Rev. Rul. 72-96

Advice has been requested whether, under the circumstances described below, the costs for a reservoir, which includes costs for a dam structure, roadway, and clearing, stripping and grading the reservoir site are for tangible property subject to depreciation and the investment credit.

On land it owned an electric utility company constructed and placed in service in 1965, a dam to impound water for use in a steam turbine electric generating plant. The dam site was prepared by stripping the river bed of overburden and excavating to bedrock. Concrete was poured to fill the joints and cracks in the bedrock and to level its profile and earth fill materials were added thereafter. The dam is of composite construction consisting of compacted material supported and protected by rock. The dam includes a reinforced concrete spillway, also excavated to bedrock, which was constructed complete with drains and floodgates. There is also a hard surfaced roadway along the top of the dam. In conjunction with the construction of the dam the reservoir area was cleared, stripped and graded.

Section 167 of the Internal Revenue Code of 1954 allows as a depreciation deduction a reasonable allowance for the exhaustion, wear and tear (including a reasonable allowance for obsolescence) of (1) property used in the trade or business, or (2) property held for the production of income.

Section 1.167(a)-1 of the Income Tax Regulations, in defining what constitutes a reasonable allowance for depreciation, states that the amounts of depreciation set aside, plus the salvage value, will at the end of the estimated useful life of the depreciable property equal the cost or other basis of the property.

Section 1.167(a)-2 of the regulations provides in part that the depreciation allowance in the case of tangible property applies only to that part of the property that is subject to wear and tear, to decay or decline from natural causes, to exhaustion, and to obsolescence. The allowance does not apply to land, apart from the improvements or physical development added to it.

Section 48(a)(1) of the Internal Revenue Code of 1954 provides, in pertinent part, that the term "section 38 property" means tangible personal property or other tangible property (not including a building or its structural components) but only if such other property is used as an integral part of among other activities, furnishing electrical energy. In order to qualify as "section 38 property," the property must be property with respect to which depreciation is allowable and must have a useful life of 4 years or more. Section 1.48-1(b) of the regulations provides that a deduction for depreciation is allowable if the property is of a character subject to the allowance for depreciation under section 167 and the basis (or cost) of the property is recovered through a method of depreciation. Section 1.48-1(d)(1) of the regulations provides, in part, that property used in the furnishing of electric energy by a person engaged in the trade or business, qualifies as "section 38 property". Section 1.48-1(d)(4) of the regulations provides that property is used as an integral part of a qualified activity if it is used directly in the activity and is essential to the completeness of the activity.

Land preparation costs are generally not considered to be tangible property subject to depreciation. See Rev. Rul. 65-265, C.B. 1965-2, 52. However, where land preparation costs are so closely associated with depreciable assets and would be retired, abandoned or replaced contemporaneously with depreciable assets they are associated with, such costs are also depreciable. See Revenue Ruling 68-193, C.B. 1968-1, 79, which clarifies Revenue Ruling 65-265.

In the instant case the costs for the land preparation of the reservoir site are closely associated with the construction of the dam. The dam including the reinforced concrete spillway with drains and floodgates and natural earth material impound water to be used in the production of electricity from steam. While the dam structure, roadway, and clearing, stripping and grading the site could not be depreciated under Revenue Procedure 62-21, C.B. 1962-2, 418, and cannot be depreciated under Revenue Procedure 72-10, page 721, this Bulletin, they are assets with respect to which depreciation is allowable and are depreciated over the reasonably expected period of use in connection with present and future steam-electric generating facilities. See Revenue Ruling 71-121, C.B. 1971-1, 80, concerning the useful life for a dam and reservoir site.

Accordingly, the reservoir in the instant case, including the dam structure, roadway, and clearing, stripping and grading of the reservoir site, is depreciable property and is "other tangible property" for investment tax credit purposes.