IRS Revenue Ruling
2000-7

 Code Secs. 263, 162, 165, 167, 263A

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26 CFR 1.263(a)-1: Capital expenditures; in general.
(Also sections 162, 165, 167, 263A; 1.165-3, 1.167(a)-8, 1.167(a)-11,
1.263A-1)

Removal costs, capital expenditures. This ruling holds that if the
retirement and removal of a depreciable asset occurs in connection with
the installation or production of a replacement asset, the costs incurred
in removing the retired asset are not required to be capitalized under
section 263 or 263A of the Code as part of the cost of the replacement
asset.


REV. RUL. 2000-7

ISSUE

If me retirement and removal of a depreciable asset occurs in
connection with the installation or production of a replacement asset, are
the costs incurred in removing the retired asset required to be
capitalized under section 263(a) or 263A as pan of me cost of the
replacement asset?


FACTS

The assets of X, a telephone company, include telephone poles A and B.
X placed Pole A in service in 1979 on land it owned. X placed Pole B in
service in 1982 on land owned by Y under the terms of an easement
permitting X to have one pole on Y's land. In 2000, X undertakes a project
to replace telephone poles in the service area in which Pole A is
situated. A's part of that project, X incurs costs in 2000 in removing and
discarding Pole A and installing a new telephone pole, Pole C, in the same
location. X also undertakes a second project to replace telephone poles in
the service area in which Pole B is situated. X installs a new telephone
pole, Pole D on Y's land, but not in the same location as Pole B. As part
of this second project and to comply with the easement, X incurs costs in
2000 in removing and discarding Pole B.


LAW AND ANALYSIS

Section 162 of the Internal Revenue Code and section 1.162-1 of the
Income Tax Regulations generally allow a deduction for all the ordinary
and necessary expenses paid or incurred during the taxable year in
carrying on any trade or business.

Section 165 allows as a deduction any loss sustained during the taxable
year and not compensated for by insurance or otherwise. For the allowance
under section 165(a) of losses arising from the permanent withdrawal of
depreciable property from use in a trade or business or in the production
of income, section 1.165-2(c) cross references section 1.167(a)-8(a),
which permits, in part, a loss from physical abandonment of retired
property.

Under sections 263(a) and 1.263(a)-1(a), no deduction is allowed for
capital expenditures, such as amounts paid for new buildings or for
permanent improvements or betterments made to increase me value of any
property. Section 1.263(a)-2(a) provides that capital expenditures include
the costs of acquisition, construction, or erection of buildings,
machinery and equipment, furniture and fixtures, and similar property
having a useful life substantially beyond the taxable year.

Section 263A generally requires taxpayers that are producing real or
tangible personal property to capitalize direct material costs, direct
labor costs, and indirect costs that are properly allocable to the
produced property. Section 263A(g)(1) provides that, for purposes of
section 263A, the term "produce" includes construct, build, install,
manufacture, develop, or improve. Under section 1.263A-1(e)(3)(i),
indirect costs are allocable to produced property under section 263A when
the costs directly benefit or are incurred by reason of the performance of
production activities.

The costs of removing an asset have been historically allocable to the
removed asset and, thus, generally deductible when the asset is retired
and the costs are incurred. A deduction generally is allowed whether a
taxpayer accounts for the retired asset in a single asset account or in a
multiple asset account (e.g., a general asset account or a mass asset
account). See section 1.165-3(b); section 1.167(a)-1(c); section
1.167(a)-11(d)(3)(x); Rev. Rul. 74-455, 1974-2 C.B. 63; Rev. Rul. 75-150,
1975-1 C.B. 73. But see section 280B, requiring that the costs of
demolishing buildings be added to the basis of the land, and section
1.165-3(a), requiring capitalization of demolition costs when the taxpayer
acquires an asset with the intent to demolish it. See, e.g., Wood County
Telephone Co. v. Commissioner, 51 T.C. 72 (1968); Rev. Rul. 69-62, 1969-1
C.B. 58.

The removal costs of Poles A and B are not required to be capitalized
under section 263(a). In both situations 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 fact that Poles
A and B are retired as part of a replacement project does not mean that
the removal costs are required to be capitalized under section 263(a).
Furthermore, the removal costs are not required to be capitalized under
section 263A because the costs are incurred for the purpose of retiring
Poles A and B and not by reason of the installation of Poles C and D. The
analysis in this ruling does not apply to the removal of a component of a
depreciable asset, the costs of which are either deductible or
capitalizable based on whether replacement of the component constitutes a
repair or an improvement. See section 1.162-4 and section 1.263(a)-1(b).


HOLDING

If the retirement and removal of a depreciable asset occurs in
connection with the installation or production of a replacement asset, the
costs incurred in removing the retired asset are not required to be
capitalized under section 263(a) or 263A as part of the cost of the
replacement asset.


APPLICATION

Any change in a taxpayer's method of accounting to conform with this
revenue ruling is a change in method of accounting to which the provisions
of sections 446 and 481 and the regulations thereunder apply. Except for
assets for which depreciation is determined in accordance with section
1.167(a)-11 (ADR), the taxpayer's new method of treating removal costs for
assets accounted for in a multiple asset account must be consistent with
the taxpayer's method of treating salvage proceeds. See Rev. Rul. 74-455.
(See sections 2.01 and 2.02 of the Appendix of Rev. Proc. 99-49, 1999-52
I.R.B. 725, for changing a taxpayer's present method of treating salvage
proceeds.) A taxpayer wanting to change its method of accounting to
conform with the holding in this revenue riding must follow the automatic
change in accounting method provisions of Rev. Proc. 99-49, except that
the scope limitations in section 4.02 of Rev. Proc. 99-49 do not apply.
However, if the taxpayer is under examination, before an appeals office,
or before a federal court with respect to any income tax issue, the
taxpayer must provide a copy of the Form 3115, Application for Change in
Accounting Method, to the examining agent(s), appeals officer, or counsel
for the government, as appropriate, at the same time that it files the
copy of the Form 3115 with the national office. The Form 3115 must contain
the name(s) and telephone number(s) of the examining agent(s), appeals
officer, or counsel for the government, as appropriate. In addition, if
the asset is public utility property within the meaning of section
168(i)(10) or former section 167(l)(3)(A), the taxpayer must comply with
the terms and conditions in section 2.01(3)(b)(vi) of the Appendix of Rev.
Proc. 99-49.


EFFECT ON OTHER DOCUMENTS

Rev. Proc. 99-49 is modified and amplified to include this change in
accounting method in the APPENDIX.


DRAFTING INFORMATION

The principal author of this revenue ruling is Beverly Katz of the
Office of Assistant Chief Counsel (Income Tax and Accounting). For further
information regarding this revenue ruling contact Ms. Katz on (202)
622-4950 (not a toll-free call).

<<END RULING>>

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