Removal costs held deductible.

• Author: Passman, Maury
• Position: Depreciable assets

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...