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Gross Receipts from Taxpayer's Construction Activities Qualify as DPGR

(Parker Tax Publishing September 2016)

The IRS National Office (IRS) concluded that gross receipts, received by a taxpayer actively engaged in the construction trade or business for projects in which it substantially renovated, constructed, or erected property, were domestic production gross receipts (DPGR). The IRS determined that that the property constructed by the taxpayer qualified as inherently permanent structures and thus the taxpayer's activities involved the construction of real property for purposes of Code Sec. 199. TAM 201638022.


The facts in TAM 201638022, some of which are redacted, indicate that a U.S. contractor (i.e., the taxpayer) engages in a construction trade or business on a regular and ongoing basis. The taxpayer engages in all phases of field construction. Specific activities performed for each job vary from project to project. The taxpayer utilizes traditional construction and craft labor resources.

The IRS LB&I Division and the taxpayer requested technical advice from the IRS National Office on whether gross receipts that the taxpayer derived from projects related to the substantial renovation, construction, or erection of unspecified property in the U.S. qualified as DPGR for purposes of Code Sec. 199. The taxpayer does not receive any income or gross receipts from the actual sale of the property produced. Taxpayer's gross receipts are derived from various projects that involve installing or replacing components of the property and erecting other property at plants and complexes. The renovations either materially increase the value of the property, substantially prolong the useful life of the property, or both. The erected property typically remains in place through its useful life, and demolition and removal of the property is rare.

Code Section 199 Deduction

Under Code Sec. 199, taxpayers can take a deduction for a percentage of their income attributable to certain production activities that take place within the United States. The deduction is equal to 9 percent of the lesser of the taxpayer's qualified production activities income (QPAI) or its taxable income. The QPAI of a taxpayer is equal to its domestic production gross receipts (DPGR) less certain expenses, losses, or deductions allocable to that DPGR.

Code Sec. 199(c)(4)(A)(ii) defines DPGR to include the gross receipts of the taxpayer which are derived from, in the case of a taxpayer engaged in the active conduct of a construction trade or business, construction of real property performed in the United States in the ordinary course of such trade or business. Reg. Sec. 1.199-3(m)(3) defines "real property" to mean buildings (including items that are structural components of such buildings), inherently permanent structures other than machinery (including items that are components of such inherently permanent structures), inherently permanent land improvements, oil and gas wells, and infrastructure.

Taxpayer and LB&I Positions

The taxpayer claimed that it performs substantial renovation, construction, or erection of property and that these activities qualify as the construction of real property for Code Sec. 199 purposes, and that gross receipts from each project are DPGR under Reg. Sec. 1.199-3(m).

The LB&I Division disagreed and opined that the taxpayer's activities do not qualify as the construction of real property for purposes of Code Sec. 199 because the taxpayer's activities involve tangible personal property, not real property.

IRS National Office Advice

The IRS National Office (IRS) disagreed with the LB&I Division. The question, the National Office said, was whether the taxpayer was constructing "real property," which, under Reg. Sec. 1.199-3(m)(3), includes "inherently permanent structures" other than "machinery."

The IRS looked at Reg. Sec. 1.263A-8(c)(3) which sets forth the general definition of "inherently permanent structures" and Reg. Sec. 1.263A-8(c)(4), which specifies that a structure that is property in the nature of machinery, or is essentially an item of machinery or equipment ("machinery"), is not an inherently permanent structure and is thus not real property. The National Office said it believed that the purpose of Reg. Sec. 1.263A-8(c)(4) is to clarify that machinery and inherently permanent structures are mutually exclusive categories of property. The scope of machinery under Reg. Sec. 1.263A-8(c)(4), the National Office said, is limited in that it does not include any property that qualifies as an inherently permanent structure under Reg. Sec. 1.263A-8(c)(3).

The IRS noted that the analysis under CCA 201211011 suggested an overlap between inherently permanent structures and machinery whereby property that qualifies as an "inherently permanent structure" must also not be "machinery." The IRS disagreed with this analysis, stating it did not think that Reg. Sec. 1.263A-8(c)(4) establishes an additional requirement through which property that qualifies as an inherently permanent structure under Reg. Sec. 1.263A-8(c)(3) may be removed from such classification if it is machinery under Reg. Sec. 1.263A-8(c)(4). Instead, the IRS determined that if the property produced by the taxpayer satisfies the definition of inherently permanent structures under Reg. Sec. 1.263A-8(c)(3), it is "real property."

The IRS then looked at Reg. Sec. 1.263A-8(c)(3) which provides that an inherently permanent structure includes property that is affixed to real property and that will ordinarily remain affixed for an indefinite period of time. This definition, the IRS stated, establishes two basic requirements for an inherently permanent structure:

(1) the structure must be affixed to real property; and

(2) the structure must ordinarily remain affixed for an indefinite period of time.

The IRS noted that Reg. Sec. 1.263A-8(c)(3) uses the term "affixed to real property" to mean "physically connected or attached," and specifies that affixation to real property may be accomplished by weight alone. But, the IRS said, because the regulation does not expressly define "indefinite," it was required to apply a reasonable interpretation. Citing CCA 200101003, the IRS interpreted the phrase to mean the "useful life" of the affixed property.

The IRS determined that the taxpayer's property satisfied the "affixed" criterion on the basis of weight alone, noting that the structures were enormously large and heavy, weighing hundreds or even thousands of tons. The structures also evidenced affixation to real property through their attachment to concrete foundations and support work. In addition, the IRS said, the structures remained affixed to real property for the duration of their useful life and even beyond that time period, as evidenced by the fact that they were typically abandoned in place. Thus, the IRS stated, the structures satisfied the second criterion of an inherently permanent structure because they remained affixed to real property for an indefinite period of time.

Because the taxpayer's property were inherently permanent structures under Code Sec. 1.263A-8(c)(3), the IRS concluded that they satisfied the definition of "real property" under Reg. Sec. 1.199-3(m)(3). Accordingly, the IRS advised that the taxpayer's activities in projects in the U.S. that involve substantial renovation, construction, or erection of the property qualified as real property construction activities and gross receipts from such projects were DPGR.

For a discussion of whether gross receipts from construction activities are DPGR, see Parker Tax ¶96,115.

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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