## Internal Revenue Bulletin: 2013-22 |

## May 28, 2013 |

.01 *In general*. This appendix provides
an extrapolation methodology an eligible taxpayer may use in connection
with a change in method of accounting to use the unit of property
and major component definitions provided by this revenue procedure.
The extrapolation methodology described in this Appendix B provides
the exclusive extrapolation methodology that is permitted under the
method of accounting provided in this revenue procedure for determining
the amount of a § 481(a) adjustment.

.02 *Scope.* This revenue procedure, including
this Appendix B, does not apply to property for which a taxpayer does
not use a unit of property determination provided in Appendix A to
this revenue procedure.

.01 *In general*. A taxpayer making a change
to apply the method of accounting provided by this revenue procedure
may use the extrapolation procedures provided in this Appendix B to
determine the § 481(a) adjustment resulting from the change
in method of accounting. Generally, the taxpayer first applies the
method to a testing period of recent, representative years, and derives
an average repair deduction under the method of accounting, as a percentage
of total capital additions (for financial accounting purposes). This
percentage, adjusted by a reduction percentage that varies based on
time, is then applied to the adjusted capital additions (for financial
accounting purposes) for prior years for which extrapolation is used
to derive a deemed § 481(a) adjustment amount for each year.
These extrapolated § 481(a) adjustment amounts are then
combined with the actual adjustment amounts for years in which the
§ 481(a) adjustment is calculated in the normal manner to
arrive at the total § 481(a) adjustment attributable to
the change in method of accounting.

.02 *Calculation methodology*. In order
to determine the amount of the § 481(a) adjustment when
extrapolation is applied, the following calculation methodology must
be used:

(1) *Testing period*. First, a testing period
is determined as follows:

(a) *In general*. The taxpayer must use
as the testing period a minimum of three consecutive taxable years
(“testing years”), except as described in paragraph 2.02(1)(b)(ii)
of this Appendix B. Generally, the final year of the testing period
is the taxable year preceding the year of change. Alternatively,
a taxpayer may choose the year of change as the final year of the
testing period.

(b) *Representative years required*. The
testing years must be representative of all years included in the
§ 481(a) adjustment.

(i) In determining whether a year is representative, a taxpayer must take into account restructuring transactions, including acquisitions and dispositions, as well as any other events, that may have triggered large capital additions.

(ii) If one of the taxable years in the testing period described in section 2.02(1)(a) of this Appendix B is not representative, the taxpayer must exclude data from the non-representative year from the testing period and use data from the fourth most recent taxable year to establish a testing period (with such fourth most recent taxable year being a testing year). If the fourth most recent taxable year is not representative either, the taxpayer must consult with its examining agent or team to determine whether extrapolation is appropriate in the taxpayer’s situation.

(c) *Additional years*. Under the extrapolation
calculation methodology, if the taxpayer has sufficient data to calculate
the repair deduction percentage for more than three years, the taxpayer
may include those years in the testing period. The additional testing
years must be consecutive years that immediately precede the original
three-year testing period, except that a year that is not representative,
as described in section 2.02(1)(b) of this Appendix B, should be excluded.
A taxpayer may not use, as an additional testing year, a year that
is separated from the rest of the testing period by more than one
non-representative year.

(2) *Repair deduction percentage*. Second,
a repair deduction percentage for each year for which extrapolation
is used (“extrapolation year”) is computed as follows,
using data from the testing period.

(a) *Repair deductions during the testing period under
the proposed method*. For each testing year, the amount
of repair expenses that would be deductible under the method of accounting
provided in this revenue procedure, before taking into account book-tax
basis adjustments, is determined.

(b) *Tentative repair deduction percentage*. The sum of the deductible repair expenses for all testing years
in the testing period, as determined under section 2.02(2)(a) of this
Appendix B, is then divided by the sum of all capital additions during
the testing period. For this purpose, a taxpayer must use capital
additions for financial statement purposes (“book capital additions”).
The resulting ratio represents the average percentage of capitalized
additions that are properly treated as deductible repair expenses
under the taxpayer’s proposed method of accounting (“tentative
repair deduction percentage”), before taking into account book-tax
basis adjustments.

(c) *Repair deduction percentage for an extrapolation
year*. The tentative repair deduction percentage is then
multiplied by a reduction percentage for each extrapolation year.
For each extrapolation year, the reduction percentage is determined
by using the formula (1- (0.10*(*X*/*Y*))), where *X* equals the number of years the
extrapolation year precedes the final year of the testing period and *Y* equals the total of number of taxable years in the testing
period. The reduction percentage for an extrapolation year multiplied
by the tentative repair deduction percentage equals the repair deduction
percentage for the extrapolation year.

(3) *Extrapolation year tentative repair deduction
amount*. Third, a tentative repair deduction amount under
the proposed method is calculated for each extrapolation year.

(a) The repair deduction amount for an extrapolation year is calculated by multiplying the repair deduction percentage for the extrapolation year (determined in section 2.02(2) of this Appendix B) by the book capital additions for the extrapolation year.

(b) In determining the repair deduction amount for an extrapolation year, a taxpayer must account for any book-tax basis adjustments for property placed in service in the extrapolation year. Book-tax basis adjustments for property placed in service in the extrapolation year may be accounted for by multiplying the tentative repair deduction amount for an extrapolation year by the taxpayer’s book-to-tax adjustment percentage for the extrapolation year. Tax adjustments that must be accounted for include, among other things, the following types of adjustments:

(i) adjustments resulting from a change in method of accounting permitted under Rev. Rul. 2000-7, 2000-1 C.B. 712, involving the treatment of the costs incurred in removing retired assets;

(ii) adjustments resulting from a change in the treatment of capitalized amounts determined under § 263A, including reductions for additional mixed service costs allocated to inventory and adjustments to account for changes to interest capitalization amounts;

(iii) adjustments arising from casualty loss deductions recognized under § 165; and

(iv) adjustments resulting from research and experimental expenditures deducted under § 174.

(4) *Repair allowance adjustment and repair deduction
amount*. Fourth, for each extrapolation year in which the
repair allowance election under § 1.167(a)-11(d)(2) (ADR
repair allowance) was made, the tentative repair deduction amount
must be reduced by the cost of repairs to generation property attributable
to ADR repair allowance property. To determine the reduction where
a prior ADR repair allowance election was made for generation property,
taxpayers must use a method comparable to the method actually used
to allocate qualified repair expenditures to repair allowance property
for that year. For example, if in applying § 1.167(a)-11(d)(2)
for the 1997 taxable year a taxpayer determined that 73 percent of
its 1997 qualified repair expenditures for generation property were
attributable to repair allowance property, then that same percentage
(73%) must be applied to determine the reduction to the repair deduction
amount otherwise calculated under section 2.02(3) of this Appendix
B. The amount determined after reducing the tentative repair deduction
amount by the cost of repairs attributable to ADR repair allowance
property is the repair deduction amount for the extrapolation year.

(5) *Tentative § 481(a) adjustment amount*. Fifth, the tentative § 481(a) adjustment amount for
each extrapolation year is determined. The tentative § 481(a)
adjustment amount for each extrapolation year is calculated by subtracting
the repair deduction amount for the extrapolation year, as determined
in sections 2.02(1) through 2.02(4) of this Appendix B, from the amount
of repair expenses the taxpayer deducted for that year under its prior
method of accounting (including § 481(a) adjustments resulting
from any prior method change). The difference, whether positive or
negative, is the tentative § 481(a) adjustment amount for
the extrapolation year.

(6) *Extrapolation year § 481(a) adjustment
amount*. Sixth, the tentative § 481(a) adjustment
amount for each extrapolation year must be adjusted to account for
any differences in depreciation, credits, or any other cumulative
differences in deductions between the extrapolation year and the year
of change resulting from the taxpayer’s proposed method of accounting.
For instance, if under the proposed method a taxpayer’s repair
deduction for an extrapolation year would be tentatively increased
by $1,000, such that the unadjusted basis of the property placed in
service would be correspondingly decreased by $1,000, the $1,000 tentative
repair deduction increase for the extrapolation year must be reduced
by the portion of the $1,000 in unadjusted basis that the taxpayer
had recovered prior to the year of change.

(7) *Total § 481(a) adjustment*. Finally, the total § 481(a) adjustment attributable
to the change to the taxpayer’s proposed method of accounting
is determined. The total § 481(a) adjustment for the year
of change is calculated by combining the § 481(a) adjustment
amounts for all extrapolation years, as described in this section
2.02, with the adjustment amounts, after taking into account book-tax
basis adjustments, for years determined under § 481(a) in
the normal manner.

.03 *Example*. In 2012, W, a calendar year
taxpayer, changes its method of accounting for all of W’s electric
generation property to use the unit of property and major component
definitions provided in Appendix A of this revenue procedure. W uses
the extrapolation methodology provided in section 2 of this Appendix
B to determine the amount of its § 481(a) adjustment attributable
to taxable years 1992 through 2008.

Following the general rule in section 2.02(1) of this Appendix B, W uses as its testing period 2009, 2010, and 2011, the three consecutive taxable years ending with 2011, the year preceding the year of change. Assume that each of 2009, 2010, and 2011 are representative of all years included in W’s § 481(a) adjustment.

W’s book capital additions for 2009, 2010, and 2011 are $3,000, $3,000, and $4,000, respectively, for a total of $10,000. Of these amounts, the portions that are properly treated as deductible repair expenses resulting from the application of W’s proposed method of accounting for 2009, 2010, and 2011, before taking into account book-tax basis adjustments, are $300, $400, and $300, respectively, for a total of $1,000.

For 2003, W’s book capital additions are $3,333. W’s book-to-tax adjustment percentage for 2003 is 90%. In 2003, W elected to apply the ADR repair allowance under § 1.167(a)-11(d)(2), which applied to 25% of W’s generation property. Under W’s prior method of accounting (prior to application of the method of accounting provided by this revenue procedure), W deducted $150 in repair expenses in 2003.

W determines its section 481(a) adjustment for 2003 as follows:

*Step 1*. W determines that it will use
taxable years 2009, 2010, and 2011 as the testing years in its testing
period.

*Step 2*. W calculates its repair deduction
percentage for 2003. First, a tentative repair deduction percentage
is calculated using data from the testing period (taxable years 2009,
2010, and 2011). Book capital additions that are properly treated
as deductible repair expenses resulting from the application of the
proposed method of accounting, before taking into account book-tax
basis adjusments, for 2009, 2010, and 2011, the testing years that
comprise the testing period, equal $1,000 ($300 + $400 + $300). Total
book capital additions for the testing period are $10,000 ($3,000
+ $3,000 + $4,000). W’s tentative repair deduction percentage
is 10% ($1,000 / $10,000).

Next, W calculates the reduction percentage for each extrapolation
year using the formula (1 - 0.10 * (*X/Y*)), where *X* equals the number of years the extrapolation year precedes
2011, the final year of the testing period, and *Y* equals 3, the number of years in the testing period. The reduction
percentage for each extrapolation year is calculated as follows:

Taxable Year |
Reduction Percentage Calculation(Step A) |
Reduction Percentage Calculation(Step B) |

2008 | 0.10 * (3/3) = 0.10 | 1 - 0.10 = 0.90 = 90.0% |

2007 | 0.10 * (4/3) = 0.133 | 1 - 0.133 = 0.867 = 86.7% |

2006 | 0.10 * (5/3) = 0.167 | 1 - 0.167 = 0.833 = 83.3% |

2005 | 0.10 * (6/3) = 0.20 | 1 - 0.20 = 0.80 = 80.0% |

2004 | 0.10 * (7/3) = 0.233 | 1 - 0.233 = 0.767 = 76.7% |

2003 | 0.10 * (8/3) = 0.267 | 1 - 0.267 = 0.733 = 73.3% |

2002 | 0.10 * (9/3) = 0.30 | 1 - 0.30 = 0.70 = 70.0% |

2001 | 0.10 * (10/3) = .333 | 1 - 0.333 = 0.667 = 66.7% |

2000 | 0.10 * (11/3) = .367 | 1 - 0.367 = 0.633 = 63.3% |

1999 | 0.10 * (12/3) = .40 | 1 - 0.40 = 0.60 = 60.0% |

1998 | 0.10 * (13/3) = .433 | 1 - 0.433 = 0.567 = 56.7% |

1997 | 0.10 * (14/3) = .467 | 1 - 0.467 = 0.533 = 53.3% |

1996 | 0.10 * (15/3) = .50 | 1 - .50 = 0.50 = 50.0% |

1995 | 0.10 * (16/3) = .533 | 1 - 0.533 = 0.467 = 46.7% |

1994 | 0.10 * (17/3) = .567 | 1 - 0.567 = 0.433 = 43.3% |

1993 | 0.10 * (18/3) = .60 | 1 - 0.60 = 0.40 = 40.0% |

1992 | 0.10 * (19/3) = .633 | 1 - 0.633 = 0.367 = 36.7% |

Finally, W’s calculates the repair deduction percentage for 2003 (7.33%) by multiplying the tentative repair deduction percentage (10%) by the reduction percentage for 2003 (73.3%).

*Step 3*. W calculates a tentative repair
deduction amount for 2003. First W multiplies its book capital additions
for 2003 ($3,333) by its repair deduction percentage (7.33%), resulting
in an initital tentative repair deduction amount of $244. Next, W
accounts for any book-tax basis adjustments for property placed in
service in 2003 by multiplying the initial tentative repair deduction
amount ($244) for 2003 by the taxpayer’s book-to-tax adjustment
percentage for 2003 (90%), resulting in a tentative repair deduction
amount of $220.

*Step 4*. W must reduce its tentative repair
deduction amount for 2003 to exclude repairs attributable to generation
property for which the taxpayer elected to apply the ADR repair allowance.
In 2003, W determined that 25 percent of its 2003 qualified repair
expenditures for generation property were attributable to repair allowance
property. Therefore, W reduces the repair deduction amount for 2003
($220) by 25% ($55), yielding a repair deduction amount for 2003 of
$165.

*Step 5*. W determines its tentative § 481(a)
adjustment amount for 2003. W subtracts the adjusted gross repair
deduction amount for 2003 ($165) from the amount of repair expenses
W deducted for 2003 under its prior method of accounting (as adjusted
for purposes of computing any prior § 481(a) adjustment)
($150). Therefore, W’s § 481(a) adjustment amount
for 2003 is negative $15.

*Step 6*. To determine its § 481(a)
adjustment amount for 2003, W must account for its decreased depreciation
deductions resulting from the additional $15 of deductible repair
expenditures permitted under the proposed method of accounting. Assuming
that the additional $15.00 of deductible repair expenditures for 2003
results in a $4.50 of reduction in cumulative depreciation expense
through the year of change that is attributable to the assets placed
in service in 2003, W’s § 481(a) adjustment amount
for the increased repair deductions that would have been permitted
in 2003 under the proposed method of accounting is negative $10.50
(-$15.00 + $4.50).

*Step 7*. To determine its total § 481(a)
adjustment, W combines the adjustments attributable to 1992 through
2008, computed using the extrapolation method in this Appendix B (as
described above for 2003), with the § 481(a) adjustments
attributable to 2009 through 2011, determined using the actual data
from those years and taking into account book-tax basis adjustments.
W must take the entire § 481(a) adjustment (whether positive
or negative) into account in 2012, W’s year of change.

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