New cable code's implications for property owners.

Changes in the National Electric Code could end up costing building owners substantial dollars. These new revisions to the code have been ratified in 33 states and may soon be mandated nationwide.

The code, which is written by the National Fire Protection Agency, addresses abandoned cabling, which is defined as any wiring that is net terminated at both ends with a connecter or designated for future use. Such wiring must either be removed or contained in metal cases when new cable is installed or when a building undergoes renovations. This represents a considerable cost to building owners.

The new code also mandates that owners meet the fire-safe rating for different types of wiring including power, fire alarm systems, fiber-optic cables, telecommunications and broadband.

The problem with old wiring is that it is coated with a substance that is flammable. Excessive wiring in walls and ceilings serves as potential fuel for fires within building walls.

Because sprinkler systems generally de net touch those areas, a tire there is impossible to contain and extremely dangerous.

There is no age requirement associated with abandoned wires; the only question is whether or net the wires terminate. Therefore, even brand new wiring that leads into vacant office space qualifies as abandoned, unless owners take steps to designate it for future use.

The real culprit in the build-up of these loose wires has been the high rate of tenant turnover in commercial buildings. Higher vacancy rate around the country has exacerbated the problem. As succeeding tenants move into the same office space, they invariably want the latest and greatest in wiring.

The typical practice by electric contractors is for new wiring to be put in with the old wiring never removed, As a result, wiring can build-up in a building's wall and ceiling spaces during a relatively short period of time.

The problem is particularly severe for those buildings that previously rented to telecommunication firms, which tend to have heavily wired space. Once these companies went out of existence, these tenants left the wirings behind them. Landlords were net clever enough to impose the requirement (usually pursuant to the lease) that the tenant must be diligent in removing cabling and wiring as they finish their leases or abandon space.

In most instances, it is likely that owners have to pay for removal of these loose wires, regardless of who installed them in the first place. Cost for the removal of abandoned cable can vary from approximately $2.5 to $4.5 per square foot. In the case of large commercial buildings that have experienced significant tenant turnover, this could add up to a significant cost.

Real estate lawyers are beginning to advise landlords to pass the cost on to tenants. Unfortunately, with the leasing market relatively soft, landlords are somewhat powerless to do so, but the cabling issue is rapidly finding its way into lease negotiations. In cases where a tenant is seeking an early renegotiation of a lease, attorneys are advising owners to amend lease documents to include a section on wiring installed during an occupant's tenancy, making the tenant responsible for keeping the cabling in compliance with the code and paying for removal of the wiring when the tenant vacates the space.

Electrical contractors are new beginning to study the matter and are becoming more aware of the issues. While the new rules apply to every building, in reality building inspectors are net going to be searching for wiring violations unless they already have a reason to be in the building (such as, where the owner is applying for a permit for new construction).

As a result, there is complete reliance on the integrity of the electrical contractor for removing the loose wires and complying with the new requirements.

This may also offer opportunities for some contractors to provide landlords with full electrical audits of their buildings, and then begin the process of removing the cables.

Landlords need to address this problem sooner than later because, while it is expensive to go in and remove old wiring, a building owner may fall out of compliance with the building code and face fines and even loose their insurance, which could ultimately result in a default on a mortgage secured by the property.

If a building is round to be out of compliance with the new code, the insurance company may net pay out on its policy.

An ancillary issue is how to treat the cost of removing loose wiring for income tax purposes. The fundamental question is whether these expenses are deductible items, or must be capitalized. Section 162 provides, in part, that a deduction is allowed for all ordinary and necessary expenses paid or incurred during the tax year in carrying out any trade or business.

Among the items specifically listed under Reg. 1.162-1(a) as business expenses are repairs. Reg. 1.162-4 expands on the meaning of repairs, and explains that the test of incidental repairs, which neither materially adds to the value of the property nor appreciably prolongs its life, but keeps it in an ordinary efficient operating condition may be deducted as an expense.

Understandably, these broad definitions are hardly the clear guidance needed to determine whether an expense is deductible or capitalizable. One of the most influential cases in the area of distinguishing deductible tests from capitalizable expenditures is Plainfield-Union Water Code., 39 TC 333 (1962). The issue there was whether a utility company that cleaned and lined a portion of its existing pipe system was entitled to deduct the cost of cleaning and lining rather than being required to capitalize the cost.

The Tax Court held that expenditure usually is a deductible repair if it: (1) returns property to the state it was in before the situation prompting the expenditure arose and, (2) it does net make the relevant property more valuable, more useful or longer-lived. The court further clarified that the relevant comparison for testing whether a repair has increased the value of the property was not with the property's value immediately before the repair, but, with its value at a time before the condition necessitating the expenditure arose.

On the particular facts before it, the court held that although cleaning and lining substantially improved the functioning of the pipe, the cleaning did net prolong the life of the pipe, increase its value, or make it adaptable to a different use. As a result, the costs were deductible repairs. (The court did note, however, that an otherwise deductible expense could be capitalizable if it is part of an overall plan of general improvement).

There is also a line of cases involving cleanup and remediation costs that could be relevant to the issue at hand. In cases where there is a cleanup and changing of use of a property, the cleanup and remediation costs may be non-deductible.

In United Dairy Farmers Inc., 267 F.3d 510, 95 AFTR2d 2001-6116 (6th Circuit 2001), the Appeals Court attempted to reconcile several cases into a coherent framework for determining when remediation and other cleanup costs are deductible or require capitalization.

These include Dominion Resource Inc., 48 F. Supp.2d 527, 83 AFTR2d 99-1350 (DC Va., 1999), aff'd. 219 F.3d 359, 86 AFTR2d 2000-5443 (4th Circuit, 2000) and the Plainfield-Union case. In the cleanup area, Rev. Rul. 94-38 also provides a comprehensive framework for analysis, although it may net be entirely on point with respect to the cost of removing wires.

According to the Sixth Circuit in the United Dairy Farmers case, three elements must be satisfied for a valid Section 162 deduction to be claimed with respect to environment clean-up cost: (1) A taxpayer must have contaminated the property of the ordinary cost of business, (2) the taxpayer must have cleaned the contamination to restore the property to its pre-contamination state and (3) the cleanup must net have allowed the taxpayer to put the property to new use. It is quite possible to reach the conclusion that the cost to remove loose wires pursuant to code can be claimed as an ordinary and necessary business expense. Whether the same will apply in the case of a major renovation is a question of facts.