On April 30, the Internal Revenue Service (IRS) issued guidance (Revenue Procedure 2013-24 http://www.irs.gov/pub/irs-drop/rp-13-24.pdf) providing definitions of “units of property” and “major components” that taxpayers may use to determine whether expenditures to maintain, replace or improve steam or electric power generation property must be capitalized (and depreciated, rather than expensed) under Section 263(a) of the Internal Revenue Code. This is of particular interest to utilities and independent power producers.
At a high level, to determine which expenditures are deductible as repairs or capitalized as improvements in this context, a determination must be made regarding to which discrete “unit of property” or “major component” such expenditures relate. Generally, for this purpose, a major component is a part of a larger unit of property.
One instance where the need to identify a discrete unit of property and a major component of such unit of property may arise is in applying the general rule that an expenditure paid to restore a unit of property is generally capitalized. A circumstance in which an expenditure is treated as paid to restore a unit of property under this rule is if such expenditure is for the replacement of a major component of a unit of property. Thus, the cost to replace a major component of an energy project must generally be capitalized. To apply this rule, it is clearly necessary to identify both the relevant unit of property and major component.
The Revenue Procedure provides bright line guidance to define precisely what constitutes discrete units of property and major components with respect to different types of power generation facilities. The IRS’ motivation for publishing the Revenue Procedure was to minimize definitional disputes with taxpayers.
Defining what constitutes a discrete unit of property or major component can be a complex determination in a generation plant composed of numerous functionally interdependent items of machinery and equipment. Revenue Procedure 2013-24 identifies and defines several common “units of property” and “major components” that are typically included in various types of power plants. For instance, one single unit of property identified and defined for a hydroelectric power station is a “dam,” defined as the “equipment that forms a barrier that impounds water and manages its flow.” The Revenue Procedure further provides that “major components” of a dam include (1) a spillway, (2) each spillway gate, (3) intakes, including trash racks and rakes, (4) a fish passage system, and (5) instrumentation and controls.
Rev. Proc. 2013-24 also provides procedures for obtaining automatic consent to change to a method of accounting that uses all, or some of, the unit of property definitions provided.