Scott Paper Co. v. Commissioner

The facts

A paper maker's primary and secondary electrical distribution served both process machinery and general building functions. The court focused on the ultimate use of the power.

What the court decided

When an electrical system serves both factory machines and the building itself, you can split it based on a load analysis. The share that runs production equipment can be personal property; the share that runs the building stays real property.

Parts the case looked at

• primary and secondary electrical distribution

Background

Scott Paper Company made paper. Its plants had primary and secondary electrical distribution systems that served two masters at once: the huge process machinery on the floor, and the ordinary building needs like lighting, heating, and ventilation.

The question was whether any of that shared electrical system could qualify as tangible personal property for the investment credit, or whether it was all a structural component of the building.

The Tax Court decided the case at 74 T.C. 137 (1980). It became the foundation for how shared electrical systems are handled in cost segregation to this day.

What the court actually analyzed

The court focused on the ultimate use of the power. Power that runs the building, lighting, heating, ventilation, air conditioning, relates to operating and maintaining a building. Power that runs the taxpayer's machinery does not.

So the court allowed an allocation. To the extent the primary electric carried loads used for production processes, it qualified for the credit. To the extent it served the overall operation or maintenance of the building, it stayed a structural component. The split was grounded in the power demand, the design load measured in kilovolt-amperes, of the machinery and equipment the system was built to serve.

This became known as the functional allocation approach. The Tax Court followed it again in Morrison, the Seventh Circuit blessed it in Illinois Cereal, the Eleventh Circuit adopted it on appeal in Morrison, and the IRS then issued AOD 1991-019 saying it would not challenge the approach for electrical systems.

How it shows up in a study

Scott Paper appears in Appendix A any time a study allocates a shared electrical system. In heavy-process buildings, manufacturing plants, food processing, data-heavy facilities, grow operations, a load analysis can move a large share of the electrical distribution to short lives.

The method is concrete: identify the end users of the power, measure or estimate the design loads, and split the system by the equipment share versus the building share. The IRS Cost Segregation Audit Techniques Guide walks examiners through this exact exercise and cites Scott Paper as the source.

Because the IRS formally acquiesced in the approach, a properly documented load study rests on ground the government has agreed not to fight.

What it does not mean

Scott Paper does not turn a whole electrical system into personal property. Only the share serving production equipment qualifies. The building share stays real property, every time.

The IRS audit guide also limits the method's reach: functional allocation applies to a building's primary and secondary electrical distribution systems. It is not a license to percentage-split every building system by analogy without support.

And the split is only as good as the load analysis behind it. A percentage with no engineering basis is an invitation to an adjustment. The method won because it was measured, not guessed.

Category

Asset classification

Outcome

Taxpayer won

Applies to

Industrial, Manufacturing, Cannabis Grow, Datacenter

Status

Vetted

This page explains a tax authority in plain words. It is not tax advice for your situation. The way this authority applies to your property is reviewed by a licensed tax professional. Citation is provided so you or your advisor can read the primary source.