INDOPCO HAS NO EFFECT ON INCIDENTAL REPAIR COST DEDUCTION, IRS RULES.

Rev. Rul. 94-12

ISSUE

Does the Supreme Court's decision in Indopco, Inc. v. Commissioner, ___ U.S. ___, 112 S.Ct. 1039 (1992), affect the treatment of incidental repair costs as business expenses which are generally deductible under section 162 of the Internal Revenue Code?

LAW AND ANALYSIS

Section 162 of the Code allows a deduction for all the ordinary and necessary expenses paid or incurred during the taxable year in carrying on any trade or business.

Section 1.162-1(a) of the Income Tax Regulations expressly provides that costs for "incidental repairs" are among the items included in deductible business expenses under section 162 of the Code. Section 1.162-4 allows a deduction for the cost of incidental repairs that keep property in ordinarily efficient operating condition and neither materially add to the value of the property nor appreciably prolong its life, provided the cost of acquisition or production or the gain or loss basis of the taxpayer's plant, equipment, or other property, as the case may be, is not increased by the amount of such expenditures. However, that section also provides that the cost of repairs in the nature of replacements that arrest deterioration and appreciably prolong the life of the property must be capitalized and depreciated in accordance with section 167.

Section 263(a) of the Code and section 1.263(a)-1(a) of the regulations provide that no deduction is allowed for any amount paid out for new buildings or for permanent improvements or betterments made to increase the value of any property or for any amount expended in restoring property or in making good the exhaustion thereof for which an allowance has been made in the form of a deduction for depreciation, amortization, or depletion.

Section 1.263(a)-1(b) of the regulations provides that capitalizable costs include amounts that (1) add to the value or substantially prolong the useful life of property, or (2) adapt property to a new or different use. However, that section also provides that amounts paid or incurred for incidental repairs and maintenance of property are not capital expenditures within the meaning of section 1.263(a)-1(a).

In Indopco v. Commissioner, ___ U.S. ___, 112 S.Ct. 1039 (1992), the Supreme Court concluded that certain legal and professional fees incurred by a target corporation to facilitate a friendly merger created significant long-term benefits for the taxpayer, and, therefore, were capital expenditures. In reaching this decision, the Court specifically rejected the argument that its decision in Commissioner v. Lincoln Savings and Loan Association, 403 U.S. 345 (1971), should be read as holding "that ONLY expenditures that create or enhance separate and distinct assets are to be capitalized under section 263." Indopco at 1044. (Emphasis in original.)

The Indopco decision clarifies that the creation or enhancement of a separate and distinct asset is not a prerequisite to capitalization. That clarification does not, however, change the fundamental legal principles for determining whether a particular expenditure can be deducted or must be capitalized. With respect to expenditures that produce benefits both in the current year and in future years, the determination of whether such expenditures must be capitalized requires a careful examination of all the facts. See section 263(a).

Thus, for example, the Indopco decision does not affect the treatment of the cost of incidental repairs under section 162 of the Code. Amounts paid or incurred for incidental repairs are generally deductible as business expenses under that section even though they may have some future benefit. Indopco at 1044. See e.g., Rev. Rul. 69-119, 1969-1 C.B. 141, and Rev. Rul. 54-578, 1954-2 C.B. 84, which hold that amounts expended to repair railroad freight cars are deductible incidental repairs if they neither materially increase the value nor appreciably prolong the useful life of the cars, but are made to keep the cars in an ordinarily efficient operating condition. But see Rev. Rul. 88-57, 1988-2 C.B. 36 (requiring capitalization of amounts expended under a general plan to rehabilitate railroad freight cars where their value was materially increased and their useful life was appreciably prolonged, even though a portion of those amounts expended, standing alone rather than as part of a general plan of rehabilitation, would have been deductible incidental repairs).

HOLDING

The Indopco decision does not affect the treatment of incidental repair costs as business expenses which are generally deductible under section 162 of the Code.

DRAFTING INFORMATION

The principal author of this revenue ruling is John P. Moriarty of the Office of Assistant Chief Counsel (Income Tax and Accounting). For further information regarding this revenue ruling, contact Mr. Moriarty on (202) 622-4950 (not a toll-free call).