For many years, contractors have been advised to look into the Section 199 tax deduction for “domestic production activities.” Although the deduction focuses on manufacturing, it’s also available for “construction of real property performed in the United States” by companies “engaged in the active conduct of a construction trade or business.”
Recently, the IRS clarified the meaning of “construction of real property” in its Technical Advice Memorandum (TAM) 201638022. TAMs don’t constitute binding precedent, but they do provide insight into the agency’s position on an issue. This particular TAM makes the Sec. 199 deduction look better for contractors.
The TAM addressed a case involving a construction company that performed substantial renovation, construction or erection of various “structures.” The guidance said the structures consisted of a series of large piping and ancillary equipment, including pumps, motors, and heaters. The structures weighed hundreds or even thousands of tons and were attached to support columns resting on concrete foundations.
The IRS’s Large Business and International ("LB&I") division concluded that the construction business wasn’t entitled to claim the Sec. 199 deduction. The LB&I recognized that the company met most of the requirements but found that the installed property wasn’t “real property” for Sec. 199 purposes.
Affixed to property
The IRS’s Chief Counsel disagreed. According to the TAM, tax regulations define real property to include “inherently permanent structures . . . other than machinery.” The TAM explains that inherently permanent structures and machinery are mutually exclusive categories. But if the subject properties constituted inherently permanent structures, they’d still meet the definition of real property for purposes of Sec. 199 — even if they possessed characteristics of machinery.
Inherently permanent structures include “property that is affixed to real property and that will ordinarily remain affixed for an indefinite period of time.” In this case, the IRS said, the structures were affixed to the real property based on weight alone, though there was evidence that they were welded or bolted to the foundations and support columns. Although the regulations don’t define “indefinite period of time,” the agency found that the structures satisfied this requirement because they were expected to remain affixed to the property for the duration of their useful lives.
A little more clarity
The Sec. 199 deduction is a potentially valuable tax break, reaching as high as 9% of qualifying income. However, the deduction might be eliminated as part of potential tax reform. (Check with your tax advisor for the latest information.) Even if it’s eliminated, you might be able to file an amended return and claim the deduction for previous years.
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