Revenue Ruling allows deduction for asset removal costs.

In February, the IRS issued Rev. Rul. 2000-7, holding that, when a depreciable asset is retired in conjunction with the installation or production of a replacement asset, the costs of removing the retired asset are not required to be capitalized under Sec. 263 or 263A as part of the replacement asset's costs. This ruling is one of a series of rulings issued by the Service in an attempt to provide some definitive guidance in the generally murky capitalization area.

The costs of removing assets have historically been allocated to the removed asset and, thus, deductible when the asset was retired. The impetus behind Rev. Rul. 2000-7 appears to be to clarify any confusion that might exist when the removal of an asset is followed by the installation of a replacement asset.

The ruling addresses two fact patterns. In the first, a telephone company removes an existing telephone pole from land it owns and installs a new telephone pole in the same location. In the second, the same taxpayer removes an existing telephone pole from land it leases as an easement and installs a new pole in a different location, but within the same easement in which the original pole was located. In both fact patterns, the taxpayer incurs costs in removing and discarding the telephone poles.

For both fact patterns, the IRS ruled that the taxpayer was not required to capitalize the removal costs under either Sec. 263(a) or 263A. Sec. 263(a) generally requires the capitalization of the cost of assets having a useful life extending substantially beyond the tax year (Regs. Sec. 1.263(a)-2(a)). Sec. 263A generally requires the capitalization of direct costs and an allocable share of indirect costs of property produced by the taxpayer or acquired by the taxpayer for resale.

The Service stated that, in both fact patterns, "the removal costs are properly allocable to the retired poles, and thus do not relate to assets having a useful life in the taxpayer's business extending substantially beyond the taxable year in which the removal costs are incurred." The retirement of the telephone poles as part of a replacement project did not affect the IRS's determination that the taxpayer was not required to capitalize the removal costs under Sec. 263(a). In addition, the costs were not required to be capitalized under Sec. 263A, because they were incurred by reason of the removal of the original telephone poles, rather than by reason of the installation of the new poles.

The Service specified that the ruling cannot be applied to determine the treatment of the costs of removing components of depreciable assets. Such removal costs are "either deductible or capitalizable based on whether replacement of the component constitutes a repair or an improvement"

A taxpayer changing its accounting method for removal costs to comply with this ruling must do so in accordance with the automatic change provisions of Rev. Proc. 99-49, except that the scope limitations of Section 4.02 of that procedure do not apply.

FROM LYNN AFEMAN, CPA, AND ROBERT M. BROWN, J.D., CPA, WASHINGTON, DC