Rev. Rul. 71-448

The Internal Revenue Service has been asked to clarify its position as set forth in Revenue Ruling 65-264, C.B. 1965-2, 53, with respect to easement and related costs incurred in connection with the acquisition of rights-of-way and for location of a taxpayer's crude oil and petroleum products pipelines, and also with respect to costs for related clearing and grading.

The taxpayer in the instant case is engaged in the transportation of crude oil and petroleum products through long distance pipe trunklines. A crude oil trunkline in this instance is a main pipeline as distinguished from field gathering lines by which crude oil is moved to refineries, or to water or rail terminals. A petroleum products pipeline is used to transport petroleum products from the refinery to market. In order to lay or construct these pipelines, various costs were incurred for, or related to, the acquisition of right-of-way easements apart from the costs associated with the construction of the pipeline facilities. Typically, in connection with the acquisition of right-of-way easements, the taxpayer agrees to pay landowners for the right to lay and maintain the pipeline within the selected rights-of-way; to pay for loss or restricted use of the land; and to pay severance and all other damage costs such as those related to improvements, crops, orchards, and timber. The taxpayer incurs costs for aerial reconnaissance and preliminary surveys for locating the appropriate rights-of-way. Among the costs related to the acquisition of the rights-of-way are those for aerial photographs, maps, and surveys, salaries, travel, legal fees, condemnation proceedings, title work, abstract and recording fees. All of the costs described in this paragraph are referred to hereafter as easement costs. These easement costs have in fact no usefulness to the taxpayer except in connection with the pipeline to which they are related. When another adjacent or loop line is laid, additional right-of-way costs applicable only to such adjacent or loop line are again incurred.

Location of the pipeline on the right-of-way requires engineering surveys and stake-outs by the taxpayer preparatory to clearing and grading. Generally, the clearing and grading of the right-of-way is contracted out by the taxpayer to pipeline contruction contractors solely for the construction of the pipeline and for the movement of heavy machinery and equipment necessary to that construction. Such contracts generally call for lump sum payments for construction of prescribed portions of the pipeline.

The costs for clearing and grading may include those for removal and disposal of timber, underbrush, and earth movement. All of the costs described in this paragraph are in fact incurred only for the particular pipeline to which they are related and, similar to additional easement costs applicable only to adjacent or loop lines, clearing and grading costs are again incurred when an adjacent or loop line is laid.

The costs for the easement and for clearing and grading referred to above do not include expenditures incurred to keep the rights-of-way clear and the pipeline in its normal operating state. Whether such expenditures are ordinary and necessary expenses or capital expenditures requires a determination based on the facts and circumstances of each case.

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

Section 1.167(a)-2 of the Income Tax Regulations provides, in part, that the depreciation allowance does not apply to land apart from the improvements or physical development added to it. When an expenditure relates to an improvement or physical development added to the land, it may be subject to a depreciation allowance if the property meets all the requirements necessary for application of the depreciation deduction. Section 1.167(a)-3 of the regulations provides in pertinent 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.

Revenue Ruling 65-264, C.B. 1965-2, 53, holds, in part, that expenditures incurred in connection with the location and acquisition of oil pipeline easements, and the costs for clearing and grading attributable to the pipeline, are for intangible assets that are subject to the allowance for depreciation, where they will no longer be useful after the expiration of the useful life of the related pipeline.

In Shell Pipe Line Corp. v. United States, 267 F.S. 1014 (S.D. Tex. 1967); Badger Pipe Line Co. v. United States, 401 Fed. (2d) 799 (1968); Texas-New Mexico Pipe Line Company v. United States, 401 Fed. (2d) 796 (Ct. Cls. 1968); and Great Lakes Pipe Line Company v. United States, 293 F.S. 1073 (W.D. Mo. 1968), the courts concluded that, based upon the facts presented, the right-of-way acquisition costs have no significant usefulness after the expiration of the limited life of the particular pipeline to which they related. Since it appears that the facts in these cases are representative factual patterns of taxpayers engaged in the transportation of crude oil and petroleum products through pipelines, the Service will no longer contend in such cases that easement costs are not subject to depreciation measured by the useful life of the particular pipeline, unless it can be shown that the facts and circumstances in a particular situation are clearly different from the factual pattern presented in these cases.

Accordingly, since in the instant case the facts indicate the easement costs have a determinable life measured by the useful life of the pipeline to which they are related, allowance for depreciation is proper. However, since easement costs are similar in nature to a license or franchise, they are investments in intangible assets that fail to qualify for the accelerated depreciation methods under section 167 of the Code, or for the investment credit provisions of the Code.

Further, amounts paid by the taxpayer for clearing and grading of the rights-of-way, whether such clearing and grading is performed by a pipeline construction contractor or by the taxpayer using his own crews and equipment, are part of the pipeline construction costs subject to depreciation measured by the useful life of the related pipeline. Such costs are investments in tangible assets that qualify for the accelerated depreciation methods of section 167 of the Code and the investment credit provisions of the Code, where applicable.

Pipeline construction costs do not include payments to pipeline construction contractors that are in fact payments to which the landowner is entitled under the agreement between the taxpayer and the landowner in negotiating the easement. For example, if under the pipeline construction contract, the contractor pays roddage fees or crop or other damages, such costs are not pipeline construction costs but are intangible easement costs.

The useful life conclusions of this Revenue Ruling do not apply to the extent that replacement of part or all of an existing pipeline on the original right-of-way is clearly contemplated or is the practice of the taxpayer. In such a case the useful life of the pipeline must be determined on the basis of all the facts and circumstances.

Revenue Ruling 71-120, C.B. 1971-1, 79, modified Revenue Ruling 65-264 to eliminate the conclusions therein with respect to high pressure natural gas pipelines. Inasmuch as this Revenue Ruling modifies Revenue Ruling 65-264 to eliminate the conclusions therein with respect to oil pipelines, Revenue Ruling 65-264 is revoked.

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 October 26, 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.