No Bonus Depreciation Deduction for Rehabilitation of Burned Agricultural Property

(Parker Tax Publishing August 2019)

The Tenth Circuit rejected a taxpayer's claim that she was entitled to bonus depreciation for, among other things, costs relating to the rehabilitation of 26 acres of burned agricultural property. While the Tax Court had denied business expense deductions for the rehabilitation costs, the IRS had allowed increased depreciation deductions in lieu of the denied deductions and the taxpayer had argued that this allowed her to take bonus depreciation as well. Wells v. Comm'r, 2019 PTC 277 (10th Cir. 2019).

Background

In 2007, a wildfire burned approximately 26 acres of a 265-acre tract of agricultural property owned by Marion Wells. Before the fire, Wells used a small part of that land for grazing. In 2011, Wells determined - after consulting a friend who had experience restoring burned land - that the fire had rendered the land hydrophobic, i.e., the heat of the fire had decreased or destroyed the land's capacity to absorb water. Wells hired Mr. Schwartz to remove burned tree stumps and boulders and turn the soil so that the entire 26-acre area could be used for forage. In 2011, she paid Mr. Schwartz $47,630 to rehabilitate the burn area.

In Wells v. Comm'r, T.C. Memo. 2011-11, the Tax Court disallowed business deductions taken by Wells relating to work performed on her property in 2010 and 2011. Wells' position at trial was that the work performed on her property in those years represented deductible repair or maintenance to existing structures or improvements, rather than replacements of those features or "new" construction. But the Tax Court determined that most of the expenses were not deductible. Expenditures in 2010 for a spring line to carry water had to be capitalized, the court said, because the replacement of the spring line was not a deductible repair but was instead part of a general plan of rehabilitation, modernization, and improvement to completely replace the spring line the costs of which, the court said, must be capitalized. The Tax Court similarly denied a deduction for replacement of an access road damaged by flooding on the property, reasoning that Wells had admitted that the work done on the access road was a complete replacement of that portion of the road. The money Wells spent on construction of a storage yard and related fencing was new construction on top of previously unimproved land and "necessarily an improvement, and consequently the costs must be capitalized," the Tax Court said.

The Tax Court also determined that the 2011 work involving the burn rehabilitation area was part of a plan of rehabilitation that must also be capitalized. The Tax Court therefore sustained the IRS's determination that Wells could not deduct any of the $47,630 spent on rehabilitating the burn area which had been disallowed in the notice of deficiency. The IRS offset some of the disallowed deductions by permitting Wells to claim increased depreciation for 2010 and 2011.

In a motion for reconsideration filed by Wells, and in subsequent computations of tax due as a result of the Tax Court's decision, Wells claimed bonus depreciation under Code Sec. 168(k) for her new storage yard, road maintenance expenses around the barn, and the 2011 expenses relating to the burn rehabilitation area. She asserted that because the Tax Court had found these expenses were for new construction she was automatically entitled to bonus depreciation under Code Sec. 168. The IRS argued that Code Sec. 168(k) only permits bonus depreciation for "qualified property" and Wells failed to explain how the burn rehabilitation area qualified under Code Sec. 168(k). The IRS further argued that her arguments were untimely and she had waived them by failing to raise them previously.

The Tax Court issued an Order and Decision denying Wells' motion for reconsideration and adopting the IRS's computations. It found Wells had raised new issues, which would require reopening the record for presentation of additional evidence. The Tax Court further reasoned that Wells had fair notice of, and an opportunity to dispute, the IRS's depreciation adjustment, but she had failed to raise any dispute concerning this issue or to present evidence concerning it at trial. It therefore found that issue waived. Wells appealed to the Tenth Circuit.

Wells presented two challenges to the Tax Court's denial of bonus depreciation. First, she argued that bonus depreciation was not a new issue in the case because it (1) requires only a mathematical calculation; (2) is mandatory; and (3) was fully supported by the Tax Court's findings, the parties' stipulations, and the evidentiary record developed at trial. Second, Wells argued that she did not waive the bonus depreciation issue because her opportunity to present the issue did not arise until the Tax Court adopted the IRS's trial position that certain disallowed items constituted new construction.

Analysis

The Tenth Circuit held that the bonus depreciation issue was a new issue and that the Tax Court did not abuse its discretion in determining that Wells waived the bonus depreciation issue.

First, the Tenth Circuit concluded that the Tax Court did not abuse its discretion in determining that the evidentiary record required further development to rule on the bonus depreciation issue. For example, the court said, the IRS had not elicited testimony from Mr. Schwartz to determine the allocation of the amounts on his invoices among the various projects he performed. As for the burn area, the Tax Court noted that Wells' testimony that it could take decades before it would grow forage could mean that such property had not been placed into service as qualifying property under Code Sec. 168(k).

Second, the Tenth Circuit noted that, (1) in her petition, Wells expressed her agreement not only with the IRS's allowance of increased depreciation, but with the exact dollar figures the IRS specified; (2) the parties had agreed prior to trial that they would seek to prove that the expenses were either depreciable or deductible, which limited the scope of issues pursued at trial; (3) even in her motion for reconsideration, Wells did not make a bonus depreciation argument, or present any concomitant discussion of the appropriate standards and factors; and (4) a Rule 155 proceeding is not the appropriate place in which to pursue issues that require additional factual development.

For a discussion of what constitutes property qualifying for bonus depreciation, see Parker Tax ¶94,200.

Disclaimer: This publication does not, and is not intended to, provide legal, tax or accounting advice, and readers should consult their tax advisors concerning the application of tax laws to their particular situations. This analysis is not tax advice and is not intended or written to be used, and cannot be used, for purposes of avoiding tax penalties that may be imposed on any taxpayer. The information contained herein is general in nature and based on authorities that are subject to change. Parker Tax Publishing guarantees neither the accuracy nor completeness of any information and is not responsible for any errors or omissions, or for results obtained by others as a result of reliance upon such information. Parker Tax Publishing assumes no obligation to inform the reader of any changes in tax laws or other factors that could affect information contained herein.

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