Rev. Rul. 65-264

The Internal Revenue Service has been asked to clarify its position on the allowance of depreciation deductions with respect to easement acquisition costs incurred in connection with the location and acquisition of oil and gas pipeline rights-of-way under easement agreements, and also with respect to costs for clearing and grading attributable to both the original pipeline and one or more looplines.

The expenditures in question may include, but are not limited to, legal fees, travel expenses and salaries of right-of-way agents, roddage fees for traversing land, severance and crop damages, and any other consideration to landowners, surveying and mapping costs, costs of clearing and grading of the rights-of-way and damages attributable thereto. The expenditures do not include the ordinary and necessary maintenance and repair expenses incurred to keep the rights-of-way in their normal operating state.

Section 167(a) of the Internal Revenue Code of 1954 provides generally that there shall be allowed as a depreciation deduction a reasonable allowance for the exhaustion, wear and tear (including a reasonable allowance for obsolescence) of property used in the trade or business, or of property held for the production of income.

Section 1.167(a)-3 of the Income Tax Regulations provides, in part, that if an intangible asset is known from experience or other factors to be of use in the business or in the production of income for only a limited period which can be estimated with reasonable accuracy, such intangible asset can be the subject of a depreciation allowance. An intangible asset, the useful life of which is not limited, is not subject to the allowance for depreciation.

The intangible assets here generally do not, like patents and copyrights, have a definitely limited life independent of their association with other assets used in the trade or business or in the production of income.

For present purposes, then, the question is whether these intangible assets have a useful life which is limited by the life of related assets having a determinable useful life.

Northern Natural Gas Company v. O'Malley and Northern Natural Gas Company v. McCrory, 277 Fed. (2d) 128 (1960), involved the depreciation of easement acquisition costs attributable to pipeline rights-of-way which were to continue "so long as such pipelines and appurtenances thereto shall be maintained." The United States Court of Appeals for the Eight Circuit, in allowing a depreciation deduction, measured the life of the rights-of-way by the estimated life of the taxpayer's proven gas reserves. Revenue Ruling 60-317, C.B. 1960-2, 452, states that the Service will not follow the decision in the Northern Natural Gas Company cases because the useful lives of the several easement agreements involved therein could not be estimated with reasonable accuracy. It continues to be the position of the Service that generally such easement acquisition costs are attributable to assets with an indeterminable useful life and that they are not depreciable based upon the asserted life of proven oil or gas reserves. Experience demonstrates that, as proven reserves are used up, new reserves usually become available to replace them in whole or part. Further, among other things, the specific oil or gas fields serviced by a pipeline may change from year to year and a pipeline may be extended or connected to other pipelines.

On the other hand, if the taxpayer can demonstrate in a particular case that certain easement acquisition costs will have a limited life because they will no longer be useful after the expiration of the useful life of a related pipeline, then such costs may be depreciated.

The taxpayer must establish that the intangible assets will not be useful in the construction of additional pipelines. For this purpose, the term "additional pipelines" includes both looplines and any replacement pipeline in the same trench. Absent such a showing, there would be no basis for a conclusion that the usefulness of the intangible assets was limited by the life of a related pipeline.

As stated in Revenue Ruling 55-729, C.B. 1955-2, 53, with reference to expenditures in connection with the development of a hydropower project, "if the useful life of the project is reasonably susceptible of measurement either now or in the future, or if it is possible to make a reasonable determination with respect to the abandonment of the project, these expenditures may be amortized over the remaining life of the project." Likewise, in the present context, if it is not possible at the time when the expenditures here in question are incurred to make a determination that the useful life of a particular easement is reasonably susceptible of measurement, but at some future time it becomes possible to make such a determination, the expenditures may be amortized over such part of the life of the easement as remains at the time of such determination.

Similarly, if the taxpayer can demonstrate in a particular case that clearing and grading will have a limited life because it will no longer be useful after the expiration of the useful life of a related pipeline, then the clearing and grading costs may be depreciated. The taxpayer must make the same kind of showing as is specified above with respect to easement acquisition costs. Those clearing and grading costs which do not meet this test may not be depreciated.

Clearing and grading costs which may be depreciated under the conditions set out above are costs of intangible assets even though their useful life is conterminous with the life of a particular pipeline.

From the above discussion, it should be apparent that easement acquisition costs and costs for clearing and grading represent expenditures for intangible assets which can in some circumstances be subject to a depreciation allowance. In accordance with the law applicable to depreciation, deductions may be allowed only where the useful life of these intangible assets can be determined with reasonable accuracy. In any given case, the burden of proof is on the taxpayer. Such burden is considered to be met where it can be factually demonstrated that the usefulness of such intangible assets will not extend beyond the expiration of the useful life of a particular pipeline to which such costs are solely related.

For purposes of this ruling, clearing and grading costs do not include costs of excavating, backfilling and regrading incurred to lay a pipeline in a trench; such costs are considered part of the cost of installing the pipeline in the trench and may be depreciated as part of the cost of constructing the pipeline although a replacement pipeline may at some later time be installed in the same trench.

Revenue Ruling 60-317, C.B. 1960-2, 452, is hereby clarified.

¹ Also released as Technical Information Release 777, dated Nov. 3, 1965.