Rev. Rul. 70-167

Advice has been requested whether, under the circumstances described below, a taxpayer (a railroad company) must, for Federal income tax purposes, treat its gains and losses from its abnormal retirement sales of freight train cars depreciated in an average rate multiple asset account (that is not fully depreciated) as being subject to the provisions of section 1231 of the Code, or whether it can credit the depreciation reserve with the salvage proceeds from the abnormal retirements (as well as the normal retirements) from the account (and thereby recognize no gains and losses), for such sales in 1968.

The taxpayer accounted for its freight train cars in several multiple asset depreciation accounts, one of which was depreciated under the straight line method using a rate based upon the average estimated useful life of the assets in the account (average rate multiple asset account). The assets in the account had not been depreciated to estimated salvage value (that is, the account was not fully depreciated). During the taxable year 1968 the taxpayer retired by sale from this account many of its freight train cars that had been held for more than six months. Some of the retirements were normal and some were abnormal within the meaning of section 1.167(a)-8(b) of the Income Tax Regulations. Prior to 1968, the taxpayer accounted for the salvage proceeds realized from its normal retirements from the account by crediting the depreciation reserve with the amount of such proceeds. This practice clearly reflected the taxpayer's income. Gains and losses were determined on abnormal retirements, all of which were by sale, and such gains and losses were recognized and treated as being subject to the provisions of section 1231 of the Internal Revenue Code of 1954. However, in 1968, the taxpayer credited the depreciation reserve with salvage proceeds from both normal retirements and abnormal retirements from the account, and no gains and losses were recognized by the taxpayer on such retirements.

Section 1.167(a)-7(b), section 1.167(a)-8(a), and section 1.167(a)-8(c)(3) of the regulations provide the general accounting rules for abnormal retirements of depreciable property from average rate multiple asset accounts. Under these regulations the asset account is credited with the full cost of the asset retired and the depreciation reserve is charged with an adjustment for depreciation determined at the rate that would have been proper had the asset retired been depreciated in a single item account (under the method of depreciation used for the multiple asset account) and using a rate based upon the expected useful life of the asset employed in determining the rate of depreciation for the multiple asset account. Thus, the adjusted basis of the abnormally retired asset is the full cost of the asset less the depreciation adjustment so determined. The difference between the salvage proceeds realized, if any, and such adjusted basis is the gain or loss on the abnormal retirement. This gain or loss must be recognized because abnormal retirements are not contemplated in arriving at the rate of depreciation for a multiple asset account (see section 1.167(a)-8(b) of the regulations), and therefore income would not be clearly reflected if the proceeds of abnormal retirements were accounted for in the same way as the proceeds of normal retirements.

Section 1.167(a)-8(a)(1) of the regulations provides that where an asset is retired by sale, recognition of gain or loss will be subject to, among other provisions, section 1231 of the Code. Section 1231(a) of the Code provides that if, during the taxable year, the recognized gains on sales or exchanges of property used in the trade or business, plus the recognized gains from the involuntary conversion of property used in the trade or business and capital assets held for more than six months, exceed the recognized losses from such sales, exchanges, and involuntary conversions, such gains and losses shall be considered as long-term capital gains and losses. If such gains do not exceed such losses, such gains and losses shall be considered as ordinary gains and losses.

The provisions of section 1231 of the Code are applicable to gains and losses on abnormal retirements from multiple asset accounts. However, gain on such a retirement is not treated under the provisions of section 1231 of the Code to the extent that the provisions of section 1245 of the Code are applicable.

Accordingly, it is held that, in the instant case, the taxpayer must account for its abnormal retirements of freight train cars from its average rate multiple asset account by determining and recognizing gains and losses on its abnormal retirement sales. The gains and losses so determined are governed by the provisions of section 1231 of the Code except to the extent that the provisions of section 1245 of the Code are applicable to the gains on such retirements.

The accounting and income tax treatment of normal retirements from an average rate multiple asset account is described in Revenue Ruling 70-165 and Revenue Ruling 70-166, page 43 and page 44, respectively.