Rev. Rul. 84-22

1984-1 C.B. 35, 1984-7 I.R.B. 4.

                       Internal Revenue Service
                                 Revenue Ruling

                  DEPRECIATION;  RAILROAD CROSS TIES REPLACED

                          Published: February 13, 1984

SECTION 167. - -DEPRECIATION, 26 CFR 1.167(a)-1: Depreciation in general

(Also Section 263; 1.263(a)-1.)

  Depreciation;  railroad cross ties replaced.  When a railroad company uses the retirement-replacement-betterment method of accounting, the cost of replacing wood cross ties with concrete ties is to be expensed as a replacement.  Rev. Rul. 68-418 revoked.

ISSUE

  When a railroad company uses the "retirement-replacement -betterment" method  (RRB) of accounting, should the cost of replacing wood cross ties with concrete ties be capitalized as a betterment or expensed as a replacement?

FACTS

  In 1961, X, a railroad company, built an addition to its railroad tracks using wooden cross ties.  X was using the RRB method of accounting for depreciation of its track structure.  In 1972, X replaced some of the wooden cross ties with concrete cross ties and treated the cost of such installation as a current expense rather than a capital expenditure.

LAW AND ANALYSIS

  Section 167(a) of the Internal Revenue Code provides as a depreciation deduction a reasonable allowance for the exhaustion, wear and tear, including obsolescence, of property used in the trade or business, or of property held for production of income.  In taxable years before January 1, 1981, former Section 167(r) provided that in the case of railroad track used by a railroad company, "reasonable allowance" includes an allowance for such track computed under the RRB method.

  Under the RRB method of depreciation, the initial investment in the track structure, including labor costs, is capitalized.  The cost of replacements, less salvage value, is expensed.  If there is replacement of part of the track structure with a betterment, the betterment portion is capitalized and the cost of the replacement portion, less salvage value, is expensed.  See Rev. Rul. 67- 22, 1967-1 C.B. 52.

  Rev. Rul. 68-418, 1968-2 C.B. 115, holds that for purposes of RRB method, the installation of concrete cross ties to replace wooden ties is a betterment, the cost of which should be capitalized under section 263 of the Code.  On the basis of the evidence presented with respect to the year in issue, 1968, the Court in Florida East Coast Railway v. United States, Trial Div. No. 22-78 (Ct.Cl.1982), 82-2 USTC 9511, concluded that the concrete cross ties there had extensive developmental failures.  Thus, those concrete cross ties could not be characterized as a betterment.

  Section 263(f) of the Code, added by the Tax Reform Act of 1976, 1976-3 C.B.  (Vol. 1) 1, provides that in the case of railroads using the RRB method of accounting, expenditures for acquiring and installing replacement ties of any material shall be accorded the same accounting treatment as expenditures for replacement ties.

  In light of the enactment of section 263(f) of the Code and the evidence in Florida East Coast Railway Co. the Service will no longer advance the position that the installation of concrete cross ties for wood cross ties is a betterment the costs of which are to be capitalized.  Rather, under the RRB method of depreciation accounting, such costs will be considered to be for replacements that can be expensed.

HOLDING

  When a railroad company uses the retirement-replacement-betterment method of accounting, the cost of replacing wood cross ties with concrete ties is to be expensed as a replacement.

EFFECT ON OTHER DOCUMENTS

  Rev. Rul. 68-418 is revoked.

  The Economic Recovery Tax Act (ERTA) of 1981, section 203(c)(1), 1981-2 C.B. 256, 284, repealed section 167(r) of the Code.  The accelerated cost recovery system (ACRS) of section 168(a) is applicable to recovery property placed in service after 1980.

Rev. Rul. 84-22, 1984-1 C.B. 35, 1984-7 I.R.B. 4.