Rev. Rul. 70-169

Advice has been requested whether, under the circumstances described below, a taxpayer (a railroad company) must, for Federal income tax purposes, recognize the gains and losses under the provisions of section 1231 of the Code on abnormal retirement sales of its freight train cars from two of its accounts, both of which are average rate multiple asset accounts that had become fully depreciated, or whether it can (1) credit the depreciation reserve with the proceeds from such sales for one of the accounts that had been depreciated to estimated salvage value, and (2) recognize gains in the amount of the proceeds from such sales with the gains recognized being treated under the provisions of section 1231 of the Code for the other account that had been depreciated to zero, for such sales in 1968.

The taxpayer accounted for its freight train cars in several multiple asset depreciation accounts, two of which had become fully depreciated. The first account had been depreciated to estimated salvage value and the second account had been depreciated to zero. Each account had been depreciated using a rate based on the average estimated useful life of the assets in the account (average rate multiple asset account). However, no depreciation had been claimed on either account for some time prior to 1968. During the taxable year 1968 the taxpayer retired by sale from these accounts many of its freight train cars that had been held for more than six months. Some of the retirements were normal and some were abnormal within the meaning of section 1.167(a)-8(b) of the Income Tax Regulations. Prior to 1968, the taxpayer recognized gains and losses on abnormal retirement disposals from the accounts, all of which occurred by sale, and treated such gains and losses under the provisions of section 1231 of the Internal Revenue Code of 1954. However, in 1968, the taxpayer accounted for abnormal retirement sales proceeds by crediting the depreciation reserve with such proceeds for the account that had been depreciated to estimated salvage value, and by recognizing gains in the amount of such proceeds for the account that had been depreciated to zero, with the gains recognized being treated under the provisions of section 1231 of the Code.

On abnormal retirements from average rate multiple asset accounts gain or loss must be recognized. This is because abnormal retirements are not contemplated in arriving at the rate of depreciation for a multiple asset account (see section 1.167(a)-8(b) of the regulations), and therefore income would not be clearly reflected if the proceeds of abnormal retirements were accounted for in the same way as the proceeds of normal retirements. See Revenue Ruling 70-167, page 46.

Section 1.167(a)-7(b), section 1.167(a)-8(a), and section 1.167(a)-8(c)(3) of the regulations provide the general accounting rules for abnormal retirements of depreciable property from multiple asset accounts. Under these regulations the asset account is credited with the full cost of the asset retired and the depreciation reserve is charged with an adjustment for depreciation determined at the rate that would have been proper had the asset retired been depreciated in a single item account (under the method of depreciation used for the multiple asset account) and using a rate based upon the expected useful life of the asset employed in determining the rate of depreciation for the multiple asset account. Thus, the adjusted basis of the abnormally retired asset is ordinarily the full cost of the asset less the depreciation adjustment so determined.

Where average rate multiple asset accounts are fully depreciated, whether to estimated salvage value or to zero, all of the assets in the accounts are fully depreciated, and the general accounting rules described above are inapplicable because these rules contemplate retirements from an account that is subject to future depreciation. Since all of the assets in a fully depreciated average rate multiple asset account are fully depreciated, the adjusted basis for determining gain or loss on an abnormal retirement sale from such an account is the retired asset's estimated salvage value, if the account has been depreciated to estimated salvage value, and zero if the account has been depreciated to zero. Where an average rate multiple asset account has been depreciated to estimated salvage value, the estimated salvage value of each abnormally retired asset is credited to the depreciation reserve when each asset is retired.

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

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

Accordingly it is held that, in the instant case, for 1968 the taxpayer must determine and recognize gains and losses on its abnormal retirement sales of freight train cars from its two average rate multiple asset accounts that had become fully depreciated. The adjusted basis for computing such gains and losses is the estimated salvage value for assets retired from the account that had been depreciated to estimated salvage value, and zero for assets retired from the account that had been depreciated to zero. The gains and losses so determined are governed by the provisions of section 1231 of the Code except to the extent that the provisions of section 1245 of the Code are applicable to the gains.

The accounting and income tax treatment of normal retirements from an average rate multiple asset account that had been fully depreciated is described in Revenue Ruling 70-168, page 47.