UNITED STATES TAX COURT

l'

137 T.C. No. 3

UNITED STATES TAX COURT

ROBERT AND KIMBERLY BROZ, Petitioners v.

COMMISSIONER OF INTERNAL REVENUE, Respondent

Docket No.

21629-06.

Filed July 7,

2011.

Ps were shareholders in a wholly owned S corporation

(S) engaged in providing wireless cellular service. The

parties dispute the length in years of the recovery period

that S must use to calculate its annual depreciation

deduction for the wireless cellular assets. Wireless

cellular assets include antenna support structures, cell

site equipment and leased digital equipment.

Held: We apply the plain language of sec. 168, I.R.C.,

in interpreting classification issues of first impression.

The plain language of Rev. Proc.

87-56,

1987-2 C.B.

674,

the

revenue procedure in effect for the years at issue, is

unambiguous as it applies to S's wireless cellular assets.

Held: The antenna support structures fall within asset

class 48.14 with a recovery period of 15 years, as specified

in Rev. Proc. 87-56, supra. The cell site equipment,

excluding the switch, and the leased digital equipment fall

within asset class 48.12 with a recovery period of 10 years.

Id.

t SERVED R -7 2011

- 2 Stephen W. Feldman and Eric T. Weiss, for petitioners.

Meso T. Hammoud, Elizabeth Rebecca Edberg, and Steven G.

Cappellino for respondent.

KROUPA, Judee:

Respondent determined over $16 million

dollars of deficienciesi in petitioners' Federal income tax for

1996,

1998,

1999,

2000 and 2001

(the years at issue).

In this report we decide whether RFB Cellular, Inc.

(RFB),

an S corporation petitioners wholly owned, is entitled to certain

depreciation deductions for wireless cellular equipment.

Specifically, we must determine whether petitioners properly

classified antenna support structures, cell site equipment and

leased digital equipment for depreciation purposes.'

that they did not .

We: find

A forthcoming report will address the

remaining seven issues.

FINDINGS OF FACT

Some of the facts have been stipulated and are so found.

We

incorporate the stipulation of facts and the accompanying

Respondent determiried a $100, 003 deficiency for 1996, a

$4,671,608 deficiency for 1998, a $3,385,533 deficiency for 1999,

a $4,954,056 deficiency for 2000, and a $3,395,214 deficiency for

2001.

2We note that the Internal Revenue Service has since

provided updated class life guidance for the ever-changing

cellular service industry. Rev. Proc. 2011-22, 2011-18 I.R.B.

737, applies for years after the years at issue.

- 3 exhibits by this reference.

Petitioners resided in Gaylord,

Michigan at the time they filed the petition.

Overview of RFB Cellular, Inc.

Petitioner husband (petitioner) formed RFB Cellular, Inc.

(RFB), a wholly owned S corporation, in 1991.

RFB was engaged in

providing wireless cellular service during the years at issue.

Petitioner had many years of experience with the cellular

industry before he formed RFB.

He was president of Cellular

Information Systems (CIS), a cellular company.

Petitioner also

served as a board member to the Cellular Telephone and Internet

Associatioh (CTIA) and was involved with lobbying efforts on

behalf of the cellular industry.

Overview of the Cellular Industry

The Federal Communications Commission (FCC) administers the

radio-frequency spectrum on which cellular carriers operate

wireless networks.

The FCC isàues licenses for wireless networks

to operate on specific broadcast frequencies on the spectrum.

The licenses are further limited to a specific geographic area.

A cellular network is operated on a grid that divides the

geographic region covered by the license into smaller cells (cell

sites).

The size of the cells depends on the anticipated amount

of cellular traffic.

In urban areas, the cells are smaller to

maximize network capacity.

In rural areas where capacity is less

of a concern, such as those areas in Michigan where RFB operated

- 4 its cellular networks, the cells are larger to provide more

coverage.

The cell site structure enables the cellular carrier

to reuse a limited number of broadcast frequencies across the

geographic region.

RFB provided cellular service to two license areas, and

operated approximately 75 cell sites, on the Michigan peninsula

during the years at issue.

Most of RFB's revenue came from

roaming charges for the use of the Michigan networks.

RFB would

make its networks available to customers of other carriers who

were traveling within the geographic area of the licenses. RFB

and other carriers sent their receivables and payables to a

clearinghouse that would sort out the charges and payments and

issue a bill to each carrier.

Operation of the Cellular Network

The three basic components of a cellular network are (1)- the

base station, which includes towers, antennas and related

electronic equipment;

(2) transmission facilities between the

base station and the switch; and (3) the switch.

Cellular

carriers added onto the existing assets to update from analog to

digital cellular technology.

A.

The Antenna Support Structures

Signals from the cellular user travel from the cellphone to

the antenna.

The antenna is mounted on a free-standing tower so

that it can transmit and receive signals across great distances.

- 5 -

The height of the tower also reduces interference with radio

signals from trees and tall buildings.

The tower is strong

enough to support the weight of the antenna and related

equipment, plus accumulated ice and snow.

The tower is also

built to withstand high winds.

RFB constructed some of its towers on top of preexisting

structures to prevent the obstruction of the antennas.

RFB used

the same towers for many years, and it would simply switch the

antenna and related equipment when it stopped working or became

obsolete.

B.

The Base Station

The base station is located at or near the base of the

tower.

The cell phone searches for a signal from the closest

base station before a call is made.

The signal from the base

station is what gives the cell phone service or "bars".

The cell

phone then sends a radio signal to the base station identifying

the user and the user's location.

A radio transmitter in the

cell phone converts the user's speech into strings of ones and

zeroes that can be transmitted as radio signals to the antenna.

The base station contains a two-way radio that converts the

radio signal from the cellphone to a form that can be transmitted

over wire cn: optical fiber to the switch.

-The radio also

converts the signal from the switch to a radio signal that can be

transmitted to the cellular user.

The radio contains some

- 6 computerized parts, including a computerized component that

amplifies the radio signals.

The base station contains some

switching software so it can route the calls if the switch no

longer functions.

The base station is housed in a small equipment shelter.

RFB typically leased the land beneath the equipment shelters for

25 years, with 5-year renewals.

The equipment shelters were

prefabricated from concrete slabs and were approximately 8 to 10

feet wide by 10 to 12 feet long.

The equipment shelters were

very heavy, and, like the towers, they were designed to remain in

service for many years.

The equipment shelters did not need to

be replaced when the base station equipment was replaced.

Instead, RFB would simply switch out the base station equipment

when it went no longer functioned or became obsolete.

The

equipment shelters had air conditioning, temperature alarm

,

systems, fire/smoke alarm systems, and intruder alarm systems.

C.

The Switch

Thes switch, which is the technological descendant of the

switchboard, is a computer system that routes the cellular calls.

Wireless calls are typically transmitted to the switch from the

base station over a landline or radio network.

The switch is

connected to the landline and other carriers.

It determines how

to route the call based on the number that is dialed.

The switch

also maintains billing records and monitors the base stations .

One switch can serve as many as 200 base stations.

The Transition From Analog to Digital Technology

RFB initially provided analog cellular service.

It began,

however, updating its equipment to provide digital service.

The

digital e uipment could handle approximately eight times as many

calls as the analog service.

The digital technology also

provided customers with additional services .

These additional

services included the ability to text, send pictures, download

ring tones and access the Internet.

Moreover, the FCC eventually

required that all cellular carriers phase out analog service and

upgrade to newer digital technology.

RFB acquired and installed the leased digital equipment so

it was ready for use in 2000 .

RFB decommissioned its analog

equipment soon after the FCC mandated the switch to digital.

RFB's Returns for the Years at Issue

RFB claimed depreciation deductions for wireless cellular

equipment during the years at issue.

RFB did not specifically

identify the items being depreciated but instead classified items

into generic categories, such as "switch equipment" and "cellular

equipment " .

RFB included all costs for towers, antennas, equipment

shelters and related land improvements in the "antenna support

structure"' asset class.

RFB depreciated the antenna support

- 8 -

equipment over seven years-under asset class 48.32.

RFB

classified a wide -variety of equipment, including the switch and

the base station, as "cell site equipment."

RFB depreciated the

cell site equipment over five to seven years under asset class

48.121.

RFB depreciated the leased digital equipment over five

years under asset class 48.121.

RFB included costs for concrete,

excavating, steel, fencing and construction in the leased digital

equipment category.

Respondent issued the deficiency notice disallowing the

depreciation deductions.

Respondent determined that the antenna

structures should be depreciated over 15 years under asset class

48.14, rather than the seven years petitioners claimed.

Respondent also determined that the cell site equipment and the

leased digital equipment, other than the switch, should be

depreciated over 10 years under asset class 48.12, rather than

the five years petitioners claimed.

Petitioners timely filed a petition.

OPINION i

We are asked to determine the appropriate class life for the

ever-changing cellular phone industry.

The parties disagree over

the characterization of certain wireless cellular equipment for

depreciation purposes.

There are three categories of equipment

at issue: '1) antenna support structures, 2) cell equipment and

- 9 -

3) leased digital equipment.

We begin by discussing depreciation

generally, then address each equipment category in turn.

I.

Depreciation Generally

A reasonable allowance for depreciation is allowed under

1

section 1673 for the exhaustion, wear and tear, and obsolescence

of property used in a trade or business or held for the

production of income.

The depreciation deduction is based on the

adjusted basis of the property, as determined under section'1011

for the purpose of.determining gain on the sale or other

disposition of the property.

Sec. 167(c).

Depreciation deductions were based on the estimated useful

life of the property before 1981.

The useful life was the period

for which the taxpayer expected to use the asset in his or her

trade or business, and did not necessarily correspond with the

economic life of the asset.

Sec. 1.167(a)-1(b), Income Tax Regs.

Congress abandoned the useful life concept in 1981 and adopted

the accelerated cost recovery system (ACRS) in effect today.

Grinalds v. Commissioner, T.C. Memo. 1993-66.

See

ACRS allows

greater depreciation for taxpayers through shortened depreciation

periods and simplifies depreciation calculations by reducing the

number of property classes.

C.B. 412, 425.

S. Rept.

Congress modified ACRS

97-44,

at 47

(MACRS)

(1981),

1981-2

in 1986 by

3All section references are to the Internal Revenue Code in

effect for the years in issue unless otherwise indicated.

- 10 prescribing mandatory depreciation methods for each ACRS class.

See Grinalds v. Commissioner, supra.

The Secretary has the authority to prescribe class lives for

each class of property.

See sec. 167(m).4

The class lives are

intended to reasonably reflect the anticipated useful life of

that class of property to a particular industry or other group.

Id.

The guideline classes and periods (lives) are "established,

supplemented, and revised" as necessary.

11(b) (4) (ii), Income Tax Regs.

Sec. 1.167(a)-

The class lives of depreciable

assets can be found in a series of revenue procedures issued by

the Secretary.

See id.

The revenue procedure in effect for the years at issue is

Rev. Proc.

87-56,

1987-2 C.B. 674.

Rev. Proc.

divides assets into two broad categories:

87-56,

supra,

(1), Asset guideline

classes 00.11 through 00.4, consisting of specific depreciable assets used in all business activities (the asset category), and

(2) asset guideline classes 01.1 through 80.0, consisting of

depreciable assets used in specific business activities (the

activity category).

The asset category takes priority over the

'Sec. 167(m) was deleted from the Code by the Omnibus Budget

Reconciliation Act of 1990, Pub. L. 101-508, sec. 11812(a) (1),

104 Stat. 1388-534.

Sec. 167(m) essentially codified the Asset

Depreciation Range system described in sec. 1.167(a)-11, Income

Tax Regs., and in particular the system of asset guideline

classes and periods found there.

See H. Rept. 92-533, at 30-35

(1971), 1972-1 C.B. 498, 514-516; S. Rept. 92-437, at 45-52

(1971), 1972-1 C.B. 559, 584-588.

- 11 -

activity category if an asset is listed in both categories.

Norwest Corp.

& Subs. v. Commissioner,

111 T.C.

105,

158

See

(1998).

"Telephone Communications" is listed as an activity in Rev. Proc.

87-56, 1987-2 C.B. at 684.

The telephone communications category

includes assets identified in asset classes 48.11 through 48.14

and used t

provide commercial and contract telephone services.

Id.

The various classes of telephone equipment are defined by

reference to the FCC's Uniform System of Accounts for Class A and

Class B Teilephone Companies

31

(1986).

(USOA).5

Public utilities,

Id.; see also 47 C.F.R. pt.

like the wireless cellular

industry, whose rates are often mandated by expenses, are

routinely required to use uniform systems of accounting

promulgated by regulatory agencies.

Commissioner,

108 T.C.

384, 403

See Sprint Corp. & Subs. v.

(1997)

(citing Pacific Enters.

Subs. v. Commissioner, 101 T.C. 1 (1993)).

&

The USOA is the

uniform system of accounting that the FCC requires

telecommunications companies to apply.

See 47 C.F.R. pt. 32.1

sPetitioners contend that respondent's expert improperly

relied on the FCC's USQA classification to classify the cellular

equipment.

Petitioners' argument overlooks that Rev. Proc. 8756,

1987-2 C.B.

674,

684,

specifically references the USOA

classification regime. Rev. Proc. 87-56, supra, adopts the FCC's

classification regime for certain types of assets. We find the

adoption reasonable given the FCC's experience and expertise in

telecommunications.

Furthermore, the reference to the USOA in

Rev. Proc. 87-56, supra, is a shorthand way of referring to

related types of equipment. The Secretary ultimately determines

the class lives.

- 12 -

(1986).

The USOA classifies telephone communications equipment'

for accounting and depreciation purposes.

The USOA classifications were revised in 1988, the year

after Rev. Proc.- 87-56, supra, was issued.'

Order, 51 Fed. Reg. 43498

(Dec. 2, 1986).

See USOA Revision

Property's present

class life, however, is determined based on the class life

applicable to such property as of a particular date, in this case

January 1, -1986.7

Accordingly, accounts in place as of that

particular date dontrol, even though the FCC has since redefined

its accounts.

404.

See Sprint Corp. & Subs. v. Commissioner, supra at

Nevertheless, we will consider the 1988 revisions of the

USOA classifications to the extent we find them helpful in

interpreting the classificátions in effect on January 1, 1986.

II.

Classification of the Equipment

We now turn to classification of the equipment.

We must

determine for the first time how certain wireless cellular

equipment should be classified.

In interpreting other

classification issues of first impression, we have applied the

'The revision changed the relevant account numbers but did

not make significant substantive changes to the classification

categories.

?In Sprint Corp.

& Subs. v. Commissioner

108 T.C.

384,

402

(1997), the date was Jan. 1, 1981 pursuant to-former sec.

168(g) (2).

We noted that "One essential theme of the ACRS was

predictable depreciation periods; that was accomplished by

freezing in time the property classifications as they were on

January 1, 1981.~ Until- further amendment by Congress, there were

to be no changes." Id. at 404. The applicable date is here Jan.

1,

1986 pursuant to sec.

168(i) (1).

- 13 -

plain language of the depreciation statutes and USOA

classifications.

Id.

We will therefore apply the plain language

to determine the proper classification of equipment category.

We

begin with the classification of the antenna support structures.

A.

The Antenna Support Structures

RFB classified a broad range of wireless cellular equipment

as "antenna supporting structures" under asset class 48.32, which

it then depreciated over seven years."

Respondent contends that

the class life should be adjusted to 15 years 'under asset class

48.14.

RFB classified the equipment as antenna supporting

structures under asset class 48.32 because the equipment was used

to support the antennas and related equipment.

Asset class 48.32

|

is in the Telegraph, Ocean Cable, and Satellite Communications

(TOCSC) activity category.

Asset class 48.32 therefore does not

apply because the TOCSC activity category involves "domesticrand

international radio-telegraph, wire-telegraph, ocean-cable" * * *

[or] sate lite communications services."

Rev. Proc. 87-56, 1987-

2 C.B. at 684.9

8RFB characterized the equipment very broadly on its

depreciation schedules. This Court bears heavily against

taxpayers whose inexactitude is of their own making. See Boque

v. Commissioner, T.C. Memo.

2007-150.

"Moreover, even if the antenna support structures were

properly classified as TOCSC property, they would have -a class

life of 24 years, rather than seven years as classified by

petitioners. Rev. Proc. 87-56, 1987-2 C.B. at 684, states that

if property described in the TOCSC classes "is comparable to

telephone distribution plant described in Class 48.14 and used

(continued...)

- 14 Instead, the equipment is more appropriately categorized in

the "Telephone Communications" activity category.

Petitioners

claim the Telephone Communications activity category is too broad

to apply to the wireless equipment at issue.

They argue that

comparing the wireless cellular equipment to equipment used by

traditional landline telephone companies is tantamount to

comparing a calculator to an abacus.

They claim that

respondent's classification ignores the physical, technological

and practical differences between the equipment.

Petitioners

argue further that wireless cellular equipment has a useful life

that is "demonstrably shorter" than that of landline equipment.

They may nonetheless not depreciate their equipment under a class

life simply because they believe it better approximates the

equipment's useful life.

Memo. 1993-66.

See Grinalds v. Commissioner, T.C.

Deductions are a matter of legislative grace, and

petitioners are entitled to deduct only the amounts prescribed by

Congress.

See INDOPCO,

Inc. v. Commissioner,

503 U.S.

79,

84

(1992).

Moreover, the plain language of Rev. Proc. 87-56, supra, is

unambiguous as it applies to RFB's equipment.

Assets in the

Telephone Communications activity category are used to provide

commercial and contract telephonic services, which petitioner

9(...continued)

for the 2-way exchange of voice and data communication which is

the equivalent of telephone communication, such property is

assigned a class life of 24 years under this revenue procedure."

- 15 provided during the years at issue.

See id., 1987-2 C.B. at 684.

The relevant asset class for the antenna support structures is

class 48.14.

This class includes "telephone distribution plant"

assets, which include "pole lines, cable, aerial wire,

underground conduits, and comparable 'equipment."

Id.

The

antenna support structures fit with the assets listed in asset

class 48.14, because they provide structural support to the

antennas and related equipment.

Furthermore, the antenna support structures are includable

in asset class 48.14 by reference to the USOA.

Asset class 48.14

includes "land improvements, as defined in FCC Part 31, Account

241."

Id.

Account 2411, which is the modified version- of

Account 241, includes "towers * * * not associated with

building", or otherwise freestanding. 'See 47 C.F.R. pt. 32.2411

(1988)."

Respondent's expert testified that RFB's towers are

appropriately classified as freestanding because the towers'

association with various buildings was purely incidental.

RFB

installed towers on top of preexisting buildings where it was

necessary to ensure that the antennas would be unobstructed.

Regardless of where they were built, the towers were freestanding

"The antenna support structures' present class life is

determined based on the class life applicable to such property as

of Jan. 1, 1986.

Here we view the 1988 revisions of the USOA

classifications as helpful in interpreting the classifications in

effect on Jan. 1, 1986.

- 16 -

structures designed for the sole purpose of providing structural

support to the antenna."

We hold, accordingly, that the appropriate asset class for

the antenna support structures is asset class 48.14.

Assets in

asset class 48.14 have a recovery .period of 15 years.

Rev. Proc.

87-56, 1987-2 C.B. at 684.

We therefore sustain respondent's

determination that petitioners improperly depreciated the antenna

support structures over a period of 7 years .

B.

The Cell Site Equipment

We now turn to classification of the cell site equipment .

RFB characterized a wide variety of cell site equipment,

including the base station and the switch, under the general

category of "cell site equipment".

RFB classified the cell site

equipment as computer-based telephone central office switching

equipment (computer-based switching equipment) under asset class

48.121 and depreciated the equipment using a 5-year life.

Respondent concedes that petitioner properly classified the

switch as computer-based switching equipment under asset class

48.121.

Respondent contends that the remaining cell site

equipment, including the base station, should be classified as

"Petitioners contend that the equipment shelters should not

be included within asset class 48.14 because they are movable

structures, and therefore cannot constitute land improvements.

Petitioners have not provided any evidence, beyond their own

self -serving testimony, that the equipment shelters were movable

by design.

- 17 -

telephone central office equipment under asset class 48.12.

Petitioners argue that the base station should be included in

asset class 48.121 because it has some of the same equipment and

can perform some of the same functions as the switch.

Asset classes, 48.121 and 48.12 both apply to telephone

central office switching equipment.

The major distinction

between the two asset classes is that asset class 48.121

"includes equipment whose functions are those of a computer or

peripheral equipment".

Id.

The term "computer" refers to a

-

programmable electronically activated device that is (1) is

capable of accepting information, applying prescribed processes

to the information,"and supplying the results of these processes

with or without human intervention, and (2) consists of a central

processing unit containing extensive storage.168(i) (2) (jB) (ii).

See sec.

"Related peripheral equipment" includes any

equipment designed to be placed under the control of the central

processing unit of a computer.

Sec. 168(i) (2) (B) (iii).

Petitioners argue that the remaining cell'site equipment

qualifies as computer equipment because it contains computerized

parts.

They emphasize that the radio uses the computer

processing system of converting transmissions into ones and

"We note that the revenue procedure in effect for taxable

years ending on or after Dec. 31, 2010 now classifies the "base

station controller (or generational equivalent) * * * [and the]

base transceiver station (or generational equivalent)" in asset

class 48.121 with a recovery period of five years. Rev. Proc.

2011-22, 2011-18 I.R.B. at 738.

- 18 -

zeroes.

Many devices, including cars and CD players, use the

same computer processing system.

We agree with respondent that,

under petitioners' analysis, virtually every asset in today's

increasingly computerized world would be labeled a computer.

Moreover, even though the remaining equipment included some

computerized parts, the equipment is not a computer.

168(i) (2) (:B).

See sec.

The key component of the base station and other

cell site equipment was the radio.

The primary purpose of the

radio was to transmit cellular communications between the cell

phone and the switch.

The radio itself did not employ computer

processing, nor did it contain a central processing unit

containing extensive storage.

We find it compelling that even

though the base station contained some of the same software as

the switch, which is classified as a computer, the base station

did not have the computer system or storage capacity to keep

billing records.

Furthermore, the radio technology has

functioned for many years without the use of computerized parts,

suggesting that those parts are only ancillary.

The presence of

some computerized components therefore does not qualify the

remaining cell site equipment as computer-based.

Finally, the plain language of Rev. Proc. 87-56, 1987-2 C.B.

at 684, places the remaining cell site equipment in asset class

48.12.

Asset class 48.12, "telephone central office equipment",

includes "central office switching and related equipment as

- 19 defined in * * *

[USOA] Account No. 221" such as "radio

transmitters and receivers."

See 47 C.F.R. pt. 32.2231 (1988).

We find that the remaining cell site equipment, including

the base station,

is instead covered by asset class 48.12, which

has a recovery period of ten years.

See id.

We therefore

sustain respondent's determination that petitioners improperly

depreciated the cell site equipment over a period of five years.

III.

The Leased Digital Equipment

We now turn to the leased digital equipment.

RFB classified

a wide varièty of digital equipment, including the base station,

the switch, and the antenna support structures, as computer-based

switching equipment under asset class 48.121.

RFB depreciated

all the digital equipment over five years under asset class

48.121.

The digital equipment comprised some of the same assets

as the analog equipment.

We find therefore,

for the reasons

cited previously, that the switch has a 5-year class life under

asset class 48.121 and the remaining cell site equipment has a

class life

f ten years under asset class 48.12.

The towers and

related land improvements have a class life of 15 years under

asset class 48.14.

Furthermore, depreciation does not begin until the asset is

placed in service.

See sec. 168(d).

An asset is placed in

service when it is "acquired and put into use."

Wilson v.

Commissioner, T.C. Memo. 2002-61, affd. 71 Fed. Appx. 623

(9th

-- 20 Cir. 2003) .

Petitioners therefore may not claim any depreciation

deductions for the leased digital equipment until 2000 .

Additional issues are being addressed in a forthcoming

opinion.