Rev. Proc. 62-21

                                SUMMARY

Group One: Guidelines for Depreciable Assets Used by Business in General

1. Office Furniture, Fixtures, Machines, and Equipment........................................... 10 years

Includes furniture and fixtures which are not a structural component of the building, and machines and equipment used in the preparation of papers or date. Includes such assets as desks; files; safes; typewriters; accounting, calculating and data processing machines; communications, duplicating and copying equipment.

2. Transportation Equipment

      Includes the following types of transportation equipment:

Includes land improvements such as paved surfaces, sidewalks, canals, waterways, drainage facilities and sewers, wharves, bridges, all fences except farm fences, landscaping, shrubbery and similar improvements. Includes agricultural land improvements not classified as soil and water conservation expenditures under the Internal evenue Code of 1954.

Excludes land improvements which are the major asset of a business, such as cemeteries or golf courses. The depreciable life of such land improvements shall be determined according to the particular facts and circumstances.

Excludes land improvements of electric, gas, steam, and water utilities; telephone and telegraph companies; and pipeline, water, and rail carriers. (These improvements are covered under Group Four.)

4. Buildings

Includes the structural shell of the building and all integral parts thereof. Includes equipment which services normal heating, plumbing, air conditioning, fire prevention and power requirements, and equipment such as elevators and escalators.

Excludes special-purpose structures which are an integral part of the production process and which, under normal practice, are replaced contemporaneously with the equipment which they house, support or serve. Nonindustrial and general-purpose industrial buildings, such as warehouses, storage facilities, general factory buildings and commercial buildings, are not special-purpose structures. Special-purpose structures shall be classified with the equipment which they house, support or serve, and their depreciable lives determined by reference to the appropriate guidelines for the particular industries.

    Type of Building

Includes equipment such as jigs, dies, molds, and patterns; returnable containers and pallets; crockery, glassware, linens, and silverware; and other subsidiary assets which are commonly and properly accounted for separately from those assets falling within the guideline classes in Group Two, Three, or Four.

Where assets in this class are accounted for under a method of depreciation using a life expressed in terms of years,/a/ the life shall be determined according to the facts and circumstances.

Group Two: Guidelines for Nonmanufacturing Activities, Excluding Transportation, Communications, and Public Utilities

In general, a single guideline class is specified for each industry included in this group. This single guideline class includes all depreciable property that is not covered by another guideline class. Thus, a single industry guideline class includes production machinery and equipment; power plant machinery and equipment; special equipment; and special-purpose structures (as defined in guideline class 4 under Group One).

Where more than one guideline class is specified for a particular industry, each guideline class covers that portion of the total depreciable property appropriate to the class.

The guideline classes in this group exclude depreciable assets covered under Group One.

1. Agriculture

Includes commercial farms and ranches, agricultural and horticultural services and forestry enterprises.

Excludes logging and sawmilling.

(a) Machinery and Equipment............................ 10 years

Includes machinery and equipment used in the production of crops and livestock and in the on-farm processing of feeds. Includes fences, but excludes other land improvements.

(b) Animals

         Cattle, breeding or dairy............................  7 years

(c) Trees and Vines

Includes trees and vines producing nuts, fruits and citrus crops.

Due consideration shall be given in each producing region to the geographic, climatic, genetic, economic and other factors which determine depreciable life.

(d) Farm Buildings..................................... 25 years

2. Contract Construction

Includes general building, special trade, heavy construction and marine contractors.

(a) General Contract Construction....................... 5 years Excludes assets used only in marine contract construction.

(b) Marine Contract Construction....................... 12 years Includes assets used only in marine contract construction.

3. Fishing

Includes the commercial catching or taking of fish and other aquatic annimals and plants.

Due consideration shall be given in each segment of the industry and in each geographical location to the relevant economic, climatic and other factors which determine depreciable life.

4. Logging and Sawmilling

Includes the cutting of timber and the sawing of dimensional stock from logs.

(a) Logging............................................. 6 years

Includes logging machinery and equipment and road building equipment used by logging and sawmill operators on their own account.

(b) Sawmills........................................... 10 years

(c) Portable Sawmills................................... 6 years

Includes sawmills characterized by temporary foundations, and a lack or minimum amount of lumber-handling, drying, and residue disposal equipment and facilities.

5. Mining............................................... 10 years

Includes the mining and quarrying of metallic and nonmetallic minerals and the milling, beneficiation and other primary preparation of such meterials.

Excludes the extraction and refining of petroleum and natural gas and the smelting and refining of other minerals.

6. Recreation and Amusement............................ 10 years

Includes recreation, entertainment and amusement establishments, such as bowling alleys, billiard and pool establishments, theaters, concert halls, and amusement parks.

Excludes facilities which consist primarily of specialized land improvements or structures, such as golf courses, swimming pools, tennis courts, sports stadia and race tracks. The depreciable life of such facilities shall be determined according to the particular facts and circumstances.

7. Services............................................ 10 years

Includes the providing of personal services such as those offered by hotels and motels, laundry and dry cleaning establishments, beauty and barber shops, photographic studios and mortuaries. Includes the providing of professional services such as those offered by doctors, dentists, lawyers, accounts, architects, enginneers, and veterinarians. Includes the providing of repair and maintenance services.

8. Wholesale and Retail Trade.......................... 10 years

Includes purchasing, selling and brokerage activities at both the wholesale and retail level and related assembling, sorting and grading of goods.

Group Three: Guidelines for Manufacturing

In general, a single guideline class is specified for each manufacturing industry. This single guideline class includes all depreciable property that is not covered by another guideline class. Thus, a single industry guideline class includes production machinery and equipment; power plant machinery and equipment; special equipment; and special-purpose structures (as defined in guideline class 4 under Group One).

Where more than one guideline class is specified for a particular industry, each guideline class covers that portion of the total depreciable property appropriate to the class.

The guideline classes in this group exclude depreciable assets covered under Group One.

1. Aerospace Industry................................... 8 years

Includes the manufacture of aircraft, spacecraft, rockets, missiles and component parts.

2. Apparel and Fabricated Textile Products.............. 9 years

Includes the manufacture of apparel, fur garments, and fabricated textile products except knitwear, knit products and rubber and leather apparel.

3. Cement Manufacture................................... 20 years

Includes the manufacture of cement.

Excludes the manufacture of concrete and concrete products.

4. Chemicals and Allied Products........................ 11 years

Includes the manufacture of basic chemicals such as acids, alkalis, salts, and organic and inorganic chemicals; chemical products to be used in further manufacture, such as synthetic fibers and plastics materials; and finished chemical products such as pharmaceuticals, cosmetics, soaps, fertilizers, paints and varnishes, explosives, and compressed and liquefied gases.

Excludes the manufacture of finished rubber and plastics products.

5. Electrical Equipment

(a) Electrical Equipment................................ 12 years

Includes the manufacture of electric household applicances, electronic equipment, batteries, ignition systems, and machinery used in the generation and utilization of electrical energy.

(b) Electronic Equipment................................ 8 years

Includes the manufacture of electronic communication, detection, guidance, control, radiation, computation, test and navigation equipment and components thereof.

Excludes manufacturers engaged only in the purchase and assembly of components. These manufacturers are included under guideline class 5(a).

6. Fabricated Metal Products............................ 12 years

Includes the manufacture of fabricated metal products such as cans, tinware, hardware, metal structural products, stampings and a variety of metal and wire products.

7. Food and Kindred Products Except Grain and Grain Mill Products Sugar and Sugar Products, and Vegetable Oil Products......... 12 years

Includes the manufacture of foods and beverages, such as meat and dairy products; baked goods; canned, frozen and preserved products; confectionery and related products; and soft drinks and alcoholic beverages.

Excludes the manufacture of grain and grain mill products, sugar and sugar products, and vegetable oils and vegetable oil products.

8. Glass and Glass Products............................. 14 years

Includes the manufacture of flat, blown, or pressed glass products, such as plate, safety and window glass, glass containers, glassware and fiberglass.

Excludes the manufacture of lenses.

9. Grain and Grain Mill Products........................ 17 years

Includes the manufacture of blended and prepared flours, cereals, feeds and other grain and grain mill products.

10. Knitwear and Knit Products.......................... 9 years

Includes the manufacture of knitwear and knit products.

11. Leather and Leather Products........................ 11 years

Includes the manufacture of finished leather products, the tanning, currying and finishing of hides and skins, and the processing of fur pelts.

12. Lumber, Wood Products, and Furniture................ 10 years

Includes the manufacture of lumber, plywood, veneers, furniture, flooring and other wood products.

Excludes logging and sawmilling and the manufacture of pulp and paper.

13. Machinery Except Electrical Machinery, Metalworking Machinery, and Transportation Equipment...................... 12 years

Includes the manufacture of machinery such as engines and turbines; farm machinery; construction and mining machinery; food products machinery; textile machinery; woodworking machinery; paper industries machinery; compressors; pumps; ball and roller bearings; blowers; industrial patterns; process furnaces and ovens; office machines; and service industry machines and equipment.

Excludes the manufacture of electrical machinery, metalworking machinery, and transportation equipment.

14. Metalworking Machinery.............................. 12 years

Includes the manufacture of metal cutting and forming machines and associated jigs, dies, fixtures and accessories.

15. Motor Vehicles and Parts............................ 12 years

Includes the manufacture of automobiles, trucks and buses and their component parts.

Excludes the manufacture of glass, tires and stampings.

16. Paper and Allied Products

(a) Pulp and Paper...................................... 16 years

Includes the manufacture of pulp from wood, rags and other fibers and the manufacture of paper and paperboard from pulp.

Excludes paper finishing and conversion into cartons, bags, envelopes, and similar products.

(b) Paper Finishing and Converting...................... 12 years

Includes paper finishing and conversion into cartons, bags, envelopes and similar products.

17. Petroleum and Natural Gas

(a) Drilling, Geophysical and Field Services............ 6 years

Includes the drilling of oil and gas wells on a contract, fee or other basis and the provision of geophysical and other exploration services. Includes oil and gas field services, such as chemically treating, plugging and abandoning wells and cementing or perforating well casings.

Excludes integrated petroleum and natural gas producers which perform these services for their own account.

(b) Exploration, Drilling and Production................ 14 years

Includes the exploration, drilling, maintenance and production activities of petroleum and natural gas producers. Includes gathering pipelines and related storage facilities of such producers.

Excludes gathering pipelines and related storage facilities of pipeline companies.

(c) Petroleum Refining.................................. 16 years

Includes the distillation, fractionation, and catalytic cracking of crude petroleum into gasoline and its other components.

(d) Marketing........................................... 16 years

Includes the marketing of petroleum and petroleum products. Includes related storage facilities and complete service stations.

Excludes petroleum and natural gas trunk pipelines and related storage facilities. Excludes natural gas distribution facilities.

18. Plastics Products................................... 11 years

Includes the manufacture of processed, fabricated and finished plastics products.

Excludes the manufacture of basic plastics materials.

19. Primary Metals

Includes the smelting, reducing, refining and alloying of ferrous and nonferrous metals from ore, pig or scrap and the manufacture of castings, forgings and other basic ferrous and nonferrous metals products.

(a) Ferrous Metals...................................... 18 years

(b) Nonferrous Metals................................... 14 years

20. Printing and Publishing............................. 11 years

Includes printing, publishing, lithographing and printing services such as bookbinding, typesetting, photoengraving, and electrotyping.

21. Professional, Scientific, and Controlling Instruments; Photographic and Optical Equipment; Watches and Clocks....... 12 years

Includes the manufacture of mechanical measuring, engineering, laboratory and scientific research instruments; optical instruments and lenses; surgical, medical and dental instruments and equipment; ophthalmic equipment; photographic equipment; and watches and clocks.

22. Railroad Transportation Equipment................... 12 years

Includes the building and rebuilding of railroad locomotives, railroad cars, and street cars.

23. Rubber Products..................................... 14 years

Includes the manufacture of finished rubber products and the recapping, retreading and rebuilding of tires.

24. Ship and Boat Building.............................. 12 years

Includes the building, repairing and conversion of ships and boats.

25. Stone and Clay Products Except Cement............... 15 years

Includes the manufacture of structural clay products such as brick, tile and pipe; pottery and related products, such as vitreous-china,

Includes permanent or well-established sawmills. plumbing fixtures, earthenware and ceramic insulating materials; concrete; asphalt building materials; concrete, gypsum and plaster products; cut and finished stone; and abrasive, asbestos and miscellaneous nonmetallic mineral products.

Excludes the manufacture of cement.

26. Sugar and Sugar Products............................ 18 years

Includes the manufacture of raw sugar, sirup or finished sugar from sugar cane or sugar beets.

27. Textile Mill Products Except Knitwear

(a) Taxtile Mill Products, Excluding Finishing and Dyeing .................................................... 14 years

Includes the manufacture of spun, woven or processed yarns and fabrics from natural or synthetic fibers.

Excludes finishing and dyeing.

(b) Finishing and Dyeing................................ 12 years

Includes textile finishing and dyeing.

28. Tobacco and Tobacco Products........................ 15 years

Includes the manufacture of cigarettes, cigars, smoking and chewing tobacco and other tobacco products.

29. Vegetable Oil Products.............................. 18 years

Includes the manufacture of vegetable oils and vegetable oil products.

30. Other Manufacturing................................. 12 years

Includes the manufacture of products not covered by other guideline classes in Group Three, such as the manufacture of fountain pens and jewelry.

Excludes property used in the manufacture of products for which this guideline is clearly inappropriate. The depreciable life of such property shall be determined according to the particular facts and circumstances.

Group Four: Guidelines for Transportation, communications, and Public Utilities

Guideline classes specified for this Group include depreciable assets other than those for which guideline classes are provided under Group One. Special-purpose structures (as defined in guideline class 4 under Group One) are included in this group.

Where more than one guideline class is specified for a particular industry, each guideline class covers that portion of the total depreciable property appropriate to the class.

1. Air Transport........................................ 6 years

Includes the commercial and contract carrying of passengers and freight by air.

2. Central Steam Production and Distribution............ 28 years

Includes the production and distribution of steam for sale.

3. Electric Utilities

Includes the production, transmission, and distribution of electricity for sale.

      (a) Hydraulic production plant.......................... 50 years

4. Gas Utilities

Includes the production, transmission, and distribution of natural and manufactured gas for sale.

      (a) Distribution facilities............................. 35 years

5. Motor Transport-Freight.............................. 8 years

Includes the commercial and contract carrying of freight by road. (Trucks, tractors and trailers are covered under guideline class 2 of Group One.)

6. Motor Transport-Passengers........................... 8 years

Includes the urban and interurban commercial and contract carrying of passengers by road. (Automobiles, buses, and taxis are covered under guideline class 2 of Group One.)

7. Pipeline Transportation.............................. 22 years

Includes the private, commercial, and contract carrying of petroleum, gas, and other products by means of pipes and conveyors. Includes trunk pipelines and related storage facilities of integrated petroleum and natural gas producers.

8. Radio and Television Broadcasting.................... 6 years

Includes commercial radio and television broadcasting.

9. Railroads

Includes the commercial and contract carrying of passengers and freight by rail.

Excludes station and office buildings, floating equipment, storage warehouses, grain elevators, and other property classified in the following Interstate Commerce Commission road accounts: (16), (56), (21), (22) (included under Group One).

Excludes property classified in Interstate Commerce Commission road accounts (8) through (12) and road account (38).

Excludes transportation equipment (guideline class 2 of Group One).

(a) Machinery and Equipment............................. 14 years

Includes property classified in the following Interstate Commerce Commission accounts:

Road accounts

(26) Communication systems

(27) Signals and interlockers

(37) Roadway machines

(44) Shop machinery

Equipment accounts

(51) Steam locomotives

(52) Other locomotives

(53) Freight-train cars

(54) Passenger-train cars

(57) Work equipment

(58) Miscellaneous equipment

(b) Structures and similar improvements................. 30 years

Includes property classified in the following Interstate Commerce Commission Road accounts:

(6) Bridges, trestles, and culverts

(7) Elevated structures

(13) Fences, snowsheds, and signs

(17) Roadway buildings

(18) Water stations

(19) Fuel stations

(20) Shops and enginehouses

(31) Power transmission systems

(35) Miscellaneous structures

(39) Public improvements construction

(c) Grading and other right-of-way improvements

Includes property classified in the following Interstate Commerce Commission road accounts:

(1) Engineering

(2 1/2 ) Other right-of-way expenditures

(3) Grading

(5) Tunnels and subways

To the extent that the asset is depreciable, the life shall be determined according to the particular facts and circumstances.

(d) Wharves and docks................................... 20 years

Includes Interstate Commerce Commission road accounts:

(23) Wharves and docks

(24) Coal and ore wharves

(e) Power plant and equipment

Includes Interstate Commerce Commission road accounts:

(29) Power plant

(45) Power plant machinery

      Electric generating equipment

Includes the providing of commercial and contract telephonic and telegraphic communication services.

Depreciable lives or depreciation rates established by the Federal Communications Commission and other governmental regulatory agencies are to be used in the computation of depreciation for tax purposes on all assets including assets covered under Group One. Where depreciable lives or depreciation rates have not been established by any governmental regulatory agency, depreciable lives shall be determined according to the particular facts and circumstances.

11. Water Transportation................................ 20 years

Includes the commercial and contract carrying of freight and passengers by water. (Vessels, barges, tugs and similar water transportation equipment are covered under guideline class 2 of Group One.)

12. Water Utilities..................................... 50 years

Includes the gathering, treatment, and commercial distribution of water.

PART II. - DESCRIPTION OF PROCEDURES TO BE FOLLOWED IN EXAMINING DEPRECIATION DEDUCTIONS

SECTION 1. IN GENERAL.

Section 167 of the Internal Revenue Code of 1954 allows as a deduction in computing taxable income a reasonable allowance for depreciation of property used in a trade or business or of property held for the production of income. The purpose of the allowance is to permit taxpayers to recover through annual deductions the cost (or other basis) of the property over its useful economic life.

The determination of the useful economic life of an asset is a matter of judgment and estimate. For this reason, it is the policy of the Internal Revenue Service generally not to disturb depreciation deductions. Therefore, adjustments in the depreciation deduction should not be proposed unless there is a clear and convincing basis for a change. The procedures set forth herein are to be followed in determining whether there is a clear and convincing basis for a change. ¹ These procedures are designed to provide taxpayers with a greater degree of certainty in determining the amount of their depreciation deductions and to provide greater uniformity in the audit of these deductions by the Internal Revenue Service.

These procedures will be used in connection with examinations of income tax returns the due date for the filing of which is on or after July 12, 1962 (without regard to extensions of time). ² These procedures apply with respect to depreciation of assets acquired before the effective date of this Revenue Procedure as well as to depreciation of assets acquired after that date. However, any taxpayer has the option of having the depreciation claimed with respect to his various item or multiple-asset accounts examined individually under presently established procedures, without regard to this Revenue Procedure. Where this Revenue Procedure is not followed, the examination of depreciation will be made in accordance with the principles set forth in Revenue Rulings 90 and 91, C.B. 1953-1, 43, 44. However, Bulletin `F' is withdrawn as a guide to examining officers for the determination of depreciable lives.

Where depreciation claimed in an income tax return is examined under this Revenue Procedure, the lives used by a taxpayer for his depreciable properties are first to be compared with the prescribed guideline lives set forth in Part I of this Revenue Procedure. These guideline lives apply to broad classes of assets rather than to individual assets. Each of these broad classes is hereinafter referred to as a `guideline class.'

Initially, any taxpayer will be allowed to use a class life for a guideline class which is at least as short as the guideline life for that class, even if a longer life has previously been used.

The comparison of the class lives used by the taxpayer with the guideline lives will be facilitated if the taxpayer's depreciation accounts correspond to the guideline classes. Any taxpayer who is depreciating his assets in item accounts, or in multiple-asset accounts which do not correspond to the guideline classes, may regroup his assets for tax purposes in depreciation accounts corresponding to the guideline classes, but he is not required to do so. Even if a taxpayer does not regroup his assets in accounts corresponding to the guideline classes, this Revenue Procedure may be applied by regrouping the assets annually, solely for the purpose of this Revenue Procedure.

Section 2 of this Part sets forth the applicable rules where a taxpayer uses a class life equal to or longer than the guideline life and section 3 sets forth the applicable rules where a taxpayer uses a class life shorter than the guideline life. Section 4 sets forth the rules for determining the class life used by the taxpayer.

SEC. 2. CLASS LIFE EQUAL TO OR LONGER THAN THE PRESCRIBED GUIDELINE LIFE.

Where the class life used by a taxpayer is equal to or longer than the guideline life for a guideline class, the depreciation deduction claimed by the taxpayer for the assets in that class will not be disturbed if the taxpayer's retirement and replacement practices for that class hereafter are consistent with the class life being used. This consistency may be demonstrated either by the reserve ratio test set forth in section 5 of this Part or by all the facts and circumstances.

The reserve ratio test is a technique for establishing objectively that the taxpayer's retirement and replacement practices for a guideline class are consistent with the class life he is using. If the test is met, the depreciation deduction for that class will not be disturbed. ³ In order to give taxpayers an opportunity where needed to conform their retirement and replacement practices with the class lives being used, the reserve ratio test will be considered to be met for the first 3 taxable years to which this Revenue Procedure applies. Any class life equal to or longer than the guideline life will not be questioned for such first 3 taxable years. Thereafter, if the test is not met, a taxpayer may by the use of presently established procedures demonstrate that his retirement and replacement practices are consistent with the class life being used.

SEC. 3. CLASS LIFE SHORTER THAN THE PRESCRIBED GUIDELINE LIFE.

.01 In general. - Where the class life used by a taxpayer is shorter than the prescribed guideline life for a guideline class, the depreciation deduction claimed by the taxpayer for the assets in that class will not be disturbed if the conditions of subsection .02, .03, .04, or .05 of this section are met. Subsection .02 sets forth the applicable rules where the class life used by the taxpayer for the taxable year under examination is shorter than the guideline life but equal to or longer than the class life used in the preceding taxable year. Subsection .03 sets forth the applicable rules where the class life used by the taxpayer for the taxable year under examination is shorter than the guideline life and also is shorter than the class life used in the preceding taxable year. Subsection .04 sets forth the applicable rules where the class life used by the taxpayer for the taxable year under examination is shorter than the guideline life and there were no assets in that guideling class in the preceding taxable year (as in the case of the first taxable year of a new taxpayer). Subsection .05 sets forth the applicable rules for taxable years subsequent to a year for which the class life was examined and accepted by the Internal Revenue Service.

.02 Class life equal to or longer than life used in preceding taxable year. - Where the class life used by a taxpayer is shorter than the guideline life for a guideline class but is equal to or longer than the class life used by the taxpayer in the immediately preceding taxable year, the depreciation deduction claimed by the taxpayer for the assets in that class will not be disturbed if either paragraph (a) or (b) of this subsection applies.

(a) Class life justified by reference to its prior use. - The depreciation deduction will not be disturbed if the taxpayer has used approximately the same class life for a period of years equal to at least one-half the class life used in the taxable year under examination, and the reserve ratio test set forth in section 5 of this Part is met, thus demonstrating that the taxpayer's retirement and replacement practices are consistent with the class life used. ⁴

(b) Class life justified by other factors. - The depreciation deduction will not be disturbed if the class life used by the taxpayer is justified for the taxable year under examination on the basis of all the facts and circumstances (see subsection .06 of this section).

.03 Class life shorter than life used in preceding year. - Where the class life used by a taxpayer is shorter than the guideline life for a guideline class and is also shorter than the class life used by the taxpayer in the immediately preceding taxable year, the depreciation deduction claimed by the taxpayer will not be disturbed if either paragraph (a) or (b) of this subsection applies.

(a) Class life justified by prior retirement and replacement practices. - The depreciation deduction will not be disturbed if the taxpayer's prior retirement and replacement practices indicate that such shorter class life is justified, as demonstrated by the following factors:

(1) the taxpayer's reserve ratio for the guideline class for the taxable year immediately preceding the taxable year under examination was below the lower limit of the appropriate reserve ratio range; ⁵ and

(2) The taxpayer has used approximately the same class life as the life used in such immediately preceding year for a period of years equal to at least one-half of the class life used in such preceding year; ⁶ and

(3) the shorter class life used in the taxable year under examination is not shorter than can be justified on the basis of the Adjustment Table for Class Lives. ⁷

(b) Class life justified by other factors. - The depreciation deduction will not be disturbed if the class life used by the taxpayer is justified for the taxable year under examination of the basis of all the facts and circumstances (see subsection .06 of this section).

.04 Class life shorter than guideline life in case of new taxpayer or new guideline class. - Where the class life used by a taxpayer is shorter than the guideline life for a guideline class and there were no assets in that class in the immediately preceding taxable year (as, for example, in the case of the first taxable year of a new taxpayer), the depreciation deduction claimed by the taxpayer will not be disturbed if the class life used by the taxpayer is justified for the taxable year under examination on the basis of all the facts and circumstances (see subsection .06 of this section).

.05 Subsequent use of class life previously justified. - Where the class life used by a taxpayer was examined by the Internal Revenue Service and was accepted by reason of subsection .02, .03, or .04 of this section, or where such class life was accepted on audit by the Internal Revenue Service under presently established procedures for examining depreciation (whether before or after the effective date of this Revenue Procedure), the depreciation deduction claimed by the taxpayer for the assets in that class in any subsequent taxable year based on that class life will not be disturbed if the taxpayer's retirement and replacement practices for that class are consistent with the class life being used. This consistency may be demonstrated either by the reserve ratio test set forth in section 5 of this Part or by all the facts and circumstances.

The reserve ratio test is a technique for establishing objectively that the taxpayer's retirement and replacement practices for a guideline class are consistent with the class life he is using. If the test is met, the depreciation deduction for that class will not be disturbed. ⁸ In order to give taxpayers an opportunity where needed to conform their retirement and replacement practices with the class lives being used, the reserve ratio test will be considered to be met for the first three taxable years to which this Revenue Procedure applies. The previously justified class life will not be questioned during that period. Thereafter, if the test is not met, a taxpayer may be the use of presently established procedures demonstrate that his retirement and replacement practices are consistent with the class life being used.

.06 Facts and circumstances. - Where a class life used by a taxpayer is shorter than the guideline life and has not been previously justified, a significant factor (except where the taxpayer is a regulated public utility) in determining whether the class life is justified for the taxable year under examination on the basis of all the facts and circumstances is the fact that the life used by the taxpayer in computing his depreciation deduction is the same as the life used in computing the depreciation shown on the taxpayer's books of account and financial statements. ⁹ Substantial weight should also be given to any other objective factors which indicate that the taxpayer intends to follow a more rapid retirement and replacement practice than is reflected in the guideline life and to whether the taxpayer has previously followed retirement and replacement practices consistent with lives previously used. Other situations in which the class life used by a taxpayer may be justified by the facts include situations (1) where there is an abnormally intensive use of assets, (2) where there are a number of assets in a guideline class which were not new when acquired by the taxpayer, (3) where there is extraordinary obsolescence which affects the particular taxpayer, and (4) where a guideline class of a particular taxpayer contains a disproportionate amount of relatively short-lived assets.

SEC. 4. DETERMINING THE CLASS LIFE USED BY THE TAXPAYER.

.01 In general. - For the purpose of comparing the class life used by a taxpayer with the guideline life for any guideline class, the class life is to be determined in accordance with the following rules:

.02 Taxpayer using guideline classes. - If a taxpayer actually depreciates assets in a depreciation account corresponding to a guideline class, the class life is the same as the life used by the taxpayer in computing the depreciation allowance for that account. However, see subsection .04 of this section where salvage is a factor in computing depreciation for that account.

.03 Taxpayer not using guideline classes. - If a taxpayer depreciates assets in item accounts or in multiple-asset accounts which do not correspond to the guideline classes, the assets will be regrouped (for the purpose of comparing the class life used by the taxpayer with the guideline life) in classes corresponding to the prescribed guideline classes. The class life used by the taxpayer for each class will then be determined by computing the weighted average of the lives used for the item or multiple-asset accounts coming within that guideline class. ¹⁰

The weighted average of the lives used by the taxpayer for the assets falling within a guideline class is to be determined as follows (regardless of the method of depreciation used by the taxpayer): Compute the straight-line depreciation, based on the life used by the taxpayer with respect to each item account or multiple-asset account coming within the guideline class. Divide the total depreciation so computed into the total basis ¹¹ of all the assets in such item or multiple-asset accounts to obtain the class life. See subsection .04 of this section where salvage is a factor in computing depreciation with respect to any assets in the guideline class.

.04 Salvage. - In any case where salvage is a factor in computing the amount of depreciation claimed by a taxpayer with respect to a guideline class, the class life is determined by dividing the straightline depreciation (computed by using the lives and salvage actually used by the taxpayer for all assets in the class) into the total basis (not reduced by salvage) of all assets in the class. For example, if the total basis of all assets in a guideline class is $1,000, and the taxpayer has used a life of 8 years for that class and has taken into account salvage of $200, he will be considered as using a class life of 10 years, since the annual straight-line depreciation based on the life and salvage used by the taxpayer for the assets in that class ($100) divided into the total basis of such assets ($1,000) is 10.

SEC. 5. RESERVE RATIO TEST.

.01 In general. - The reserve ratio test is an objective technique for establishing that the depreciation reserve for assets in a guideline class bears a reasonable relationship to the basis of those assets. In many cases, this test can be used to demonstrate that the retirement and replacement practices being followed by a taxpayer with respect to a guideline class are consistent with the class life being used. In cases where the test is not met, whether the taxpayer's retirement and replacement practices are consistent with the class life being used must be determined on the basis of all the facts and circumstances. Section 6 sets forth the rules for lengthening a class life where it cannot be justified by either the reserve ratio test or all the facts and circumstances.

Subsection .02 of this section sets forth the general rule for applying the reserve ratio test. Subsection .03 sets forth a transition rule. Because of the operation of the transition rule, the reserve ratio test will be considered met for the first three taxable years to which this Revenue Procedure applies.

Table 2 in Part III of this Revenue Procedure sets forth the appropriate ratios of depreciation reserves to basis, taking into account the method of depreciation, the life, and the rate of growth for any particular guideline class. This table also prescribes upper and lower limits of acceptable ranges for reserve ratios. In addition, Part III contains the rules for computing the taxpayer's reserve ratio for a guideline class and for selecting the appropriate reserve ratio range for that class from the Reserve Ratio, Table.

.02 General rule. - Where the reserve ratio test is being used to demonstrate that a taxpayer's retirement and replacement practices with respect to a guideline class are consistent with the class life being used, the test will be met if the taxpayer's reserve ratio for that class does not exceed the upper limit of the appropriate reserve ratio range. Any taxpayer who has been retiring and replacing assets in a guideline class consistent with the life previously used and who continues to do so will not exceed the appropriate upper limit. Even if the taxpayer adopts a shorter class life after the publication of this Revenue Procedure, his reserve ratio will not exceed the appropriate upper limit, so long as his retirement and replacement practices are thereafter consistent with the shorter class life. In these situations, the taxpayer will satisfy the general rule for applying the reserve ratio test and the transition rule set forth in subsection .03 of this section will not be needed.

Where the taxpayer's reserve ratio for a guideline class does exceed the upper limit (and the transition rule does not apply), the taxpayer may, by the use of presently established procedures, resort to other factors to demonstrate that his retirement and replacement practices are consistent with the class life being used. ¹²

.03 Transition rule. - Where a taxpayer's retirement and replacement practices with respect to a guideline class have been inconsistent with the life previously used, the reserve ratio for that class may exceed the upper limit of the appropriate reserve ratio range and thus fail to meet the general rule for applying the reserve ratio test. If this occurs with respect to any one or more of the first 3 taxable years to which this Revenue Procedure applies, the following transition rule supersedes the general rule set forth in subsection .02 of this section:

(a) The reserve ratio test will be considered to be met for the first 3 taxable years to which this Revenue Procedure applies.

(b) The taxpayer will be given a period of years (commencing with the first year to which this Revenue Procedure applies) equal to the guideline life for that class to bring his reserve ratio within the upper limit of the appropriate reserve ratio range, provided the reserve ratio is moving toward the appropriate upper limit during this period. So long as the reserve ratio is moving toward this upper limit, the reserve ratio test will be considered to be met during this period.

(c) The reserve ratio will be considered as moving toward the appropriate upper limit so long as the amount by which the reserve ratio exceeds such upper limit for any taxable year during the period is lower than it was for any one of the 3 preceding taxable years.

If the reserve ratio for a guideline class has not come within the upper limit of the appropriate reserve ratio range by the close of the period described in paragraph (b) of this subsection, or if the reserve ratio is not moving toward such upper limit (within the meaning of paragraph (c) of this subsection) for any taxable year during this period after the first 3 taxable years, then the transition rule ceases to apply and the general rule set forth in subsection .02 of this section for the application of the reserve ratio test shall apply.

.04 Application of reserve ratio test in case of a new taxpayer or a new guideline class. - The guideline classes of a new taxpayer or a new guideline class of an existing taxpayer will necessarily have low reserve ratios for a period of years. Therefore, a new taxpayer or any taxpayer with a new guideline class will ordinarily be able to use the guideline life (or a shorter class life, if justified by all the facts and circumstances) for a replacement cycle, and, of course, thereafter if his retirement and replacement practices are consistent with the class life being used. If the taxpayer's reserve ratio for such a guideline class does exceed the upper limit of the appropriate reserve ratio range during the first replacement cycle, ¹³ the taxpayer may, by the use of presently established procedures, resort to other factors to demonstrate that his retirement and replacement practices are consistent with the class life being used.

SEC. 6. LENGTHENING A CLASS LIFE WHICH CANNOT BE JUSTIFIED.

.01 In general. - Where a class life used by a taxpayer cannot be justified under any of the rules set forth in this Part, that life shall be lengthened in accordance with subsection .02 or .03 of this section. ¹⁴ However, a class life shall not be lengthened beyond the shortest life which can be justified for the guideline class under all the facts and circumstances for the taxable year under examination. ¹⁵ See subsection .04 of this section for rules relating to the taxable year in which a class life is to be lengthened.

.02 Lengthening a class life which is equal to or longer than the guideline life. - Where a class life used by a taxpayer is equal to or longer than the guideline life for a guideline class, and the taxpayer's retirement and replacement practices are not consistent with the class life used, the class life shall be lengthened in accordance with the Adjustment Table for Class Lives. ¹⁶ This table and the instructions for its use are set forth in section 3 of Part III of this Revenue Procedure.

.03 Lengthening a class life which is shorter than the guideline life. - Where a class life used by a taxpayer justified under any of the rules set forth in this Part, the class life shall be lengthened as follows:

(a) In any case where the reserve ratio test may be used as a technique for demonstrating that the taxpayer's retirement and replacement practices are consistent with the class life used, and the consistency cannot be demonstrated either by the reserve ratio test or by all the facts and circumstances, the class life shall be lengthened in accordance with the Adjustment Table for Class Lives. ¹⁷

(b) In any other case, the class life shall be lengthened to the shortest life previously justified for that guideline class, or to the guideline life if no shorter life has been previously justified. ¹⁸

.04 Year in which class life is to be lengthened. - If a class life is lengthened under subsection .02 or .03(a) of this section, it shall be lengthened only for a taxable year for which (1) the reserve ratio test is not met (under the general rule or the transition rule for applying the test), and (2) the class life used cannot be justified on the basis of all the facts and circumstances. The class life shall not be lengthened for any earlier taxable year. If a class life is lengthened under subsection .03(b) of this section, it shall be lengthened only for a taxable year for which the class life used cannot be justified on the basis of all the facts and circumstances.

PART III.-THE RESERVE RATIO TABLE AND THE ADJUSTMENT TABLE FOR CLASS LIVES AND INSTRUCTIONS FOR THEIR USE

SECTION 1. IN GENERAL.

Part II of this Revenue Procedure utilizes a reserve ratio test in a number of instances. A reserve ratio is the ratio of the depreciation reserves for the assets in any guideline class to the basis ¹⁹ of those assets. The reserve ratio test is an objective technique which can be used to demonstrate that the retirement and replacement practices being followed by a taxpayer with respect to a guideline class are consistent with the class life being used. A taxpayer's reserve ratio also can be used to show that he is entitled to use a shorter class life than he has used in the past.

The reserve ratio test is made by comparing a taxpayer's reserve ratio for a guideline class with an appropriate reserve ratio range. Table 2 (Reserve Ratio Table) is used to select the appropriate reserve ratio range. Table 3 (Adjustment Table for Class Lives) is used to determine an adjustment in the class life used by a taxpayer where an adjustment based on the table is indicated under Part II of this Revenue Procedure.

SEC. 2. INSTRUCTIONS FOR APPLYING THE RESERVE RATIO TABLE.

The following rules are to be used in applying the Reserve Ratio Table:

.01 Computation of taxpayer's reserve ratio. - The first step in applying the Reserve Ratio Table is to compute the taxpayer's reserve ratio for a guideline class. The reserve ratio is computed by dividing the total depreciation reserves for all the assets in that class (at the close of the taxable year) by the total basis of all those assets (at the close of that year). ²⁰ For this purpose, however, if any portion of the basis of any asset in a guideline class is subject to amortization under sections 168 or 169 of the 1954 Code (or corresponding provisions of prior law) on is recovered by means of the additional first-year depreciation allowance provided by section 179 of the 1954 Code, that portion shall be excluded from the total basis of all the assets in the class and any amortization or depreciation deducted with respect to that portion shall be excluded from the total depreciation reserves for the class.

.02 Selecting the appropriate reserve ratio range. - The second step in applying the Reserve Ratio Table is to select the appropriate reserve ratio range from the table. To identify the appropriate reserve ratio range for a guideline class, it is necessary to know (a) the method of depreciation being used for the assets in the guideline class, (b) the test life for the class, and (c) the rate of growth for the class.

(a) Method of Depreciation. - The method of depreciation used for the assets in a guideline class means the method actually used by the taxpayer in computing depreciation for tax purposes with respect to those assets, such as the straight-line method, the double-declining balance method, the 150-percent declining balance method, or the sum-of-the-years digits method. See subsection .03 of this section where a taxpayer uses more than one method of depreciation with respect to assets falling within a single guideline class.

(b) Determining the test life. - The test life ²¹ for a guideline class is to be determined under the following rules:

(1) Class life equal to or longer than the guideline life. - Where the class life used by a taxpayer is equal to or longer than the guideline life for a guideline class, the test life is the guideline life for that class, unless subparagraph (4) of this paragraph applies.

(2) Class life equal to or longer than life previously justified. - Where the class life used by a taxpayer is equal to or longer than the life justified for a guideline class in a preceding taxable year under section 3.02, 3.03, or 3.04 of Part II of this Revenue Procedure or under presently established procedures, the test life is the previously justified life, unless subparagraph (4) of this paragraph applies.

(3) Class life not previously justified. - Where the class life used by a taxpayer is shorter than the guideline life for a guideline class and has not previously been justified-

(A) for purposes of section 3.02(a) of Part II of this Revenue Procedure (class life justified by reference to its prior use), the test life is the class life used in the taxable year under examination;

(B) for purposes of section 3.03(a) of Part II of this Revenue Procedure (Class life justified by prior retirement and replacement practices), the test life is the class life used for the taxable year immediately preceding the taxable year under examination.

(4) Lengthened class life. - Where the class life used by a taxpayer has been lengthened under section 6 of Part II of this Revenue Procedure, the test life is the life to which the class life was lengthened.

(c) Determining the rate of growth ²² for a guideline class. - The rate of growth for a guideline class may be determined from the Rate of Growth Conversion Table (Table 1). To use that table, it is necessary to know (1) the asset ratio for the guideline class, and (2) the class life period for that class.

(1) The asset ratio. - The asset ratio for a guideline class is computed by dividing the total basis of all the assets in the class at the close of the taxable year for which the rate of growth is being determined (referred to hereinafter as the growth rate year) by the total basis of all the assets in the class at the close of the taxable year ending one class life period earlier (referred to hereinafter as the base year). ²³

(2) The class life period. - The class life period for a guideline class is a period of years equal to the class life used by the taxpayer for the class for the growth rate year. ²⁴ Thus, if the class life used by the taxpayer for a guideline class for the growth rate year is 10 years, the class life period for that class is 10 years and the base year is the 10th taxable year preceding the growth rate year. However, see subparagraph (3) if the base year falls before the first taxable year to which this Revenue Procedure applies.

(3) Substitute class life period. - To compute the asset ratio for a guideline class, it is necessary to know the total basis of the assets in that class at the close of both the base year and the growth rate year. Records adequate for this purpose may not be available for some taxable years preceding the date of publication of this Revenue Procedure. Therefore, if a base year with respect to a guideline class is a taxable year for which the income tax return was due to be filed before July 12, 1962, and the taxpayer does not have sufficient information to determine the total basis of the assets in that class at the close of that taxable year, then the earliest taxable year for which sufficient information is available may be used as the base year provided that (1) such substitute base year is not later than the first taxable year to which this Revenue Procedure applies, and (2) there are at least 2 taxable years intervening between such year and the growth rate year. ²⁵ In this case, the period of years between the close of the substitute base year and the close of the growth rate year shall be considered as the class life period for the purpose of applying the Rate of Growth Conversion Table.

(d) Selecting the appropriate reserve ratio range. - After the test life and the rate of growth have been determined for a guideline class, the appropriate reserve ratio range for that class is to be selected from the Reserve Ratio Table, using (1) the method of depreciation used by the taxpayer for the class, (2) the test life set forth in the table which is closest to the test life determined for the class, and (3) the rate of growth for the class. The reserve ratio range so determined will consist of an appropriate reserve ratio, and upper and lower limits of a range for acceptable reserve ratios.

.03 Special rule where different methods of depreciation are used for assets falling within a single guideline class. - If a taxpayer uses two or more different methods of depreciation with respect to assets falling within a guideline class, the appropriate reserve ratio range for that class is the weighted average of the separate reserve ratio ranges determined for the different methods of depreciation. The separate reserve ratio range for each method of depreciation is determined in accordance with subsection .02 of this section, using the test life and rate of growth for the entire guideline class in connection with each method.

(a) The upper limit. - The upper limit of the weighted average of these separate ranges is computed as follows:

(1) multiply the upper limit of each separate reserve ratio range determined for a separate method of depreciation by a fraction, the numerator of which is the total basis of the assets in the guideline class as to which that method of depreciation was used and the denominator of which is the total basis of all the assets in that class; and

(2) total the resulting figures.

(b) The lower limit. - The lower limit of the weighted average of these separate ranges is computed in like manner.

SEC. 3. INSTRUCTIONS FOR APPLYING ADJUSTMENT TABLE FOR CLASS LIVES.

.01 In general. - Where the rules contained in Part II of this Revenue Procedure indicate that a shorter class life used by a taxpayer may be justified by reference to the Adjustment Table for Class Lives, or that a class life used by a taxpayer should be lengthened in accordance with that Table, the appropriate class life is to be determined from Table 3.

.02 Using Adjustment Table to justify shorter class life .-Where a shorter class life than used in preceding taxable years is to be justified on the basis of the Adjustment Table for Class Lives (see section 3.03(a) of Part II of this Revenue Procedure), the shortest class life that can be so justified may be found in the second column in the Table, opposite the class life used by the taxpayer for the year immediately preceding the taxable year under examination.

.03 Using Adjustment Table to lengthen a class life. - Where a class life used by a taxpayer is to be lengthened under section 6.02 or 6.03(a) of Part II of this Revenue Procedure, the class life to which the life used by the taxpayer should be lengthened may be found in the fourth column in the Adjustment Table for Class Lives, opposite the appropriate 3-year average class life. The 3-year average class life is determined by adding the class lives used by the taxpayer for the taxable year under examination and the 2 preceding taxable years and dividing the resulting total by 3. ²⁶

               TABLE 1. Rate of Growth Conversion Table

NOTE. -- The ratio shown in the first row for each test life is the theoretically appropriate ratio for a stabilized account growing at the indicated rate, calculated on the assumption that there is no dispersion of asset lives about the test life. The reserve ratio accepted under this procedure as theoretically appropriate is therefore higher than if it were corrected for the fact that some assets will be retired earlier and some later than the period of the test life.

The range shown below each theoretical reserve ratio indicates the lower and upper limits of acceptable reserve ratios. The upper limit of the reserve ratio range is that reserve ratio which would result if all assets were held for a period 20 percent longer than the test life. The lower limit of the reserve ratio range is the ratio which would result if all assets were held for a period 10 percent shorter than the test life. As in the case of the theoretically appropriate ratios, the ranges accepted are at a higher level than would result were dispersion of lives taken into account in the calculations. The ratios shown are rounded to the nearest percent and will depart from mathematically calculated values to that extent.

                 TABLE 3

² See section 6.02 and section 6.03(a) of Part III of this Revenue Procedure.

Appendix I

FORMULAE USED IN CALCULATING RESERVE RATIOS AND THE RESERVE RATIO RANGE ¹

Revenue Procedure 62-21 may be applied in connection with examinations of depreciation computed under several generally used methods, including the (1) straight line, (2) double declining balance, (3) 150 percent declining balance, and (4) sum of the years-digits methods.

The straight line method prorates the cost of the asset over its life uniformly. ² If the asset is depreciated over N years, the depreciation taken is 1/ N times the asset cost in each year.

The double declining balance method permits depreciation equal to 2/ N times the undepreciated cost of the asset. ³ The 150 percent method is similar. Under it the depreciation deduction is 1.5/ N times the undepreciated cost of the asset.

The sum of the years-digits method of depreciation permits depreciation in each year at a rate equal to the remaining life of the asset divided by the sum of all the years' digits corresponding to the estimated useful life of the asset. ⁴

The cumulative total of all depreciation claimed on an asset will be shown in the depreciation reserve. For a single asset the relationship, R , between its depreciation reserve and the basis of the asset is given by the following formulae in which N is the useful life estimate used in computing depreciation and k is the number of years for which depreciation has been claimed:

Method of

                        ((2)(5) - 1)(11) - 25 74

The reserve ratio for a group of assets purchased in several years is the average of the reserve ratios, R , corresponding to assets acquired in each year appropriately weighted by investment in that year. If each year's acquisitions exceed the previous year's acquisitions by a constant proportion, i, and assets from the T previous years prior to the present are included in the group, the weighted average reserve ratio, W , for the group is given by the following formula:

                T

The formula is based on the assumption that acquisitions increase at a rate i . This assumption implies that the asset account as a whole will grow at a rate i . Therefore either the rate of growth of assets or the rate of growth of acquisitions may be used in the formula.

The appropriate reserve ratios shown in the Reserve Ratio Table (Table 2) are computed according to the formula for W assuming that T , the replacement period, is equal to N , the period of years over which assets are depreciated. To calculate the reserve ratio range, .9 N and 1.2 N were calculated to determine periods 10 percent shorter and 20 percent longer than the depreciation period. Values were obtained for the reserve ratio for the integral values of T just greater and just below .9 N and 1.2 N . The lower limit and the upper limit of the reserve ratio range were then obtained by interpolating between the four calculated values of the reserve ratio.

The following example of how the reserve ratio is calculated in a specific case illustrates the derivation of the formula. Assume the depreciation period is 5 years and that depreciation is taken on the double declining balance method. Assume also that the account has been growing at 5 percent and that assets are replaced after 6 full years of use. The company's property accounts would therefore contain investments made in the current year and 5 prior years. (Those investments made in the sixth prior year are all retired during the year.)

                                                        Total

Appendix II

Questions and Answers ¹

GENERAL APPROACH

1. Question:

Do the new guideline lives represent a liberalization of the depreciable lives contained in Bulletin `F' or of the depreciable lives actually used at present?

Answer:

Both. Because the guideline lives pertain to large classes of assets rather than to individual items, it is possible in prescribing these guideline lives to take into account technological changes and other economic factors which affect the useful life of assets to a greater extent than was possible in prescribing the lives contained in Bulletin `F'. Similarly, because it is difficult for any taxpayer to show the effect of technological change, etc., on the life of an individual asset, the guideline lives will permit a shortening of depreciable lives actually used at present.

Thus, the new guidelines are substantially shorter than the Bulletin `F' lives, and, for most taxpayers, are shorter than the lives presently being used.

2. Question:

Won't these new guideline lives soon become out of date as is the case with the present Bulletin `F'?

Answer:

It is expected that these new guideline lives will be reviewed periodically to insure that they keep pace with technological developments and other factors which result in property becoming obsolete at a faster rate than expected. The guidelines will be easier to keep up to date than Bulletin `F' because they deal with broad classes of assets rather than with thousands of individual items.

3. Question:

At present, depreciation is based on the useful life of property in the taxpayer's own trade or business. How does this depreciation reform affect this approach?

Answer:

The depreciation reform retains this approach. Every taxpayer should continue to base his depreciable lives on his own best estimate of the period of their use in his trade or business. The new reform provides guideline lives, based on analyses of statistical data and engineering studies and assessments of current and prospective technological advances, for each industry in the United States. The guidelines which have been developed are felt to provide reasonable standards for taxpayers in the various industries and if used will be presumed to be acceptable unless subsequent events show that they are not appropriate for a particular taxpayer's circumstances. Of course, to no extent do the new guidelines foreclose a taxpayer from using even shorter depreciable lives if his particular retirement and replacement practices are more progressive than those of the industry of which he is a part. Thus, under the depreciation reform, depreciation continues to be based on the concept of useful life of property to the taxpayer. However, wider latitude is provided for the taxpayer in making his own best estimate of useful life, and objective standards are provided wherever possible for determining when the taxpayer's estimate should not be disturbed.

4. Question:

If this depreciation reform does not alter the useful-life approach to depreciation, how does it provide for shorter lives and elimination of controversy?

Answer:

The depreciation reform provides for shorter lives first by providing new up-to-date guideline lives for classes of assets in lieu of the average lives for individual assets set forth in Bulletin `F', and second by placing greater emphasis on the economic life of property to the taxpayer rather than its physical life. The reform will eliminate controversy by giving greater leeway to taxpayers in estimating lives, by making adjustments by examiners largely dependent on objective standards rather than individual judgments, and by the use of guidelines for broad classes of assets rather than myriads of individual items.

5. Question:

Will this depreciation reform help only the taxpayer who has lagged in his replacement practices or will it also help the taxpayer who has been following progressive replacement practices?

Answer:

Unquestionably the depreciation reform will benefit all taxpayers, although in different ways. As to those taxpayers who have been following more progressive replacement practices, so as to entitle them to continue using lives shorter than the new guidelines, the principal benefit of the reform lies in the elimination of controversy over what lives are proper. In addition, the Reserve Ratio Table will provide objective guides for establishing that a taxpayer is entitled to use even shorter lives than he has used in the past. Moreover, the progressive taxpayer may use even shorter lives if they are justified by all the facts and circumstances.

6. Question:

Will this depreciation reform help the small taxpayer as well as the large corporation?

Answer:

There are a number of aspects of the depreciation reform which will benefit the small taxpayer. First, there is the level at which the new guideline lives are set. These are substantially lower than the lives prescribed as a guide in Bulletin `F'. Therefore, all small taxpayers who heretofore have relied on Bulletin `F' in setting useful lives for some or all of their assets will benefit from the new lower guideline lives. Second, there is the use of the reserve ratios to show that useful lives even shorter than the guideline life are justified. This should be especially helpful to small taxpayers since in the case of a small taxpayer such things as variations in asset mix, technological innovations, and purchases of some used assets are likely to have a greater impact on the proper life to be used in the future than in the case of a large taxpayer, yet the small taxpayer might well find it difficult to establish precisely what that impact will be. Third, the opportunity to support lives shorter than the guidelines by reference to the facts and circumstances of the particular case will be of special benefit to the small taxpayer. This will permit recognition of deviations from industry-wide norms that are likely to occur in connection with small taxpayers. Fourth, the elimination of so-called `penalty rates' should be of major importance to the small taxpayer. Fifth, the transition rule for applying the reserve ratio test should be of special significance to those smaller taxpayers whose reserves have become unreasonably high because their past retirement and replacement practices have not conformed with the lives which they used for depreciation purposes. This transition rule will enable them to obtain the funds with which to adopt more progressive replacement practices. Finally, since use of the Revenue Procedure is optional, those small taxpayers desiring to remain under established procedures may continue to do so.

7. Question:

In the case of a taxpayer who uses lives equal to the guideline lives, but fails to replace assets consistent with such lives, do the new guidelines and the reserve ratio test merely postpone for a number of years the controversy that exists today?

Answer:

Even though in some cases lives used by taxpayers may be lengthened to a point above the new guideline lives, there are several important reasons why this will not result in the controversies that are present today. First, a taxpayer using the new guidelines will not be challenged unless and until his depreciation reserves are unreasonably high as compared with his depreciable assets. This removes the question of when to challenge lives from the ambit of the individual examiner's judgment and makes it subject instead to objective arithmetic standards, thus eliminating one of today's major areas of dispute and also achieving uniformity in the treatment of taxpayers. Second, where the lives used by a taxpayer are lengthened, the new lives will generally be determined objectively by the use of an adjustment table and thus will no longer be a matter of individual judgment. The fact that some taxpayers may in the future be required to use lives longer than the guidelines should not result in any significant controversies.

8. Question:

In prescribing new guideline lives, does the depreciation reform merely shift the area of dispute from the question of useful life to the question of salvage?

Answer:

No. If the class life being used by the taxpayer for all assets in a single guideline class is equal to or longer than the guideline life, then neither the lives nor the salvage used for individual items will be disturbed under the Revenue Procedure. If the class life, which is of course based on both the lives and any salvage used by the taxpayer, is shorter than the guideline life, it may be justified either by the objective tests provided or by all the facts and circumstances. Once justified, the class life, including the salvage, will not be disturbed in subsequent years so long as replacement practices are thereafter consistent with that life.

9. Question:

How does this guideline approach compare with the Canadian approach to depreciation?

Answer:

The guideline approach of the Revenue Procedure avoids the rigidity of the Canadian system. The guideline approach permits taxpayers to use lives shorter than the guideline lives whereas the Canadian system does not permit the use of lives shorter than the prescribed lives, regardless of a taxpayer's retirement and replacement practices. In addition, unlike the Canadian system, this reform provides a separate class for production machinery and equipment in each different industry. This permits obsolescence and other factors which affect the economic lives of assets to be taken into account in accordance with the facts relating to the particular industry.

10. Question:

Will the new Revenue Procedure result in immediate changes in the organizational structure of the Internal Revenue Service for the handling of depreciation issues or questions?

Answer:

No immediate organizational changes are contemplated. Detailed instructions will be issued and special training courses are planned for all technical personnel concerned with depreciation matters to ensure uniform application of the depreciation reform. In addition, the Internal Revenue Service will watch closely progress in operating under the new Procedure with a view to introducing organizational or procedural changes where necessary to assure effective administration.

GUIDELINE LIVES

11. Question:

If some assets are used for a period of years longer than the guideline life, will the taxpayer be required to lengthen the life used in depreciating those assets or in depreciating assets which eventually replace those assets?

Answer:

No. It is to be expected that some assets will be held longer than the guideline life. The guideline life is an overall life for a class which will include assets having a wide range of lives. The fact that a number of assets are held for periods longer than the guideline life does not in itself mean that the guideline life is inappropriate.

12. Question:

Will a taxpayer be permitted to prove a life shorter than the guideline life for those assets which have a shorter life and use the guideline life for the other assets in that class?

Answer:

No. In comparing the lives used by the taxpayer with the guideline lives, the class life being used for a guideline class must be determined with reference to the lives of all of the assets in that class. This is the only way that the new guideline lives will provide an effective test. Otherwise, the taxpayer would demonstrate shorter lives for all the shorter-lived assets falling within a class, and would use the guideline life for all his longer-lived assets. This would defeat the purpose of the broad class approach which is based on an overall guideline life for a class containing assets having a broad range of lives.

13. Question:

Will a taxpayer who uses the new guideline lives be permitted to do so indefinitely?

Answer:

A taxpayer using lives equal to or longer than the guideline lives will not be challenged at any time so long as his retirement and replacement practices are consistent with the lives being used. This consistency may be demonstrated by the reserve ratio test as well as by presently established procedures. In any event, the taxpayer will not be subject to challenge for at least the first 3 taxable years to which the new Revenue Procedure applies.

14. Question:

If a taxpayer wishes to continue using a class life longer than the guideline life for several years after the Revenue Procedure becomes effective, will he in later years be permitted to use the guideline life?

Answer:

Yes.

15. Question:

It appears from the Revenue Procedure that a taxpayer may regroup his assets in classes corresponding to the guideline classes, in order to facilitate comparing the class lives with the guideline lives and applying the reserve ratio test. Does this regrouping constitute a change in method of accounting which requires the consent of the Commissioner of Internal Revenue?

Answer:

The regrouping of assets is not considered a change in method of accounting. Therefore the consent of the Commissioner is not required.

16. Question:

Will the same method of computing depreciation (straight-line, declining balance, sum-of-the-years digits) have to be applied with respect to all assets falling within a single guideline class?

Answer:

No. The taxpayer may use different methods of computing depreciation for different assets falling within a single guideline class provided that each method of depreciation is proper for the asset being depreciated. Thus, for example, the taxpayer may use the doubledeclining balance method of depreciation for the assets which he acquires new, and the straight-line method for those he acquires used. However, in order to compute the class life used for the assets in a guideline class for the purpose of comparison with the buideline life, it may be necessary to compute depreciation for all the assets in the class on a straight-line basis. It is to be emphasized that this straight-line figure is used only to determine the weighted average of the lives being used by the taxpayer and that it has no bearing on the actual method of depreciation that may be used.

17. Question:

Where a taxpayer uses a class life equal to the guideline life, must that same life be used consistently?

Answer:

This Revenue Procedure does not change present regulations. Under section 1.167(a)-1(b) of the regulations, a taxpayer may modify depreciable lives for any taxable year in the light of conditions existing at the end of that year.

18. Question:

How do the new guideline lives apply with respect to assets acquired used?

Answer:

The guideline lives measure the expected useful economic lives of assets acquired new. It is not possible to prescribe guidelines for used assets since the useful life of any used asset depends upon its age at the time it is acquired. However, the fact that a taxpayer has a substantial amount of used assets in a guideline class would be taken into account as a factor demonstrating that a life shorter than the guideline life may be justified for that class.

RESERVE RATIO

19. Question:

Apart from establishing that a taxpayer's reserve ratio falls within the range of acceptable reserve ratios, what use can be made of the reserve ratio test set forth in section 5 of Part II of the Revenue Procedure?

Answer:

The reserve ratio test will be useful to a taxpayer as an indication of whether his retirement and replacement practices are consistent with the class life being used. A taxpayer will be able to determine from the trend of his reserve ratios for successive years whether his practices are as progressive as he may believe them to be. Thus, the reserve ratio test will provide the taxpayer with information which may be useful in the making of business decisions as well as information which will be useful for tax purposes.

20. Question:

Can a taxpayer whose reserves are high for the first taxable years to which this Revenue Procedure is applicable use a class life equal to the guideline life? Under what circumstances will he be permitted to continue using that life?

Answer:

In order to give every taxpayer the opportunity to bring his practices into line with the new guideline lives, he will be allowed to use the new guidelines regardless of his present reserve ratios. He will be given a period of years up to a full replacement cycle to bring his reserves to an acceptable level, providing that the reserves are moving toward this level during this period.

21. Question:

Isn't it normal to have fluctuations in the ratios of depreciation reserves to depreciable assets? Will these ordinary fluctuations result in a failure to meet the reserve ratio test?

Answer:

It is normal to have a certain amount of fluctuation in depreciation reserve ratios. However, the Reserve Ratio Table has been devised to take this into account. The table provides a broad range for acceptable reserve ratios. This range is designed to provide a substantial amount of leeway before the ratio of a particular taxpayer will be considered unreasonably high.

22. Question:

Suppose that the assets in a guideline class are actively used on the average for a period equal to the guideline life, but thereafter some are retained on a standby status instead of being retired. Will this result in the accumulation of unreasonable depreciation reserves so that the taxpayer eventually will fail to meet the reserve ratio test?

Answer:

The reserve ratio ranges have been designed to provide a substantial amount of leeway to the taxpayer. Thus, a taxpayer will be able to continue to meet the reserve ratio test even though he retains some equipment on a standby basis. If the reserve ratio of a taxpayer retaining standby equipment fails to meet the reserve ratio test, the taxpayer has the opportunity to demonstrate that the class life used is appropriate on the basis of all the facts and circumstances.

23. Question:

What will cause the depreciation reserves for a guideline class to become unreasonably high?

Answer:

The reserves will become unreasonably high if a taxpayer's retirement and replacement practices are not consistent with the class life being used for depreciation purposes. Underlying factors causing this inconsistency might include (1) that the taxpayer's asset composition for a guideline class is not typical of the industry as a whole but consists primarily of assets with useful lives which are longer than the class life being used by the taxpayer, (2) that the taxpayer is leasing a substantial amount of assets having useful lives shorter than the class life used by the taxpayer for the guideline class into which the leased assets would fall if they were owned by the taxpayer, and (3) that the taxpayer is retaining and continuing to depreciate (in a multiple-asset account) assets which no longer are being used in the trade or business.

In addition, high reserves may be caused by the fact that a guideline class contains relatively few assets, most of which are nearing the end of their useful lives. This could be true even where the taxpayer's retirement and replacement practices are consistent with the class life used. In such a case, the high reserves could readily be explained and the class life used by the taxpayer could still be justified on the basis of the taxpayer's retirement and replacement practices.

24. Question:

If the Reserve Ratio Table indicates that a taxpayer has unreasonably high depreciation reserves, will the lives used by the taxpayer automatically be lengthened?

Answer:

Not automatically. Unreasonably high depreciation reserves may be an indication, as under present practice, that the lives used by a taxpayer should be lengthened. However, the taxpayer will always be permitted to show, by the use of established procedures, that his retirement and replacement practices are consistent with the lives being used.

25. Question:

If the taxpayer's reserve ratio would not be considered unreasonably high for the year under examination, may the examiner take into account, in examining that year, the fact that the reserve ratio becomes unreasonably high in a year intervening between the year under examination and the time of audit?

Answer:

No. The examiner should be concerned only with the reserve ratio for the year under examination. The fact that the reserve ratio becomes unreasonably high in a subsequent year will not be considered in connection with an earlier year that may be under examination.

26. Question:

If a taxpayer uses the guideline life for a class of assets but does not retire or replace assets consistent with that life, he will accumulate a high depreciation reserve. If that taxpayer subsequently is required to use a class life longer than the guideline life, would the depreciation reserve have to return to normal before he would again be permitted to use the guideline life?

Answer:

This taxpayer could use the guideline life again as soon as he could show that his retirement and replacement practices were consistent with the guideline life. This consistency could be demonstrated in either of two ways: The first would be on the basis of all the facts and circumstances. The second would be if the taxpayer's reserve ratio declined to the point where it came within the reserve ratio range for the lengthened class life. Thus, the taxpayer would not have to `work off' the entire amount of the excessive depreciation previously deducted before again being permitted to use the guideline life.

27. Question:

What does the theoretically appropriate reserve ratio mean?

Answer:

The theoretically appropriate reserve ratio is the ratio of accumulated depreciation reserves to the total basis of the assets in a guideline class which results when the taxpayer for more than a replacement cycle has followed policy of additions to and retirements from that class consistent with the class life used.

28. Question:

What do the upper and lower limits of the reserve ratio ranges represent?

Answer:

The upper limit of the reserve ratio range is the reserve ratio for a taxpayer's guideline class which would result if the assets in that class were used for a period 20 percent longer than the class life used by the taxpayer. The lower limit of the reserve ratio range is the reserve ratio for a taxpayer's guideline class which would result if the assets were used for a period 10 percent shorter than the calss life used by the taxpayer.

29. Question:

How does the Reserve Ratio Table account for the fact that the timing of retirement of assets is dispersed about a class life, so that some assets are retired after a period of time shorter than the class life used by a taxpayer while other assets may last considerably longer than that life?

Answer:

In practice, retirements in any guideline class will be dispersed about the class life used by the taxpayer. However, the theoretically appropriate reserve ratios in the table are based on the assumption that there is no dispersion in the retirement of assets, i.e., that all assets are retired exactly when they age to the class life used. This assumption is necessary because the dispersion factor for every taxpayer is different and it is therefore not feasible to take this factor into account.

Were a dispersion factor included in the mathematical computation of each appropriate reserve ratio, the resulting ratios would be smaller than the tabulated ratios in all cases. The upper and lower limits of the reserve ratio ranges would also be lower than indicated in the table. Thus, the effect of disregarding the dispersion factor is to provide an additional margin of leeway respecting the range of acceptable reserve ratios.

30. Question:

During the past decade, the cost of depreciable equipment has risen substantially. How does the Reserve Ratio Table take into account this fact that prices have been rising?

Answer:

The structure of the Reserve Ratio Table automatically compensates for past inflation. This is true because inflation causes both the taxpayer's reserve ratio and the appropriate reserve ratio range to decline. The taxpayer's reserve ratio falls because his relatively more expensive, recently-acquired assets have had little depreciation charged against them, whereas relatively more depreciation has been charged against the older, less expensive equipment. Rising prices will also automatically push up the dollar basis of depreciable property, thus increasing the indicated rate of growth and lowering the appropriate reserve ratio range.

MISCELLANEOUS ASPECTS

31. Question:

If a taxpayer wishes to use lives longer than the guideline lives, consistent with his replacement policy, will losses incurred on retirements be disallowed on the ground that depreciation based on the shorter guideline life was `allowable' (within the meaning of section 1016(a)(2) of the 1954 Code) even though it was not claimed by the taxpayer.

Answer:

No. The new lives are only guidelines. They will not be used to determine what is the `allowable' amount of depreciation. The taxpayer should claim the amount of depreciation that is appropriate for his own trade or business. He is not required to use the guidelines if he feels that they are too short to reflect his actual retirement and replacement practices.

However, if artificially long lives are assigned to assets for the purpose of manipulating the depreciation deduction, an adjustment to basis under section 1016(a)(2) of the Code may be made for the depreciation properly `allowable' in the past even though it was not claimed and allowed. Present law is not changed in this respect by this depreciation reform.

32. Question:

If a taxpayer's reserve ratio is below the lower limit, it is probable that the taxpayer is entitled to use shorter depreciable lives. Is this low reserve ratio an indication that the taxpayer has taken too little depreciation in the past and that the basis of the property should be reduced for depreciation which was `allowable' even though not claimed by the taxpayer?

Answer:

No. The taxpayer's reserve ratio is not an indication that depreciation not taken was `allowable' under section 1016(a)(2). The rules concerning the application of section 1016(a)(2) are not affected by the Revenue Procedure.

33. Question:

Questions often arise as to whether particular expenditures are deductible expenses or are capital expenditures which should be recovered through depreciation. How does this depreciation reform affect the resolution of these questions?

Answer:

The depreciation reform does not affect the classification of expenditures as capital or expense. Questions in this area must be resolved on the basis of presently established principles. The depreciation reform affects only those expenditures which are properly chargeable to capital and recoverable through depreciation deductions.

34. Question:

How will retirements of assets be treated under the depreciation reform?

Answer:

The depreciation reform does not change the regulations dealing with the proper treatment of retirements of assets, how to determine whether a retirement is normal or abnormal, etc. The treatment of retirements will continue to be determined under the regulations under section 167. Thus, if a taxpayer is using a method of accounting under which no gain or loss is recognized at the time of a normal retirement of an asset from a multiple-asset account, the taxpayer may continue to use this method after the publication of the depreciation reform so long as this method clearly reflects income. If a taxpayer is using a method of accounting, as to either item or multiple-asset accounts, under which gain or loss is recognized upon disposition, then gain or loss will continue to be recognized under the present regulations applicable to the item or multiple-asset accounts.

35. Question:

Section 167(d) and the regulations thereunder provide that the taxpayer and the district director may enter into an agreement as to the useful life of any property, and that the agreement shall be binding until such time as new circumstances come into existence. After the publication of the depreciation reform, will taxpayers be permitted to modify these agreements?

Answer:

The adoption of the depreciation reform itself will be considered as a new factor which justifies a taxpayer in modifying any agreement previously made. Thus, if the taxpayer wishes to modify an agreement previously made, he should notify the district director in accordance with the regulations under section 167(d).

36. Question:

Under the Revenue Procedure, the use of the same life in computing the depreciation deduction and in computing the depreciation shown on the books of account and financial statements is considered a significant factor in justifying a class life shorter than the guideline life. Does the significance of this factor vary according to the circumstances of the case?

Answer:

Yes. This factor is significant in the case of a publicly-held corporation since the depreciation shown on the books of account and financial statements is published and has independent importance to stockholders and other persons outside the management of the corporation. In the case of a corporation which is not publicly held, the booking factor is also significant where the figures shown on the books of account and financial statements have independent importance to persons other than the owners of the corporation, such as lending institutions and fiduciaries for employee profit-sharing plans. The booking factor would be less significant in the case of a closelyheld corporation where the books of account and financial statements are not relied on by persons outside the corporation. Since regulated public utilities may be required to use depreciable lives for book purposes that differ from those used in computing the depreciation deduction, their booking practice is not a significant factor.

37. Question:

If a class life used by a taxpayer is required to be lengthened because of a failure to retire and replace assets consistent with the life used, how much will the class life be lengthened?

Answer:

The life will be lengthened to the point where it reflects the taxpayer's actual retirement and replacement practices; it will not be lengthened so as to compensate for the fact that excessive depreciation may have been taken in the past. This will result in the elimination of the present so-called `penalty rates.'

38. Question:

If a class life used by a taxpayer is to be lengthened in accordance with the Adjustment Table for Class Lives, but the taxpayer maintains item accounts, how will the useful lives assigned by the taxpayer to each account be lengthened?

Answer:

The taxpayer will lengthen those item lives which he chooses to lengthen so long as the overall class life is not shorter than the appropriate class life shown in the Adjustment Table.

39. Question:

Can a taxpayer who changes from the unit-of-production method of computing depreciation to a useful-life method (expressed in terms of years) under the blanket consent contained in the Revenue Procedure justify a class life shorter than the guideline life by the fact that the reserve ratio for the guideline class is low?

Answer:

Where the reserve ratio for a guideline class is lower than the lower limit of the appropriate reserve ratio range for that class, this fact will justify the use of a class life shorter than the guideline life only where the ratio reflects the retirement and replacement practices of the taxpayer during a substantial period of years. Under section 3.02(a) and section 3.03(a) of Part II of the Revenue Procedure, the use of approximately the same class life for a substantial period of years is essential before the fact of a low reserve ratio becomes significant. Therefore, a taxpayer who changes from the unit-of-production method would not be able to justify a class life shorter than the guideline life by a low reserve ratio since he has not previously been using a class life expressed in years.

40. Question:

How does the depreciation reform apply to a taxpayer using the retirement method of accounting or some other similar method?

Answer:

The new guidelines and the procedures for using them are not applicable to a taxpayer using the retirement method of accounting. Any taxpayer who wishes to change from the retirement method to a useful-life method of depreciation must obtain consent from the Commissioner of Internal Revenue in accordance with the provisions of section 446(e) and the regulations thereunder.

41. Question:

How does the depreciation reform apply to affiliated corporations which file consolidated returns?

Answer:

The new guideline lives and the reserve ratio test are to be applied to each corporation separately, regardless of the fact that the corporations are members of an affiliated group which is filing a consolidated return.

42. Question:

How does the depreciation reform apply in the case of a partnership?

Answer:

The new guideline lives and reserve ratio test apply to the partnership as an entity.

43. Question:

Footnote 20 in Revenue Procedure 62-21 indicates that fully-depreciated assets used in a taxpayer's trade or business must be taken into account in computing the taxpayer's reserve ratio. How are fully-depreciated assets to be treated for other purposes, such as computing the amount of depreciation, the class life, and the rate of growth?

Answer:

The treatment of fully-depreciated assets for these other purposes depends on the method of grouping assets employed by the taxpayer. If the taxpayer uses accounts in which fully-depreciated assets maintain their identities, such as in item accounting or where assets are segregated by year of acquisition, then when any such asset or group of assets becomes fully depreciated, it should no longer be taken into consideration in computing depreciation, the class life, or the rate of growth. Thus, the basis of such fully-depreciated assets must be excluded from the total basis of the assets in the guideline class which is used to compute the class life and the rate of growth.

On the other hand, if the taxpayer consolidates his assets on a permanent basis into accounts corresponding to the guideline classes, these accounts should include all depreciable assets used in the taxpayer's trade or business, whether or not previously considered fully depreciated. This is because the assets in this type of multiple-asset account lose their individual identities and no particular item still in use can be considered as being fully depreciated. In this case, the assets previously considered as fully depreciated should be taken into consideration in computing the amount of allowable depreciation, the class life, and the rate of growth.

Regardless of the taxpayer's method of grouping assets, however all assets used in the taxpayer's trade or business which fall within a guideline class must be taken into consideration in computing the reserve ratio for that class.

44. Question:

Section 2.01 of Part III of Revenue Procedure 62-21 indicates that the portion of the basis of any asset in a guideline class which is subject to amortization under sections 168 or 169 of the 1954 Code (or corresponding provisions of prior law) or is recovered by means of the additional first-year depreciation allowance provided by section 179 shall be excluded from the total basis of the assets in the class for the purpose of computing the taxpayer's reserve ratio. How are these amounts which are subject to section 168, 169, or 179 to be treated for other purposes, such as determining the class life and the rate of growth?

Answer:

These amounts should be excluded from the total basis of the assets in a guideline class for all purposes of Revenue Procedure 62-21. However, only that portion of the basis of an asset which is subject to section 168, 169, or 179 should be excluded. The balance of the basis which is recoverable through normal depreciation allowances should be taken into account for purposes of applying Revenue Procedure 62-21.

45. Question:

In situations where Revenue Procedure 62-21 indicates that the taxpayer's depreciation deduction is not to be distributed, may his salvage estimate be adjusted?

Answer:

No. Under the rules of the Revenue Procedure, not disturbing the depreciation deduction claimed means accepting the judgment of the taxpayer as to both useful lives and salvage, as indicated in footnotes 3 and 8 of the Revenue Procedure. Thus, if the taxpayer meets the conditions of the Revenue Procedure, his salvage estimates should not be challenged, regardless of whether be is using item or multiple-asset accounts.

46. Question:

Where Revenue Procedure 62-21 is being used, may assets be depreciated below a reasonable salvage value?

Answer:

Section 1.167(c) of the Income Tax Regulations provides that `. . . in no event shall an asset (or an account) be depreciated below a reasonable salvage value.' This provisions is still fully effective. However, since the determination of a reasonable salvage value is a matter of judgment and estimate, Revenue Procedure 62-21 sets forth rules governing when the taxpayer's judgment as to the reasonableness of the depreciation deduction claimed, including the reasonableness of his salvage estimate, will not be challenged. Therefore, if the conditions of the Procedure are met, depreciation will not be disallowed on the ground that the taxpayer's salvage estimate is not reasonable. However, the depreciation deduction claimed for an asset in the taxable year of its disposition may be governed by Revenue Ruling 62-92, C.B. 1962-1, 29.

47. Question:

Revenue Procedure 62-21 provides that if its conditions are met, neither the lives nor the salvage assigned by the taxpayer will be disturbed. If a taxpayer in the mining industry or the oil and gas industry meets the conditions of the Revenue Procedure, may he allocate the depreciation among the various mining or oil and gas properties in any way he sees fit?

Answer:

Where a taxpayer meets the conditions of Revenue Procedure 62-21 for not having his depreciation disturbed, he has a great deal of latitude in determining the depreciation attributable to the individual assets in the guideline class. However, if a taxpayer in the mining or oil and gas industry allocates the depreciation for a guideline class in an unrealistic manner solely for the purpose of avoiding the application of the 50-percent limitation on percentage depletion provided by section 613(a) of the 1954 Code, the examining agent may challenge the depreciation allocated to the various mining or oil and gas properties, notwithstanding the fact that the taxpayer meets the conditions of the Revenue Procedure for that guideline class. In such a case, the examining agent may not challenge the overall class life used by the taxpayer, but he may question the allocation of the overall depreciation for the guideline class to the various depletable properties.

48. Question:

Revenue Procedure 62-21 encourages taxpayers using item accounts to adopt multiple-asset accounts corresponding to the guideline classes. May a taxpayer who adopts such accounts change his treatment of retirements without consent of the Commissioner to conform to the underlying principles of accounting for multiple-asset accounts, that is, may the bases of normal retirements from the multiple-asset accounts be charged to the depreciation reserve and the salvage proceeds be credited to the reserve, or should gain or loss be reported on these retirements as was required before the regrouping?

Answer:

Any taxpayer who regroups his assets into multiple-asset accounts on a permanent basis for purposes of facilitating the use of Revenue Procedure 62-21 may use the accounting practice under which the bases of normal retirements from multiple-asset accounts are charged to the depreciation reserve and the salvage proceeds are credited to the reserve so long as that practice clearly reflects income. Alternatively, such a taxpayer may use the practice of reporting all receipts from salvage as ordinary income so long as that practice clearly reflects income. See section 1.167(a)-8(e)(2) of the Income Tax Regulations. At the time the taxpayer regroups his assets into multiple-asset accounts, he may adopt either of these practices without securing the prior consent of the Commissioner.

49. Question:

Section 3.05, Part II, of Revenue Procedure 62-21 provides in part that:

* * * where such class life was accepted on audit by the Internal Revenue Service under presently established procedures for examining depreciation (whether before or after the effective date of this Revenue Procedure), the depreciation deduction claimed by the taxpayer for the assets in that class in any subsequent year based on that class life will not be disturbed if the taxpayer's retirement and replacement practices for that class are consistent with the class life being used.

What constitutes `acceptance on audit by the Internal Revenue Service under presently established procedures for examining depreciation'?

Answer:

The class life used by a taxpayer will be considered to have been accepted on audit for purposes of applying the provisions of the Revenue Procedure in all situations in which the audit report shows adjustments to depreciation or contains comments that the depreciation deduction was examined but not adjusted, or where other specific evidence indicates that the depreciation deduction was examined. If there is no specific evidence either in the audit report or elsewhere that the depreciation deduction was examined, or if there was no audit of the return, the class life used by the taxpayer will not be considered to have been accepted on audit.

GUIDELINE CLASSES

50. Question:

How are assets to be classified in the prescribed guideline classes where a taxpayer engages in more than one industrial or commercial activity?

Answer:

The assets falling within the guideline classes in Group One (guidelines for depreciable assets used by business in general) should first be classified in the appropriate guideline classes contained in Group One. If the taxpayer is engaged in only one activity described in Group Two, Three, or Four, the remaining assets should be classified in the guideline class for that activity. If, however, the taxpayer is engaged in more than one activity, the assets used in each activity should be classified in the appropriate guideline class for that activity, except for the assets used in an activity which is considered insubstantial for the purpose of applying Revenue Procedure 62-21. An activity will be considered as insubstantial where the total basis of the assets used in that activity is less than three percent of the total basis of the assets used in all activities carried on by the taxpayer (excluding assets which fall within the guideline classes contained in Group One). If an activity carried on by the taxpayer is considered insubstantial, the assets used in that activity should be classified in the guideline class for the activity which the insubstantial activity primarily serves or with which it is most closely associated.

These principles may be illustrated by the following examples:

(1) Corporation M mines coal and iron ore and markes steel and steel products. Corporation M has the following assets, excluding assets which fall in the guideline classes contained in Group One:

   Assets used in mining.................................  $500,000

(2) Assume that Corporation M also provides bowling alleys for its employees, and that the equipment used in connection with the bowling alleys has a basis of $50,000. Since the total basis of the assets used in the bowling alleys is less than three percent of the total basis of the assets used in mining, steel making, and recreational facilities, the recreation and amusement activity carried on by M Corporation will be considered to be insubstantial. If the bowling alleys are used primarily by employees who work in Corporation M's steel plant, the equipment used in the bowling alleys should be classified in Class 19(a) of Group Three (ferrous metals).

51. Question:

How should an item of production machinery or equipment be classified if it is used in the manufacture of products connected with two or more guideline classes?

Answer:

It should be classified according to its primary use. The primary use of an asset may be determined in any reasonable manner. This principle may be illustrated by the following example:

Corporation N makes metal stampings some of which are sold for use in the aerospace industry and some of which are sold for use in other activities. Corporation N has the following assets, excluding assets which fall in the guideline classes contained in Group One:

 Assets used only in making component parts for the

52. Question:

How should equipment, such as power plant equipment, be classified if it services machinery falling in two or more different guideline classes?

Answer:

Such equipment should be classified according to its primary use. Thus, if power plant equipment services machinery identified with two different manufacturing activities, the total basis of the power plant equipment should be included in the guideline class which contains the production machinery which the power plant equipment primarily serves. The purimary use of such equipment may be determined in any reasonable manner.

53. Question:

What rules should be applied where the primary use of an asset changes?

Answer:

Once an asset has been properly classified in a guideline class according to its primary use, it will generally continue to be classified in the same guideline class throughout the period of its use in the taxpayer's trade or business. However, if the primary use of an asset changes, the taxpayer has the option of continuing to classify the asset according to its original classification or of reclassifying it according to its new primary use. If the asset is reclassified, the basis and depreciation reserve attributable to the asset should be removed from the first guideline class and added to the total basis and total depreciation reserve for the second guideline class.

54. Question:

May different groups of assets, each used in connection with a separate activity described in Group Two, Three, or Four be combined and treated as falling in one guideline class for the purpose of applying Revenue Procedure 62-21?

Answer:

Assets used in one substantial activity should not be combined with assets used in another substantial activity for the purpose of applying Revenue Procedure 62-21. The assets used in each substantial activity fall in a separate guideline class. As indicated in the answer to Question 50, however, the assets used in an insubstantial activity are to be classified in one guideline class with the assets used in a substantial activity.

55. Question:

What rules should be applied where an insubstantial activity becomes substantial or a substantial activity becomes insubstantial?

Answer:

If an insubstantial activity becomes substantial, the taxpayer has the option of continuing to classify the assets used in the activity in the same guideline class as theretofore, or he may establish a new guideline class for the activity by removing the basis of the assets used in that activity, and the depreciation reserves attributable to those assets, from the guideline class in which they have been classified and placing them in a separate guideline class.

Similarly, if a substantial activity becomes insubstantial, the taxpayer has the option of continuing to maintain a separate guideline class for the activity, or of transferring the assets used in that activity to the guideline class for the activity which the insubstantial activity primarily serves or with which it is most closely associated.

56. Question .

If a building is constructed so that it is useful in only one particular industry, is it a special-purpose structure?

Answer:

The fact that the use of a building is restricted by the manner in which it is constructed does not in itself make the building a special-purpose structure. A special-purpose structure is one which is an integral part of the production process, and which is so closely associated with the equipment which it houses, supports, or serves that it would normally be replaced (entirely or in large part) contemporaneously with that equipment.

59. Question:

What activities are considered `mining' for the purpose of applying Revenue Procedure 62-21?

Answer:

The activities which are considered to be `mining' for the purpose of computing percentage depletion will be considered to be `mining' for the purpose of classifying machinery and equipment in guideline class 5 of Group Two (mining). Assets used in an activity of a type considered as mining shall be included in guideline class 5 of Group Two even though the taxpayer is not entitled to a depletion allowance with respect to that activity. For example, if a taxpayer is operating a concentrating plant, the assets used in that activity should be classified in guideline class 5 even though the taxpayer does not have an economic interest in the mineral in place and thus is not entitled to a depletion allowance.

COMPUTATION OF CLASS LIFE

58. Question:

How is the class life used by a taxpayer to be computed where he uses the double-declining balance or the sum-of-the-years digits method of depreciation with respect to some or all of the assets in a guideline class?

Answer:

As indicated in Revenue Procedure 62-21, the class life is computed by dividing the total straight-line depreciation with respect to all assets in the guideline class into the total basis of all those assets. If the taxpayer is actually using the straight-line method of depreciation with respect to assets in the guideline class, the straight-line depreciation for the purpose of computing the class life is the same as the depreciation deduction claimed by the taxpayer. If the taxpayer is using the double declining balance method of depreciation with respect to any asset or multiple-asset account falling in the guide-line class, the straight-line depreciation with respect to that asset or account for the purpose of computing the class life is obtained by multiplying the total basis of the asset or account by one-half the double declining balance rate used by the taxpayer. If the taxpayer is using the sum-of-the-years digits method of depreciation with respect to any asset or multiple-asset account falling in the guideline class, the straight-line depreciation with respect to that asset or account for the purpose of computing the class life is the amount of depreciation that would be claimed as a deduction under the straight-line method if the remaining balance in the account (computed as if the taxpayer had been using the straight-line method) were spread over the remaining life of the account used in computing depreciation under the sum-of-the-years digits method. For this purpose, the same amount of salvage (if any) should be used in computing the straight-line depreciation as the taxpayer used in computing depreciation under the sum-of-the-years digits method.

The following examples illustrate the computation of the class life: (1) Taxpayer A uses the straight-line method of depreciation with respect to all assets falling within a guideline class and estimates that such assets have no salvage value.

                  Cost (or    Life used    Depreciation     Actual

                                                   Depre-      Actual

                                     Depre-

                        Life     Depre-   Actual              Straight

                      Life                   Actual          Straight

                      Life                   Actual          Straight

                                                               Strai-

                                                               Strai-

(9) Taxpayer H uses the straight-line method of depreciation with respect to all the assets falling within a guideline class. The total basis of all the assets in the class is $100,000 and the total depreciation reserve is $50,000. If H wishes to group all the assets in a single account corresponding to the guideline class and use a class life equal to the guideline life, he may take depreciation of $10,000 since the total basis ($100,000) divided by the total straight-line depreciation ($10,000) would produce a class life of 10 years.

(10) Taxpayer J uses the double-declining balance method of depreciation with respect to all the assets falling within a guideline class. The total basis of all the assets in the class is $100,000 and the total depreciation reserve is $60,000. If J wishes to group all the assets in a single account corresponding to the guideline class and the a class life equal to the guideline life, he may take depreciation of $8,000 (20% $x($100,000-$60,000)). This is equal to twice the straight-line rate which is the reciprocal of the guideline life times the remaining balance of the account.

(11) Taxpayer K uses the sum-of-the-years digits method of depreciation with respect to all the assets falling within a guideline class. The total basis of all assets in the class is $100,000 and the total depreciation reserve is $66,000. However, the depreciation reserve if K had been using the straight-line method of depreciation would be $50,000. If K wishes to group all the assets in a single account corresponding to the guideline class and use a class life equal to the guideline life, he may take depreciation of $11,333.33. This is computed as follows: K must first compute what the remaining life of the account would be if he used a class life equal to the guideline life and the straight-line method of depreciation. The remaining life based on these assumptions is 5 years (the remaining balance in the account using the straight-line method ($50,000) divided by the amount of straight-line depreciation which would be allowable to a person using a class life equal to the guideline life ($10,000)). Table I in Regulation Section 1.167(b)-3(a)(2)(ii) provides decimal equivalents for each remaining life of a sum-of-the-years digits account. To determine the amount of allowable depreciation, it is necessary to multiply the decimal equivalent for a 5-year remaining life (.3333) times the remaining balance in the account ($34,000), thus obtaining a depreciation allowance of $11,333.33.

(12) Taxpayer L has four assets falling in a single guideline class. He has been using item accounts and has been depreciating the accounts under different methods of depreciation. He wishes to continue this practice. If L computed his depreciation in the current year without changing his rates from those used in the past, it would be computed as follows:

                                                               Strai-

             Basis  Life          Straight- Straight- Actual   Actual

Under Revenue Procedure 62-21, in computing the class life used by a taxpayer, the total straight-line depreciation with respect to all assets in a guideline class is divided into the total basis of those assets. In the case of additions to the guideline class during the taxable year, the basis of each addition will generally be included in the depreciation accounts of the taxpayer at the close of the year, but less than a full year's depreciation will generally have been claimed with respect to these additions. In the case of retirements from the guideline class during the year, some depreciation will generally have been claimed as to each retirement, but the basis of the assets retired will have been removed from the taxpayer's depreciation accounts. How are additions and retirements during the year to be taken into account in computing the class life so as to avoid distortion?

Answer:

In computing the class life, the basis of each addition and retirement during the taxable year must be apportioned consistent with the amount of depreciation claimed with respect to each addition and retirement. The proper portion of the basis of each asset added or retired during the taxable year to be taken into account is that portion which bears the same relationship to the total basis of the asset as the amount of depreciation taken for the taxable year with respect to the asset bears to the amount of depreciation that would be taken for a full taxable year. Thus, for the purpose of computing the class life, the total basis of the assets in a guideline class means the basis of each asset in the class on which a full year's depreciation is claimed plus a proportionate part of the basis of each asset acquired or retired during the year on which less than a full year's depreciation is claimed. This system for the handling of additions and retirements provides for an accurate relationship between depreciation and basis and also prevents an overweighting of additions and retirements in relation to the other assets in the guideline class.

¹ Amendment I, published in I.R.B. 1962-46, 23 making various changes in part 1 has been incorporated herein; this amendment was released as Technical Information Release 405, dated October 19, 1962. The tables in part III, beginning at page 444, were published as Announcement 62-82, I.R.B. 1962-38, 12. They supersede the illustrative tables published as part of Revenue Procedure 62-21, I.R.B. 1962-30, 6, at page 32.

PART I.

¹ Amendment I, published in I.R.B. 1962-46, 23, making various changes in Part 1 has been incorporated herein; this amendment was released as Technical Information Release 405, dated October 19, 1962.

/a/ These items are more usually and properly accounted for under a method of accounting other than a method of depreciation using a life expressed in terms of years. The method used by the taxpayer may be continued if it is consistently used and clearly retlects income. It should be noted that the cost (or other basis) of any asset used in a trade or business and having a useful life of one year or less may be deducted currently and in not subject to depreciation.

PART II.

¹ Since the prescribed guideline lives are expressed in terms of years, the procedures set forth herein cannot be applied to assets depreciated under the unit-of-production, machinehour, or similar methods of depreciation. If any asset in a guideline class is depreciated under one of these methods, these procedures are not applicable to that guideline class. Whether depreciation claimed by the taxpayer with respect to that guideline class is reasonable will continue to be determined under Revenue Rulings 90 and 91, C.B. 1953-1, 43, 44. However, if a taxpayer using one of these methods changes to a useful-life method (expressed in terms of years) of computing depreciation for tax purposes in filing his income tax return for the first taxable year to which this Revenue Procedure applies or for the first taxable year ending on or after July 12, 1962, he will be deemed to have filed a timely application for consent to make such a change and such consent is hereby granted.

² This Revenue Procedure does not apply with respect to examinations of depreciation elaimed for taxable years for which returns were due to be filed before July 12, 1962. The examination of depreciation claimed for such taxable years will be made in accordance with Revenue Rulings 90 and 91, C.B. 1953-1, 43, 44. Moreover, the guideline lives set forth in Part I of this Revenue Procedure will not be regarded as evidence of the appropriate useful lives to be used where taxpayers did not follow retirement and replacement practices consistent with those lives during the years under examination. In general, any taxpayer will be permitted to use the Reserve Ratio Table set forth in Part III of the Revenue Procedure to demonstrate that his retirement and replacement practice supports the life used or a proposed change in the life used, provided that the circumstances are analogous to those set forth in section 3.02(a) or 3.03(a) of Part II of this Revenue Procedure. In this connection, however, the transition rule of section 5.03 of Part II may not be used.

³ In the context of this Revenue Procedure, not disturbing the depreciation deduction means not disturbing either the lives or salvage used by the taxpayer. Of course, the correct basis of assets must be used in computing the depreciation deduction. In addition, where the useful life of an individual asset must be used to determine eligibility for a special method of computing depreciation or for any other provision where eligibility depends on the useful life of the individual asset, such life must be determined for that purpose without regard to this Revenue Procedure. Examples of instances where the useful life of an individual asset must be so determined include (1) section 167(c) where the useful life of an asset must be 3 years or more to qualify for certain accelerated methods of depreciation, and (2) section 179 where the useful life of an asset must be 6 years or more to qualify for the additional first-year depreciation allowance. Moreover, the depreciation deduction claimed for an asset in the taxable year of its disposition may be governed by Revenue Ruling 62-92, C.B. 1962-1, 29.

⁴ Because of the structure of the Reserve Ratio Table, the fact that the reserve ratio test is met for a particular class life is not meaningful, for the purpose of justifying a class life shorter than the guideline life by reference to its prior use, unless that class life has been used for a substantial period of years. As to meeting the reserve ratio test where a class life has been used for a substantial period of years, the reserve ratio test will, because of the operation of the transition rule, be considered to be met for the first 3 taxable years to which this Revenue Procedure applies. See section 5.03(a) of this Part.

⁵ In some cases, the fact that the reserve ratio is below the lower limit is not meaningful in determining whether the use of a shorter class life is justified by the taxpayer's retirement and replacement practices. Since a new taxpayer or a taxpayer with a new guideline class of assets will necessarily have low reserve ratios, such fact is not meaningful until a guideline class has a history equal in years to the guideline life for that class. Similarly, this fact is not meaningful where the retirement or acquisition of assets in a guideline class produces a sudden and unusual decrease in a taxpayer's reserve ratio when compared with the reserve ratio for the immediately preceding taxable year. In these cases, the fact that a reserve ratio is below the lower limit cannot be used to justify a class life shorter than the guideline life. Whether the taxpayer's prior retirement and replacement practices for a guideline class justify the shorter class life used by the taxpayer must be determined on the basis of all the facts and circumstances.

⁶ Because of the structure of the Reserve Ratio Table, the fact that a taxpayer's reserve ratio is below the lower limit of the appropriate reserve ratio range for a particular class life is not meaningful, for the purpose of justifying a class life shorter than the guideline life by reference to prior retirement and replacement practices, unless that class life has been used for a substantial period of years.

⁷ This table and the instructions for using it are set forth in section 3 of Part III of this Revenue Procedure. If the taxpayer's reserve ratio for a guideline class is below the lower limit of the appropriate reserve ratio range, the Adjustment Table for Class Lives will indicate which shorter class life is consistent with the taxpayer's retirement and replacement practices. If the taxpayer uses an even shorter class life, it cannot be justified on the basis of the table, but must be justified on the basis of other facts and circumstances.

⁸ See footnote 3.

⁹ Where this factor is relied upon as a significant factor in justifying the class life being used, the life used by the taxpayer for tax purposes in succeeding years should continue to correspond to the life used in computing the depreciation shown on the books of account and financial statements if the taxpayer wishes to retain the benefits of the reserve ratio test under subsection .05 of this +section. If such lives do not correspond, the taxpayer may be required to justify the class life used in such succeeding taxable years on the basis of all the facts and circumstances pertaining to such years.

¹⁰ If any multiple-asset account maintained by the taxpayer overlaps two or more of the prescribed guideline classes, the taxpayer should provide sufficient information to enable the weighted average of the lives for all the assets coming within each such guideline class to be computed with reasonable accuracy, considering the circumstances of the particular case.

¹¹ The term `basis' as used in this Revenue Procedure means cost or other basis, adjusted only as provided in section 1016(a)(1).

¹² In certain cases, the fact that the taxpayer's reserve ratio for a guideline the upper limit of the appropriate reserve ratio range is not meaningful as an indication that the taxpayer's retirement and replacement practices are not consistent with the class life used. For example, the pattern of retirements and replacements of assets in a guideline class may produce wide fluctuations in a taxpayer's reserve ratio for that class whereby in some years the reserve ratio exceeds the upper limit of the appropriate reserve ratio range and in other years the reserve ratio falls below the lower limit of such range. Wide fluctuations of this nature in the reserve ratio may occur where a taxpayer's guideline class contains relatively few assets, most of which are retired at or about the same time. Immediately before the retirement of these assets, the reserve ratio would exceed the upper limit of the appropriate reserve ratio range; after their retirement, the reserve ratio would fall below the lower limit of such range.

¹³ Since the depreciation reserve for a new guideline class of a new or existing taxpayer is initially zero, it is unlikely that the reserve ratio will exceed the appropriate upper limit during the first replacement cycle. If this does occur, it will presumably occur toward the end of the cycle. Whether the fact that the upper limit is exceeded is meaningful depends on the facts and circumstances. See footnote 12.

¹⁴ If the assets in a guideline class are depreciated in a number of item or multiple-asset accounts, the lives used by the taxpayer for such accounts should be lengthened so that the weighted average of such lives is equal to the lengthened class life.

¹⁵ Where the class life is lengthened to the shortest life that can be justified on the basis of all the facts and circumstances, the lengthened class life may be used by the taxpayer in subsequent taxable years if the taxpayer's retirement and replacement practices thereafter are consistent with the use of that class life.

¹⁶ In any case where the reserve ratio test may be used as a technique for demonstrating that the taxpayer's retirement and replacement practices are consistent with the class life used, and such consistency cannot be demonstrated either by the reserve ratio test or by all the facts and circumstances, the Adjustment Table for Class Lives provides a technique for determining objectively the class life which is consistent with the taxpayer's practices. If a class life used by the taxpayer is lengthened to a life longer than the guideline life, the class life may not be shortened subsequently until such time as (1) the reserve ratio decreases to a point within the upper limit of the reserve ratio range for the lengthened class life, or (2) a shorter life is justified by reason of other facts and circumstances. Furthermore, the lengthened class life may not be lengthened subsequently unless the amount by which the reserve ratio exceeds the upper limit of the appropriate reserve ratio range continues to increase for a period of at least 3 years, after which that life may be lengthened on the basis of all the facts and circumstances.

¹⁷ See footnote 16.

¹⁸ Since the reserve ratio test is not available as a technique for justifying the class life used in cases to which subsection .03(b) of his section applies, the initial adjustment to the class life used must be made without regard to the Adjustment Table for Class Lives. However, where the class life used by a taxpayer is lengthened under subsection .03(b) of this section, the lengthened life shall be considered the class life used by the taxpayer for the purpose of applying the reserve ratio test. Normally, this test would be met. Thus, there would be no further adjustment to the class life, and that life may be used by the taxpayer in subsequent taxable years if his retirement and replacement practices thereafter are consistent with the use of that class life. However, if the test is not met and consistency cannot be demonstrated by all the facts and circumstances, the class life may be further lengthened under subsection .02 or .03(a) of this section for the same taxable year for which the class life was lengthened under subsection .03(b) of this section.

¹⁹ The term `basis' as used in this Revenue Procedure means cost or other basis, adjusted only as provided in section 1016(a)(1).

²⁰ If the basis and depreciation reserve attributable to any asset in a guideline class have been removed from the asset and reserve accounts but the asset is still being used in the taxpayer's trade or business, that basis and depreciation reserve are to be taken into account in computing the taxpayer's reserve ratio for the class. If any multiple-asset account maintained by the taxpayer overlaps two or more guideline classes, the taxpayer should provide sufficient information to enable the portion of the depreciation reserve for that account which is attributable to assets falling within each guideline class to be determined with reasonable accuracy, considering the circumstances of the particular case.

²¹ The class life used by a taxpayer may vary from year to year. If there are variations, the representative class life for applying the Reserve Ratio Table would be the average class life used by the taxpayer over a period of years. To avoid any difficulties that may be encountered in computing this average, paragraph (b) of this subsection provides test lives which should be used in various situations to select the appropriate reserve ratio range. Generally, the suggested test life is slightly more favorable to the taxpayer than an average of class lives used over a period of years. However, if a taxpayer is using the sum-of-the-years dights method of depreciation, an average of class lives may in certain instances be more favorable than the suggested test life. A taxpayer therefore has the option of using an average of the class lives used for a guideline class for the three taxable years preceding the taxable year under examination in lieu of the otherwise prescribed test life.

²² Technically, the rate of growth for a guideline class is the average annual compounded percentage increase in the total basis of the assets in the class measured from the close of a base year to the close of the growth rate year.

²³ If a taxpayer does not maintain sufficient records to enable the rate of growth to be computed for a guideline class, the reserve ratio test cannot be applied. Consequently, whether the taxpayer's retirement and replacement practices are consistent with the class life being used would have to be determined on the basis of all the facts and circumstances.

²⁴ Where a taxpayer's guideline class has a history equal in years to less than the class life period (as, for example, in the case of a new taxpayer), the class life period will be considered to be the period of years between the close of the first taxable year of the guideline class and the close of the growth rate year, provided that there are at least 2 taxable years intervening between the first year and the growth rate year. Since a rate of growth cannot be computed for the first 3 taxable years of a taxpayer's guideline class, the reserve ratio test will be considered to be met during that period.

²⁵ Since the reserve ratio test is considered to be met for the first 3 taxable years to which this Revenue Procedure applies, it will generally not be necessary to compute the rate of growth during this period. However, if a taxpayer's reserve ratio for a guideline class exceeds the upper limit of the appropriate reserve ratio range in the fourth taxable year to which this Revenue Procedure applies, it will be necessary to determine the rate of growth for that class for the 3 preceding taxable years in order to apply the transition rule set forth in section 5.03 of Part II. These determinations unavoidably require information respecting base years before the effective date of this Revenue Procedure. If a taxpayer does not have suflicient information to determine rates of growth for these 3 preceding taxable years, the appropriate reserve ratio range for these taxable years will be considered to be the same as the appropriate range for the fourth taxable year to which this Revenue Procedure applies. In one situation, it will be necessary to compute the rate of growth for one of the first 3 taxable years to which this Revenue Procedure applies. This is where a taxpayer is seeking to justify a class life shorter than the guideline life under section 3.03(a) of Part II of this Revenue Procedure for one of those taxable years.

²⁶ Since the class life used by a taxpayer for a guideline class may vary from year to year, a 3 year average is used to insure that the life used in applying the Adjustment Table is representative.

APPENDIX I.

¹ This appendix to the tables explains the formulae which were used in computing the appropriate reserve ratios and the reserve ratio ranges. The indicated formulae may be used to calculate appropriate reserve ratios and the reserve ratio ranges for test lives and rates of growth for which values are not shown.

² Throughout this discussion it is assumed that salvage is zero.

³ In the first full year the depreciation allowed is 2/ N times the asset cost; the second year the depreciation allowed is 2/ N (1-2/ N ) times the asset cost; the third year the depreciation is 2/ N (1-2/ N -2/ N (1-2/ N )) times the asset cost, etc.

⁴ Mathematically stated, the sum of the years-digits method permits depreciation equal to 2 N/N(N + 1) times the cost of the asset in the first year, 2( N -1)/ N(n + 1) times the cost of the asset in the second year, 2( N -2)/ N(N + 1) in the third year, etc.

⁵ The formulation here indicates the cumulative depreciation reserve against a single item being depreciated. For the first N years the reserve increases as more depreciation is charged annually. After N years the property is fully depreciated, no further deductions are claimed, and the reserve equals 1.

APPENDIX II.

¹ Questions and answers 1-42 were published as part of Revenue Procedure 62-21, I.R.B. 1962-30, 6; 43-59 were announced separately in Announcement 62-84, I.R.B. 1962-40, 33.