the investment tax credit.
The court ruled that the alliance wall panels used by La Petite Academy were an inherently permanent structural component relating to the operation or maintenance of the buildings and not eligible for the investment tax credit.
An Alliance Wall Panel is a porcelain surface laminated to gypsum board. The outer surface is manufactured at extremely high temperatures to create a very smooth and durable surface that can potentially be drawn on by the tenant. The company that produces these panels markets the panels as an educational tool for conference rooms and laboratories, etc. A key factor with this is that they did not market the ability to move these panels with ease as another case mentioned below did. They are used in place of ordinary drywall panels however they may not be painted or have a wall covering installed on them as it would simply flake off.
An investigation took place to determine how the panels are actually attached which creates the biggest argument against the plaintiff. The removal of these panels requires a drawn out process which in the end damages approximately 10%-20% of the actual panel. The removal of the ceiling tile/ceiling grid and “L” channel adjacent to the alliance wall panels is necessary. In addition to this, all plumbing must be disconnected or capped as well as the electrical outlets removed within that wall. The fastening system requires nails above the ceiling lines and behind the flooring base. Various companies have in fact purchased alliance wall panels for use in a removable partition system involving tracks and allowing that wall to be removed easily. These would then be deemed possible for an ITC. To be technical, all walls may actually be moved and removed, but the Court believes that when the Senate spoke in terms of moveable and removable, it had in mind partitions which are readily moved and able to remain in the same condition after removal as they were before.
We were unable to locate legal precedents that are contradictory with the ruling in this case for this particular asset. Alliance wall panels must not be compared to Fiberglass Reinforced Paneling as the manufacturing, installation, and removal process of alliance wall panels is much more extensive.
Examples of Similar Applications
In Minot, 435 F.2d at 1369, Minot was involved in non-load bearing partitions that were manufactured in an assembly-line process which could be installed in almost any type of building and were in fact not an integral part of a physical structure. The United States Court of Appeals for the Eight Circuit notes the simplicity of the installation process:
“Their installation is a simple process consisting of fastening a channel to the floor and the ceiling, putting the partitions in place and fastening them. The channels are then attached with a No. 8 sheet metal screw at the ceiling and a small masonry nail in the floor at approximately three foot intervals.
La Petite Academy argued that mansard facades are similar to false balconies and exterior ornamentation which would be 1245 Property. The purpose of the façade is to provide branding image decor and to provide a more aesthetic look to the outside of the building.
The court asked if the mansard roofing is an inherently permanent structural component of the building related to the operation or maintenance of the building. If removed it would leave the building exposed to the outside elements and cause the building envelope not to be closed. So decided it is an inherently permanent structural component related to the operation or maintenance of the building.
Next they considered how the property was attached and would it be easy to remove or would redesign have to take place for other components of the building for it to be removed? The mansard roofing contains lighting and wiring inside it and gutters on the outside. If the mansard was removed you would have to install the last row of bricks, metal coping, and gutters for rain water distribution. Additionally, you would have to figure out a way to hang the lights off the side of the building. So basically it would require redesign and it would not be easily removed.
Lastly the court considered does the property have no more than an incidental relation to the operation or maintenance of the building, similar to ornamental exterior finishes and false balconies? Since the building envelope would be exposed and vulnerable to the exterior elements, it does not have an incidental relation to the operation or maintenance of the building.
A mansard roof in architectural terms refers to a style of hip roof characterized by two slopes on each of its four sides with the lower slope being much steeper, almost a vertical wall. The upper slope, usually not visible from the ground, is pitched at the minimum needed to shed water.
One of the key factors in the case was the construction design. The mansard roof in question was triangular shaped, had two feet by four feet pine framing, exterior plywood sheets, felt, and covered with an asphalt/cedar roofing shingles. The building has a soffit that protrudes from the mansard roof framing that has the gutter attached on the outside and interior lighting and wiring within the soffit. Additionally, the last layer of bricks was left off the exterior wall to provide for the mansard roof attachment to the structure walls.
The court noted that the mansard roof was part of the initial construction of the buildings and was integrated into the overall roof system remaining permanently in place. The court observed that removal of the mansard roof would result in the direct exposure of various building components to water, snow, wind, and moisture damage. They concluded that the roof had a more than incidental relationship to the operation or maintenance of the building.
In Boddie-Noell court case, the taxpayer’s argument was that the mansard roof was decorative in nature. The court rejected, based upon Senate Report 95-1263, that the panels were analogous to false balconies and only incidentally related to the operation or maintenance of the building. The court found that the roof panels performed the essential function of keeping out the elements
The plaintiff treated the fencing in as tangible personal property with a 5-year recovery period. The fencing is four feet tall, with posts set in concrete footings located below the frost line, and gates on either end for entry access. The court based their argument on the Treasury regulations definition of tangible personal property as “tangible property except land and improvements thereto, such as buildings or other inherently permanent structures (including any items which are structural components of such buildings or structures). Thus, buildings, swimming pools, paved parking areas, wharves and docks, bridges, and fences are not tangible personal property.” Treas. Reg. section 1.48-1(c) (as amended in 1983) (emphasis added).
The plaintiff advanced an argument that the fencing was an “accessorial” or “unique” asset to the business and therefore qualified for the investment tax credit. They used the argument that the nature of running child care facilities necessitated the fencing as part of the playground equipment required by state and local law. They also contended that the fences are solely used to segregate for safety purposes. Additionally, La Petite states that they have historically moved the fencing to accommodate the constantly changing size of age groups.
The court found that the fencing was specifically excluded for the regulations as tangible personal property under Treasury Regulation 1.48-1(c)(as amended in 1983). Also, since the fence posts are set in concrete footings, located below the frost line, they are intended to be permanent. Furthermore, the argument provided that they were required per State and Local codes was also denied based on previous court cases Morrison, Inc. v. Commissioner, 51 T.C.M. (CCH) 748, 760 [¶86,129 PH Memo TC](1986) and Duaine v. Commissioner, 49 T.C.M. (CCH) 588, 596 [¶85,039 PH Memo TC](1985). In both of these cases, equipment was purchased to meet local health codes, and in both cases the investment tax credit was denied for this equipment.
In light of these factors, the playground fencing at issue is considered to be a structural component, and thusly ineligible for the investment tax credit.
Rev. Proc. 87-56 – Asset Class 00.3 – Land Improvements: Specifically calls out fencing as a land improvement. Additionally, per Rev. Proc. 87-56, playground fencing does not meet the definition of a building or structural component of a building as defined in §1.48-1(e).
The plaintiff argued that the lighting is different from the main structural exterior lighting and that it serves as wall washers for the building to emphasize its brand at night. The purpose of these lights is to provide enhanced visibility to people who drive by it. The client tries to use Metro Nat’l Corp. v. Commissioner, 52 T.C.M. (CCH) 1440, 1448 (1987-38) to compare the lights to exterior decorative lights. In the clients assessment these lights do not relate to the buildings maintenance or operation.
The court consider two questions: 1) Do the lights have an incidental relation to the operation or maintenance of the building?; and 2) do the lights act as purely a passive advertising mechanism and only accent the walls? Due to the fact that the lights are an inherently permanent structural component of the building because they are not easily removable from the soffits and that they have dual purpose by providing the only lights for illumination outside the building. These lights are not similar to the lights in Metro Nat’l Corp. v. Commissioner, 52 T.C.M. (CCH) 1440, 1448 (1987-38). The court decided that the lights are more like the lights in Duaine v. Commissioner, T.C. Memo. 1985-39, which was denied the investment credit.
Each mansard soffit has 10, 150-watt light fixture sets that are on the underside of the soffit. These 10 lights provided the only illumination for the sidewalks outside the building. The plaintiff provided evidence that the lights not only washed the walls and illuminated the building but, they also provide lighting for the sidewalks which went out to the parking lot and all around the building.
The Metro Nat’l Corp. v. Commissioner [CCH Dec. 43,649(M) ], 52 T.C.M. (CCH) 1440, 1448 (1987) case is based on purely decorative lighting that has no more than an incidental relationship to the operation or maintenance of a building.
Examples of Similar Applications
The Duaine v. Commissioner [CCH Dec. 41,845(M) ], 49 T.C.M. (CCH) at 596 case sets the court precedent of exterior lighting only being tangible personal property if it does not light up the parking lot or provide lights along walkways to the building. Since the lights only provide illumination on the walkway, the court found that the exterior lights were an inherently permanent structural component of the building and therefore did not qualify for the investment tax credit.
In La Petite Academy a comprehensive fire protection system was installed in the building which included alarm horns, an alarm control panel, magnetic holder/closers on kitchen doors, emergency lighting fixtures, heat and smoke detectors and exit light fixtures. The taxpayer argued that because it was required by local building code for child care and educational facilities as well as the safety features that the system offered that the items should qualify for the ITC.
The court found that these items are structural components of the building because they service the entire building and are not eligible for the ITC.
Fire protection refers to measures taken to prevent fire from becoming destructive, reduce the impact of uncontrolled fires, and save lives and property. A heat detector is a fire alarm device designed to respond when the thermal energy of a fire increases the temperature of a heat sensitive element in the detector. A smoke detector is a fire protection device that automatically detects and gives a warning of the presence of smoke. An emergency light is a battery backed lighting device that switches on automatically when a building experiences a power outage. An exit sign is a sign posted along exit routes within buildings that indicate the direction of travel to the nearest exit. These signs typically read “EXIT” and may have distinctive colors, illumination, or arrows indicating the direction to the exit.
In this case, the Court relied on Revenue Ruling 75-178 in which safety equipment, to the extent they are not necessary to and used directly with a single machine, act to service the entire building and thus constitute structural components of the building. The court also relied on the precedents set in Morrison v Commissioner, T.C. Memo 1986-129 and Duaine v Commissioner, T.C. Memo 1985-39 and refused to give the investment credit for purchases of equipment due to health codes.
In summary, fire protection and heat and smoke detector systems that are specifically designed for a process and operate independently from other fire protection systems do qualify as personal property. Likewise, a case could be made that if additional emergency lighting is installed because of the business that the taxpayer operates in that lighting may be treated as personal property. However a system that services the entire building does not qualify as personal property because it is viewed as a structural component of the building.
In Texas Instruments v Commissioner, T.C. Memo 1992-306, the court found that Fire Protection Systems specially designed for the chemical exhaust systems and which provided fire protection to this specific system only were eligible for the ITC.
In Morrison Inc. v Commissioner, T.C. Memo 1986-129, the court found that emergency lighting could be treated as 1245 property for this taxpayer. The emergency lighting served a special function in the taxpayer’s cafeteria where large numbers of people are served and must not only exit but finish eating and pay for their meals in the event of a power blackout.
Examples of Similar Applications
In Texas Instruments v Commissioner, T.C. Memo 1992-306, the court found that the general fire protection system for the building was treated as 1250 property. The case law supports this position so if a taxpayer is going to take fire protection or emergency lighting as 1245 property they should be certain that their facts align with the cases with contradictory positions that are described here.
The restroom accessories within the subject facility consisted of mirrors, paper towel dispensers, and toilet paper dispensers located in both the adult and children’s restrooms. Lavatories and accessories for the children’s restrooms are located in the classroom area and are mounted at children’s height.
The taxpayer argued that the quantity of these accessories are dictated by state regulations concerning child care institutions and thus are accessorial to its unique childcare business. The court cited the Morrison and Duaine and refused to give investment tax credits for purchases of equipment due to health codes.
The Court acknowledged the restroom accessories and handicap toilet cabinet are removable, however they are generally meant to stay permanently in place, and they can foresee few, if any, occasions on which they would be removed.
The taxpayer also argued that the restroom accessories are not useable for people requiring them at average adult height, however the Court countered that the items could easily be moved to adult height.
As a result the Court ruled that the restroom accessories and handicap toilet cabinet constitute structural components of the building.
Restroom accessories are generally considered real property based on the argument that they relate to the operation of the building. The IRS has consistently classified restroom accessories as real property in the Cost Segregation Audit Techniques Guide (ATG) and elsewhere. The restroom accessories category in the ATG includes: (paper towel dispensers; electric hand dryers;, towel racks or holders; cup dispensers; purse shelves; toilet paper holders; soap dispensers or holders; lotion dispensers, sanitary napkin dispensers and waste receptacles, coat hooks, handrails, grab bars; mirrors; shelves; vanity cabinets; counters and ashtrays; and other items generally found in public restrooms that are built into or mounted on walls or partitions). The restroom partitions category in the ATG includes shop made and standard manufacture toilet partitions, typically metal, but may be plastic or other materials.
We were unable to locate legal precedents for restroom accessories that are contradictory to the ruling in this case.
There are several supporting cases including the Hospital Corp. of America case which also characterized bathroom accessories for bathrooms located in patient rooms as structural components, rejecting the argument that patient bathrooms were provided as a specialized business need. Toilet partitions were determined to be structural components in the Metro National Corporation case where the court focused on the fact that the partitions were not likely to be removed and related to the operation and maintenance of the building. Similarly, restroom accessories were structural components in the Morrison Incorporated case.
It seems pretty clear that the IRS considers restroom accessories to be structural components and therefore real property. Similar situations where these principles may be considered are in hotel rooms where the sink and associated millwork/accessories are located outside of the actual restroom, and showers/locker rooms in fitness facilities.
The Court determined that the grease trap and electrical service to the kitchen counter are specifically included in the treasury regulation definition of “structural components” and are therefore not eligible for the investment tax credit.
A grease trap is a drain which is embedded in a kitchen floor or outside a building that is ultimately connected to the exterior sewer lines.
La Petite argued that because state laws require grease traps, they are accessorial to its business and thus qualify for tax credit. The Court again rejected the argument that state law requirements qualify specific items to be tangible personal property.
The Court found that plumbing fixtures, along with electrical service to the kitchen counter and related wiring, are specifically included in the treasury regulation definition of “structural components.”
Subsequent to this case, kitchen grease traps were determined to be tangible personal property in the Hospital Corp. of America case. The court ruled that kitchen grease traps are assets accessory to petitioners’ business and do not constitute structural components of the buildings.
The Morrison Incorporated case stated that “although we give great weight to respondent’s regulations, we do not read the words “plumbing and plumbing fixtures” in a vacuum just as we did not read the words “electric wiring” in a vacuum in Scott Paper Co. v. Commissioner, …We focus on petitioners’ use of the drains in the kitchen and conclude that they do not relate to the general drainage of waste from the building but rather, drain wastes resulting from petitioners’ food preparation activities.
There is a dumpster enclosure located at each La Petite facility. It’s constructed using eight foot high wood fencing with a gate on one side for access. The enclosure is constructed on a concrete pad with the post footings set below the frost line. The Plaintiff states that the enclosures serve a safety as well as a decorative function.
The court countered with the fact that the enclosure could easily be adaptable to any business function that utilized the building and appears permanent in nature. Consequently, the dumpster screen is integral to the operation and maintenance of the building and therefore ineligible for the investment tax credit.
Rev. Proc. 87-56 – Asset Class 00.3 – Land Improvements: Specifically calls out fencing as a land improvement. Also, per Rev. Proc. 87-56, the playground fencing and dumpster enclosure do not meet the definition of a building or other structural component as defined in regulation section 1.48-1(e).
The Court determined that assets such as a thermal recovery system are specifically included in the treasury regulation definition of “structural components” and are therefore not eligible for the investment tax credit.
The thermal recovery system is attached to the building’s fresh water supply designed to preheat water before it enters the building water heater. The Court found that plumbing fixtures like this system act to service the entire building and are specifically included in the Treasury Regulation definition of “structural components.”
This case basically lumps the entire plumbing system into the definition of structural components. Cases such as Hospital Corp. of America and Morrison Incorporated provide the ability to allocate portions of the plumbing system to shorter recovery periods based on their use.
However, the thermal recovery system in La Petite is used to preheat water entering the water heater which serves the entire building including the restrooms and other structural components. Although the reasoning behind the ruling can reasonably be argued, the resulting classification as real property for the thermal recovery system would be difficult to argue.
Thermal recovery systems can reasonably be considered personal property in different situations based on their use. For instance, a manufacturing facility that has a thermal recovery system as part of a closed loop process water system can be considered personal property.
The IRS ATG lists ‘Plumbing – Special Water Systems’ as personal property in Industry Specific Guidance for Pharmaceutical and Biotechnology. This category includes “special water systems separate from the building’s or other inherently permanent structure’s plumbing systems which are used to produce specialty water such as deionized water (DI) or water for injection (WFI) which is required in a manufacturing process or research and experimentation activity. Includes filters, tanks, pumps, specialized piping, valves, and end use connections.”
This area of the La Petite case relates to specialty doors where the Plaintiff claimed they were used for the purpose of keeping children out of dangerous areas, out of the reception area, and in their classrooms.
The court finds that the specialty doors do not qualify for ITC as the IRS specifically defines the term “structural components” to include “doors.” The main argument the IRS states is that these doors are designed to stay in place. The court also stated that even though a door might be easily removable, it still constitutes a structural component.
The kitchen bypass doors consists of two separately mounted half doors, one above the other which are used between the classrooms and they typically consist of only a lower panel of a half door. The Dutch door is a two panel door similar to the kitchen pass-through doors and is used to separate the reception and entryway from the children’s areas of the building. The kitchen pass through doors consist of an opening in a wall which looks into the kitchen and is there for serving food, etc. They are these doors allow supervisors to continue to monitor the children while they usually accompanied with a coiling door. The Plaintiff claims that are temporarily in another room.
Though the IRS does include that doors are a part of the structural component of the building, we do believe there is an argument in the case of specialty doors. Though these doors are designed to stay in place, they are in fact there because of the operation and maintenance of the business instead of the building. As the Plaintiff states, these doors are there for the purpose of keeping children out of dangerous areas and the half doors are designed so the supervisors can monitor the children while they are temporarily away. They were put in with the mindset that this business would use them the way they are now.
Within the Morrison Incorporated Case, Eliason Doors, which are special lightweight double action doors installed to prevent accidents in heavily trafficked areas, are not function as an integral part and were not designed to be used as a permanent door. Removal of these doors would not detract to the usefulness of the user because they have no more than an incidental relationship to the operation and maintenance of the building. The doors are necessary to assist the taxpayer in the operation of its cafeterias. The court thus concluded that the doors were not structural components of the cafeterias. The same assumptions within the Morrison Case can be applied to the La Petite case. These specialty doors are necessary to assist the taxpayer in the operation of its daycare facilities and were not designed to be used as a permanent door.
Examples of Similar Applications
The IRS is quite clear when it comes to specialty doors qualifying for an ITC. One can go back to the Morrison Incorporated Case and present a strong argument when it comes to classifying doors as being an integral part of a business and not being designed to be used as a permanent door.