First Ever Tax Court Case on Section 199 Domestic Production Deduction

In the first Tax Court case opinion on Section 199 deduction activities, the Tax Court today sided with the taxpayer in Gibson & Associates, Inc. v. Commissioner, 136 T.C. No. 10 (February 24, 2011).

The taxpayer undertook three types of construction projects in its business. The first category, “casualty” projects, involved work performed on infrastructure that was significantly damaged by an act of God or by a casualty such as a fire or an overheight or an overweight vehicle hitting or traveling on a bridge.  The second category, “new construction” projects, involved work that petitioner performed primarily as a subcontractor on contractors’ multi-million dollar projects involving major rehabilitation of real property.  The third category, “rehabilitation” projects, involved work that petitioner performed as a contractor rehabilitating dilapidated real property (primarily infrastructure).

The Tax Court, in its first opinion on the Section 199 Domestic Production Activities Deduction set forth a two-part test with respect to construction projects:  (1) Did the work renovate a major component or substantial structural part of real property and (2) did the renovations materially increased the value of the real property, substantially prolonged the useful life of the real property, and/or adapted the real property to a different or new use?

The taxpayer took that position that it “erected” or “substantially renovated” real property and therefore the disputed amount is DPGR.  The IRS argued that such work fell outside of the meanings of those terms and therefore the disputed amount is not DPGR.

In a victory for the taxpayer on Section 199 deductions, the Tax Court sided with the taxpayer in concluding that based on expert testimony on issues such as bridge rehabilitation, where their expert testified that  “with $200,000 of rehabilitation work after 30 years, the value increases from $100,000 to $300,000 and the life of the bridge is extended from 40 years to 60 years.”  The taxpayer’s expert concluded that the taxpayer’s major rehabilitation work on a bridge increased each bridge’s value by the cost of the rehabilitation work and prolonged the bridge’s useful life by 20 years.  Thus, the revenue from this activity was DPGR (Domestic Production Gross Receipts) for purposes of the Section 199 Domestic Production deduction.

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