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Large Business & International Directive for Taxpayers Changing to the Method of Accounting Provided in Rev. Proc. 2013-24 for Steam or Electric Generation Property

June 10, 2013

LB&I Control No: LB&I-04-0713-005
Impacted IRM 4.51.5

 

MEMORANDUM FOR ALL LARGE BUSINESS & INTERNATIONAL EMPLOYEES

 

FROM: Paul D. DeNard
Acting Commissioner, Large Business & International Division

 
SUBJECT: Large Business & International Directive for Taxpayers
Changing to the Method of Accounting Provided in Rev. Proc. 2013-24 for Steam or Electric Generation Property

                                   

Introduction

This memorandum provides direction to the field in the examination of a taxpayer eligible to change to the method of accounting provided in Rev. Proc. 2013-24 for steam or electric generation property.  The revenue procedure provides definitions of units of property and major components taxpayers may use to determine whether expenditures to maintain, replace, or improve steam or electric power generation property must be capitalized under § 263(a) of the Internal Revenue Code.

LB&I Directive No. 04-0313-001(issued March 22, 2013) which replaced Directive 04-0312-004 (issued March 15, 2012) (hereinafter  "Stand Down Directive") requires agents to stand down or suspend current examination activity on certain issues involving:

  1. Whether costs incurred to maintain, replace or improve tangible property must be capitalized under I.R.C. § 263(a); and
  1. Any correlative issues involving the disposition of structural components of a building or dispositions of tangible depreciable assets.

The Stand Down Directive continues to apply to whether costs incurred to maintain, replace or improve steam or electric generation property must be capitalized under I.R.C. § 263(a) and to any correlative issues involving the disposition of structural components of a building or dispositions of tangible depreciable assets.

The use of the definitions of units of property and major components provided in Rev. Proc. 2013-24 is only permitted under the terms and conditions contained therein, and should not be considered for purposes of resolving capitalization issues in prior open exam years under any circumstances.  This steam or electric generation property   directive provides the guidance for addressing prior open exam years. This directive applies to taxpayers who are eligible to use Rev. Proc. 2013-24, whether or not a request to change to the definitions of units of property and major components has been filed.

Background

Taxpayers that generate steam or electric power incur significant expenditures to maintain, replace, and improve generation property.  Whether these expenditures are deductible as repairs under I.R.C. § 162 or must be capitalized as improvements under § 263(a) depends on whether the expenditures materially increase the value of the property or appreciably prolong its life.   In general, under I.R.C. §263(a) the cost of replacing a unit of property or major component must be capitalized. 

A generation plant is composed of numerous functionally interdependent items of machinery and equipment, and it can be difficult to identify which items constitute discrete units of property, major components, or something else.  As a consequence, taxpayers and the Internal Revenue Service often disagree about whether the cost to replace a particular item is a capital or deductible expense. 

A taxpayer's method for determining whether an expenditure is deducted or is capitalized, including unit of property and major component definitions, is a method of accounting under I.R.C.§ 446.  I.R.C. § 446(e) and Income Tax Regulation § 1.446-1(e) require taxpayers to secure the consent of the Commissioner before changing a method of accounting for Federal income tax purposes.  Regulation §1.446-1(e)(3)(ii) authorizes the Commissioner to prescribe administrative procedures setting forth the limitations, terms, and conditions necessary to permit a taxpayer to obtain consent to change a method of accounting.

Rev. Proc. 2013-24 provides definitions of units of property and major components for steam or electric generation property to which taxpayers may apply I.R.C. § 263(a) to determine whether expenditures to maintain, replace, and improve steam or electric generation property are required to be capitalized.  For those taxpayers eligible to change to using the unit of property and major component definitions provided in Rev. Proc. 2013-24, this directive sets forth guidance to the field related to examination activity relating to capital versus repair treatment for expenditures on utility steam or electric generation property.

Planning and Examination Guidance - Tax Years Ending Before December 31, 2012

For taxable years ending before December 31, 2012, examiners should discontinue current examination activity involving whether costs incurred to maintain, replace, or improve steam or electric generation property must be capitalized under I.R.C. § 263(a).  This discontinuation only applies to positions taken on original returns filed for the years ending before December 31, 2012.  Please contact the LB&I Issue Practice Group (IPG) for Deductible and Capital Expenditures for guidance on claims.

Revenue Procedure 2013-24 waives the scope limitations for a request to change a method of accounting that normally apply to a taxpayer under examination, for the taxpayer’s first, second and third taxable year ending after December 30, 2012.  If a taxpayer with applicable asset expenditures has not changed to using the definitions of units of property and major components provided in Rev. Proc. 2013-24 for its first, second or third taxable year ending after December 30, 2012, the examiner should follow the guidance under Planning and Examination Guidance – Tax Years Ending On or After December 31, 2012 as provided in the next section.   

Discontinuing the examination of the capital versus repair expense issue should include the following steps:

  1. Withdraw Forms 4564, Information Document Request, or portions thereof, relating to the development of this issue for steam or electric generation property.
  1. Withdraw all outstanding Forms 5701, Notice of Proposed Adjustment, which propose an adjustment to repair expenses related to whether costs incurred to maintain, replace, or improve steam or electric generation property must be capitalized under I.R.C. § 263(a).
  1. Develop and issue a Form 5701 with a Form 886-A, Explanation of Adjustments, containing the following language:

The Service neither accepts nor rejects the position stated in the tax return related to the method to determine the proper repair expense with respect to steam or electric generation property. [Insert taxpayer name] will be allowed a three-year period to change to all, or some, of the definitions of units of property and major components provided in Rev. Proc. 2013-24.  If all, or some, of the definitions are adopted, a change in method of accounting can be made in accordance with Section 6 of Rev. Proc. 2013-24 for all of the steam or electric generation property.  If [Insert taxpayer name] has not changed to using the unit of property and major component definitions provided in Rev. Proc. 2013-24 in its first, second or third taxable year ending after December 30, 2012, the repair expense will be subject to risk assessment and possible examination for taxable years ending on or after December 31, 2014.

  1. After the taxpayer has signed the Form 5701 with the 886A, Explanation of Adjustments, upload the documents into the Information Management System (IMS) to substantiate for the subsequent examination team that the taxpayer was notified of the Service's position to discontinue the issue.
  1. Retain copies of pertinent workpapers in the IMS file or other central location permitted by I.R.M. 4.46.7.2.3(c) & (d).
  1. Complete the Form 5346, Examination Information Report, in accordance with the specific instructions provided for this issue located on the IPG for Deductible and Capital Expenditures website.
  1. Confirm the issue was input into IMS as follows: UIL 263.14-01, and Issue Tracking Attribute Code 1400.

 

Planning and Examination Guidance – Tax Years Ending On or After December 31, 2012

When examining returns of utility companies for taxable years ending on or after December 31, 2012, examiners should determine if the taxpayer filed a Form 3115, Application for Change in Accounting Method, to change to using the definitions of units of property and major components provided in Rev. Proc. 2013-24.

  1. If the taxpayer changes to all, or some, of the definitions of units of property and major components, then the examiner should determine if the change is  consistent with Rev. Proc. 2013-24 (including whether the I.R.C. § 481(a) adjustment was accurately computed).  If the change is not consistent, then a determination needs to be made whether the taxpayer correctly changed to the method, and the examiner, if needed, may consult with the IPG for Deductible and Capital Expenditures for further guidance.
  1. Section 481(a) adjustment
    1. When changing under the Rev. Proc. 2013-24, a taxpayer must take the entire net § 481(a) adjustment into account (whether positive or negative) in computing taxable income in the year of change.
    2. If, prior to the issuance of Rev. Proc. 2013-24, the taxpayer filed a Form 3115 to change the treatment of expenditures for steam or electric generation property, then the I.R.C. § 481(a) adjustment resulting from a change under Rev. Proc. 2013-24 (“new I.R.C. § 481(a) adjustment”) should account for any previous I.R.C. § 481(a) adjustment (“old I.R.C. § 481(a) adjustment”). 
    3. The new I.R.C. § 481(a) adjustment must properly account for steam or electric generation property repair expenses that were computed under the taxpayer’s prior method and deducted under I.R.C. § 162 in the interim years between the old and new I.R.C. § 481(a)adjustments.
  1. If the taxpayer does not change to all, or some, of the definitions of units of property and major components provided in Rev. Proc. 2013-24 for the first or second taxable year ending after December 30, 2012, then the examiner should not commence any examination activity involving the repair deduction claimed with respect to steam or electric generation property since the taxpayer could still change to the method for the third taxable year ending after December 30, 2012.
  1. If the taxpayer does not change to all, or some, of the definitions of units of property and major components provided in Rev. Proc. 2013-24 for the first, second, or third taxable year ending after December 30, 2012, then the agent should perform a risk assessment to determine the materiality of the repair deduction claimed with respect to the steam or electric generation property.  If the result of the risk assessment is deemed to be material, the examiner should examine the deduction utilizing I.R.C. § 263(a) and the Treasury Regulations under § 263(a).

Contacts

If you have any questions, please contact the IPG for Deductible and Capital Expenditures.

This Directive is not an official pronouncement of law and cannot be used, cited, or relied upon as such.

 

cc:     Division Counsel, LB&I
         Chief, Appeals

Page Last Reviewed or Updated: 15-Jul-2013