SECTION 2. EXTRAPOLATION METHODOLOGY

.01 In general . A taxpayer using the safe harbor method of accounting provided by this revenue procedure may use the extrapolation procedures provided in this Appendix A for purposes of redetermining, in connection with calculating a § 481(a) adjustment, whether costs to maintain, replace, and improve transmission and distribution property are deductible as repairs under § 162 or must be capitalized as improvements under § 263(a).

.02 Calculation methodology . In order to determine the amount of the § 481(a) adjustment for a year in which extrapolation is applied, the following calculation methodology must be utilized:

(1) First, a repair deduction percentage shall be computed as follows using data from a minimum of the three most recent taxable years, including the year of change (“testing period”).

(a) For each taxable year of the testing period, the sum of deductible repair expenses under the safe harbor method provided in this revenue procedure must be reduced by the sum of the repair expenses the taxpayer had taken under its method of accounting prior to application of the safe harbor. The results of this subtraction are added together into a total sum of additional (or reduced) deductions resulting from the application of the safe harbor method during the testing period.

(b) The total sum of additional (or reduced) deductions calculated in step (a) is divided by the sum of all capital additions during the testing period. The resulting ratio represents the weighted average percentage of capitalized additions that are properly treated as additional (or reduced) deductible repair expenses (“tentative repair deduction percentage”). For this purpose, to determine the sum of all capital additions taxpayers shall use capital additions for financial statement purposes.

(c) Multiply the tentative repair deduction percentage by a haircut percentage for each taxable year prior to the testing period for which the taxpayer will use extrapolation. For each taxable year that extrapolation is used the haircut percentage is determined by using the formula (1- (0.10*( X / Y ))) where X equals the number of years the extrapolation year precedes the year of change and Y equals the total of number of taxable years in the testing period. The haircut percentage for a taxable year multiplied by the tentative repair deduction percentage equals the repair deduction percentage for the taxable year.

(2) Second, a repair deduction amount for each taxable year outside the testing period (for which extrapolation is being used) shall be calculated by multiplying the repair deduction percentage for the taxable year by the capital additions for the year (except property which was subject to the repair allowance under § 1.167(a)–11(d)(2)). For this purpose, capital additions must include all basis adjustments required by § 1011 (including any applicable audit adjustments for the taxable year) except for the following:

(a) any adjustments that require tax basis to be reduced before depreciation is computed ( e.g., § 179, § 179D, or similar provisions; § 44 and § 46, or similar provisions), and

(b) adjustments described in § 1016(a)(2) and § 1016(a)(3). (3) Basis adjustments required by § 1011 include, but are not limited to, the following: (a) adjustments resulting from a change in accounting method permitted under Rev. Proc. 2000–7, 2000–1 C.B. 227, involving the treatment of the costs incurred in removing retired assets;

(b) adjustments resulting from a change in the treatment of capitalized amounts determined under § 263A, including reductions for additional mixed service costs allocated to inventory and adjustments to account for changes to interest capitalization amounts;

(c) adjustments arising from casualty loss deductions recognized under § 165; and (d) adjustments resulting from research and experimental expenditures deducted under § 174. (4) The basis of electric transmission and distribution property calculated after taking into account the repair deduction basis adjustment and other basis adjustments under section 2.02(2) above is the basis that should be used to determine the deductions allowable or income tax credits available that require tax basis to be reduced before any depreciation is computed (for example, § 179, § 179D,

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or similar provisions; § 44 and § 46; or similar provisions). The net amount for each asset after the reduction in basis for such deductions and credits is that property’s § 1.168(b)–1(a)(3) unadjusted depreciable basis, which is the basis before taking into account § 1016(a)(2) and (3) adjustments.

(5) For each taxable year in which the § 1.167(a)–11(d)(2) repair allowance election was made, the repair deduction amount determined in section 2.02(2) of this Appendix A for the taxable year must exclude additional repairs attributable to property for which the taxpayer elected to apply the § 1.167(a)–11(d)(2) repair allowance. To determine the amount to exclude from the § 481(a) adjustment, taxpayers must use a method comparable to the method actually used to allocate qualified repair expenditures to repair allowance property for that year. For example, if in applying § 1.167(a)–11(d)(2)(b) for the 1997 taxable year a taxpayer determined that 73 percent of its 1997 qualified repair expenditures were attributable to eligible repair allowance property, then that same percentage (73%) must be applied to determine the reduction to the repair deduction amount otherwise calculated under section 2.02(2) of this Appendix A.

(6) The § 481(a) adjustment must account for any tax credit and depreciation deduction adjustments in each taxable year resulting from the additional (or reduced) repair deductions claimed under the safe harbor method provided in this revenue procedure.

.03 Consecutive year requirement . Under the extrapolation calculation methodology, if sufficient data is available to calculate the repair deduction percentage for more than three years, the taxpayer may use data from such additional years only if the additional years are consecutive to the testing period and prior to the year of change.

.04 Representative years required . The data from the taxable years used to calculate the repair deduction percentage must be representative of all years included in the § 481(a) adjustment.

(1) In determining whether the sampled years are representative, a taxpayer must take into account restructuring transactions including acquisitions and dispositions, as well as any other events that may have triggered large capital additions.

(2) If events or transactions create an aberration in a sampled year, then consideration should be given to expanding the sampled years, expanding the number of sample items drawn from that year, or removing the year from the sample.

.05 Example . X changes its method of accounting to the transmission and distribution property safe harbor method of accounting in 2010. X uses the extrapolation methodology provided in section 2 of this Appendix A to determine the amount of its § 481(a) adjustment attributable to taxable years 2007 through 2001. X ’s capital additions for financial statement purposes for 2002 are $10,000. In 2002 X elected to apply the repair allowance under § 1.167(a)–11(d)(2), which applied to 25% of X ’s transmission and distribution property.

Step 1 . X calculates its tentative repair deduction percentage using data from the three consecutive taxable years 2010, 2009, and 2008. Capital additions for financial statement purposes properly treated as additional deductible repair expenses resulting from the application of the safe harbor method for 2010, 2009, and 2008 are $500, $300, and $200, respectively. Capital additions for financial statement purposes for 2010, 2009, and 2008 are $ 6,000, $3,000, and $1,000, respectively. The tentative repair deduction percentage is computed as follows:

$1,000/$10,000= 10%

Step 2 . X calculates the haircut percentage for each taxable year that extrapolation is used using the formula (1 - 0.10 * ( X/Y )), where X equals the number of years the extrapolation year precedes the year of change and Y equals the total of number of taxable years in the testing period. The haircut percentage for each taxable year that extrapolation is used is calculated as follows:

Step 3 . X ’s repair deduction percentage for 2002 is 7.33%, which is computed by multiplying the tentative repair deduction percentage (10%) by the haircut percentage for 2002 (73.3%).

Step 4 . X ’s repair deduction amount for 2002 before additional tax adjustments and exclusion of additional repairs attributable to property for which the taxpayer elected to apply the § 1.167(a)-(11)(d)(2) repair allowance is $733 ($10,000 * 7.33%).

Step 5 . X determines that tax adjustments reduce the 2002 calculated repair deduction amount by $33. X reduces the calculated repair deduction amount for 2002 by $33, resulting in a repair deduction of $700 before excluding repair amounts attributable to property for which the taxpayer elected to apply the § 1.167(a)-(11)(d)(2) repair allowance.

Step 6 . X must reduce its repair deduction amount for 2002 to exclude additional repairs attributable to property for which the taxpayer elected to apply the § 1.167(a)–11(d)(2) repair allowance. In 2002, X determined that 25 percent of its 2002 qualified repair expenditures were attributable to eligible transmission and distribution property. Therefore, X reduces the repair deduction amount for 2002 by 25%. Accordingly, X reduces the $700 calculated through Step 5 by $175 ($700 X 25%), resulting in a repair deduction amount for 2002 of $525 ($700 - $175).

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Step 7 . To determine its § 481(a) adjustment amount for 2002, X must account for its decreased depreciation deductions resulting from the additional $525 of deductible repair expenditures resulting from the application of the safe harbor method. Assuming that the additional $525 of deductible repair expenditures for 2002 results in a $300 reduction in depreciation deductions through the year of change, X ’s § 481(a) adjustment amount attributable to 2002 is negative $225 (-$525 + $300).

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