Rev. Rul. 73-202

Advice has been requested whether, under the facts described below, a taxpayer may, in computing the depreciation allowable under section 167(a) of the Internal Revenue Code of 1954, use an averaging convention described in section 1.167(a)-10(b) of the Income Tax Regulations.

The taxpayer files its income tax returns on the calendar year basis. During the taxable year it made a large unusual purchase of machinery consisting of several units having a total cost of $1,600,000. The total cost of such machinery purchased during the prior 10 years did not exceed $250,000 in any year and was purchased at various times throughout the year. It was anticipated that there would again be this pattern in future years. The unusually large amount of new machinery purchased during the taxable year had a life longer than four years and was placed in service in a new multiple asset account on December 20.

The taxpayer maintained several multiple asset accounts for its other depreciable property. Numerous assets are added to and retired from these accounts during the taxable year. In computing its depreciation deduction the taxpayer uses an averaging convention based on certain timing assumptions. The taxpayer used the same averaging convention in computing the depreciation on the newly acquired machinery.

Section 1.167(a)-10(b) of the regulations provides, in part, that the period for depreciation of an asset shall begin when the asset is placed in service and shall end when the asset is retired from service. However, in the case of a multiple asset account, the amount of depreciation may be determined by the use of an averaging convention, i.e., by an assumed timing of additions and retirements. For example, it might be assumed that all additions and retirements to the asset account occur uniformly throughout the taxable year, in which case depreciation is computed on the average of the beginning and ending balances of the asset account for the taxable year. Or, it may be assumed that all additions and retirements during the first half of a given year were made on the first day of that year and that all additions and retirements during the second half of the year were made on the first day of the following year. Thus, a full year's depreciation would be taken on additions in the first half of the year and no depreciation would be taken on additions in the second half. In any taxable year in which the averaging convention substantially distorts the depreciation allowance for the taxable year, it may not be used.

The objective of the regulation is to simplify the accounting problem where numerous assets are acquired or disposed of during the taxable year. In that situation the use of an averaging convention avoids specific detailed calculations from the day assets are placed in service or retired but, at the same time, does not substantially distort the amount of the depreciation deduction. However, an averaging convention may not be used for additions while using the actual period of service for retirements and, similarly, an averaging convention may not be used with respect to very large and unusual purchases (such as a major unit of the taxpayer's assets or a new plant facility) where under these circumstances the clear effect is to substantially distort the depreciation allowance for the year.

Accordingly, under such circumstances the computation of the depreciation deduction may not be determined under an averaging convention. The period for depreciation of such an asset begins when the asset is placed in service and ends when it is retired from service. The foregoing limitation has no application to the first year convention under the class life system (ADR). See section 167(a)-11(c)(2) of the regulations.