Rev. Rul. 72-403

Advice has been requested whether the costs of acquiring easements for electric transmission and distribution lines and the related costs of clearing and grading are subject to depreciation for Federal income tax purposes.

The taxpayer is engaged in the production, transmission and distribution of electrical energy through a network system consisting of electric generating plants at various geographical locations, the energy from which feeds into a transmission system that is interconnected with distribution systems located in cities, municipalities, and other consumer areas throughout the geographical areas served. In order to construct the transmission and distribution systems, the taxpayer incurs a variety of costs for, or related to, the rights-of-way easements and for the construction of the overhead pole and tower lines.

Location of the transmission and distribution lines over the rights-of-way requires engineering surveys and some clearing and grading depending upon the variation in terrain and the extent and kind of vegetation.

Typically, in the acquisition of right-of-way easements for electric transmission and distribution lines, the taxpayer agrees to pay the landowner for: the right to use a strip or portion of land over which electric transmission and distribution lines will be constructed, the loss or restricted use of the land, and severance and all other damage costs such as those related to improvements, crops, orchards, and timber. The taxpayer may also incur other costs related to the acquisition of the rights-of-way such as for aerial reconnaissance and photographs, maps, surveys, salaries, travel, legal fees, condemnation, title work, abstract and recording fees. All of the costs described in this paragraph are referred to here as easement costs.

The only benefit the taxpayer receives from these easement costs are in connection with the location and construction of the electric transmission and distribution lines. The taxpayer retains the easement rights-of-way by agreement with the landowner only for and so long as the rights-of-way are used for the transmission and distribution lines. In accordance with the terms of the easement agreement, the taxpayer has the right to enter upon the rights-of-way to clear and grade the land, and to locate, repair, maintain, and replace the overhead transmission and distribution lines.

The demands of safety, inspection of lines, repair and maintenance of the lines, and making replacements require that the rights-of-way be kept clear of brush, trees and other vegetation. Whether the costs for clearing of brush, trees and other vegetation are ordinary and necessary expenses or capital expenditures requires a determination based on the facts and circumstances in each case.

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

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

Section 1.167(a)-3 of the regulations provides, in pertinent part, that if an intangible asset is known from experience or other factors to be of use in the business or in the production of income for only a limited period which can be estimated with reasonable accuracy, such intangible asset can be the subject of a depreciation allowance.

In Pennsylvania Power and Light v. United States, 411 F.2d 130 (Ct. Cl. 1969), and Virginia Electric and Power Company v. United States, 411 F.2d 1314 (Ct. Cl. 1969), the Service's position that there is no connection between the life of the easements and the life of the electric transmission and distribution lines installed on the rights-of-way was upheld. The courts were able, nevertheless, to approximate, on the basis of expert testimony that took into account advancements in technology, a useful life for the transmission line easements ranging from 67 to 100 years and a useful life for the distribution line easements ranging from 41 to 50 years, and were then able to hold that the initial clearing and grading of the rights-of-way would generally have the same life as the easements for the transmission or distribution lines.

The conclusion that the initial clearing and grading were not independent assets but were part of the cost of the easements led the courts to conclude that such clearing and grading were not subject to accelerated depreciation. In a number of cases involving the transmission of oil or gas by pipeline, the courts held such costs to be part of the construction costs and therefore costs for tangible assets. See Commonwealth Natural Gas Corp. v. United States, 395 F.2d 493 (4th Cir. 1968); and Southern Natural Gas Co. v. United States, 412 F.2d 1222 (Ct. Cl. 1969). Further consideration indicates that the initial clearing and grading for electric transmission and distribution lines is part of the construction of such lines even though clearing and grading is generally not again necessary when such lines are replaced on the same easements. In view of the above, the Service will recognize that the costs of acquiring easements for electric transmission and distribution lines and the related initial costs of clearing and grading are subject to depreciation. The costs of the easements are investments in intangible assets and not subject to the accelerated depreciation methods or the investment credit provisions of the Code.

The costs of initial clearing and grading are investments in tangible assets and are subject to the accelerated depreciation methods and may be subject to the investment credit provisions of the Code.

Revenue Ruling 71-121, C.B. 1971-1, 80, is modified to the extent that it held that the clearing and grading costs related to the transmission line easements from a hydroelectric site to the first point of interconnection with a transmission and distribution system are depreciable intangible assets. Also, the initial clearing and grading costs relating to transmission line easements in Revenue Ruling 71-121, as modified herein, and the transmission and distribution line easements in this Revenue Ruling are not included in any of the asset guideline classes in Revenue Procedure 72-10 for the purposes of sections 1.167(a)-11 or 1.167(a)-12 of the regulations.

Similarly, Revenue Ruling 71-120, C.B. 1971-1, 79, relating to right-of-way easements for natural gas transmission pipelines, and Revenue Ruling 71-448, C.B. 1971-2, 130, relating to right-of-way easements for crude oil and petroleum products pipelines, are modified to provide that the clearing and grading related to the right-of-way easements therein are not included in any of the asset guideline classes in Revenue Procedure 72-10 for the purposes of sections 1.167(a)-11 or 1.167(a)-12 of the regulations.

An average useful life of 84 years will be accepted for the easements and the initial clearing and grading relating to electric transmission lines. An average useful life of 46 years will be accepted for the easements and the initial clearing and grading relating to electric distribution lines. A taxpayer may utilize shorter lives if they are warranted on the basis of all of the facts and circumstances.

Pursuant to the authority contained in section 7805(b) of the Code, the principles of this Revenue Ruling will not be applied for taxable years ending on or before August 21, 1972, the date this Revenue Ruling is published in the Internal Revenue Bulletin, to require an adjustment to basis of easements and related initial clearing and grading of transmission and distribution lines under section 1016(a)(2) of the Code except where a taxpayer has claimed and been allowed a deduction for depreciation of these assets for prior taxable years.

See Revenue Ruling 71-121 regarding adjustment to basis of easements and related clearing and grading of a transmission line from a hydroelectric site to the first point of interconnection with a transmission and distribution system.

Revenue Ruling 71-120, C.B. 1971-1, 79, Revenue Ruling 71-121, C.B. 1971-1, 80, and Revenue Ruling 71-448, C.B. 1971-2, 130, are hereby modified.