Internal Revenue Service
Revenue Ruling

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 Rev. Rul. 70-1

1970-1 C.B. 54

Sec. 162
Sec. 263

IRS Headnote

Treatment of expenditures for reballasting railroad track by a taxpayer using the "retirement method" of accounting for depreciation.

Full Text

Rev. Rul. 70-1

Advice has been requested concerning the treatment for Federal income tax purposes of expenditures incurred by a taxpayer to apply additional ballast to its railroad tracks that have been previously ballasted.

The taxpayer, a railroad company, uses the "retirement method" of accounting for depreciation for the track structure. Under such method, which is described in Revenue Ruling 67-22, C.B. 1967-1, 52, "additions" are capitalized, "replacements with betterments" are partly capitalized and partly expensed, "replacements in kind and quality" are expensed, and "retirements without replacements" are expensed.

When originally constructing the new railroad tracks, the taxpayer applied ballast in accordance with its specifications for such tracks, and the cost of the ballast was capitalized. Since the tracks were originally constructed, the taxpayer has maintained the ballast for such tracks by using the "patch method." Under this method, additional ballast is applied to short segments of track, as required, to replace ballast lost, for example, through pulverization, erosion, disintegration, abrasion or other reasons. As long as the taxpayer used only the patch method, the ballast depth did not increase, nor did it result in a general raising of the track elevation.

Use of the patch method contrasts with the usual railroad industry practice of "out-of-face" ballasting (lifting the tracks out of the existing ballast and adding new ballast) of long stretches of track under an annual program.

After several years of using the patch method, the taxpayer instituted a five-year ballasting program to "reconstruct" certain of its track ballast sections, but it continued the "patch method" on its other tracks. Under the five-year ballasting program, the existing ballast is to be removed down to the bottom of the ties. New ballast is to be applied in varying quantities to provide a new, clean ballast section.

Except at certain locations, such as underpasses and on bridges where an increase in height is unacceptable, the track is to be raised on the new ballast, and the overall ballast depth increased.

The taxpayer proposes to account for the ballasting of its railroad tracks, under the five-year program, as follows: (1) the cost of ballast applied to tracks previously ballasted is to be expensed, regardless of whether the ballast merely replaces ballast lost or increases the ballast depth and raises the track; (2) however, if a superior type of ballast is applied (for example, cinders replaced with slag or stone), it is to be treated as a betterment (the difference between the cost of the ballast added over the current cost of the ballast replaced is to be capitalized), and the remainder of the cost of the ballast replaced (lost) is to be treated as expense; and (3) labor to place the ballast and to resurface track following the addition of ballast is to be treated as expense whether the cost of the ballast is to be capitalized or expensed.

Section 263 of the Code provides, in pertinent part, that generally no deductions shall be allowed for any amount paid out for permanent improvements or betterments made to increase the value of any property or estate.

Section 1.162-4 of the Income Tax Regulations states, in pertinent part, that the cost of incidental repairs which neither materially add to the value of the property nor appreciably prolong its life, but keep it in an ordinarily efficient operating condition, may be deducted as an expense provided the cost of acquisition, or production, or gain or loss of the taxpayer's plant, equipment or other property, as the case may be, is not increased by the amount of such expenditures.

Increasing the depth of ballast is an improvement, but under the retirement method of accounting, to capitalize resurfacing labor would duplicate the labor cost incurred for the initial surfacing (already capitalized and still in the capital account) with no additional benefit. Therefore, all the labor costs for applying the initial ballast is capitalized; but in a later application of ballast (whether the ballast cost is capitalizable in whole or in part) the labor to resurface the track is treated as expense.

Accordingly, it is held that cost for the additional ballast applied to the railroad track previously ballasted is to be capitalized by the taxpayer in those cases where the ballast depth is increased and the track raised, but the cost of the ballast added that merely replaces in kind ballast lost is an expense. Where a superior type of ballast is used in replacement, the ballast added is to be treated as a betterment to the extent that the cost is in excess of the current price of the type of ballast replaced; the remainder of the cost of the ballast added is to be treated as an expense (except to the extent the ballast depth is increased and the track raised). Furthermore, the cost of the labor to resurface the track as a result of the reballasting is an expense regardless of whether the ballast cost is capital or expense. Whether the additional ballast applied merely replaced ballast lost, or resulted in the ballast depth being increased and the track raised, is a question of fact coming under the jurisdiction of the District Director of Internal Revenue.