Tax Research Memo

Tax Research Memo Template

March 28, 2014

Relevant Facts

Pima and Southern Railroad (PSRR) needs to replace 30-mile section of its track. The old track is fully depreciated, and the cost shown is net of 200,000 salvage value received for the scrap metal. The new track is an improved type and it is expected to last 35 to years. PSSR received a bid from a contractor to replace the track for the following amounts:

Cost of new track $5,000,000

Installing new track $3,000,000

Road bed grading and improvements $2,500,000

Removing old track ( net of salvage) $1,500,000

Total $12,000,000

Specific Issues

1. Can any of the cost be deducted or must all the cost be capitalized or written off over a period of years?

2. What are potential problems would PSRR encounter with the uniform capitalization rules under § 263A?

Conclusions

1. Capital expenditures for permanent improvements or betterments made to increase the value of any property are not deductible for federal income tax purposes. Under Rule §263(a)(1), PSSR must capitalize all cost related to the installation of the new track.

2. According to the IRS Publication 535 (2013), “If you retire and remove a depreciable asset in connection with the installation or production of a replacement asset, you can deduct the costs of removing the retired asset. However, if you replace a component (part) of a depreciable asset, capitalize the removal costs if the replacement is an improvement and deduct the costs if the replacement is a repair. “The cost of removing the track can be deducted rather than capitalized. The cost associated with removal of the track is to retire an asset not by reason of installing the new asset. PSSR can claim a deduction for removing the old track in the current year.

Support

Rule §263(A)(1) provides that no deduction is allowed for (1) any amount paid out for new buildings or permanent improvements or betterments...