Removal costs held deductible.

Under Rev. Rul 2000-7, the IRS recently confirmed that costs incurred in retiring and removing depreciable assets need not be capitalized as part of the replacement asset's costs. This taxpayer-favorable ruling is another effort by the IRS National Office, in the wake of INDOPCO, Inc., 503 US 79 (1992), to address the thorny issue of whether a particular expense must be capitalized or deducted when incurred.

The ruling considered two fact situations. In the first, a telephone pole located on a telephone company's land was removed and replaced with a new pole in the same spot. In the second, a pole located on a tract of land under the terms of an easement that permitted the taxpayer to have only one pole was removed and replaced with a new pole in a different spot on the land. In both situations, the old poles were removed as part of larger projects to replace poles in service areas; the removals were necessitated (physically or legally) by the installation of the new poles.

The removal costs were held to be properly allocable to the retired poles, not to the installation of the new poles, and, thus, not related to assets with useful lives extending substantially beyond the tax year. Therefore, the removal costs were not required to be capitalized.

A caveat is that Rev. Rul. 2000-7 does not apply to the removal of a component of a depreciable asset, the cost of which is either deductible or subject to capitalization based on whether replacement of the component constitutes a repair or an improvement; see Regs. Secs. 1.162-4 and 1.263(a)-1(b). Also, the ruling does not address the situations governed by Sec. 280B, which requires expenditures incurred in the demolition of a structure to be capitalized as part of the basis of the land on which the structure is located.

Ruling's Implications

Rev. Rul. 2000-7 (which was requested by a coalition of utility industry trade associations in response to a position taken in a proposed IRS Coordinated Issue Paper (CIP)) should resolve the removal cost issue for those industries. At the same time, the basic issue underlying the ruling is not fact-specific and has broad potential applicability. There is nothing unique about replacing telephone poles or other utility property.

The critical issue is whether the removal costs relate to the asset being removed or to the new asset being installed; that is, whether the removal cost of one asset can be considered an installation cost of some other replacement asset. The ruling answered this question on legal and policy grounds, by addressing the most challenging fact patterns presented in the removal cost controversy: removal was necessitated by installation of new assets (as either a physical or legal requirement) and replacement occurred as part of a larger project. The ruling should also apply to a variety of removal costs, such as those incurred in removing underground storage tanks (effectively revoking a contrary position taken in a CIP in the Petroleum Industry Specialization Program).

Questions Remain

Publication of Rev. Rul. 2000-7 appears to have settled the removal cost controversy. However, most large corporate taxpayers continue to face multiple INDOPCO-related issues in each open audit cycle, and some tax practitioners believe that the IRS National Office's reading of INDOPCO is difficult to reconcile with the aggressive approach taken by some examining agents in the field.

Absent a broader resolution, the Service has been active in addressing INDOPCO issues through published guidance on specific industries that could have wider application. Rev. Rul. 2000-7 is one of three rulings from the 1999 business plan published to date; see Rev. Ruls. 99-23 (on investigatory costs) and 2000-4 (on ISO 9000 costs). This approach will likely continue. The 2000 IRS business plan lists a number of specific INDOPCO rulings (such as cyclical maintenance costs, sales commissions paid to obtain new customers, mutual fund launch costs and loan origination fees) and indicates that more general guidance may be forthcoming.

Taxpayers are also waiting for judicial guidance on two specific INDOPCO issues currently on appeal: FMR, 110 TC 402 (1998) (First Circuit) (mutual fund start-up costs); and Norwest, 112 TC 8 (1999) (Eighth Circuit) (investigatory costs). The Third Circuit recently issued its opinion in PNC Bancorp, 5/19/00, holding that loan origination costs are deductible.

FROM MAURY PASSMAN, J.D., LL.M., WASHINGTON, DC

Robert Zarzar, CPA
Partner
Washington National Tax Services
PricewaterhouseCoopers
Washington, DC