In recent Chief Counsel Memo #20125201F, the IRS concludes that open-air parking garages are considered buildings rather than land improvements for tax purposes.
The IRS attorneys go on to say that the taxpayer’s conclusion to the contrary warrants the assessment of a negligence penalty. That is a pretty harsh result given that the tax law for this issue is not all that clear.
How to Depreciate Property?
For tax purposes, depreciation refers to the deduction one is able to take for the cost of acquiring or improving the capital assets. This frequently involves buildings, as with parking structures.
Depreciation builds on the accounting principle that expenses should be recovered over time as income is produced. You start with capitalizing costs and then taking a depreciation expense over time. This matching of expense and income is fundamental to our financial system. Depreciation accomplishes this by allowing a deduction over time as the income produced by the property is received. This accounts for the useful life of the asset. Once the useful life is up, the asset should have no cost left to depreciate. This useful life concept is fundamental to tax depreciation.
This deduction is found in Section 167(a). It provides a depreciation allowance for the exhaustion, wear and tear of property used in a trade or business or held for the production of income. This is the tax terminology for the accounting matching principle.
Tax depreciation deductions are based on the convention and then class lives of the asset.
The convention can either be under the Modified Accelerated Cost Recovery System (“MACRS”) or the General Depreciation System (“GDS”). There are numerous distinctions between the two. Suffice it to say that MACRS often allows quicker recovery of capital costs. Thus, most taxpayers prefer MACRS.
Revenue Procedure 87-56, 1987-2 C.B. 674, sets forth the class lives of assets that are necessary to compute the depreciation allowances under § 168 (“MACRS”). This guidance includes lists of categories of assets and identifies the class lives for each category.
What is an Open-Air Parking Garage?
Let’s start with what counts as a parking garage. Specifically, let’s focus on an open-air parking garage.
These are structures that have a ramp and more than one level. They allow vehicles to travel up and down the ramp and park along the sides of the ramp. The ramps provide shelter and protection for the cars and people on lower levels. So only those cars and people on the top level are exposed to the sun, rain, snow, etc.
The parking space and ramps are not enclosed. Most of the outside walls are open, allowing fumes to escape. These structures usually do not require heating or air conditioning. They may include one or more stairwells and possibly an elevator. They may include interior lighting and fire suppression systems.
How Long Do You Depreciate Parking Garages
This brings us back to our question in this article. How long do you depreciate parking garages?
If you were to pull the guidance above, you would see that a building generally has a 39-year recovery period for depreciation purposes; whereas, a land improvement generally has a 15-year recovery period. You can find these rules in Section 168. The bonus depreciation rules can be found in subsection (k) of Section 168.
The shorter recovery period for property classified as a land improvement generally produces a larger depreciation deduction in the current tax year.
This timing issue is why taxpayers, like the one cited in the IRS memo, would prefer a shorter recovery period. This is where advanced tax planning can help.
Are Open-Air Parking Garages Land Improvements?
Parking garages are often part of the building structure. This means that the parking garage is depreciated based on whether the building is used for residential or non-residential purposes.
This same analysis applies to depreciating a carport.
The parking garage in this case was a stand-alone structure. It was not even connected to a building.
The IRS memo concludes that open-air parking garages like this one are not land improvements. This means that it is more akin to a parking lot rather than a parking garage structure.
But the taxpayer made compelling arguments as to why his open-air parking garages are buildings and not land improvements.
The taxpayer argued that:
- The applicable regulations are invalid as they depart from the legislative history;
- The garages are not buildings because they do not have floor-to-ceiling walls, a conventional roof, and they do not share supporting structural elements; they offer only minimal shelter from the elements or protection from vandalism and theft and their primary purpose is storage of vehicles; and
- The garages are land improvements because they are merely parking lots stacked one on top of another and not “garages” as that term is commonly understood.
The IRS field advice rejects each of these arguments based largely on a literal reading of the rules in the applicable regulations and certain concessions in the taxpayer’s submissions. This is consistent with Coordinated Issue Paper LMSB4-0709-029, which the IRS authored in 2009.
Are Parking Garages Eligible for Section 179?
Parking garages are generally not eligible for Section 179 expensing. This is because they are not Section 1245 property and cannot qualify as qualified improvement property.
With that said, certain components of the parking garage may qualify for Section 179. The rules provide for this. This includes the roof, ventilation, fire protection and alarm systems, and HVAC systems.
Typically open-air garages like the one in this instance do not have these components.
Final Thoughts on Depreciating Parking Garages
Despite assertions from the IRS, it is not altogether clear whether the taxpayer’s position is incorrect. This ambiguity should be read in the taxpayer’s favor. It certainly shows that the taxpayer’s facts warrant the imposition of a negligence penalty.
It is also not clear whether the IRS would reach the same conclusion if the facts were slightly different, such as if the parking garage was designed in a way that no one floor functioned as a roof for a lower floor, if the parking garage was situated entirely underground, or if the parking garage had an additional primary function–such as storage for supplies, tools, or other equipment.
If anything, this field advice serves as another warning to taxpayers that a contrary position will be challenged by IRS examiners and may have to be resolved by the IRS Appeals Office or the tax court.