120% Limitation; Depreciation Rules; Useful Lives

October 1, 2009

Average Reasonably Expected Life Limitation:

Pursuant to Section 147(b) of the Code, a private activity bond (with certain exceptions) is not a “qualified bond” if the average maturity of the bonds exceeds 120% of the average reasonably expected economic life of the facilities being financed with the net proceeds of the bond issue.  In determining the average reasonably expected economic life, such determination must include not only the facilities financed directly with the bonds, but also facilities financed with bonds or other obligations refunded or refinanced with the bonds.  Thus, the full rule is as follows:

The Average maturity of the Bonds cannot exceed 120 percent of the aggregate “average reasonably expected economic life” of (a) the facilities financed with the proceeds of the Bonds and (b) any facilities financed with proceeds of bonds or other obligations, if any, refunded or refinanced with proceeds of the Bonds.

The term “reasonably expected economic life” means (a) with respect to machinery, equipment and other tangible depreciable property (other than buildings or structural components), the asset guideline period (midpoint class life) which would be applicable with respect to such property under Section 167(m) of the Code determined without regard to paragraph (4) thereof and as if the borrower had made an election under such Section, and (b) with respect to buildings and other structural improvements, the guideline life for such property determined under Rev. Proc. 62-21, 1962-2 C.B. 418.

The “reasonably expected economic life” of the project is to be determined as of the later of (i) the closing date or (ii) the date on which the project is or was placed in service (or expected to be placed in service).

Facilities given an original economic life of 40 years include only property that constitutes a building or an integral part thereof, which integral part (i) is not removable without damage to such part of the building of which it is a part and (ii) is not used with respect to, or designed to permit or facilitate the operation of, any particular piece of equipment or non-real property.

“Fundamentals of Municipal Bond Law 2007” explains that economic lives are not based on ACRS for purposes of the Section 147 rule and instead (as evidenced by legislative history of TEFRA) can be determined on a case-by-case basis.  The legislative history of TEFRA, however, provides a safe harbor to determine economic lives by use of midpoint lives under the ADR system and guideline lives under Rev. Proc. 62-21 for structures.

A special rule exists which permits the issuer to make an election relating to the 120% life test in the case of certain qualified 501(c)(3) pool bonds.  See Section 147(b)(4).

Relevant Guidance:

Rev. Proc. 87-56, 1987-42 I.R.B. 4:  Sets forth the class lives of property that are necessary to compute the depreciation allowances available under I.R.C. 168 of the Code.  (Applicable depreciation methods, applicable recovery periods and applicable conventions that must be used in computing depreciation allowances under I.R.C. 168 are described in Rev. Proc. 87-57.)  This revenue procedure states that Rev. Proc. 83-35 no longer applies to property subject to depreciation under I.R.C. 168, other than as a basis for determining the class lives of property.  IRS Publication 946 (How to Depreciate Property) describes how to use the two class life and recovery period tables.  The publication states the following:  You will need to look at both Table B-1 (the Specific Depreciable Assets used in all Business Activities table) and B-2 (Depreciable Assets used in the Following Activities table) to find the correct recovery period.  Generally, if the property is specifically listed in Table B-2 under the type of activity in which it is used, you use the recovery period listed under the activity in that table.  Use the tables in the order shown below to determine the recovery period of your depreciable property:

  1. Check Table B-1 for a description of the property.  If it is described in Table B-1, also check Table B-2 to find the activity in which the property is being used.  If the activity is described in B-2, read the text, if any, under the title to determine if the property is specifically included in that asset class. If it is, use the recovery period shown in the appropriate column of B-2 following the description of the activity.  If the activity is not described in Table B-2 or if the activity is described but property either is not specifically included in or is specifically excluded from the asset class, then use the recovery period shown in the appropriate column following the description of the property in B-1.
  2. Check Table B-2.  If the property is not listed in Table B-1, check Table B-2 to find the activity in which the property is being used and use the recovery period shown in the appropriate column following the description.

Predecessors to Rev. Proc. 87-56:

The 2009 U.S. Master Depreciation Guide, by CCH Tax Law Editors, provides a description of the predecessors to Rev. Proc. 87-56, which is useful to understanding the development of the current asset classes in Rev. Proc. 87-56.  The Guide describes the following procedures and publications:

  • Bulletin F (revised January 1942): Provides an asset-by-asset listing of useful lives.
  • Rev. Proc. 62-21: Provides useful lives (“guideline lives”) for assets used by businesses in general, and guideline lives for assets used in specified business activities (“guideline classes”).  Supplement II consists of questions and answers to asset taxpayers in applying the Revenue Procedure.
  • Rev. Proc. 71-25: Sets forth asset guideline classes, asset guideline periods and asset depreciation ranges for purposes of the Asset Depreciation Range System (ADR).
  • Rev. Proc. 72-10: Supercedes Rev. Proc. 71-25 and updates the classes, periods and ranges. Also supercedes Rev. Proc. 62-21.
  • Rev. Proc. 77-10: Supercedes Rev. Proc. 72-10.
  • Rev. Proc. 83-35: Updates and supercedes Rev. Proc. 77-10. The asset guideline periods (midpoint class lives) set forth in this Procedure are also used in defining the classes of recovery property under the ACRS.

Rev. Rul. 2003-81:

Rev. Rul. 2003-81, which addresses depreciation and class lives with respect to assets owned by a utility.  The description of the law provides helpful understanding of the general context of class lives:

Section 167(a) of the Internal Revenue Code provides that there shall be allowed as a depreciation deduction a reasonable allowance for the exhaustion and wear and tear of property used in a trade or business or held for the production of income. The depreciation deduction provided by § 167(a) for tangible property placed in service after 1986 generally is determined under § 168. This section prescribes two methods of accounting for determining depreciation allowances: (1) the general depreciation system in § 168(a); and (2) the alternative depreciation system in § 168(g). Under either depreciation system, the depreciation deduction is computed by using a prescribed depreciation method, recovery period, and convention.

For purposes of either § 168(a) or § 168(g), the applicable recovery period is determined by reference to class life or by statute. See, for example, § 168(e). Section 168(i)(1) provides that the term “class life” means the class life (if any) that would be applicable with respect to any property as of January 1, 1986, under former § 167(m) as if it were in effect and the taxpayer had made an election under that section. Prior to its revocation, § 167(m) provided that in the case of a taxpayer who elected the asset depreciation range system of depreciation, the depreciation deduction would be computed based on the class life prescribed by the Secretary that reasonably reflects the anticipated useful life of that class of property to the industry or other group.

Section 1.167(a)-11(b)(4)(iii)(b) of the Income Tax Regulations provides rules for classifying property under former § 167(m). Property is included in the asset guideline class for the activity in which the property is primarily used. Property is classified according to primary use even though the use is insubstantial in relation to all of the taxpayer’s activities.

Rev. Proc. 87-56 sets forth the class lives of property that are necessary to compute the depreciation allowances under § 168. Rev. Proc. 87-56 establishes two categories of depreciable assets: (1) asset classes 00.11 through 00.4, which consist of specific assets used in all business activities (asset categories); and (2) asset classes 01.1 through 80.0, which consist of assets used in specific business activities (activity categories) based on broadly defined industry classifications. The same item of depreciable property may be described in both an asset category and an activity category, in which case the item is classified in the asset category unless specifically excluded from the asset category or specifically included in the activity category. See Norwest Corporation & Subsidiaries v. Commissioner, 111 T.C. 105 (1998) (item included in both an asset category and an activity category (furniture and fixtures) should be placed in the asset category). The asset classes described below are set forth in Rev. Proc. 87-56.

Asset class 00.11, Office Furniture, Fixtures, and Equipment, includes furniture and fixtures that are not a structural component of a building. This asset class includes assets such as desks, files, safes, and communications equipment. Assets in this class have a recovery period of 7 years for purposes of § 168(a) and 10 years for purposes of § 168(g).

Asset class 00.3, Land Improvements, includes improvements directly to or added to land, whether the improvements are section 1245 property or section 1250 property, provided the improvements are depreciable. Examples of the assets might include sidewalks, roads, canals, waterways, drainage facilities, sewers (not including municipal sewers in Class 51), wharves and docks, bridges, fences, landscaping, shrubbery, or radio and television transmitting towers. Asset class 00.3 does not include land improvements that are explicitly included in any other class, and buildings and structural components as defined in § 1.48-1(e) of the regulations. Assets in this class have a recovery period of 15 years for purposes of § 168(a) and 20 years for purposes of § 168(g).

Asset class 49.13, Electric Utility Steam Production Plant, includes assets used in the steam power production of electricity for sale, combustion turbines operated in a combined cycle with a conventional steam unit and related land improvements. This asset class also includes package boilers, electric generators and related assets such as electricity and steam distribution systems as used by a waste reduction and resource recovery plant if the steam or electricity is normally for sale to others. Assets in this class have a recovery period of 20 years for purposes of § 168(a) and 28 years for purposes of § 168(g).

Rev. Proc. 87-56 is an extension and modification of Rev. Proc. 62-21, 1962-2 C.B. 418. Rev. Proc. 62-21 abandoned the asset by asset approach of depreciation. Instead, all assets used in a particular industry classification (business activity), regardless of their nature, were grouped into a single class. See also The Adoption of the Asset Depreciation Range (ADR) System, Announcement 71-76, 1971-2 C.B. 503, 507. Rev. Proc. 62-21 included, in addition to assets grouped by broad industrial classifications, certain broad general asset classifications.

Special Rule on Treating Land:

There are also special rules on how to treat land in the calculation of the determination of economic life.  See Section 147(b)(3)(B).  Generally, if you are financing the acquisition of a building (which includes the underlying land), you don’t include in the “financed facilities” for purposes of the 120% rule the portion of the acquisition price relating to the land.  In other words, if the borrower indicates that the borrower spent a total of $500x to purchase the building, the borrower would need to identify how much of that purchase price is allocated to the land.  That amount would be excluded from the 120% calculation (assuming it is less than 25% of the net proceeds of the bonds).

Example Lives:

Fire trucks: 10 – 15 years, based on experience (fire trucks are not listed in Rev. Proc. 87-56)

Street sweepers: Perhaps 8 – 10 years, based on experience (also here)

Water rights: 30 years, treated as if the rights were land under I.R.C. 147 (water rights are not listed in Rev. Proc. 87-56). In some instances, the water rights contract may contemplate a short term, in which case it would be reasonable to use the shorter term.

Sports stadiums: 30 years, if you believe The Economics of Sports Facilities and Their Communities, by John Siefried and Andrew Zimbalist.

Artwork: See Rev. Proc. 68-232.

Sitework:  If sitework is done in connection with the construction of a building or structure, some bond counsel would assign the same life to the sitework as to the buildings or structures. [Cite needed]

Water utilities:  Can be up to 50 years, as described in Rev. Proc. 87-56 (49.3)

Wireless telecommunications:  See Rev. Proc. 2011-22

Land fill: Perhaps a useful life of 100 years is reasonable? See http://www.epa.gov/osw/conserve/tools/fca/docs/chap4.pdf

Hospital facilities:  See “Estimated Useful Lives of Depreciable Hospital Assets” published by the American Hospital Association

See also “Paul E. Gruenwald, American Appraisal Associates, Governmental Accounting Focus, Estimating Useful Lives for Capital Assets.”

Computer software:  See PLR 200515006.  Applies to analysis under I.R.C. 147.  There is a statutory three-year safe harbor under Revenue Procedure 2000-50.

See IRM 1.35.6.10 for other example lives assigned for governmental accounting purposes.

Utility Smart Meters:  See TAM 201244015.  At least five years, but may be longer.  See also this description from PWC.

See http://www.dummies.com/how-to/content/calculating-the-useful-life-of-a-fixed-asset.html:

Depreciation Recovery Periods for Business Equipment
3-year property Tractor units and horses over two years old
5-year property Cars, taxis, buses, trucks, computers, office machines (faxes, copiers, calculators, and so on), research equipment, and cattle
7-year property Office furniture and fixtures
10-year property Water transportation equipment, single-purpose agricultural or horticultural structures, and fruit- or nut-bearing vines and trees
15-year property Land improvements, such as shrubbery, fences, roads, and bridges
20-year property Farm buildings that are not agricultural or horticultural structures
27.5-year property Residential rental property
39-year property Nonresidential real estate, including a home office but not including the value of the land

Depreciation Rules for Property Financed with Private Activity Bonds (and LIHTCs):

Pursuant to the 1984 TEFRA Act, all property financed with IDBs, except low-income rental housing, is precluded from the use of an accelerated basis of recovery under ACRS.  The 1986 Act modified ACRS (hence, MACRS) for property placed in service after December 31, 1986.  Under the general provisions of MACRS, the cost of most eligible personal property is recovered over 3, 5, 7 or 10 years using the double-declining balance method, switching to the straight-line method to maximize the depreciation allowance.  The cost of property other than low-income rental housing financed with tax-exempt bonds is recovered using the straight-line method over the asset’s ADR midpoint life (40 years for most real property).  See I.R.C. 168(g)(1) and http://www.ksmcpa.com/blog/tax-exempt-or-taxable-financing-the-impact-on-investment-recovery

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TEFRA Approval (I.R.C. 147(f))

September 1, 2009

GENERAL RULE:

Section 147(f)(2)(B)(i) requires an issue to be approved by any governmental unit if such issue is approved by the applicable elected representative of such governmental unit after a public hearing following reasonable public notice.

WHAT IS REASONABLE PUBLIC NOTICE:

The statute is silent on what constitutes reasonable public notice. Section 5f.103-2(g)(3) of the Regulations provides guidance on this subject. Note that the IRS has proposed changes to this section of the Regulations to be implemented as Section 1.147(f)-1 “Public Approval of Private Activity Bonds” – these proposed changes have not been implemented yet.

According to Section 5f.103-2(g)(3) of the Regulations, Reasonable Public Notice means the following:

  1. Published notice which is reasonably designed to inform residents of the affected governmental units, including residents of the issuing unit and the governmental unit where a facility is to be located, of the proposed issue; and
  2. Notice must state the time and place for the hearing; and
  3. Notice must include the following: (a) general functional description of the type and use of the facility to be financed, (b) the maximum aggregate face amount of obligations to be issued with respect to the facility, (c) the initial owner, operator or manager of the facility, (d) the prospective location of the facility by its street address or, if none, by a general description designed to inform readers of its specific location; and
  4. Notice must be published no fewer than 14 days before the hearing; and
  5. Publication of notice presumed reasonable to inform residents of the approving governmental unit if given in the same manner and same locations as required of the approving governmental unit for any other purposes for which applicable state or local law specifies a notice of public hearing requirement.
  6. Publication of notice presumed reasonable to inform affected residents in the locality of the facility only if published in one or more newspapers of general circulation available to residents of that locality or if announced by radio or television broadcast to those residents.

Note that the current requirement is that the “maximum” aggregate face amount be included. Some bond counsel believe that the expected face amount may be increased by a healthy “buffer” amount (perhaps up to 20% of the expected amount) in order to cover unanticipated adjustments in the face amount prior to pricing but after publication of the TEFRA notice.  The Proposed Regulations would change this requirement, however, to provide that there may not be any “substantial” deviations in the “public approval information.”  Therefore, if, e.g., the difference between the maximum aggregate face amount and the actual aggregate face amount is greater than 5% of the net proceeds, there exists a “substantial” deviation.  The public approval requirement in this case is not met until certain special “curing” requirements are met.  In other words, while current regulations do not have a “substatial” deviation threshold, care must be taken under the Proposed Regulations to ensure that the difference between the stated maximum aggregate face amount is not greater than the 5% limit.

Insubstantial Deviations:

PLR 201430001:  State nonprofit corporation’s proposed use of bond proceeds to construct described athletic facility for exclusive use of university and its athletics department is insubstantial deviation from uses of bond proceeds described in stated notice and won’t cause bonds to fail to meet public notice and approval requirements.

PLR 200821031:  State agency’s proposed use of bond proceeds to further its maritime operations at city port by making improvements to described parcel is insubstantial deviation from uses of bond proceeds described in stated notice, and won’t cause bonds to fail to meet public notice and approval requirements.

PLR 200703017:  Exempt organization’s planned use of bond proceeds to substantially rehabilitate building on new property that will be functionally integrated into existing facility is insubstantial deviation from statutory public note and approval requirements.

PLR 200050026:  Org.’s planned transferred use of bond proceeds to improve and purchase new property is insubstantial deviation from statutory public notice and approval requirements.

PLR 200049022:  Transferred use of bond proceeds from one hospital to another is insubstantial deviation from statutory public notice and approval requirements.

PLR 9851005:  The Service has ruled that the proposed use of unexpended bond proceeds for developing a tract of land will be an insubstantial deviation from information contained in a public notice issued to comply with public notice requirements.

PLR 9609032:  A medical center’s proposed use of bond proceeds for a project at a different site than originally anticipated was an insubstantial deviation from the public notice and approval requirements.

PLR 9508029:  Two hospital facilities located approximately one mile apart, with equipment moved from one to the other.

PLR 9452021:  Use of bond proceeds to finance a hospital’s working capital expenditures was an insubstantial devision from the public notice requirements where there were exigent circumstances for such use of proceeds.

PLR 931109:  Cost savings leave a medical center with remaining bond proceeds.  The medical center plans to use those proceeds to construct an additional medical clinic at another location.  Ruled that the corporation has not given adequate public notice of the additional project despite the claim that the new facility would be part of an integrated health care system.

PLR 9220032:  Similar to the 1993 ruling above, except that cost savings were to be used for facility across the street from the original facility.  This was ruled to be an “insubstantial deviation.”

PLR 8948007:  The Company is a manufacturer and wholesale distributor. It operates two facilities, the Road Facility and the Street Facility, located three-fourths of one mile apart within the City. The City is located within the County. Related products are manufactured at both facilities and sold to the same customers.

PLR 8831046:  There was an error in the street address number of the facility to be financed.  Ruled that the error was an “insubstantial deviation” under Temp. Reg. 5f 103-2(f)(2) and that the notice and approval met the requirements of I.R.C. 147(f)(2).

PLR 8411077:  Argument that it is too burdensome to list all properties not accepted.  The notice must include specific locations.

TEFRA PROCEEDINGS REQUIRED IN REFUNDING BOND ISSUES:

Section 147(f)(2)(D) of the Code states that:

No approval under section 147(f)(2)(A) [which requires the approval] is necessary with respect to any bond which is issued to refund (other than to advance refund) a bond approved under subparagraph (A) (or treated as approved under subparagraph (C)) unless the average maturity date of the issue of which the refunding bond is a part is later than the average maturity date of the bonds to be refunded by such issue.  For purposes of the preceding sentence, average maturity is determined in accordance with subsection (b)(2)(A).

Note that section 147(f)(2)(D) – the exception to TEFRA – applies only to current refundings.  It does not provide for deemed approval for advance refunding issues.

Under prior law, described in Treas. Reg. 5f.103-2(b)(1), the requirement merely stated that the refunding obligation have a maturity date which is “not later than the maturity date of the obligation to be refunded.”  There is no revised regulation that more fully describes the current rule in Section 147(f)(2)(D).

If under the rules of section 147(f)(2)(D) no approval is necessary because the average maturity date of the refunding bonds is not later than the average maturity date of the refunded bonds, write “No approval needed under section 147(f)(2)(D) of the Code” in line 37 of the April 2011 IRS Form 8038.

Section 147(f)(2)(D) refers to an “issue” of which the refunding bond is a part (see also Treas. Reg. 5f.103-2(b)(1)).  What analysis is needed if the issue of bonds consists of a new money portion and a current refunding portion?  Can the issue, for section 147(f)(2)(D) purposes, be treated as two issues?  The language in section 147(f)(2)(A) states that the entire issue must satisfy the approval requirement – not merely a portion of the issue.  The exception in section 147(f)(2)(D) further provides that the average maturity date of the entire issue – not merely a portion of such issue – must not be later than the average maturity date of the refunded bonds.  Thus, the express language does not appear to allow a multipurpose-style differentiation between a new money and a refunding portion of the bonds in order to satisfy the exception.  Nevertheless, a valid argument for separating the issue into two separate issues for purposes of section 147(f)(2)(D) may be available in the definition of “Issue” in Treas. Reg. 1.150-2(c).  Indeed, Treas. Reg. 1.150-1(c)(3) can be used to elect a separate issue, at least for purposes of section 147(f)(2)(D).  Remember, a separate IRS Form 8038 would need to be filed.

VALIDITY PERIOD:

Public approval may be given once for a three-year plan of financing, which may contemplate several bond issues occurring within three years after the initial issue date of the first bonds issued pursuant to the approved plan.  This rule includes refunding bonds that refund private activity bonds issued pursuant to the approved plan which are issued within the three-year period.

QUESTIONS AND ANSWERS:

Q: May a TEFRA notice identify alternative sites or alternative facilities to be financed? A: PLR 9851005. Alternate sites in TEFRA notice were okay. Bond proceeds used on site across the street from TEFRA identified site was okay.

Q: What is the limitation on use of bond proceeds on TEFRA identified site where the use may go beyond what was specifically identified? A: PLR 200821031. Use for maritime operations.

Q: How long is a TEFRA approval valid for? A: Under Section 147(f)(2)(C), if there has been public approval of the plan for financing a facility, such approval constitutes the approval for any additional bond issue (a) which is issued pursuant to that plan within 3 years after the date of the 1st bond issue that was issued pursuant to that approval, and (b) all or substantially all of the proceeds of such additional bond issue will be used to finance the facility or to refund previous financing under such plan.  So, if the project described in the TEFRA is still valid for the new issue, that TEFRA remains valid for three years after the first bond issue that is done under the TEFRA.

Q: What to do if bond-financed property is mobile and is moved throughout the country?  Consider Rev. Rul. 80-12 and similar rulings relating to trailers and rolling stock.  PLR 8213107, PLR 8235049, PLR 8307012, PLR 8311047, PLR 8324053, REV. RUL. 77-281, REV. RUL. 80-12

OTHER MATTERS:

PLR 200126006:  State’s acting governor fulfills I.R.C. 147(f)(2)(B) requirement that private activity bonds be approved by an elected representative for purposes of treating bonds as qualified bonds.

PLR 9622032:  The state agency’s proposed public notice and hearing regarding its issuance of bonds will not satisfy the public approval requirements where the notice will not include the name of the initial owner, operator or manager of the facility and will not include the prospective location of the facility, either by street address or by general description designed to inform the public of the specific location.

PLR 9123058:  Authority with two counties on the board.  One county’s designated agent who was an elected representative qualified as an “applicable elected representative” for purposes of giving public approval.