Section 100.3350 Property Factor (IITA Section 304)

TITLE 86: REVENUE

CHAPTER I: DEPARTMENT OF REVENUE

PART 100 INCOME TAX

SECTION 100.3350 PROPERTY FACTOR (IITA SECTION 304)

Section 100.3350  Property

Factor (IITA Section 304)

a)         In general.  The property factor of the apportionment formula

for each trade or business of a person shall include all real and tangible

personal property owned or rented by such person and used during the tax

period  in the  regular  course  of such trade or business.  The term

"real and tangible personal property" includes land, building,

machinery, stocks of goods, equipment, and other real and tangible personal

property but does not include coin or currency.  Property used in connection

with the production of nonbusiness income shall be excluded from the property

factor.  Property used both in the regular course of a person's trade or

business and in the production of nonbusiness income shall be included in the

factor only to the extent the property is used in the regular course of the

person's trade or business.  The method of determining that portion of the

value to be included in the factor will depend on the facts of each case.  The property

factor shall include the average value of property includable in the factor.

See subsection (g), below.

b)         Property used for the production of business income.  Property

shall be included in the property factor if it is actually used or is available

for or capable of being used during the tax period in the regular course of the

trade or business of the person.  Property held as reserves or standby

facilities or property held as a reserve source of materials shall be included

in the factor.  For example, a plant temporarily idle or raw material reserves

not currently being processed are includable in the factor.  Property or

equipment under construction during the tax period (except inventoriable goods

in process),  shall be excluded from the factor until  such property is

actually used in the  regular course of the trade or business of the person

ll be included

in the factor.  For example, a plant temporarily idle or raw material reserves

not currently being processed are includable in the factor.  Property or

equipment under construction during the tax period (except inventoriable goods

in process),  shall be excluded from the factor until  such property is

actually used in the  regular course of the trade or business of the person.

If the property is partially used in  the regular course  of the trade or

business of the person while under construction, the value of the property to

the extent  used shall be included in the property factor.  Property used in

the regular course of the trade or business of the person shall remain in the

property factor until its permanent withdrawal is established by an

identifiable event such as its conversion to the production of nonbusiness

income, its sale, or the lapse of an extended period of time (normally five

years) during which the property is held for sale.

1)         Example 1:  Corporation A closed its manufacturing plant in

State X and held such property for sale.  The property remained vacant until

its sale one year later.  The value of the manufacturing plant is included in

the property factor until the plant is sold.

2)         Example 2:  Same as above except that the property was rented

until the plant was sold.  The plant is included in the property factor until

the plant is sold.

3)         Example 3:  Corporation A operates a chain of retail grocery

stores.  The corporation closed Store A, which was then remodeled into three

small retail stores, such as a dress shop, dry cleaning, and barber shop, which

were leased to unrelated parties.  The property is removed from the property

factor on the date the remodeling of Store A commenced.

c)         Consistency in reporting

)         Example 3:  Corporation A operates a chain of retail grocery

stores.  The corporation closed Store A, which was then remodeled into three

small retail stores, such as a dress shop, dry cleaning, and barber shop, which

were leased to unrelated parties.  The property is removed from the property

factor on the date the remodeling of Store A commenced.

c)         Consistency in reporting.  In filing returns with this State,

if a person departs from or modifies the manner of valuing property, or of

excluding or including property in the property factor used in returns for

prior years, the person shall disclose in the return for the current year the

nature and extent of the modification.  If the returns or reports filed by the

person with all states to which the person reports under Article IV of the

Multistate Tax Compact or the Uniform Division of Income for Tax Purposes Act

are not uniform in the valuation of property and in the exclusion or inclusion

of property in the property factor, the person shall disclose in its return to

this State the nature and extent of the variance.

d)         Numerator.  The numerator of the property factor shall include

the average value of the real and tangible personal property owned or rented by

the person and used in this State during the tax period in the regular course

of the trade or business of the person.  Property in transit between locations

of the person to which it belongs shall be considered to be at the destination

for purposes of the property factor.  Property in transit between a buyer and

seller which is included by a person in the denominator of its property factor

in accordance with its regular accounting practices shall be included in the

numerator according to the state of destination

perty in transit between locations

of the person to which it belongs shall be considered to be at the destination

for purposes of the property factor.  Property in transit between a buyer and

seller which is included by a person in the denominator of its property factor

in accordance with its regular accounting practices shall be included in the

numerator according to the state of destination.  The value of mobile or

movable property such as construction equipment, trucks or leased electronic

equipment which are located within and without this State during the tax

period, shall be determined for purposes of  the numerator of the factor on the

basis of total time within the State during the tax period.  An automobile

assigned to a traveling employee shall be included in the numerator of the

factor of the state to which the employee's compensation is assigned under the

payroll factor or in the numerator of the state in which the automobile is

licensed.

e)         Valuation of owned property.  Property owned by the person

shall be at its  original cost.  As a general rule  "original cost"

is the basis of property for  federal  income  tax  purposes  at  the  time  of

acquisition  and will  not reflect any federal adjustments thereafter for

deductions for depreciation, depletion,  amortization and  the  like.

1)         In addition,  however, the  valuation will include the

original  cost, at  acquisition, of  any capital improvement as  well as

partial dispositions  of  any portion by reason of sale, exchange, abandonment,

etc.

2)         However, capitalized intangible drilling and development costs

shall be included in the property factor whether or not they have been expensed

for either federal or state tax purposes

however, the  valuation will include the

original  cost, at  acquisition, of  any capital improvement as  well as

partial dispositions  of  any portion by reason of sale, exchange, abandonment,

etc.

2)         However, capitalized intangible drilling and development costs

shall be included in the property factor whether or not they have been expensed

for either federal or state tax purposes.  Intangible drilling and development

costs include such elements as wages, fuel, repairs, hauling, draining,

roadbuilding, surveying, geological works, construction of derricks, tanks,

pipelines, and other physical structures necessary for the drilling of wells

and their preparation for the production of oil and gas, and supplies incident

to and necessary for the drilling of wells and clearing of ground.

3)         Example 1:  Corporation  W  acquired  a  factory building in

this State at a cost of $500,000 and 18  months  later  expended  $100,000

for  major remodeling of  the  building.  The  corporation files its  return

for the current taxable year on the calendar-year  basis. Depreciation

deduction in the  amount of  $22,000  was  claimed  on  the building for  its

return  for the current taxable year.  The value  of the  building includable

in the numerator  and denominator  of  the  property factor is  $600,000 as the

depreciation deduction is not  taken into  account  in  determining  the value

of the building for purposes of the factor.

4)         Example 2:  During  the current  taxable year, X Corporation

merges into  Y  Corporation  in  a tax-free  reorganization under the Internal

Revenue Code.  At  the time  of  the  merger,  X Corporation owns  a factory

which X  built  five years earlier  at a  cost of  $1,000,000. X has been

depreciating  the factory at the rate of two percent per  year, and  its basis

in X's hands at the time  of the  merger is  $900,000

t  taxable year, X Corporation

merges into  Y  Corporation  in  a tax-free  reorganization under the Internal

Revenue Code.  At  the time  of  the  merger,  X Corporation owns  a factory

which X  built  five years earlier  at a  cost of  $1,000,000. X has been

depreciating  the factory at the rate of two percent per  year, and  its basis

in X's hands at the time  of the  merger is  $900,000.  Since the property is

acquired by  Y in  a transaction  in which, under the Internal Revenue Code,

its basis in Y's  hands is  the same as its basis in X's, Y includes the

property in  Y's property factor at X's  original cost,  without adjustment for

depreciation, i.e., $1,000,000.

5)         Example 3:  Corporation Y acquires the assets of Corporation

X  in a  liquidation by  which  Y  is entitled to  use its  stock cost  as the

basis of the X  assets under  26 U.S.C.  Section 334(b)(2) (i.e. stock

possessing  80  percent  control  is purchased  and liquidated  within  two

years). Under these circumstances, Y's cost of the assets is the  purchase

price  of the  X stock, prorated over the X assets.

A)        If original cost of property is unascertainable, the property

is included in the factor  at its  fair market  value as of the date of

acquisition by the person.

B)        Inventory  or stock  of goods  shall  be included in  the

factor  in accordance  with the valuation method used for federal income tax

purposes.

C)        Property acquired  by  gift  or  inheritance shall be included

in the factor at its basis for  determining  depreciation  for  federal income

tax purposes.

f)         Valuation

of rented property.

1)         Property rented  by the person is valued at eight times the

net annual rental rate.  The net annual rental rate  for any  item of  rented

property is the annual  rental rate  paid by  the person  for such property,

less the aggregate annual subrental rates paid by subtenants of the person

ning  depreciation  for  federal income

tax purposes.

f)         Valuation

of rented property.

1)         Property rented  by the person is valued at eight times the

net annual rental rate.  The net annual rental rate  for any  item of  rented

property is the annual  rental rate  paid by  the person  for such property,

less the aggregate annual subrental rates paid by subtenants of the person.

(See Section 100.3380(a)  for special rules where  the use  of such  net

annual  rental rate produces  a negative  or clearly  inaccurate value or

where property is used by the person at no charge  or rented  at a  nominal

rental rate.)  Subrents are  not  deducted  when  the  subrents constitute

business  income because  the property which  produces  the  subrents  is

used  in  the regular course  of a  trade or  business  of  the person  when

it  is producing  such income. Accordingly there is no reduction in its value.

A)        Example A:  Corporation A receives subrents from a  bakery

concession  in a  food market operated by  it.  Since  the  subrents  are

business income  they are  not deducted from the rent  paid by Corporation A

for the food market.

B)        Example B:  Corporation  B rents  a 5-story office building

primarily for  use  in  its multistate business,  uses three  floors for its

offices  and  subleases  two  floors  to various other businesses and persons

such as professional people,  shops  and  the  like. The rental of the two

floors is attendant to the operation  of the corporation's trade or business.

Since the  subrents are business income they  are not  deducted from the rent

paid by the corporation.

C)        Example C:  Corporation  C rents a 20-story office  building

and  uses  the  lower  two stories for its general corporation headquarters.

The remaining  18 floors are subleased to  others.  The  rental  of  the

eighteen floors  is  not  attendant  to  but rather is separate from the

operation of the corporation's trade  or business

deducted from the rent

paid by the corporation.

C)        Example C:  Corporation  C rents a 20-story office  building

and  uses  the  lower  two stories for its general corporation headquarters.

The remaining  18 floors are subleased to  others.  The  rental  of  the

eighteen floors  is  not  attendant  to  but rather is separate from the

operation of the corporation's trade  or business.  Since the subrents are

nonbusiness income they are to be  deducted  from  the  rent  paid  by  the

corporation.

2)         "Annual rental rate" is the amount paid as rental

for property  for a  12-month period  (i.e.,  the amount of  the annual

rent).  Where property is rented for  less than a 12-month period, the rent

paid  for  the  actual  period  of  rental  shall constitute the  "annual

rental  rate" for the tax period.  However, where a corporation has rented

property for  a term of 12 or more months and the current tax  period covers  a

period of less than 12 months  (due, for example, to a reorganization or

change  of accounting  period), the  rent paid for the short tax period shall

be annualized.  If the rental  term is  for less than 12 months, the rent

shall  not be  annualized beyond  its  term. Rent shall  not  be  annualized

because  of  the uncertain duration  when the  rental term is on a month to

month basis.

A)        Example A:  Corporation  A which ordinarily files its  returns

based  on a calendar year is merged  into Corporation  B on  April 30. The net

rent paid under a lease with 5 years remaining is  $2,500 a  month.  The rent

for the tax  period January  1 to  April  30  is $10,000.  After the  rent is

annualized the net rent is $30,000 ($2,500 X 12).

B)        Example B:  Same  facts  as  in  Example  A except that  the

lease would have terminated August 31.  In this case the annualized net rent is

$20,000 ($2,500 X 8)

April 30. The net

rent paid under a lease with 5 years remaining is  $2,500 a  month.  The rent

for the tax  period January  1 to  April  30  is $10,000.  After the  rent is

annualized the net rent is $30,000 ($2,500 X 12).

B)        Example B:  Same  facts  as  in  Example  A except that  the

lease would have terminated August 31.  In this case the annualized net rent is

$20,000 ($2,500 X 8).

3)         "Annual rent" is the actual sum of money or other

consideration payable, directly or indirectly, by the person  or for its

benefit for the use of the property and includes:

A)        Any amount  payable for  the use  of real or tangible

personal  property,  or  any  part thereof, whether  designated as  a fixed sum

of  money  or  as  a  percentage  of  sales, profits or otherwise.

Example:  A

corporation  pursuant  to  the terms of  a lease,  pays a lessor $1,000 per

month as a base rental and at the end of the year pays  the lessor  one

percent  of  its gross sales of $400,000.  The annual rent is $16,000  ($12,000

plus  one percent of $400,000 or $4,000).

B)        Any amount  payable as additional rent or in lieu of  rents,

such  as  interest,  taxes, insurance, repairs  or any other items which are

required  to be paid by the terms of the lease or  other arrangement,  not

including amounts paid  as service  charges,  such  as utilities, janitor

services,  etc.  If  a payment  includes  rent  and  other  charges

unsegregated, the  amount of  rent shall  be determined by  consideration of

the relative values of the rent and the other items.

i)          Example i:  A corporation, pursuant to the terms  of a

lease, pays the lessor $12,000 a  year rent  plus taxes in the amount of

$2,000  and  interest  on  a mortgage in  the amount of $1,000.  The annual

rent is $15,000.

ii)         Example ii:  A corporation stores part of its inventory in a

public warehouse

consideration of

the relative values of the rent and the other items.

i)          Example i:  A corporation, pursuant to the terms  of a

lease, pays the lessor $12,000 a  year rent  plus taxes in the amount of

$2,000  and  interest  on  a mortgage in  the amount of $1,000.  The annual

rent is $15,000.

ii)         Example ii:  A corporation stores part of its inventory in a

public warehouse. The  total  charge  for  the  year  was $1,000 of which $700

was for the use of storage space  and $300  for  inventory insurance, handling

and shipping charges, and  C.O.D. collections.  The annual rent is $700.

C)        "Annual rent" includes royalties based on extraction

of natural resources, whether represented by delivery or purchase.  For this

purpose, a royalty includes any consideration conveyed or credited to a holder

of an interest in property that constitutes a sharing of current or future

production of natural resources from such property, irrespective of the method

of payment or how such consideration may be characterized, whether as a

royalty, advance royalty, rental or otherwise.  "Annual rent"  does

not  include incidental day-to-day expenses  such as  hotel or motel

accommodations, daily rental of automobiles, etc.

4)         Leasehold improvements shall, for the purposes of the property

factor, be treated as property owned by the person regardless of whether the

person is entitled  to remove  the  improvements  or  the improvements revert

to the lessor upon expiration of the  lease.  Hence,  the  original  cost  of

leasehold improvements  shall be  included in the factor.

g)         Averaging

property values

1)         As a general rule the average value of property owned by the

person shall be determined by averaging the values at the beginning and ending

of the tax period.  However, the Director may require or allow averaging by

monthly values if such method of averaging is required to properly reflect the

average value of the person's property for the tax period

Averaging

property values

1)         As a general rule the average value of property owned by the

person shall be determined by averaging the values at the beginning and ending

of the tax period.  However, the Director may require or allow averaging by

monthly values if such method of averaging is required to properly reflect the

average value of the person's property for the tax period.  Averaging by

monthly values will generally be applied if substantial fluctuations in the

values of the property exist during the tax period or where property is

acquired after the beginning of the tax period or disposed of before the end of

the tax period.

2)         Example:  The monthly value of the person's property was as

follows:

January

$ 2,000

July

$ 15,000

February

2,000

August

17,000

March

3,000

September

23,000

April

3,500

October

25,000

May

4,500

November

13,000

June

10,000

December

2,000

TOTAL

$120,000

A)        The average value of the person's property includable in the

property factor for the taxable year is determined as follows: $120,000 divided

by 12 = $10,000

B)        Averaging with respect to rented property is achieved

automatically by the method of determining the net annual rental rate of such

property as set forth in subsection(e) above.