Morrison: Why Electrical Allocation Can Be Percentage-Based

Can one electrical distribution system be divided between different property classifications on a percentage basis? Morrison, Inc. v. Commissioner, T.C. Memo. 1986-129, aff'd, 891 F.2d 857 (11th Cir. 1990), provides an important answer. The Tax Court followed the functional allocation approach developed in Scott Paper when analyzing the primary electrical distribution systems of cafeteria buildings, and the Eleventh Circuit affirmed that approach. The ATG explains that the court accepted percentage-based treatment and focused on the ultimate use of the electricity distributed through the system. For CostSegRx engineers, Morrison reinforces an important distinction: a percentage can be the conclusion of an electrical analysis, but it should not be the assumption that begins one.

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Key Takeaways

• Morrison applied functional allocation to the primary electrical distribution systems of cafeteria buildings.
• The Eleventh Circuit accepted percentage-based allocation and focused on the ultimate use of electricity.
• A supported percentage can divide an electrical distribution system between § 1245 property and § 1250 property.
• The ATG applies functional allocation specifically to a building's primary and secondary electrical distribution systems.
• Modern ATG methodology derives the percentage from electrical demand loads and design documentation rather than a standard assumption.
• Two properties with the same electrical cost can produce different supported allocations because their demand loads differ.
• In electrical functional allocation, the percentage is an engineering result, not a rule of thumb.

What Did Morrison Decide About Electrical Allocation?

Morrison, Inc. v. Commissioner dealt in part with the primary electrical distribution systems of cafeteria buildings.

The ATG explains that the Tax Court allowed a portion of the primary electrical system to be treated as tangible personal property for Investment Tax Credit purposes. In reaching that result, the court followed the functional allocation approach previously used in Scott Paper.

The ATG's case-law table reflects the same point by identifying Morrison's primary electrical distribution system as containing both § 1245 property and § 1250 property.

That is important.

The court did not require the entire primary electrical distribution system to receive one classification.

Instead, the analysis recognized that portions of an interconnected electrical system could serve different functions.

Some electrical capacity could support equipment.

Other electrical capacity could support the operation and maintenance of the building.

Morrison therefore reinforces a concept that can initially seem counterintuitive to investors.

One physical system can contain costs associated with more than one property classification.

That does not mean the allocation can be arbitrary.

It means the system must be analyzed.

Why Did the Eleventh Circuit Accept Percentage-Based Allocation?

On appeal, the Eleventh Circuit affirmed the Tax Court's use of functional allocation.

The ATG highlights three broad conclusions from the appellate decision.

First, the court accepted that taxpayers could claim Investment Tax Credit treatment on a percentage basis.

Second, it adopted the Tax Court's focus on the ultimate use of the electricity distributed by Morrison's primary electrical systems.

Third, it concluded that the Tax Court's approach was consistent with the purpose of the Investment Tax Credit.

The first point is especially important for modern electrical cost segregation.

A percentage allocation is not inherently improper merely because the electrical distribution system functions as an interconnected whole.

But the second point tells us how the percentage must be understood.

The allocation follows function.

Where does the electricity go?

What does it ultimately serve?

How much of the electrical system was designed around those loads?

These are engineering questions.

That is why CostSegRx treats functional allocation of electrical systems as a system analysis rather than an accounting assumption.

What Does a Percentage Actually Represent?

A functional-allocation percentage should represent the relationship between the electrical distribution system and the loads it was designed to serve.

That is very different from saying:

“Thirty percent of electrical is usually personal property.”

Morrison does not establish such a standard percentage.

The ATG's current methodology requires the types of property served by the electrical distribution system to be analyzed and costs to be allocated proportionally by electrical demand load. It instructs the examiner to record and tally the demand load associated with § 1245 property and § 1250 property and then determine their proportions of the electrical distribution system.

That makes the percentage an output.

Suppose the supported analysis produces a 35% allocation associated with qualifying § 1245 property.

The engineering reasoning is not:

“We selected 35%, so now we need to justify it.”

The reasoning should run in the opposite direction.

The engineer identifies the loads.

The engineer determines what those loads serve.

The engineer analyzes the electrical design.

The engineer calculates the proportions.

The resulting percentage follows from that work.

That difference is critical to a defensible study.

Where Does the Functional Allocation Approach Apply?

The 2025 ATG includes an important limitation.

It states that the functional allocation approach is applied only to a building's primary and secondary electrical distribution systems.

That prevents Morrison from becoming a blanket percentage-allocation rule for every building system.

The ATG separately explains how individual hook-ups and branch circuits should be addressed.

Hook-ups and branch circuits serving building-related items such as HVAC, general-use power outlets, lighting, and other building services should be recovered over the recovery period of the building.

Hook-ups and branch circuits supplying dedicated machinery and equipment used as an integral part of the taxpayer's business should be recovered over the appropriate recovery periods of the equipment they serve, based on § 168 and Rev. Proc. 87-56.

This distinction is important for CostSegRx engineers.

The primary and secondary distribution system may require proportional allocation.

A dedicated branch circuit may instead be traced directly to the particular equipment it serves.

A general-use circuit presents different facts.

The engineering method should match the physical system being analyzed.

This is consistent with CostSegRx's broader guidance on defending 5-year property classifications, where documentation and property-specific support are more important than assumptions based on asset names.

How Does the ATG Build a Supported Electrical Percentage?

The modern ATG provides a structured engineering methodology.

Step 1 is to determine whether components of the electrical distribution system are inherently permanent structures by applying the six-factor Whiteco test.

Step 2 is to determine whether the electrical distribution system serves building operation and maintenance or supplies power to tangible personal property or other qualifying tangible property. The ATG specifically recognizes that an electrical distribution system, or components of it, can serve both purposes.

Step 3 is functional allocation. The types of property served by the system are analyzed, and costs are allocated proportionally according to electrical demand load.

Step 4 is to record and tally the demand load for the § 1245 property and § 1250 property. Once the complete demand load is established, the proportional allocation can be determined.

The ATG also says the building's electrical design plans must be studied.

Panel schedules and the electrical load summary or calculation are identified as important source documents. The guide warns that a residual method is not appropriate and highly recommends that a qualified and knowledgeable person, such as an engineer, perform the analysis.

That gives investors a useful way to evaluate a claimed electrical percentage.

Ask where it came from.

Was it derived from electrical plans?

Were demand loads analyzed?

Were the end-use assets identified?

Were building loads distinguished from qualifying equipment loads?

Can the calculation be reproduced?

If the only explanation is that the percentage is “typical,” the methodology is missing.

A quality cost segregation study should be able to explain how significant classifications and allocations were developed, not merely report the final number.

How Can Two Identical Electrical Costs Produce Different Allocations?

Illustrative example only. Actual classifications, demand loads, allocations, costs, recovery periods, depreciation deductions, and tax results depend on the specific property, electrical design, engineering analysis, documentation, applicable authority, and taxpayer circumstances.

Assume two commercial facilities each have $800,000 of supported primary and secondary electrical distribution system cost.

The dollar amount is identical.

Facility A has substantial dedicated operating equipment. After the engineers review the electrical plans, panel schedules, load calculations, and end uses, the supported demand-load analysis shows that 40% of the relevant electrical distribution system is associated with qualifying § 1245 property.

Facility B has the same $800,000 electrical system cost, but most of its demand supports general lighting, HVAC, general-use receptacles, and other building functions. Its supported analysis produces a 15% allocation associated with qualifying § 1245 property.

The electrical cost is the same.

The allocation is not.

That is exactly why a standard percentage is unreliable.

Electrical system cost does not tell us what the system serves.

The building type alone does not tell us.

Even two properties operating similar businesses can have different equipment, electrical designs, demand factors, and distribution configurations.

The ATG notes that there can be substantial differences in the physical characteristics and engineering design criteria between manufacturing plants and public buildings such as offices, retail stores, and restaurants.

CostSegRx engineers therefore work from the actual property.

The percentage comes after the load analysis.

What Is the Most Important Lesson From Morrison?

Morrison strengthened the functional allocation framework established in Scott Paper.

The Eleventh Circuit accepted percentage-based treatment and adopted the focus on the ultimate use of electricity.

After Morrison, the IRS revised AOD 1991-019 and stated that it would not challenge the functional allocation approach set forth in Scott Paper for determining the eligibility of building electrical systems as § 38 property.

The ATG then carries that methodology into its modern electrical distribution guidance.

But Morrison should not be reduced to the statement that “electrical can be allocated by percentage.”

That leaves out the most important part.

How was the percentage determined?

The current ATG describes functional allocation as complex and labor intensive. It involves determining the cost of specific parts of the electrical distribution system, analyzing overall electrical demand load, and appropriately allocating the primary and secondary electrical distribution systems between § 1245 property and § 1250 property.

That is the CostSegRx engineering principle worth remembering.

A supported percentage is useful because it summarizes the result of the analysis.

It should never replace the analysis.

A percentage can be the conclusion of an electrical allocation analysis. It should not be the assumption that begins one.