Best Buy Seeks Changes to Proposed 'Repair' Regs

Dear Sir or Madam:

On behalf of Best Buy Co., Inc., Baker Botts L.L.P. is pleased to present the enclosed comments to the temporary and proposed regulations published by the Department of the Treasury and the Internal Revenue Service on December 27, 2011, regarding deduction and capitalization of amounts paid or incurred to improve tangible property. Best Buy appreciates your consideration of its comments and concerns and would welcome the opportunity to discuss these issues further.

By way of background, Best Buy is a leading multi-channel global retailer and developer of technology products and services. The Best Buy family of brands and partnerships collectively generates more than $50 billion in annual revenue. Approximately 170,000 employees apply their talents to help bring technology to life for our customers through retail locations, online sales channels, multiple call centers, in-home solutions, product delivery, and activities in our communities. In local communities across the United States, Best Buy operates over 1,400 stores.

While largely consistent with prior iterations of proposed regulations, Best Buy is concerned that the Temporary Regulations represent a fundamental change in the treatment of expenditures relating to the repair or permanent improvement or betterment of tangible property, a body of law that has been developed over decades of judicial decisions and administrative guidance. The new standards set forth in the Temporary Regulations are less clear and less administrable than the existing, long-standing tests in this area, and if significant changes are not made in the final regulations, the Temporary Regulations' treatment of expenditures for the improvement of tangible property will result in substantially increased compliance costs for both taxpayers and the Service and ultimately will lead to significant controversies. Moreover, due in large part to the componentization of buildings into building structure and building systems, promulgation of the Temporary Regulations in current form would disproportionately harm Best Buy and other large "big box" retailers that own or lease stores and generate commerce in communities throughout the United States. On the other hand, implementing clear, objective standards would reduce taxpayers' burdens, improve compliance, and result in fewer controversies, thereby benefitting all parties and achieving the stated objectives of the Temporary Regulations.

Section I of this letter discusses the Temporary Regulations' disparate treatment of buildings with respect to the effective identification of the appropriate unit of property. Section II addresses the objectives of the Temporary Regulations -- to achieve clarity, administrability, and reduction in controversy regarding the deduction and capitalization of expenditures relating to tangible property -- and Best Buy's concerns that various provisions of the Temporary Regulations will have the opposite effect. Section III addresses the exclusion of buildings from the routine maintenance safe harbor and sets forth reasons why buildings should qualify for this safe harbor. Section IV examines the challenges posed by the new rules regarding the disposition of building components. Section V recommends clarifications and modifications to the de minimis rule and proposes a general book-tax conformity rule. Section VI discusses miscellaneous issues relating to removal costs, inherently facilitative amounts, and plant property.

I. Componentization of Buildings

Before commenting on the betterment and restoration standards adopted by the Temporary Regulations, Best Buy feels compelled to register its significant concerns with the Temporary Regulations' inconsistent and inequitable treatment of buildings as compared to other types of tangible property. The Temporary Regulations properly provide that a building and its structural components together constitute a single unit of property. However, for the first time in what is now the third version of the section 263(a) regulations, Treasury and the Service propose to componentize that unit of property (the entire building) into its building structure and eight or more separate building systems (the HVAC system, plumbing system, electrical system, escalators, elevators, fire protection and alarm system, security system, and gas distribution system, as well as possibly more) and to separately apply the betterment and restoration tests to the building structure and the separate building systems (the components of the building) rather than to the unit of property (the building). As discussed in greater detail below, this disparate treatment of buildings, and the functionally interdependent systems and components they comprise, is inconsistent with both case law and the treatment of other complex property under the Temporary Regulations.

Section I discusses (i) functional interdependence, which is the established standard for identifying the relevant unit of property, and the Temporary Regulations' departure from that standard with respect to buildings; (ii) the out-dated, conclusory, and contradictory court decisions cited in the Preamble to the Temporary Regulations (the "Preamble") in support of building componentization; and (iii) the inequities and administrative burdens created by building componentization. Best Buy strongly urges Treasury and the Service to treat a building as a single unit of property in the same manner as other complex assets covered by the Temporary Regulations. In the event that Treasury and the Service retain the inequitable and inconsistent componentization approach for buildings alone, however, this section also recommends certain modifications aimed at mitigating the inconsistency of this approach and reducing the inevitable controversies that will result from it.

In Ingram Industries, Inc. v. Commissioner, 80 T.C.M. 532 (2000), the Tax Court considered expenditures incurred for cyclical towboat engine repairs. The Service argued that the towboat's engine should be considered separately from the towboat in determining whether the engine repair costs should be capitalized. The Tax Court disagreed, concluding that the entire towboat was the relevant unit of property. While the court did not articulate a clear analysis for identifying the unit of property, it emphasized that (i) as a matter of industry practice, the engines are not purchased or treated separately from the towboats; (ii) the life of the towboat and the life of the engine, if properly maintained, are coterminous; (iii) the engines are designed to be maintained without removing them from the towboat; and (iv) the engines were not regularly and periodically replaced over the life of the towboat.

A second unit of property decision was issued by the Ninth Circuit decision in Smith v. Commissioner, 300 F.3d 1023 (9th Cir. 2002), which addressed the deductibility of the costs of relining reduction cells in the taxpayer's aluminum smelting plant. The cells were arranged in such a way that a given cell could be taken out of the line (generally consisting of 130 cells that share the same electric current) for replacement of the cell lining. While on average, eight to ten reduction cells were taken out of the line at any given time, the taxpayer's electrical system was configured in a way such that a minimum of 112 functioning cells were required to operate the system on a sustained basis. The taxpayer argued that the 130-cell line rather than an individual cell was the appropriate unit of property for purposes of determining the deductibility of the relining costs, reasoning that a minimum of 112 cells were required to operate the line on a sustained basis. Accepting the Service's argument that each cell could operate by itself, however, the court rejected the taxpayer's argument, reasoning that it was the design of the taxpayer's electrical system rather than the characteristics of the cells themselves that required a minimum of 112 operating cells. Smith therefore stands for the proposition that a unit of property must be able to operate by itself (i.e., a property's component parts should not constitute units of property separate and distinct from its functionally interdependent parts because they cannot operate by themselves).

Finally, in FedEx v. United States, 291 F. Supp. 2d 699 (W.D. Tenn. 2003) aff'd, 412 F.3d 617 (6th Cir. 2005), the United States District Court for the Western District of Tennessee issued the most explicit analysis to date regarding the determination of the appropriate unit of property. In FedEx, the court held that the costs incurred during engine shop visits ("ESVs") with respect to the taxpayer's jet aircraft engines were deductible as ordinary and necessary business expenses under IRC § 162. In so holding, the district court directly confronted the issue regarding whether the tax treatment of the ESV costs was to be determined with respect to a discrete component part (i.e., the engine) of a larger item of property (the aircraft) or, instead, with respect to the larger item of property as a whole. Citing Ingram and Smith, the court set forth the factors for identifying the appropriate unit of property:

In addition to these court decisions, Treasury and the Service have independently reached similar conclusions. For example, the Treasury regulations under IRC § 263A state that "[a] unit of real property includes any components of real property . . . that are functionally interdependent."³ Similarly, in Rev. Rul. 2001-4, 2001-1 C.B. 295, which is factually similar to FedEx, the Service considered the costs incurred by a commercial airline for heavy maintenance visits ("HMV" or "HMVs") with respect to the airframes of its aircraft. An HMV involved (i) extensive disassembly of the airframe; (ii) performance of numerous inspection and maintenance tasks on the disassembled airframe for the purpose of preventing deterioration of the inherent safety and reliability levels of the airframe; (iii) repair or replacement of those parts as to which wear or other discrepancies were detected; and (iv) installation of structural reinforcements between body frames in a small area in the lower aft fuselage to reduce skin wrinkling. The taxpayer incurred costs of $2 million for the labor and materials necessary to perform an HMV on the airframe of the aircraft, which the taxpayer acquired sixteen years earlier for $15 million (excluding the cost of engines). The Service ruled the HMV costs to be deductible, focusing on whether they increased the value or prolonged the useful life of the airframe as a whole.

A comparison of buildings with the aircraft considered in FedEx and in Rev. Rul. 2001-4 reveals many similarities. Both buildings and aircraft consist of structural components that are functionally interdependent with a large number of integrated systems, including air conditioning systems, plumbing systems, security systems, electrical systems, fire-protection and alarm systems, and even a gas distribution system to a varying extent. As a result, applying the functional interdependence analysis of FedEx (and consistent with the conclusion in Rev. Rul. 2001-4), a building, like an aircraft and other complex equipment, should be treated as a single unit of property for purposes of determining whether to deduct or capitalize expenditures. While the Temporary Regulations generally retain the "functional interdependence" standard and even acknowledge that a building as a whole constitutes a single "unit of property," they inexplicably depart from the well-reasoned opinion in FedEx (and other authorities discussed above) to isolate buildings for a unique and disparate exception.⁴ Under this exception, the analysis of whether an expenditure is deductible or must be capitalized hinges on whether the expenditure results in an improvement to the "building structure" or to any one of eight enumerated "building systems," rather than on whether the expenditure results in an improvement to the actual unit of property -- the building itself.⁵ As a result, despite the many similarities between buildings and aircraft, an aircraft is treated as a single unit of property under both FedEx and the Temporary Regulations for purposes of determining whether an expenditure should be capitalized, whereas a building is componentized into building structure and building systems.

Best Buy believes that a building's building structure and building systems, as a functionally interdependent set of component parts, should be considered for all purposes as a single unit of property, consistent with the reasoning in FedEx. Accordingly, the betterment and restoration standards set forth in the Temporary Regulations should be applied to the entire building, without separate componentization of its systems, just as they are applied to other complex assets. Consistent treatment of tangible property within the regulations is sound tax policy, holding all industries to the same standard.

• In Hill v. Commissioner, T.C. Memo 1983-112, the Tax Court required capitalization of costs incurred to install a new water heater and oil furnace in the taxpayer's rental property. The Tax Court reached its decision solely on the basis of Treasury Regulation § 1.263(a)-2(a), which provides that capital expenditures include "the cost of acquisition, construction, or erection of buildings, machinery and equipment, furniture and fixtures, and similar property having a useful life substantially beyond the taxable year." Because the decision in Hill concludes only that the cost to replace the water heater and furnace is a capital expenditure, the Preamble's reference to this decision in support of building componentization assumes that the court viewed the costs of replacing the water heater and furnace as a "cost of acquisition, construction, or erection of buildings." An equally plausible reading of the case, however, is that the court viewed the replacement cost as a "cost of acquisition . . . of . . . machinery and equipment . . . having a useful life substantially beyond the taxable year." While this latter reading would lead to a similar conclusion with respect to the question of capitalization (i.e., the costs incurred to replace a water heater and furnace must be capitalized), it does not provide even implicit precedent for the building componentization approach adopted in the Temporary Regulations.

• In Stewart Supply Co., Inc. v. Commissioner, 22 T.C.M. 246 (1963), the Tax Court held that costs incurred to replace a wall of its building and make electrical connections were capital expenditures. The court's conclusion, however, makes clear that the court viewed the building itself, rather than the wall or the electrical system, as the relevant unit of property, as evidenced by the court's finding that (i) "the value of the building was appreciably increased as the result of the erection of the new wall," (ii) "the building with its brand new front would have brought a higher price than the same building with its old front," and (iii) "the installation of the new front increased the useful life of the building."⁷ Thus, the reasoning of the court's decision clearly contradicts, rather than supports, the componentization approach adopted by the Temporary Regulations.

• In First Nat'l Bank v. Commissioner, 30 B.T.A. 632 (1934), the court held that the costs incurred for extensive replacements of a building's electrical wiring system was a capital expenditure. Since the court provided no analysis of why the expenditures resulted in an increased value or prolonged useful life of either the wiring system or the building, its holding is conclusory and does not support componentization.

• In Georgia Car and Locomotive Co., 2 B.T.A. 986 (1925), the court concluded that the replacement of the roof on taxpayer's shop must be capitalized. Since the court provided no analysis of why the expenditures resulted in an increase in value or a prolonging of the useful life of either the roof or the building as a whole, its holding is conclusory and does not support componentization.

In view of the foregoing, Treasury and the Service can easily address the concerns that led to the building componentization approach without isolating buildings for inconsistent and inequitable treatment simply by applying the Major Component Replacement Test. By contrast, the componentization approach not only creates a disproportionate burden on retailers like Best Buy, but the adoption of the componentization approach with respect to all types of "restorations," as well as with respect to "betterments" and "adaptations to a new or different use," goes significantly beyond the rulings in the court decisions cited as support for such an approach.

In addition, componentization of buildings results in unfair and disparate treatment of taxpayers in different lines of business based on the degree to which the use of buildings is a significant part of their business. For example, most of the repair and maintenance costs incurred by a taxpayer that operates a fleet of buses will relate to the buses. Under the Temporary Regulations, these repairs will be analyzed with respect to each bus as the unit of property, and the disparate results of building componentization will have relatively little impact. By contrast, buildings comprise a very significant part of most retailers' business, with the result that a large portion of their repair and maintenance costs relate to buildings. These taxpayers suffer the adverse consequences of building componentization disproportionately as compared to other taxpayers, such as the owner of the bus fleet.

The relevance of a particular building system varies significantly for different types of buildings. For example, a high-rise apartment building has a substantial plumbing system for restrooms and kitchens, whereas a department store may only have a single set of restrooms. Nevertheless, the Temporary Regulations would componentize all buildings, regardless of type, function, or usage, into the enumerated "building systems" and building structure, which Best Buy contends would lead to capitalization conclusions inconsistent with current case law. If the recommended elimination of the componentization of a building under the Temporary Regulations is not accepted after appropriate consideration, then Best Buy urges Treasury and the Service to modify the componentization rules to provide that a given building structure or system will be treated as a separate component only if it is functionally significant to the building as a whole. Specifically, Best Buy recommends that Treasury and the Service modify the Temporary Regulations to include the following three-step analysis by which to determine whether work performed on a building system or a component of the building structure must be capitalized under the Temporary Regulations' improvement standards.

• First, the building system and/or component of the building structure that is the subject of the analysis must be clearly identified (e.g., the plumbing system, the electrical system, or the building exterior).

• Second, a determination must be made whether the identified building system or component of the building structure is functionally significant to the building in question (e.g., is the plumbing system functionally significant to the particular building in question?). Changes associated with a functionally insignificant or immaterial building system (or an immaterial component of the building structure) should never constitute an improvement of the building under the Temporary Regulations.

• Third, expenditures made with respect to a functionally significant building system or building structural component should be capitalized only if the change, as measured by the relevant standard of the Temporary Regulations, to that particular building system as a whole or to that component of the building structure is material (e.g., is replacing a specified number of toilets material to the plumbing system as a whole?).¹²

II. Objectives of the Temporary Regulations -- Clarity, Administrability, and Reduction in Controversy

The tax treatment of expenditures made to maintain, repair, or improve tangible property materially impacts virtually every taxpayer in every industry. As a result, the Preamble emphasizes that the objectives of the Temporary Regulations are to provide clarity and reduce controversy in this area.¹³ On a fundamental level, Treasury and the Service can best achieve these objectives by clarifying, but not changing, long-standing law and by implementing well-defined, objective standards for taxpayers to use in applying the law. Unfortunately, numerous provisions of the Temporary Regulations generally favor new facts and circumstances-based standards over long-established case law,¹⁴ regulatory and administrative guidance, and objective standards that could be more readily applied and administered. As a result, the Temporary Regulations seem destined to materially lessen clarity that was established by decades of case law and regulatory and administrative guidance, as well as create new areas of uncertainty that are ripe for controversy.

Prior to the adoption of the Temporary Regulations, the deductibility of repair and maintenance costs was governed by fairly simple and well-developed standards. The starting point for this analysis was IRC § 162 (and its predecessors),¹⁵ which allows a deduction for ordinary and necessary expenses paid or incurred during the taxable year in carrying on a trade or business. IRC § 263(a) limits the reach of IRC § 162, however, stating that no deduction is allowed for "any amount paid out for new buildings or permanent improvements or betterments made to increase the value of any property or estate . . . [or] any amount expended in restoring property or in making good the exhaustion thereof for which an allowance has been made." As a consequence, expenditures falling within the proscription of IRC § 263(a) must be capitalized.

The Treasury regulations under IRC § 162 have long set forth the primary tests for determining whether an expenditure relating to tangible property was deductible or must be capitalized: whether the expenditure (i) materially increased the value of the subject property, (ii) appreciably prolonged the property's useful life, or (iii) kept the property in an ordinarily efficient operating condition.¹⁶ The courts engrafted an additional test, that being whether the expenditure adapted the property to a new or different use.¹⁷ The scope and application of these tests have been developed by courts over nearly eight decades, resulting in a body of law that, with minor additional clarification, taxpayers and the Service could easily apply and interpret.

The Temporary Regulations largely discard these long-established tests and substitute standards providing that an expenditure results in an improvement of property (and thus must be capitalized) if it results in a "betterment" or "restoration" of the property or adapts the property to a new or different use.¹⁸ The Temporary Regulations provide that an expenditure results in a "betterment" if it (i) ameliorates a material condition or defect that either existed prior to the taxpayer's acquisition of the unit of property or arose during the production of the unit of property; (ii) results in a material addition (including a physical enlargement, expansion, or extension) to the unit of property ("Addition Test"); or (iii) results in a material increase in capacity, productivity, efficiency, strength, or quality of the unit of property or the output of the unit of property ("Capacity/Quality Test").¹⁹ The Temporary Regulations provide that an expenditure results in a "restoration" if made for the replacement of a part or combination of parts that comprise a major component or a substantial structural part of a unit of property (defined above as the "Major Component Replacement Test").²⁰ Finally, under the Temporary Regulations, an expenditure adapts a property to a new or different use if the property's use following the expenditure is not consistent with the intended ordinary use of the unit of property at the time originally placed in service by the taxpayer ("New Use Test").²¹

IRC § 263(a) -- the statutory provision sought to be explained by the Temporary Regulations -- provides that no deduction is allowed for any amount paid "for permanent improvements or betterments made to increase the value of any property or estate." Ignoring for the time being the statutory requirement that any improvement or betterment be permanent in nature, the new tests implemented by the Temporary Regulations depart from the clear standard in the statute -- made to increase the value of property -- and substitute standards that presumably reflect Treasury's determination that an inquiry into how an expenditure affects a property's "fair market value is [not] an appropriate standard."²² Instead, the new "betterments" standards are designed to encompass expenditures that, in the view of Treasury and the Service, "generally would increase the fair market value of the unit of property." ²³ Similarly, the Temporary Regulations substitute the new "restoration" standards to serve as a proxy for determining whether the property's useful life has been prolonged.²⁴ On the other hand, the judicial concept of keeping an asset in an ordinarily efficient operating condition is embedded in the routine-maintenance safe harbor, which, as discussed below, is inapplicable to buildings and their structural components. Finally, while IRC § 263(a) requires capitalization only of expenditures resulting in "permanent" improvements or betterments, the standards under the Temporary Regulations can result in the capitalization of expenditures for changes to property that are not permanent at all.²⁵ In sum, the Temporary Regulations do not seek to clarify existing law, but instead represent a fundamental change that disregards decades of judicial and administrative law in this area.

Query whether Treasury and the Service can ignore plain statutory language and implement new standards that do not conform to unambiguous statutory language and that render obsolete long-standing judicial decisions and administrative guidance. In any event, the wholesale replacement of such an expansive body of law necessarily will be accompanied by significant negative consequences. The inevitable controversy that will result from these changes in law can only be mitigated if the new rules apply objective standards and carefully define the meaning of the terms used in the new standards. The following discussion illustrates some of the significant uncertainties created by the Temporary Regulations and proposes objective standards to further the goal of improving clarity and administrability and reducing controversy in this area.

For example:

• The Temporary Regulations provide no explanation or guidance as to what constitutes a material increase of the productivity of a building. Is productivity in this context intended to be reflected by increased manufacturing output or increased sales? If so, what quantitative standard applies to determine whether such increase is material? Applied to the building structure or a building system, no guidance is provided as to how a roof, wall, floor, foundation, HVAC system, plumbing system, electrical system, fire protection and alarm system, security system, or gas distribution system can be made materially more productive.

• Aside from energy consumption, it is unclear what types of expenditures could be expected to make a building, building structure, or building system (other than HVAC and perhaps the electrical system) more efficient, much less materially more efficient.

• Other than obvious examples of increases in strength to support greater loads, the Temporary Regulations fail to explain what constitutes a material increase in the strength of a building, a building structure, or a building system.

• Similarly, the Temporary Regulations fail to include standards by which the "quality" of a building, building structure, or building system is to be measured and what constitutes a material increase in quality.

• Finally, the Temporary Regulations do not define the "output" of a building structure or a building system and how such output is materially increased. Specifically, no guidance is provided as to the output of a roof, wall, floor, foundation, HVAC system, plumbing system, electrical system, fire protection and alarm system, security system, or gas distribution system, much less how such output can be materially increased. Moreover, in the context of a building, it is unclear how output differs from productivity.

The overriding purpose for refreshing retail spaces is to enable the retailer to maintain market share relative to its competitors and to accommodate changes to its product mix. In the case of Best Buy, developments in technology frequently necessitate changes in the layout and display features of its stores. For example, in response to the evolution of televisions from "tube-type" to "flat panel," Best Buy was required to alter the layout of its stores to accommodate wall-mounted display of televisions. Similarly, as the manner in which music is delivered to consumers has changed (from vinyl, to tape, to CD, and now to digital), Best Buy has conformed its stores' layout to accommodate these advances in technology. In this respect, retail stores are fundamentally different from other industries where the building is not customer-facing (e.g., manufacturing facilities, warehouses, general office space, etc.). Moreover, store refreshes do not have as a significant purpose the repair of normal wear and tear from customer traffic; that issue is generally addressed by annual store maintenance budgets.

In purpose and effect, the costs incurred to refresh a retail store are analogous to the costs incurred to achieve, maintain, and renew ISO 9000 certification, as described in Rev. Rul. 2000-4, 2000-1 C.B. 331. As explained in the ruling, ISO 9000 certification, which lasts from two to four years and, with expenditure of additional sums, may be renewed annually, improves the overall quality or attractiveness of the taxpayer's business operations, provides a marketing advantage by differentiating the taxpayer from its competitors, enables the taxpayer to retain existing customers (repeat business), and enables the taxpayer to expand its business to new markets and new customers (increased market share). Rev. Rul. 2000-4 holds that the ISO 9000 certification costs are deductible under IRC § 162, reasoning as follows:

Best Buy agrees that the refresh work described in this example should not constitute a betterment, but notes that no clear explanation is given as to the manner in which this conclusion was reached. Instead, the example simply states that the conclusion was reached "[c]onsidering the facts and circumstances, . . . including the purpose of the expenditure, the physical nature of the work performed, the effect of the expenditure on buildings' structure and systems, and the treatment of the work on [the taxpayer's] applicable financial statements." Issues raised by Example 6 include:

• The example contemplates a reconfiguration of only a "small" number of display tables and racks, but provides no guidance regarding what standard is used to measure when the number of tables and racks will no longer be considered "small," or whether that fact alone would suffice to prevent the costs from qualifying as deductible "refresh" costs.

• Example 6 provides no insight as to whether the conclusion under the Capacity/Quality Test would change if two or more walls were moved, or whether the type of walls being moved (e.g., load bearing or non-load bearing) is significant.²⁷

• On its applicable financial statement the taxpayer capitalizes the building refresh costs and amortizes them over a five-year period. While this fact, by itself, apparently is insufficient to result in the conclusion that the refresh constitutes a betterment, the Temporary Regulations do not explain the relative significance of the manner in which an expenditure is treated on a taxpayer's applicable financial statement.²⁸

• ii. Example 7

This example posits that the replacement fixtures were "upgrades" with respect to the existing fixtures. No explanation is given, however, with respect to what factors will cause a fixture, such as a sink or a toilet, to be of materially higher quality than those that were replaced, so as to cause an increase in the quality of the plumbing system as a whole. Moreover, the example fails to explain why (or how) bathrooms in a retail store constitute a material part of, or serve a significant function in, the overall use of the building to conduct retail sales. Consequently, Example 7 not only provides little practical guidance for applying the Capacity/Quality Test to a store refresh, it serves as a glaring example of the fact that certain of the building systems enumerated in the Temporary Regulations are significantly less important in the context of a given building as compared to buildings of a different type or function.

The example concludes that (i) the upgrade of the wiring and replacement of the recess lighting throughout the stores materially increase the productivity, efficiency, and quality of the electrical systems; (ii) the amounts paid to remove and rebuild walls, replace ceiling tiles, rebuild facades, replace doors, and replace flooring materially increase the productivity, efficiency, and quality of the buildings' structure; and (iii) the amounts paid for the refresh of the store buildings described in Example 6 must be capitalized because these expenditures directly benefitted or were incurred by reason of the improvements to the taxpayer's store buildings' structures and electrical systems.³⁰

The various types of changes made to the retail store described in Example 8, combined with the lack of any explanation of how such changes materially increased the productivity, efficiency, and quality of the applicable building structure, practically eliminates any explanatory value of the example. For example, changes in store layout are driven predominantly by consumer demands, changes in product mix, and customer demographics. If, in response to these factors, the display of certain merchandise is moved from an area near the front of the store to an area towards the rear of the store, query why the movement of non-load bearing display walls and dressing areas to accommodate such changes results in a material increase in the productivity of the building structure, a material increase in the efficiency of the building structure, or a material increase in the quality of the building structure, particularly if the walls, when moved, were constructed of identical materials and in the same manner as those that were removed. Moreover, it is unclear from the example what types of changes would cause a wall (and thus the building structure as a whole) to be more productive, more efficient, or of higher quality. Finally, it is unclear how the changes in store layout in Example 8 differ from the layout changes to the stores' interiors described in Example 6, which were affected to make the stores more attractive and the merchandise more accessible to customers.

Similarly, the construction of facades around door openings generally entails basic carpentry work. Query how changes of this nature can materially increase the productivity, efficiency, or the quality of the building structure. Moreover, to the extent that the addition of the facades make the doorways more appealing, query how that differs from the change in the paint scheme described in Example 6, which presumably was done to make the store more appealing to customers.

With regard to the replacement of carpet with ceramic flooring to delineate departments and direct customer traffic, Example 8 offers no explanation of how or why such work causes the building structure to be more productive, more efficient, or of higher quality, particularly given that changes in store layout in Example 6 to make merchandise more accessible to customers resulted in no material increase in productivity, efficiency, or quality of the building structure. Similar questions arise with respect to the described changes in ceiling tiles and lighting. In addition, Example 8 provides no explanation or guidance as to the application of the materiality standard.

More importantly, Example 8 readily demonstrates that the betterment standards are not a valid substitute for the tried and true standard of a material increase in value. Clearly, no potential buyer of the store building would agree to pay a higher purchase price as a result of the store refresh described in the example, because a subsequent user of the building would demolish the existing store interior and conform the interior build-out to its styles and merchandising requirements. In addition, a refreshed store has no enhanced value to its current owner as compared to the value of the store prior to the conditions necessitating the refresh (i.e., changes in product mix, customer demographics, consumer demands, and other factors affecting market share); instead, store refreshes are performed primarily to maintain market share that existed before these conditions arose. Accordingly, while there are no reported cases on store refreshes, the conclusion reached in Example 8 likely would be different than the decision expected to be reached by a court applying current law precedents.

Finally, it is impossible to reconcile the conclusions set forth in Example 8 with those of Rev. Rul. 2000-4 (the ISO 9000 ruling), in which the expenditures enhanced the marketability of the taxpayer's services or products and yielded future benefits such as repeat business or increased market share. Notwithstanding these benefits, the associated costs were held to be deductible because they primarily benefitted current sales or operations. Similarly, although building refreshes have incidental future benefits, such costs are incurred principally to benefit current operations by addressing changes in consumer demands, customer demographics, and product mix. Accordingly, the conclusions in Example 8 are inconsistent with the holding in Rev. Rul. 2000-4 that expenditures that primarily benefit current operations generally are deductible.

As demonstrated by the foregoing, it is imperative that the Temporary Regulations include detailed guidance of the manner in which the productivity, efficiency, strength, and quality standards are to be applied to buildings, building structure, and building systems. In the absence of such guidance, it is unclear how taxpayers, much less the courts, will determine the appropriate tax treatment of store refreshes that are certain to be factually different from the examples provided in the Temporary Regulations. In addition, as discussed in subsection II.B below, it is vital that the Temporary Regulations be revised to include a clear, objective materiality standard to be applied with respect to the enumerated standards.

• The Major Component Replacement Test fails to provide standards by which a taxpayer should measure the quantitative or qualitative significance of a component.

• It is unclear whether a component that constitutes a "large portion of the physical structure" of the unit of property necessarily constitutes a major component. Likewise, what constitutes a "large" portion of each type of building system is unclear, as is the issue of whether "large" is to be measured by physical size, by mass, or by some other physical characteristic.

• The Major Component Replacement Test provides no guidance as to how taxpayers should determine whether a component serves a "discrete" function in the operation of a unit of property.

• The Major Component Replacement Test does not provide a standard by which taxpayers can determine whether a component of a unit of property performs a "critical" function in the operation of the unit of property (and therefore could be a major component of the property), or merely "affects" the function of the unit of property (and therefore might not be a major component of the unit of property).

• b. Examples under the Major Component Replacement Test

Example 11 under the restoration rules considers the replacement of the power switch assembly on a drill press used in the taxpayer's production of dies. The power switch assembly controls the supply of electric power to the drill press. The example concludes that the power switch assembly, which is stated to be a "small" component of a drill press that "can be removed and installed with relative ease," is not a major component or substantial structural part of the drill press.³² No explanation is given of the basis for the conclusion that the power switch assembly is a "small" component or of the relative significance of the ease with which it can be removed and installed. Assuming that the ease with which a component part can be removed and installed is a significant factor, no guidance is given regarding how taxpayers should measure "ease of removal and installation." Furthermore, the example does not explain why the power switch assembly does not perform a discrete and critical function in the drill press.

Example 13 under the restoration rules involves a taxpayer that owns a large retail store and discovers a leak in the roof that has caused a major portion of the sheathing and rafters to rot. As a result of this damage, the taxpayer replaces a "significant" portion, but less than the entirety, of the roof. The example concludes that the replacement of a "significant portion" of the roof is a replacement of a major component or substantial structural part.³³ No guidance is given on what qualitative or quantitative factors caused the replaced portion of the roof to qualify as "significant."

Example 15 under the restoration rules considers a taxpayer that owns a building in which it provides medical services. The building contains one HVAC system, which comprises a single furnace, an air conditioning unit, and duct work that distributes heat or air conditioning throughout the building. The example concludes that the replacement of the furnace results in a restoration because the furnace performs a discrete and critical function in the operation of the HVAC system, and is therefore a major component or substantial structural part of a building system.³⁴ The fact that there is only one furnace in the building essentially dictates the outcome, such that the example provides little practical guidance as to how the Major Component Replacement Test should be applied under different facts.

In contrast, Example 17 under the restoration rules considers an office building that a taxpayer uses to provide services to its customers and that has ten roof-mounted units that provide heating and air conditioning to different parts of the building. Example 17 concludes that the replacement of two of the roof-mounted units is not a restoration, because the two units, by themselves, do not constitute a large portion of the physical structure of the HVAC system or perform a discrete and critical function in the operation of the system. ³⁵ No explanation is provided as to why the individual units are not considered to provide a "discrete and critical function" or whether the conclusion would be the same if three or four units (or more) were replaced instead of two. Furthermore, one wonders whether the conclusion in Example 17 could change if, as a result of the failure of the two roof-mounted units, portions of the building would be without heat or air conditioning.

Like the Capacity/Quality Test, it is readily apparent that the lack of objective standards and clear definitions in the Major Component Replacement Test will foster significant uncertainty for Best Buy and other retailers. Notably, the 2008 proposed regulations contained a 50% threshold (relating to value or physical structure) for determining whether a replacement constituted a major component or substantial structural part.³⁶ This threshold was removed from the Temporary Regulations due to concerns that the threshold would "lead to results that are drastically different from the results reached in the case law and rulings in this area."³⁷ Despite this concern, Best Buy is strongly of the view that the regulations should contain an objective threshold to mitigate the substantial uncertainty created by the Major Component Replacement Test.

In Plainfield-Union, the Tax Court considered expenditures incurred by a public utility to line its pipes and water mains with cement to address tuberculation. In holding that the process of cleaning and lining the pipes was a deductible repair, the Tax Court set forth the appropriate comparison for determining whether an expenditure materially increases the value or prolongs the life of property:

Because the Temporary Regulations fail to apply the Plainfield-Union test to restorations, expenditures that would be deductible under existing case law must be capitalized under the Temporary Regulations.⁴⁰ For example, the decision in Illinois Merchants Trust involved repairs to a seven-story building on the bank of the Chicago River. Due to sudden and unexpected lowering of the water level, some of the wooden piles that formed the building's foundation were exposed to the action of the air and other elements. Dry rot of the exposed portions immediately set in, and the wall on the river side of the building settled so materially that the entire building threatened to collapse. To prevent the total loss of the building, it was necessary to saw off the rotted piles at a point below the lower water level and insert concrete supports between the ends of the submerged piles and the floor of the building. The repair also required removal of "a large portion of the ground floor," and work to shore up and raise the partially collapsed wall.

Consistent with the principles of Plainfield-Union⁴¹ (i.e., comparing the condition of the property after the repairs with the condition of the property immediately prior to the condition necessitating the repair -- in this case, the sudden and unexpected drop in the water level), the court correctly concluded that the expenditures were deductible repairs, rather than capital improvements. By contrast, the restoration examples in the Temporary Regulations presumably would reach the opposite conclusion on the basis that the taxpayer in Illinois Merchants Trust replaced a major component or substantial structural part (i.e., portions of the foundation and a large portion of the ground floor) of the building, and that therefore the costs incurred should be capitalized. Accordingly, to remain consistent with current case law, the restoration rules should be modified to incorporate the Plainfield-Union test.

• Example 2 considers a building consisting of twenty retail spaces that are designed to be reconfigured (i.e., to allow adjoining spaces to be combined) and concludes that expenditures incurred to combine a retail space with two adjoining retail spaces within the building (by removing the walls separating the spaces) are consistent with the intended, ordinary use of the building structure at the time it was placed in service.

• Example 3 considers a building consisting of twenty retail spaces and concludes that amounts paid to paint the walls and refinish the floors in anticipation of selling the building do not constitute a new or different use of the building.

A review of some of the examples to the betterment and restoration provisions illustrates the difficulty in determining whether a change to property is "material" under the Temporary Regulations. In all instances, the examples fail to provide sufficient explanation to support the stated conclusion with respect to whether a change is material. In addition, on the basis of the examples that provide quantitative information to describe the extent of a change to property, taxpayers are likely to calculate percentages and incorrectly conclude that the examples imply a range of objective "materiality" thresholds. In fact, the examples that provide quantitative information imply percentages that relate only to stated components of a building structure or building system (i.e., to the subcomponents of the building), but fail to provide any quantitative explanation of the relative value, cost, or physical size of that component as compared to the entirety of the building structure or the relevant building system.⁴² Consequently it is impossible for taxpayers to decipher any threshold within which an "improvement" to a building structure or building system will be deemed to be material. Moreover, the use of different terms having essentially the same meaning -- a material addition, a material increase in capacity, productivity, etc., a major component, and a substantial structural part -- add confusion and will lead to increased controversy. For example:

• Example 7 under the betterment rules considers amounts paid by a retailer to remove and replace the bathroom fixtures (toilets, sinks, and plumbing fixtures) with upgraded bathroom fixtures in all of its retail buildings. The taxpayer also replaced the floor and wall tiles that were removed or damaged in the installation of the new fixtures. Without explanation, the Temporary Regulations conclude that the mere replacement of bathroom fixtures with upgraded fixtures results in a material increase in the quality of the buildings' plumbing system and therefore must be capitalized.⁴³ Example 7 fails to explain any qualitative or quantitative differences between the existing and replacement fixtures that would allow Best Buy or other retailers to reasonably and practically determine whether a change in the quality of fixtures is so significant that it results in a material upgrade to the building's entire plumbing system.

• Example 11 under the betterment rules involves a taxpayer that owns a hotel having unreinforced terra cotta and concrete parapets and overhanging cornices around the roof perimeter. In response to a city ordinance implementing new safety standards, the taxpayer removes the old parapets and cornices and replaces them with new ones made of glass fiber-reinforced concrete, making them lighter and stronger than the originals. The new parapets and cornices are attached to the hotel using welded connections rather than wire supports, which makes them more resistant to damage from lateral movement. While the example states that these expenditures materially increased the structural soundness (i.e., the strength) of the hotel structure, and therefore must be capitalized,⁴⁴ no explanation is given to indicate how the enhancement in strength was measured, or why that difference constituted a material increase in strength.

• Example 16 under the betterment rules involves a taxpayer that owns a factory building with a storage area on the second floor. The taxpayer incurs costs to replace the columns and girders supporting the second floor to permit storage of supplies with a gross weight that is 50% greater than the previous load-carrying capacity of the storage area. The example concludes that this expenditure results in a material increase in the load-carrying capacity of the building structure, and therefore must be capitalized.⁴⁵ It is unclear whether this example is intended to establish a ceiling (expressed as a percentage) above which the Capacity/Quality Test will require capitalization, or whether the same conclusion would apply to a 40% increase in load-carrying capacity. Furthermore, although taxpayers are likely to conclude from this example that a 50% increase in capacity is material, the example offers no explanation with respect to the relative significance of the storage area on the second floor as compared to the building structure as a whole.

• Example 18 under the betterment rules involves a taxpayer that owns harbor facilities that include a channel leading from the loading/unloading slip to a river. At the time the harbor facilities were purchased, the channel was 150 feet wide, 1,000 feet long, and 20 feet deep. The channel is subject to siltation and, by the next taxable year, the channel depth had been reduced to 18 feet. The taxpayer pays a contractor to re-dredge the channel to its original depth of 20 feet, which the example concludes does not result in a material increase in capacity or a material addition (which, of course, is the correct conclusion given the fact that, under Plainfield-Union, any amount of re-dredging should be deductible as long as the channel remained operational for its intended purpose).⁴⁶ From this example, taxpayers might conclude that an 11% increase in capacity is not material. In fact, however, this example does not clarify the materiality standard at all because, applying the Plainfield-Union test, there was a 0% increase in the channel's capacity as compared with its capacity prior to the effects of siltation.

• Example 12 under the restoration rules involves a taxpayer that owns a large retail store and discovers a leak in the roof that has caused a major portion of the sheathing and rafters to rot. As a result of this damage, the taxpayer replaces the entire roof. The example concludes that the roof is a major component or substantial structural part of the building structure, and therefore the cost to replace it must be capitalized.⁴⁷ Although this example implies that a replacement of an entire roof is material, no discussion is provided as to whether the same conclusion would apply to all buildings types (e.g., the roof on a sprawling warehouse or manufacturing building generally has substantially greater significance, at least in terms of total building costs and surface area, than the roof on a high-rise office building).

• Example 13 under the restoration rules involves the same facts as Example 12, except that the taxpayer replaces a "significant" portion, but less than the entirety, of the roof. The example concludes that the replacement of a "significant portion" of the roof is a replacement of a major component or substantial structural part.⁴⁸ No guidance is given on what percentage of the roof was replaced, the cost of the replacement relative to the cost of either the building or original roof, or any other qualitative or quantitative factors that caused the replaced portion of the roof to qualify as "significant." Moreover, had roof leaks in Examples 12 and 13 been caused, for example, by a storm that occurred shortly after the building was placed in service, the failure to apply the Plainfield-Union test in the context of the restoration rules potentially will lead to results that differ from current case law.

• Example 17 under the restoration rules involves an office building having ten roof-mounted units that provide heating and air conditioning to different parts of the building. Example 17 concludes that the replacement of two of the roof-mounted units is not a restoration, because the two units, by themselves, do not constitute a large portion of the physical structure of the HVAC system or perform a discrete and critical function in the operation of the system.⁴⁹ Although taxpayers are likely to infer a 20% materiality threshold from this example, the example describes the replacement of 20% of only one component of the HVAC system, rather than 20% of the entire HVAC system. Furthermore, no explanation is given as to what percentage of the total cost, value, or physical size of the HVAC system as a whole is attributable to the replaced units. Because the two roof-mounted units that were replaced constitute a much smaller, unspecified percentage of the physical structure of the HVAC system as a whole, the example provides little practical guidance with respect to any materiality threshold.

• Example 19 under the restoration rules examines a taxpayer that replaces the wiring throughout its building with new wiring that meets building code requirements. The example concludes that the wiring is a major component of the building's electrical system, and therefore that this expense must be capitalized.⁵⁰ This example, like others, fails to describe the relative value, cost, or physical size of the replaced item (the wiring) with respect to the relevant building system (the electrical system) as a whole. Furthermore, to the extent that the example concludes that the replacement of all (or nearly all) of a building system is material, it provides little practical guidance to taxpayers.

• Example 20 under the restoration provisions involves a taxpayer that owns a retail building with men's and women's restrooms on two out of the three floors. The taxpayer replaces the plumbing fixtures, but not the pipes, in all of the restrooms with modern style fixtures of similar quality and function. The example concludes that the plumbing fixtures comprise a large portion of the physical structure of the plumbing system, and therefore that the costs must be capitalized.⁵¹ Although this example, like other examples, might be read to imply that a replacement of all (or nearly all) of a building system is material, the example provides no information as to relative cost or value from which to quantify the materiality of the replaced fixtures as compared to the plumbing system as a whole. Moreover, given the relative functional insignificance of restrooms in large retail stores, the conclusion that a betterment or restoration results from the mere change of plumbing fixtures would seem nonsensical.

• Example 21 under the restoration provisions involves the same facts as Example 20, except that the taxpayer replaces only three out of twenty sinks. The example concludes that the replaced sinks do not comprise a large portion of the physical structure of the plumbing system.⁵² Although taxpayers are likely to infer a 15% materiality threshold from this example, the example describes the replacement of 15% of only one component of the plumbing system, rather than 15% of the entire plumbing system. Furthermore, no explanation is given as to what percentage of the total cost, value, or physical size of the plumbing system as a whole is attributable to the replaced sinks. Because the three replaced sinks constitute a much smaller, unspecified percentage of the plumbing system as a whole, the example provides little practical guidance with respect to any materiality threshold.

• Example 23 under the restoration provisions involves a taxpayer that replaced 30 out of 300 exterior windows in a large office building. The example concludes that the replaced windows do not comprise a large portion of the physical structure of the building structure or perform a discrete and critical function.⁵³ Although taxpayers are likely to infer a 10% materiality threshold from this example, the example describes the replacement of 10% of only one component of the building structure, rather than 10% of the entire building structure. Furthermore, no explanation is given as to what percentage of the total cost, value, or physical size of the building structure as a whole is attributable to the replaced windows. Because the 30 replaced windows constitute a much smaller, unspecified percentage of the building structure as a whole, the example provides little practical guidance with respect to any materiality threshold.

• On the other hand, Example 24 under the restoration provisions involves the same facts as Example 23 except that the taxpayer replaced 200 out of 300 windows. The example concludes that the replaced windows constitute a large portion of the building's physical structure and perform a discrete and critical function.⁵⁴ Although taxpayers are likely to infer a 67% materiality threshold from this example, the example describes the replacement of 67% of only one component of the building structure, rather than 67% of the entire building structure. Furthermore, no explanation is given as to what percentage of the total cost, value, or physical size of the building structure as a whole is attributable to the replaced windows, making the example difficult to apply in other contexts (e.g., query whether the conclusion is the same in the case of a large warehouse that has only three exterior windows). Because the 200 replaced windows constitute an unspecified percentage of the building structure as a whole that is (likely significantly) less than 67%, the example provides little practical guidance with respect to any objective materiality threshold. Moreover, query why 200 windows perform a discrete and critical function in a building, but 30 windows do not.

Many of the difficulties of applying the new standards could be resolved if, as discussed in Section I, Treasury and the Service were to simply apply the Major Component Replacement Test to buildings and abandon the building componentization approach adopted in the Temporary Regulations. Alternatively, although less preferable than a wholesale abandonment of the building componentization approach, the Temporary Regulations would be substantially improved if building componentization were limited to functionally significant building systems and components of the building structure (as discussed in the three-part analysis set forth in Section I.E). Whether or not building componentization is retained, however, a flood of controversy will result from the Temporary Regulations' new standards unless an objective materiality standard is adopted. Accordingly, Best Buy urges Treasury and the Service to explicitly provide that "materiality" is a condition modifying all of the standards adopted in the Temporary Regulations and to add an objective, bright-line test by which to determine whether a change is material. If an objective materiality standard is not adopted, Best Buy requests that the Temporary Regulations expressly state that determinations of functional significance and materiality will be made in a manner consistent with existing case law.

III. Routine-Maintenance Safe Harbor

The Temporary Regulations provide a safe harbor from capitalization for amounts paid for "routine maintenance" performed on a unit of property "other than a building or a structural component of a building."⁵⁵ "Routine maintenance" is defined as recurring activities that a taxpayer reasonably expects to perform more than once during the class life of the unit of property and that are necessary as a result of the taxpayer's use of the unit of property to keep the unit of property in its ordinarily efficient operating condition.⁵⁶ While Best Buy commends Treasury and the Service for adopting an objective safe harbor that will generally reduce controversy in this area, the safe harbor should be extended to apply equally to all types of tangible property, including buildings.

The Temporary Regulations should treat buildings consistently with the treatment of other complex assets that comprise functionally interdependent components. As discussed in detail above, buildings are analogous to aircraft in terms of the types of systems that they comprise and the functional interdependence of their structural components. Furthermore, both buildings and aircraft are required to undergo routine maintenance on a recurring basis during their long class lives. In light of these similarities, it is inconsistent and inequitable to treat the expenditures incurred during an aircraft's continuous maintenance program (such as that described in Example 1 in the safe-harbor rules),⁵⁷ which can entail extensive disassembly of the airframe and engines, accomplishment of numerous inspections, and replacement of worn or defective parts, as deductible "routine maintenance," while similar, and potentially less extensive, periodic maintenance of a building is excluded from the safe harbor. Similar comparisons could also be made to other types of complex, long-lived assets that qualify for the safe harbor, such as towboats⁵⁸ and freight cars.⁵⁹ Given the clear analogies between buildings and these other types of property, Best Buy submits that there is no justifiable policy reason to permit aircraft, towboats, and freight cars to qualify for the routine-maintenance safe harbor, while arbitrarily and unfairly excluding buildings.

Treasury's reasons for excluding buildings from the routine-maintenance safe harbor appear to stem either from concerns that expenditures for replacements of major building components, which would otherwise be capitalized, could be currently deducted under the safe harbor, or from concerns relating to a building's long class life. In this regard, the Preamble states as follows:

It is unreasonable to deny taxpayers the benefit of the safe harbor with respect to all recurring building costs simply to ensure that a few major costs are capitalized. If extending the current safe harbor to include buildings would permit the deduction of the cost of major replacements that should otherwise be capitalized, Best Buy proposes that this concern be addressed by modifying the definition of "routine maintenance" to make clear that routine maintenance does not include expenditures incurred to replace a major component or substantial structural part of a unit of property under Treas. Reg. § 1.263(a)-3T(i)(1)(vi), rather than by excluding buildings from the safe harbor altogether. In this way, buildings and other types of property would be treated similarly, while still addressing the concerns raised in the Preamble.

With respect to Treasury's concern that the safe harbor cannot be appropriately applied to property with a long class life, Best Buy fails to see how a building's 39-year class life provides any significantly different opportunity to deduct costs that should not qualify for the safe harbor than the 18-year class life of a towboat, the 14-year class life of a freight car, or the 12-year class life of an aircraft. In fact, the longer an asset's life, the more routine maintenance it will require and therefore, the more inequitable it is to exclude such an asset from this safe harbor. Merely because a building has a longer class life than other complex units of property does not justify disparate treatment of its maintenance costs. Certainly, retailers should not suffer inequitable treatment simply because their customer-facing assets are long-lived buildings rather than airplanes, buses, or boats.

IV. Disposition of Building Components

Best Buy welcomes the decision to permit taxpayers to treat the retirement of a building component as a disposition and recognize the resulting loss.⁶¹ Best Buy is concerned, however, with the significant practical challenges that will arise in applying this new rule. Existing fixed asset accounting systems are not designed to track the costs of a building's structural components. As a result, the tracking of these costs, even prospectively, under the new rules will require significant system changes and time to implement. Moreover, because real estate transactions (whether for the purchase of an existing building or the construction of a new building) typically do not separately identify the cost of a building's structural components, the new rules will require taxpayers to perform costly valuation analyses to allocate the cost basis among the various building components. These issues are compounded even further in the case of buildings that taxpayers presently own or lease, where taxpayers must manually sort through volumes of available records to try to re-create the necessary information. The inevitable result of these complexities, contrary to the objectives of the Temporary Regulations, will be increased controversies between taxpayers and the Service.

Best Buy acknowledges the flexibility of the Temporary Regulations in this regard, which allows taxpayers to use "any reasonable method that is consistently applied" to determine the basis and depreciation attributable to a retired component.⁶² Because the determination as to whether a method is "reasonable" is inherently subjective, however. Best Buy requests that Treasury and the Service provide additional guidance in the form of specific examples of methods that, if employed, would be considered reasonable. In the absence of such guidance, retirement losses will become a new area of significant controversy between taxpayers and the Service.

Best Buy specifically recommends that Treasury and the Service endorse a method whereby taxpayers could estimate the remaining adjusted basis of a retired component by starting with the cost of the replacement component, and then further adjusting that amount for inflation (calculated using an objective inflation index, such as the Consumer Price Index) and depreciation based on the method utilized to depreciate the building as a whole for tax purposes. In addition to providing a reasonable estimate of the retired asset's remaining adjusted basis, this proposed method has the added benefit of being administrable and verifiable, thereby eliminating much of the potential for controversy that is inherent in other methods.

V. De Minimis Rule

Best Buy applauds Treasury's and the Service's decision to retain the de minimis rule set forth in Treas. Reg. § 1.263(a)-2T(g) and to extend its application to amounts paid to acquire or produce property, including materials and supplies, used in improvements. Best Buy believes, however, that several clarifications should be made with respect to the de minimis rule. Best Buy also recommends that Treasury and the Service consider the adoption of a general book-tax conformity rule as described below.

Best Buy believes this rule would significantly aid both the Service and taxpayers for a number of reasons. First, a book-tax conformity rule has a built-in safeguard against abuse. The economic incentives for taxpayers to minimize current expenses for financial statement purposes will operate as a strong natural check on their incentive to claim current tax deductions for expenses that might otherwise be capitalized, and independent audits by third-party auditors will ensure that earnings are reflected accurately. To create the appropriate tension between a taxpayer's book and tax reporting, the election to apply this rule should only be available to taxpayers with an "applicable financial statement." Second, this rule would eliminate many compliance burdens, particularly for large taxpayers like Best Buy, which would no longer need to separately analyze thousands of immaterial expenditures incurred throughout the year in the normal course of business to determine whether the amounts must be capitalized or expensed. In addition, taxpayers could simplify their recordkeeping activities by not worrying about correctly tracking the differences between book and tax reporting. Finally, this rule could be easily administered and audited. Rather than analyzing individual expenses to determine whether they are properly capitalized, examining agents would simply need to confirm that the treatment matches the taxpayer's book treatment, and that the appropriate tax recovery periods and depreciation methods are applied, thereby decreasing the controversy related to the timing of the deductions.

VI. Miscellaneous Items

In addition to the foregoing, Best Buy notes its concerns with regard to the following miscellaneous items.

² 291 F.Supp.2d 699, 710.

³ Treas. Reg. § 1.263A-10(b)(1).

⁴ Treas. Reg.§ 1.263(a)-3T(e)(2)(ii).

⁵ Treas. Reg. § 1.263(a)-3T(e)(2)(ii)(B)(1)-(8).

⁶ 76 Fed. Reg. at 81066.

⁷ 22 T.C.M. (CCH) at 249 (emphasis added).

⁸See, e.g., LaSalle Trucking Co. v. Comm'r, 22 T.C.M. (CCH) 1375, 1380 (1963) (petroleum hauling truck was unit of property); Shore v Comm'r, 18 T.C.M. (CCH) 721, 724 (1959), rev'd on other grounds, 286 F.2d 742 (5th Cir. 1961) (marine cargo vessel was unit of property); Standard Motors v. United Slates, 61 2 U.S.T.C. 1j9639 (E.D.La. 1961) (boat was unit of property); Maier Brewing Co. v. Comm'r, 54 T.C.M. (CCH) 46, 64 (1987) (FT boat was unit of property); Bloomfield Steamship Co v Comm'r. 33 T.C. 75, 84 (1959) (ship was unit of property); Jacks v. Comm'r, 55 T.C.M. (CCH) 968. 970 (1988) (CAT loader was unit of property): Hudlow v Comm'r, 30 T.C.M. (CCH) 894, 923 (1960) (forklift was unit of property); West Virginia Steel Corp v Comm'r. 34 T.C. 851, 853 (1960) (truck was unit of property); Harrah's Club v. United States. 661 F.2d 203, 206 (Ct. Cl. 1981) (automobile was unit of property); Hawaiian Sugar Co. v. Comm'r, 13 B.T.A. 683 (1928) (entire sugar mill was unit of property); L & L Marine Services, Inc., 34 T.C.M. (CCH) 312 (1987) (barges were unit of property); Libby & Blouin, Ltd. v. Comm'r, 4 B.T.A. 910 (1926) (entire evaporator was unit of property); Schroeder v. Comm'r, 72 T.C.M. (CCH) 185 (1996) (barns were unit of property); Shore v. Comm'r, 18 T.C.M. (CCH) 721 (1959) (vessel was unit of property); The Commodore. Inc. v. Comm'r, 46 B.T.A. 718 (1942) (building was unit of property).

⁹ 76 Fed. Reg. at 81066.

¹⁰ Treas. Reg. § 1.263(a)-3T(i)(1)(vi).

¹¹ See also AmeriSouth XXXII, Ltd. v. Comm'r, T.C. Memo 2012-67 (Mar. 12, 2012) (holding that structural components are depreciated over the life of the residential real property).

¹² Issues relating to determining whether a change is "material" are separately discussed in detail in Section II.B.

¹³ 76 Fed. Reg. 81065 ("A goal of both the 2006 and 2008 proposed regulations was to reduce controversy and provide clarity in determining whether an amount is paid for an improvement that must be capitalized under section 263(a)."). Given that the Temporary Regulations are a continuation of the same project as the proposed regulations, the objectives of the Temporary Regulations remain unchanged.

¹⁴ Ironically, despite the Temporary Regulations' overall rejection of long-standing case law in this area, when it is convenient the Preamble picks out a select number of cases to support the new rules. See e.g., Preamble, 76 Fed. Reg. at 81066 ("Compared to the approach provided in the 2008 proposed regulations, the approach contained in these temporary regulations produces results that are more consistent with current law. See, for example, Smith v. Commissioner, 300 F.3d 1023 (9th Cir. 2002) (holding that costs to replace a substantial portion of floor were capital expenditures); Tsakopoulous v. Commissioner, T.C. Memo. 2002-8 (holding that costs to replace the roof on a portion of the suites of a shopping center were capital expenditures); Hill v. Commissioner, T.C. Memo. 1983-112 (holding that costs to replace the water heater and furnace in rental property were capital expenditures); Stewart Supply Co v. Commissioner, T.C. Memo. 1963-62 (holding that costs to replace the front wall of a building and make electrical connections to that wall were capital expenditures); First Nat'l Bank v. Commissioner, 30 B.T.A. 632 (1934) (holding that costs of replacing the electrical system in a bank building were capital expenditures); Georgia Car and Locomotive Co., 2B.T.A. 986 (1925) (holding that costs of a new roof on a building were capital expenditures). The approach for buildings is conceptually similar to the plant property rule discussed below, which segregates plant property into units of property that perform discrete and major functions within the plant.").

¹⁵ The deduction for "ordinary and necessary" business expenses was included in federal income tax law as early as 1913, the year in which Congress enacted the Revenue Act of 1913 following the ratification of the 16th Amendment to the United States Constitution. Revenue Act of 1913, ch. 16, 38 Stat. 114. § ll.G.b (1913). This deduction has also appeared in each codification of the Internal Revenue Code since that time.

¹⁶ Treas. Reg. § 162-4. This regulation was initially adopted by Treasury in 1958. T.D. 6291 (Apr. 3, 1958).

¹⁷Illinois Merchants Trust Co v Comm'r, 4 B.T.A. 103, 106 (1926), acq. (V-2 CB 2).

¹⁸ Treas. Reg. § 1.263(a)-3T(d)(1).

¹⁹ Treas. Reg. § 1.263(a)-3T(h).

²⁰ Treas. Reg. § 1.263(a)-3T(i)(1)(vi).

²¹ Treas. Reg. § 1.263(a)-3T(j)(1).

²²See REG-168745-03, RIN 1545-BE18, 71 Fed. Reg. 48590, at 48598 (stating that "the proposed regulations attempt to clarity and expand the standards in the current regulations") (emphasis added) and 71 Fed. Reg. at 48601 ("the IRS and Treasury Department do not believe that fair market value is an appropriate standard").

²³ 71 Fed. Reg. at 48601 ("the value factors in the proposed regulations [that have carried over to the Temporary Regulations] are intended to be objective indications of work performed that generally would increase the fair market value of the unit of property") (emphasis added). Notably, recognizing that these new standards could require taxpayers to capitalize expenditures that did not result in an increase in the property's value, commentators responded to the 2006 proposed regulations by requesting that taxpayers be allowed to override the new standards by proving that the activity did not actually increase the property's fair market value. The Service and Treasury rejected these requests, claiming that "whether an amount paid should be capitalized as a betterment to a unit of property depends upon the purpose, the physical nature, and the effect of the work for which the amounts were paid, and not upon an analysis of the fair market value of the property before and after the work." 73 Fed. Reg. at 12844. Importantly, this conclusion departs from current case law. including at least one of the cases cited in the Preamble. See Stewart Supply, 22 T.C.M. (CCH) at 249 ("the building with its brand new front would have brought a higher price than the same building with its old front") (emphasis added).

²⁴ The preamble to the proposed regulations published in 2006 makes clear that the "restoration" standard replaces the requirement that an expenditure appreciably prolong the property's useful life. See 71 Fed. Reg. at 48598 (Aug. 21, 2006) ("the proposed regulations attempt to clarify and expand the standards in the current regulations by setting forth rules to determine . . . whether there has been a restoration of property (the useful life rules).").

²⁵ Consider, for example, Example 8 under the betterment test, which concludes that a retail store's "periodic" cosmetic changes and changes in layout must be capitalized. Treas. Reg. § 1.263(a)-3T(h)(4) Ex. 8. The fact that the cosmetic changes and changes in layout are periodic implies that they are not permanent.

²⁶ Treas. Reg. § 1.263(a)-3T(h)(4) Ex. 6.s

²⁷ Although Example 8 involves the removal and rebuilding of multiple walls to move built-in changing rooms, the large number of other factual differences between these two examples make it impossible to reach conclusions with respect to the effect of movement of walls.

²⁸ Although Example 6 could be contrasted with Example 8, in which the taxpayer capitalized and amortized the building refresh costs over a ten-year period on its applicable financial statement, the large number of other factual differences between these two examples make it impossible to reach conclusions with respect to the relative significance of the manner in which an expenditure is treated on a taxpayer's applicable financial statement,

²⁹ Treas. Reg. § 1.263(a)-3T(h)(4) Ex. 7.

³⁰ Treas. Reg. § 1.263(a)-3T(h)(4) Ex. 8.

³¹ Treas. Reg. 1.263(a)-3T(i)(4).

³² Treas. Reg. § 1.263(a)-3T(i)(5) Ex. 11.

³³ Treas. Reg. § 1.263(a)-3T(i)(5) Ex. 13.

³⁴ Treas. Reg. § 1.263(a)-3T(i)(5) Ex. 15.

³⁵ Treas. Reg. § 1.263(a)-3T(i)(5) Ex. 17.

³⁶ Preamble, 76 Fed. Reg. at 81065.

³⁷ 76 Fed. Reg. at 81075. Given that the Temporary Regulations' standards fundamentally change nearly eight decades of case law in this area, Best Buy again notes the inconsistency of Treasury's professed concern for remaining consistent with case law.

³⁸Id. at 337-338 (emphasis added),

³⁹Id. at 340.

⁴⁰ Best Buy acknowledges that the Plainfield-Union test is applied with respect to betterments. Treas. Reg. § 1.263(a)-3T(h)(3)(iii). The Plainfield-Union test, however, applies not only to determinations regarding whether the value of property has been materially increased, but also to determinations regarding whether a property's useful life has been prolonged. Consequently, there is no justification for limiting the application of the Plainfield-Union test to betterments.

⁴¹ Although the decision in Illinois Merchants Trust preceded the decision in Plainfield Union, its holding is consistent with Plainfield-Union. In fact, the Tax Court cites Illinois Merchants Trust in support of its decision in Plainfield-Union.

⁴² Complicating matters further, the betterment examples involve tests that explicitly employ a materiality threshold (e.g., the Addition Test or the Capacity/Quality Test), whereas the restoration examples involve tests that only implicitly address the question of materiality (e.g., the Major Component Replacement Test, which looks to whether the affected major component or structural part comprises "a large portion of a physical structure" -- in effect, whether it is material).

⁴³ Treas. Reg. § 1.263(a)-3T(h)(4) Ex. 7.

⁴⁴ Treas. Reg. § 1.263(a)-3T(h)(4) Ex. 11.

⁴⁵ Treas. Reg. § 1.263(a)-3T(h)(4) Ex. 16.

⁴⁶ Treas. Reg. § 1.263(a)-3T(h)(4) Ex. 18.

⁴⁷ Treas. Reg. § 1.263(a)-3T(i)(5) Ex. 12.

⁴⁸ Treas. Reg. § 1.263(a)-3T(i)(5) Ex. 13.

⁴⁹ Treas. Reg. § 1.263(a)-3T(i)(5) Ex. 17.

⁵⁰ Treas. Reg. § 1.263(a)-3T(i)(5) Ex. 19.

⁵¹ Treas. Reg. § 1.263(a)-3T(i)(5) Ex. 20.

⁵² Treas. Reg. § 1.263(a)-3T(i)(5) Ex. 21.

⁵³ Treas. Reg. § 1.263(a)-3T(i)(5) Ex. 23.

⁵⁴ Treas. Reg. § 1.263(a)-3T(i)(5) Ex. 24.

⁵⁵ Treas. Reg. § 1.263(a)-3T(g)(1).

⁵⁶Id.

⁵⁷ Treas. Reg. § 1.263(a)-3T(g)(5) Ex. 1.

⁵⁸ Example 8 under the routine-maintenance safe harbor concludes that the routine-maintenance safe harbor applies to towboats, another complex asset having numerous structural components and a long class life. As illustrated by Example 8, the taxpayer is permitted to deduct regular maintenance of the towboat's diesel engines because the maintenance is necessary to keep the engines in ordinarily efficient operating condition and such maintenance is expected to be conducted more than once during the 18-year class life of the towboat. Treas. Reg. § 1.263(a)-3T(g)(5) Ex. 8.

⁵⁹See Treas. Reg. § 1.263(a)-3T(g)(5) Ex. 7 (although this example concludes that the safe harbor does not apply, it implies that regular maintenance activities on railroad freight cars would qualify for the routine-maintenance safe harbor if performed more than once during the 14-year class life of the property).

⁶⁰ 76 Fed. Reg. at 81070.

⁶¹ Treas. Reg. § 1.168(i)-8T.

⁶² Treas. Reg. § 1.168(i)-8T(e)(2).

⁶³ The De Minimis Ceiling is equal to the greater of: (i) .1% of the taxpayer's gross receipts for the taxable year as determined for federal tax purposes, or (ii) 2% of the taxpayer's total depreciation and amortization expense for the taxable year as determined in its applicable financial statement. Treas. Reg. 1.263(a)-2T(g)(1).

⁶⁴ Treas. Reg. § 1.263(a)-2T(g)(7), (8) Exs. 2, 3.

⁶⁵See Treas. Reg. § 1.263(a)-2T(g)(8) Ex. 4 (concluding that the cost of computers, office chairs, briefcases, and books did not exceed the De Minimis Ceiling because the taxpayer elected not to apply the de minimis rule to the costs of the books) and Treas. Reg. § 1.263(a)-2T(g)(8) Ex. 3 (concluding that only the portion of the expenditure that exceeded the De Minimis Ceiling was excluded from the scope of the de minimis rule).

⁶⁶ 76 Fed. Reg. at 81064.

⁶⁷ Treas. Reg. § 1.263(a)-2T(d)(1), (g)(1).

⁶⁸ 76 Fed. Reg. at 81070.

⁶⁹Id.

⁷⁰INDOPCO, Inc. v. Comm'r, 503 U.S. 79, 84 (1992).

⁷¹ Treas. Reg. 1.263(a)-2T(f)(3)(ii).

⁷² Treas. Reg. § 1.263(a)-3T(e)(3)(ii)(A).

⁷³ Treas. Reg. § 1.263(a)-3T(e)(3)(ii)(B).