Hawaii Administrative Rules
Title 18 - DEPARTMENT OF TAXATION
Chapter 235 - INCOME TAX LAW
Subchapter 6 - RETURNS AND PAYMENTS; ADMINISTRATION
Section 18-235-110.7-04 - Section 38 property

Universal Citation: HI Admin Rules 18-235-110.7-04

Current through November, 2024

(a) In general. Section 38 property is defined as:

(1) Property which is (A) tangible personal property, or (B) other tangible property;

(2) Recovery property (within the meaning of I.R.C. section 168, without regard to useful life), or any other property with respect to which depreciation is allowable to the taxpayer; and

(3) Property which has an estimated useful life or recovery period (determined as of the time the property is placed in service) of three years or more. A property shall have the same estimated useful life or recovery period as that which is used for depreciation or ACRS purposes.

(b) Tangible personal property.

(1) In general. Tangible personal property (other than a central air conditioning or heating unit), as defined in paragraph (2), may qualify as section 38 property regardless of whether it is used as an integral part of an activity (or constitutes a research or storage facility used in connection with such activity) specified in subsection (c).

(2) "Tangible personal property", defined. For purposes of the credit, the term tangible personal property" means any tangible property except land and improvements thereto, such as buildings or other inherently permanent structures (including items which are structural components of the buildings or structures). The terms "building" and "structural components" are defined in subsection (1). Thus, buildings, swimming pools, paved parking areas, wharves, docks, bridges, and fences are not tangible personal property. Tangible personal property includes all property (other than structural components) which are contained in or attached to a building. Property such as production machinery, printing presses, transportation and office equipment, refrigerators, grocery counters, testing equipment, display racks and shelves, and neon and other signs, which are contained in or attached to a building constitute tangible personal properties for purposes of the credit. Further, all property in the nature of machinery (other than structural components of a building or other inherently permanent structure) shall be considered tangible personal property even though located outside a building. For example, a gasoline pump, hydraulic car lift, or automatic vending machine, although annexed to the ground, shall be considered tangible personal property.

(c) Other tangible property. In addition to tangible personal property, other tangible property (not including a building and its structural components) may qualify as section 38 property if one of the following three conditions is met:

(1) The property is used as an integral part (as defined in subsection (d)) of manufacturing, production, extraction, or furnishing transportation, communication, electrical energy, gas, water, or sewage disposal services;

(2) The property is a research or storage facility used in connection with an activity referred to in paragraph (1):
(A) Examples of research facilities include wind tunnels and test beds;

(B) Examples of storage facilities include oil and gas storage tanks;

(C) Although a research or storage facility must be used in connection with one of the specified activities in paragraph (1), the taxpayer-owner of the facility need not be engaged in the specified activity. For example, if a research or storage facility is used in connection with a manufacturing process, the taxpayer-owner of the facility need not be engaged in the manufacturing process; or

(3) The property is a facility used in connection with an activity referred to in paragraph (1) for the bulk storage of fungible commodities (including commodities in a liquid or gaseous state).

(d) "Integral part", defined. Property is used as an integral part of one of the specified activities in subsection (c) if it is used directly in the activity and is essential to the completeness of the activity.

(1) Examples include fences used to confine livestock and telephone poles. In the case of manufacturing, for example, all properties used by a taxpayer to acquire or transport raw materials or supplies to the point where the actual processing commences (e.g., dock), or to process raw materials into the taxpayer's final product, are considered property used as an integral part of manufacturing.

(2) Property such as pavements, paved parking areas, inherently permanent advertising displays, inherently permanent outdoor lighting facilities, or swimming pools, although used in the operation of a business, ordinarily is not used as an integral part of any of the specified activities in subsection (c), and therefore does not qualify for the credit.

(3) Property shall be considered to be used as an integral part of one of the specified activities in subsection (c) if it is used by either the owner of the property or the lessee of the property.

(e) "Manufacturing, production, and extraction", defined. The terms manufacturing, production, and extraction include:

(1) the construction, reconstruction, or making of property out of scrap, salvage, junk, new, or raw material by processing, manipulating, refining, or changing the form of an article, or by combining or assembling two or more articles;

(2) the cultivation of the soil;

(3) the raising of livestock; and

(4) the mining of minerals. Examples include property used as an integral part of the extraction, processing, or refining of metallic and nonmetallic minerals; the construction of roads, bridges, or housing; the processing of meat, fish, or other foodstuffs; the cultivation of orchards, gardens, or nurseries; the production of lumber, lumber products, or other building materials; the fabrication or treatment of textiles, paper, or glass; and the rebuilding, as distinguished from the mere repairing, of machinery.

(f) "Transportation business", defined. A transportation business includes airlines, bus companies, shipping or trucking companies, and oil pipeline companies.

(g) "Communication business", defined. A communication business includes telephone, telegraph, or cable companies, and radio or television broadcasting companies.

(h) "Bulk storage", defined. Bulk storage means the storage of a commodity in a large mass prior to its consumption or use. For example, if a facility is used to store macadamia nuts which have not been sorted or processed, the facility is used for bulk storage; however, if a facility is used to store macadamia nuts that have been sorted and canned, it is not used for bulk storage.

(i) Recovery or depreciable property requirement. Section 38 property must be either recovery property (within the meaning of I.R.C. §168, without regard to useful life), or any other property with respect to which depreciation is allowable to the taxpayer.

(1) If only part of a property is depreciable, only a pro rata portion of the property may qualify as section 38 property.

(2) Example. Paragraph (1) is illustrated as follows:

A property is used 90 percent of the time in a trade or business, and 10 percent of the time for personal purposes. In this case, only 90 percent of the basis of the property may qualify as section 38 property which is eligible for the credit.

(3) Property does not qualify as section 38 property to the extent that a deduction for depreciation thereon is disallowed under I.R.C. §274 (regarding the disallowance of certain entertainment, etc., expenses).

(j) Boilers fueled by oil or gas. Generally, any boiler, used in Hawaii, which is primarily fueled by petroleum or petroleum products (including natural gas) qualifies as section 38 property.

(k) Energy property.

(1) In general. Certain energy property qualifies as section 38 property. The energy property must be intended to reduce the amount of oil, natural gas, or other energy consumed in heating or cooling a building or used in an industrial process.

(2) "Energy property", defined. Energy property is:
(A) Alternative energy property. Alternative energy property consists of the following types of property:
(i) A boiler, the primary fuel for which will be an alternate substance. An alternate substance is any substance other than oil, natural gas, or any product of oil and natural gas;

(ii) A burner (including necessary on-site equipment to bring the alternate substance to the burner) for a combustor other than a boiler if the primary fuel for the burner will be an alternate substance;

(iii) Equipment for converting an alternate substance into a synthetic liquid, gaseous, or solid fuel;

(iv) Equipment designed to modify existing equipment which uses oil or natural gas as fuel or as feedstock so that the existing equipment will use either a substance other than oil and natural gas, or oil mixed with a substance other than oil and natural gas (where the other substance will provide not less than twenty-five percent of the fuel or feedstock);

(v) Equipment to convert coal (including lignite), or any non-marketable substance derived therefrom, into a substitute for a petroleum or natural gas derived feedstock for the manufacture of chemicals or other products, or coal (including lignite), or any substance derived therefrom, into methanol, ammonia, or a hydroprocessed coal liquid or solid;

(vi) Pollution control equipment required (by federal, state, or local regulations) to be installed on or in connection with equipment described in clauses (i) to (v);

(vii) Equipment used for the unloading, transfer, storage, reclaiming from storage, and preparation (including, but not limited to, washing, crushing, drying, and weighing) at the point of use for an alternate substance for use in equipment described in clauses (i) to (vi). This includes equipment used for the storage of fuel derived from garbage at the site at which fuel was produced from garbage; and

(viii) Equipment used to produce, distribute, or use energy from a geothermal deposit, but only, in the case of electricity generated by geothermal power, up to (but not including), the electrical transmission state. A geothermal deposit is a geothermal reservoir consisting of natural heat which is stored in rocks or in an aqueous liquid or vapor (whether or not under pressure). The deposit shall not be treated as a gas well.

(B) Solar or wind energy property. Solar or wind energy property means any equipment which uses solar or wind energy to:
(i) Generate electricity;

(ii) Heat or cool (or provide hot water for use in) a structure; or

(iii) Provide solar process heat.

(C) Specially defined energy property. Specially defined energy property is property which is installed in an existing industrial or commercial facility to reduce the amount of energy consumed in the existing industrial or commercial process. The term includes a recuperator, heat wheel, regenerator, heat exchanger, waste heat broiler, heat pipe, automatic energy control system, turbulator preheater, combustible gas recovery system, economizer, modifications to alumina electrolytic cells, modifications to chlor-alkali electrolytic cells, or any other property of a kind specified by the department, the principal purpose of which is to reduce the amount of energy consumed in an existing industrial or commercial process and which is installed in an existing industrial or commercial facility.

(D) Recycling equipment.
(i) In general. Recycling equipment includes any equipment which is used exclusively to sort and prepare solid waste for recycling or in the recycling of solid waste.

(ii) Certain equipment not included. The term recycling equipment does not include any equipment used in a process after the first marketable product is produced or in the case of recycling iron or steel, any equipment used to reduce the waste to a molten state and in any process thereafter.

(iii) Ten percent virgin material allowed. Any equipment used in the recycling of material which includes some virgin materials shall not be treated as failing to meet the exclusive requirements of clause (i) if the amount of the virgin materials is ten percent or less.

(iv) Certain equipment included. The term recycling equipment includes any equipment which is used in the conversion of solid waste into a fuel or into useful energy such as steam, electricity, or hot water.

(E) Hydroelectric generating property. Hydroelectric generating property means property installed at a hydroelectric site which is:
(i) Equipment for increased capacity to generate electricity by water (up to, but not including, the electrical transmission stage); and

(ii) Structures for housing the generating equipment, fish passageways, and dam rehabilitation property, required by reason of the installation of equipment described in clause (i).

(F) Cogeneration equipment.
(i) In general. Cogeneration equipment means property which is an integral part of a system for using the same fuel to produce both qualified energy and electricity at an industrial or commercial facility.

(ii) "Qualified energy", defined. Qualified energy means steam, heat, or other forms of useful energy (other than electric energy) to be used for industrial, commercial, or space-heating purposes (other than in the production of electricity).

(iii) "Industrial", defined. Industrial includes the purification of water and the desalinization of water.

(G) Biomass property qualifies for the credit. Biomass property means property which is a boiler, the primary fuel for which is an alternate substance, a burner (including necessary on-site equipment to bring the alternate substance to the burner) for a combustor other than a boiler if the primary fuel will be an alternate substance, or equipment for converting an alternate substance into a qualified fuel, including equipment used to store fuel derived from garbage at the site at which such fuel was produced from garbage. For purposes of defining biomass property, an alternate substance means any substance other than an inorganic substance and coal (including lignite) or any coal product. Biomass property also includes pollution control equipment which is required to be installed on or in connection with the above equipment, as well as equipment used for the unloading, transfer, storage, reclaiming from storage, and preparation at point of use of an alternate substance for use in that equipment.

(l) Property which generally does not qualify as section 38 property. Certain classes of property which generally do not qualify as section 38 property and thereby are not eligible for the credit include:

(1) A building or its structural components.
(A) "Building", defined.
(i) In general. A building is any structure or edifice which encloses a space within its walls, and is usually covered by a roof. The purpose of the structure or edifice is, for example, to provide shelter or housing, or to provide working, office, parking, display, or sales space. The term includes, among other structures, apartments, factory and office buildings, warehouses, barns, garages, bus stations, and stores. The term also includes any such structure which is constructed by or for a lessee, even if the structure must be removed, or ownership of the structure reverts to the lessor at the termination of the lease.

(ii) Property which is excluded from the definition of building and which thereby may be eligible for the credit. A building does not include a structure which is essentially an item of machinery or equipment; or a structure which houses property used as an integral part of manufacturing, producing, extracting, or furnishing transportation, communications, electrical energy, gas, water, or sewage disposal services if the use of the structure is so closely related to the use of the property that the structure can be expected to be replaced when the property it initially houses is replaced.

(iii) Factors which indicate that a building or structure is closely related to the use of a particular property it houses include the following: the structure is specifically designed to provide for the stress and other demands of the property; and the structure could not be economically used for other purposes. Examples of such structures include oil and gas storage tanks, feed storage bins, silos, and crop shelters.

(B) "Structural component", defined.
(i) In general. A structural component includes parts of a building such as walls, partitions, floors, ceilings, and permanent coverings therefor such as paneling or tiling; windows and doors; all components (whether in, on, or adjacent to the building) of a central air conditioning or heating system, including motors, compressors, pipes, and ducts; plumbing and plumbing fixtures (e.g., sinks and bathtubs); electric wiring and lighting fixtures; chimneys; stairs, escalators, and elevators, including all components relating to the operation or maintenance of a building.

(ii) Property which is excluded from the definition of structural component and thereby may be eligible for the credit. The term structural component does not include property which is contained in or attached to a building such as production machinery, the sole justification for the installation of which is to meet temperature or humidity requirements which are essential for the operation of other machinery or the processing of materials or foodstuffs. Machinery may meet this sole justification test even though it incidentally provides for the comfort of employees, or serves, to an insubstantial degree, areas where the temperature or humidity requirements are not essential.

(C) Whether property is classified as a structural component is largely determined by the manner of attachment to the land or the structure, and how permanently the property is designed to remain in place. The following are among the factors which the department may consider in making this determination:
(i) The manner of affixation (permanent or detachable) of the property to the land;

(ii) Whether the property is capable of being moved, and whether it has in fact been moved;

(iii) Whether the property is designed or constructed to remain permanently in place;

(iv) Circumstances which tend to show the expected or intended length of affixation;

(v) Whether the removal of the property is substantial and time consuming;

(vi) Whether the property is readily removable; and

(vii) The extent of damage that the property will sustain if it is removed.

(2) Property purchased for use in a foreign trade zone (as defined under chapter 212, HRS).

(3) Property used by an organization which is exempt from the tax imposed by chapter 235, HRS, unless the property is used predominantly in an unrelated trade or business, the income from which is subject to tax under chapter 235, HRS (with respect to the imposition of tax on unrelated business income of charitable, etc., organizations).
(A) "Property used by an organization", defined. Property used by an organization means property owned by the organization.

(B) Example. Subparagraph (A) is illustrated as follows:

A tax-exempt organization which is not subject to the imposition of tax under chapter 235, HRS, places in service a copying machine. The copying machine is used in an income producing activity which is subject to taxation under chapter 237, HRS. The tax-exempt organization has no unrelated trade or business income subject to tax under chapter 235, HRS (with respect to the imposition of tax on unrelated business income of charitable, etc., organizations). The copying machine would be considered to be property used by the organization. Although the copying machine may otherwise qualify for the credit, since the organization is not a taxpayer subject to the imposition of tax under chapter 235, HRS, the organization cannot claim a credit for the copying machine.

(4) Intangible property (e.g., patent, copyright, subscription list).

(5) Property used for lodging.
(A) "Property used for lodging", defined. Property used for lodging is property which is used predominantly to furnish lodging; or in connection with the furnishing of lodging.
(i) "Property used predominantly to furnish lodging", defined. Property used predominantly to furnish lodging includes that which is used in the living quarters of a lodging facility (e.g., beds, other furniture, refrigerators, ranges, and other equipment).

(ii) "Lodging facility", defined. A lodging facility includes an apartment house, hotel, motel, dormitory, or other facility (or part of a facility) where sleeping accommodations are provided and let; however, the term does not include a facility which is used primarily as a means of transportation (e.g., aircraft, vessel) or to provide medical or convalescent services, even though sleeping accommodations are provided.

(iii) "Property used predominantly in connection with the furnishing of lodging", defined. Property used predominantly in connection with the furnishing of lodging includes that which is used to operate a lodging facility or to serve tenants, whether furnished by the owner of the lodging facility or another person (e.g., lobby furniture, office equipment, laundry, and swimming pool facilities). However, property used in furnishing, to the management of a lodging facility or its tenants, electrical energy, water, sewage disposal services, gas, telephone services or other similar utility services shall not be treated as property used in connection with the furnishing of lodging (e.g., gas and electric meters, telephone poles and lines, telephone station and switchboard equipment, and water and gas mains which are furnished by a public utility).

(B) Exceptions.
(i) A nonlodging commercial facility which is available to persons not using the lodging facility on the same basis as it is available to tenants of the lodging facility may qualify as section 38 property which may be eligible for the credit. Examples include restaurants, drug stores, grocery stores, and vending machines located in the lodging facility.

(ii) Property used by a hotel, motel, or other similar establishment in connection with the trade or business of furnishing lodging where the predominant portion (i.e., more than one-half) of the accommodation in the hotel, motel, or other similar establishment is used by transients may qualify as section 38 property which is eligible for the credit. An accommodation shall be considered to accommodate transients if the rental period is normally less than thirty days. Thus, if greater than one-half of the living quarters of a hotel, motel, or other similar establishment is used during the taxable year to accommodate transients, the property used by the hotel, motel, or other similar establishment may qualify as section 38 property. On the other hand, if one-half or less of the living quarters of a hotel, motel, or other similar establishment is used during the taxable year to accommodate transients, the property used by the hotel, motel, or other similar establishment would not qualify as section 38 property.

(iii) Coin-operated vending machines and coin-operated washing machines and dryers may qualify as section 38 property.

(m) The definition of section 38 property is limited to the provisions in this section.

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