Rev. Rul. 71-121

Advice has been requested whether, under the circumstances described below, acquisition costs for a reservoir easement together with certain transmission line easements of a hydroelectric project of an electric utility company are subject to depreciation for Federal income tax purposes.

The costs of the reservoir easement consist of payments for the right to flood, for damages for road inundation and destruction of timber within the flooded area, for relocation of roads from within the reservoir area, for relocation of telephone lines, and for removal and reconstruction of a fish hatchery required under the terms of the Federal project license.

The costs incurred for transmission line easements with related clearing and grading are for the acquisition of rights to construct an electric transmission line from the hydroelectric generating site to the first point of interconnection with an existing electric transmission and distribution system.

Section 167 of the Internal Revenue Code of 1954 provides for an allowance for depreciation as follows:

(a) General Rule.--There shall be allowed as a depreciation deduction a reasonable allowance for the exhaustion, wear and tear (including a reasonable allowance for obsolescence)--

(1) of property used in the trade or business, or

(2) of property held for the production of income.

Section 1.167(a)-3 of the Income Tax Regulations provides in part, as follows: Intangibles. 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, the length of which can be estimated with reasonable accuracy, such an intangible asset may be the subject of a depreciation allowance. * * *

In the construction and development of the hydroelectric power project it was necessary for the company to acquire an easement for a reservoir site, access thereto, and the right (1) to relocate and reconstruct roads, telephone lines, and a fish hatchery, and (2) to flood the area thereby destroying the timber within it. These rights are similar in nature to a license or franchise in, over, or under the land of another and therefore are intangible assets when obtained. The subsequent exercise of such rights by rebuilding the roads, relocating the telephone lines, and reconstructing the fish hatchery at a new location, as well as paying for the destroyed timber and other damages, does not alter their intangible character. These rights are integral parts of the easements related to and part of the hydroelectric project site development and the costs incurred in exercising such rights are part of the easement acquisition costs. So too are the costs incurred for the transmission line easements with related clearing and grading that give the right to transmit electricity from the hydroelectric generating site to the first point of interconnection with the transmission and distribution system.

In Union Electric Co. of Missouri v. Commissioner, 10 T.C. 802 (1948), affirmed, 177 F. 2d 269 (1949), a useful life to the taxpayer was able to be determined on a rough approximation basis with respect to the dam used in connection with the hydroelectric power project. Whether the dam would ever be replaced at the end of its determinable useful life was purely speculative. It follows that whether the project as a whole will last longer than the dam is likewise speculative. See also Kentucky Utilities Co. v. Glenn and companion case, 250 F. Supp. 265 (1965).

In view of the foregoing, intangible easements acquired by a utility company for use in connection with a hydroelectric power project could, on the same rough approximation basis on which the life of the dam was determined, have a useful life equal to or coterminous with the life of the dam.

It is held that the reservoir easement acquisition and relocation rights acquired by the electric utility company in connection with the development of the hydroelectric power generating site, together with transmission line easements with related clearing and grading, from the hydroelectric site to the first point of interconnection with the transmission and distribution system, are intangible assets depreciable over the same life as the dam serving the hydroelectric site. As intangible assets these floodage and transmission line easements with related clearing and grading are not subject to the investment tax credit provided under section 38 of the Code or the accelerated methods of depreciation provided for in section 167(c) of the Code.

The conclusion stated above is not in accord with Revenue Ruling 55-729, C.B. 1955-2, 53, which stated that the Internal Revenue Service would not accept the position of the Union Electric Co., case. Pursuant to the authority contained in section 7805(b) of the Code, the principles of this Revenue Ruling will not be applied for taxable years ending on or before March 8, 1971, the date this Revenue Ruling is published in the Internal Revenue Bulletin, to require an adjustment to basis under section 1016(a)(2) of the Code, except where a taxpayer has claimed and been allowed a deduction for depreciation of these assets for prior taxable years.

The 50-year guideline class life for Hydraulic Production Plants under class 3(a), Group Four of Part One of Revenue Procedure 62-21, C.B. 1962-2, 418, Depreciation Guidelines and Rules, represents a composite average life that includes the relatively long lived dam and relatively short lived assets, such as generating machinery, etc. However, guideline class 3(a) does not include reservoir easements because at the time Revenue Procedure 62-21 was issued reservoir easements were not considered depreciable under Revenue Ruling 55-729. Therefore, taxpayers utilizing the provisions of Revenue Procedure 62-21 in connection with the computation of the depreciation of hydroelectric properties must use the identical useful life for such easements as is used by the taxpayer for the dam itself and must include such easement costs in the computations of class life, rate of growth, and reserve ratios for purposes of Revenue Procedure 62-21.

Revenue Ruling 55-729 is revoked.