Rev. Rul. 70-168

Advice has been requested whether, under the circumstances described below, a taxpayer (a railroad company) must, for Federal income tax purposes, continue to (1) credit depreciation reserve with the amount of the salvage proceeds realized for an account depreciated to estimated salvage value, and (2) credit ordinary income with the amount of such proceeds for an account depreciated to zero (from its normal retirement sales of freight train cars depreciated in its two average rate multiple asset accounts), or whether it must recognize gains and losses under the provisions of section 1231 of the Code, 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 accounted for the salvage proceeds realized from normal retirements from the account depreciated to estimated salvage value by crediting the depreciation reserve with the amount of such proceeds, and for the account depreciated to zero by crediting ordinary income with the amount of such proceeds. Gains and losses were determined on abnormal retirements from both accounts. However, in 1968, the taxpayer determined and recognized gains and losses on its normal retirement sales, claiming that such gains and losses were subject to the provisions of section 1231 of the Internal Revenue Code of 1954.

Section 1.167(a)-7(b) and section 1.167(a)-8 of the regulations provide the general accounting rules for normal retirement sales of depreciable property from average rate multiple asset accounts. In general the asset account is credited with the full cost of the asset retired and the depreciation reserve is charged with the same amount. The regulations provide three accounting practices that ordinarily may be used to account for the salvage proceeds realized from such a normal retirement sale. These are: (1) crediting the depreciation reserve (see section 1.167(a)-7(b) and section 1.167(a)-8(e)(2) of the regulations), (2) recognizing gain or loss (see section 1.167(a)-8(1) and section 1.167(a)-8(c)(1) of the regulations), and (3) crediting ordinary income (see section 1.167(a)-8(e)(2) of the regulations).

Where an average rate multiple asset account has been depreciated to estimated salvage value or to zero, all of the assets in the account are fully depreciated, and the only accounting practice for retirements from that account that clearly reflects income is recognition of the gain or loss thereon. Since in the instant case the accounts are fully depreciated, and since use of either of the alternative practices contemplate that an account will be subject to future depreciation, the alternative practices may not be used.

In the case of a normal retirement sale from a fully depreciated average rate multiple asset account, the gain or loss on such a retirement will be equal to the difference between the proceeds realized on the retirement, if any, and the adjusted basis of the retired asset. See section 1.167(a)-8(a)(1) and section 1.167(a)-8(c)(1) of the regulations. The adjusted basis of assets normally retired from an average rate multiple asset account that has been depreciated to estimated salvage value (used in determining the depreciation deductions) is the estimated salvage value of the retired asset. The adjusted basis of assets normally retired from a multiple asset account that has been depreciated to zero is zero. Where an average rate multiple asset account has been depreciated to estimated salvage value, the estimated salvage value of each normally 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 normal retirements from average rate multiple asset accounts where gains and losses are recognized. However, gain on 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 correctly recognized gains and losses on normal retirements of freight train cars from its two 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. 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 abnormal retirements from an average rate multiple asset account that had been fully depreciated is described in Revenue Ruling 70-169, below.