Cell Towers

[Edsel]

Have a large client bidding on constructing 20 cell towers between two regional large cities.

He will have ownership/title to the towers for a brief period of time before selling them to a multiconglomerate communications company.  He would be under contract to sell to them after they are operable for 12-18 months.

I am aware depreciation on property does not start until the property is placed in service.

My question is what is the holding period for LT capital gains?  Does it include the time the unit is construction in progress?  Construction should not take more than 60 days depending on delivery time for equipment, but since he is going to sell the towers anyway, the question is extremely relevant.

This is a critical question because it will affect the choice of entity.  C Corps get no benefit from LTCG.

 

[ILLMAS]

Can they be treated as inventory?  

[SaraEA]

At first I thought inventory too--no capital treatment.  But if he is going to operate them for a year or two, that doesn't sound like inventory (unless he's in the business of selling used cell towers).

[Edsel]

Don't think they would be inventory.  The business is contracting, and the purpose for retaining the towers for as much as 12-18 months is (i)to assure operability and (ii)to subsidize construction costs by allowing the contractor 12 months of revenue upon commissioning.

We have to ask ourselves if he is in the "business" of selling cell towers.  Historically he is not, however, this project is so big that it eclipses prior business revenue.  Normally, he is $15-$20 MM annually, and this thing could be $300MM.  (I would not reveal his actual numbers, but use these numbers so the reader could grasp the situation).

I have also had a problem finding MACRS and ADS lives under which these things may be depreciated (if at all).  There is a series of class 48 and 49 stuff which include various kinds of communication equipment.

[jklcpa]

Hmm, these are interesting questions on these classifications, and I was waiting for more of these details.  I don't have much in the way of definitive answers but some information that you may find helpful.

The first determination that must be made before getting to questions of holding period and depreciable lives is to determine whether this is income in the ordinary course of business as a contractor.  From the outset, he has a firm contract to build these towers that ultimately culminates in the sale, with some added revenue along the way.  How will this other revenue be classified, as rental income or something else? Will he be reporting this separate from the contracting business? 

IF you decide that this is separate from the contracting business and call these trade or business assets to be depreciated:   Regarding the depreciation lives, here is a letter ruling (safe link to IRS/pdf) that has a lengthy discussion with descriptions of the different types of towers and their various components, and it details out which asset classes and respective lives each of the types or components would fall into. It's only one letter ruling, but it should be useful as a starting point and should lead you to the proper classifications. It seems to me that you would not only have the construction cost dates to track, but the various components also.

As to your question of how the holding period is determined for self-constructed assets used in a trade or business, so that I don't have to write it all out myself, this article from a CPA at McGladry specializing in real estate is excellent and should answer your question of when the holding period starts.  The example is of a building but the concepts would be applied in the same manner if you decide that these towers are used in a business.  Keep in mind that the Draper case that is cited was in 1954 when IRS used more than 6 mos out as long-term. As we all know, the holding period for long-term is now always one year as defined by sec 1222(3). 

 

[Edsel]

Good reading material Miss Judy.  Reading through the item subclasses to class 48 and 49, it appears that the exact selection does not necessarily depend on the structure itself, but the kind of transmission going through the tower (e.g. cellular conversation, cable, radio, etc.)  Your article seems to suggest that a "safe harbor" could be 7 MACRS and 12 ADS.

The McGladry article brings out yet another issue.  Perhaps we should NOT be considering the performance of the contract as two separate segments being (i)construction of the tower and (ii)operation of the tower for 12-18 months.  This has been my approach with depreciation occurring during segment (ii).

Based upon the economic substance, it is clear that the ultimate communications megaconglomerate which will pay the contractor is allowing the contractor some 12-18 months of revenue in order to subsidize the cost of construction.  Using this approach, the entire revenue stream and all related expenses are taken as a whole instead of segmented.  If this is the case, there would be no depreciation expense or LTCG.  I certainly am not qualified to decide whether the contract should be taken in two segments or as a whole.

The decision referred to in the McGladry article (circa 1960) determined that the portion of costs incurred prior to the holding period would create LTCG and costs incurred within the holding period would be short-term.  An old citation to be sure but no reason to think that it would be pre-empted by anything that has occurred since.  In order for any portion to qualify for LTCG, detail records would have to be kept as to when construction costs were incurred, and components purchased.

I may back off of this and let a Big 8 firm do it.  (Big 8 is, I think, reduced to Big 4 nowadays)

[JohnH]

You might want to back off for another reason or two.  Being asked to recommend the choice of entity alone is reason enough.

[Catherine]

I see plenty of reasons to back off from this one.  Choice of entity is not generally a "back-off" flag for me - as long as the reason to have me involved in the decision is tax and accounting repercussions, not legal.  As soon as the discussion approaches legal, I tell folks "I'm not a lawyer and don't even play one on television" which generally makes them laugh but reinforces that I don't provide any legal advice - except to talk to a lawyer for legal advice! 

In this instance, though, it seems that the legal aspects are substantial (conglomerates all by themselves are a big flag; THEY will have big-ticket lawyers watching their interests, the builder should have equal protection).

[SaraEA]

11 hours ago, Edsel said:

An old citation to be sure but no reason to think that it would be pre-empted by anything that has occurred since.

Not sure if this refers to the McGladry article or the court cases, but I want to share what I learned about case law in my master's program (which was a law course, taught by JDs, because the IRC is a law).  Case law is like building a brick building, brick by brick, and never gets old unless the law itself changes.  Courts routinely rely on previous decisions made by other courts, mainly adding clarity to a similar case or dissecting a nuance.  In fact if there is no case law for a particular issue, courts go back to English Common Law--what the English settlers brought with them to America!  While in academic writings we seek the "latest" research, in case law 1957 (or 1857) is just as good as 2017.  When you're trying to gather substantial authority, don't be afraid to cite "old" court decisions.  PS.  Edsel is making a wise decision to pass this one on to someone bigger and smarter, with more E&O insurance.

[Catherine]

57 minutes ago, SaraEA said:

Case law is like building a brick building

Yes, and the danger of case law is that each case can "drift" the law a bit further from original intention.  After a number of decades,  it is possible for "case law" to support doctrines completely antithetical to the clear meaning and intent of the original law.  Somehow they need to figure how to balance nuances against original purposes.

[jklcpa]

Right, Edsel's comment appears to be about the case law from the McGladry article written in 2015, and that's why I wasn't too uncomfortable posting it with the only caveat being the change in LTCG holding period that was used in the 1950's. 

[Lee B]

I also  wonder how your client will make the cash flow work paying for all the labor and construction expenses  then having to  wait for 12 to 18 months .

He will definitely need quality legal advice plus an ironclad contract.

[Edsel]

Where on earth did the idea come from that he has to wait 12-18 months for his money? 

He does have expensive legal advice and banking advice - whether it's "quality" or not, I dunno.  He has been quite business savvy in the past - I also suspect he has phantom backing from a couple of US congressmen.  The awarding of contracts this large is tampered with by vested interests behind the scenes more often than not.  He also thinks he has "quality tax advice" - y'all can comment if you wish.  I'm thinking he'll need to get this advice from someone who has more E&O insurance than I do...

Do any of y'all want to be recommended to this guy?  You perhaps can make a little money.

[jklcpa]

The idea probably came from your statements indicating that he retains title, that you were thinking of putting them in service, and that he has a contract to sell 12-18 months later. 

The more I hear and think about this, the more convinced I am that these towers should not be in a business and listed as in service by him.  I'm still circling back to thinking of this as one gigantic construction transaction because of your statements about the revenue stream subsidizing his construction costs that sound a lot more like progress payments based on the a project's completion than anything else so that at a minimum he covers his cost and the large chunk of profit is realized at the end.

Maybe the real question here should have been something like "in what period(s) is the sale recognized and reported?"

 

[Edsel]

The more I read comments and learn from the available material, the more inclined I am to believe this entire thing should be considered a single construction project with revenue to be recognized on a percentage-of-completion method.  The percentage-of-completion should be based on projected timing of receipts instead of projected cost estimates-to-complete.