SECTION 2. EXTRAPOLATION

METHODOLOGY

.01 Application. A taxpayer making a change to apply the NGSH Method may use the extrapolation procedures provided in this Appendix B to determine the § 481(a) adjustment resulting from the change in method of accounting for the safe harbor method for linear property and the safe harbor method for non-linear property, if applicable. A taxpayer may choose to use this extrapolation procedure for its change to the safe harbor method for linear property, for its change to the safe harbor for non-linear property, or for both changes. The extrapolation procedures are performed separately for the safe harbor method for linear property and the safe harbor method for non-linear property to determine the respective § 481(a) adjustment. Generally, the taxpayer first applies the method to a testing period of recent, representative years and derives an average repair deduction under the method of accounting as a percentage of total capital additions for financial accounting purposes. This percentage, adjusted by a reduction percentage that varies based on time, is then applied to the adjusted capital additions for financial accounting purposes for prior years for which extrapolation is used to derive a deemed § 481(a) adjustment amount for each year. These extrapolated § 481(a) adjust

ment amounts are then combined with the actual adjustment amounts for years in which the § 481(a) adjustment is calculated in the normal manner to arrive at the total § 481(a) adjustment attributable to the change in method of accounting.

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

(1) Testing period . First, a testing period is determined as follows:

(a) In general . The taxpayer must use as the testing period a minimum of three consecutive taxable years (testing years), except as described in section 2.02(1)(b) (ii) of this Appendix B. Generally, the final year of the testing period is the taxable year preceding the year of change. Alternatively, a taxpayer may choose the year of change as the final year of the testing period.

(b) Representative years required . The testing years must be representative of all years included in the § 481(a) adjustment.

(i) In determining whether a year is representative, a taxpayer must take into account restructuring transactions, including acquisitions and dispositions as well as any other events that resulted in significant capital changes.

(ii) If one of the taxable years in the testing period described in section 2.02(1) (a) of this Appendix B is not representative, the taxpayer must exclude data from the non-representative year from the testing period and use data from the fourth most recent taxable year to establish a testing period (with such fourth most recent taxable year being a testing year). If the fourth most recent taxable year is not representative either, the taxpayer may not use an extrapolation methodology for determining the amount of a § 481(a) adjustment attributable to its change to the NGSH Method under this revenue procedure.

(c) Additional years . Under the extrapolation calculation methodology, if the taxpayer has sufficient data to calculate the repair deduction percentage for more than three years, the taxpayer may include those years in the testing period. The additional testing years must be consecutive years that immediately precede the original three-year testing period, except that a

year that is not representative, as described in section 2.02(1)(b) of this Appendix B, must be excluded. A taxpayer may not use, as an additional testing year, a year that is separated from the rest of the testing period by more than one non-representative year.

(2) Repair deduction percentage . Second, a repair deduction percentage for each year for which extrapolation is used (extrapolation year) is computed as follows, using data from the testing period.

(a) Repair deductions during the test- ing period under the proposed method . For each testing year, the amount of repair expenses that would be allowable as deductions under the NGSH Method, before taking into account book-tax basis adjustments, is determined.

(b) Tentative repair deduction per- centage . The sum of the repair expenses allowable as deductions for all testing years in the testing period, as determined under section 2.02(2)(a) of this Appendix B, is then divided by the sum of all capital additions during the testing period. For this purpose, a taxpayer must use capital additions for financial statement purposes (book capital additions). The resulting ratio represents the average percentage of capitalized additions that are properly treated as repair expenses allowable as deductions under the NGSH Method (tentative repair deduction percentage), before taking into account book-tax basis adjustments.

(c) Repair deduction percentage for an extrapolation year . The tentative repair deduction percentage is then multiplied by a reduction percentage for each extrapolation year. For each extrapolation year, the reduction percentage is determined by using the formula (1 - (0.10*( X / Y ))), where X equals the number of years the extrapolation year precedes the final year of the testing period and Y equals the total number of taxable years in the testing period. The reduction percentage for an extrapolation year multiplied by the tentative repair deduction percentage equals the repair deduction percentage for the extrapolation year.

(3) Extrapolation year tentative repair deduction amount . Third, a tentative repair deduction amount under the proposed method is calculated for each extrapolation year.

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(a) The repair deduction amount for an extrapolation year is calculated by multiplying the repair deduction percentage for the extrapolation year (determined in section 2.02(2) of this Appendix B) by the book capital additions for the extrapolation year.

(b) In determining the repair deduction amount for an extrapolation year, a taxpayer must account for any book-tax basis adjustments for property placed in service in the extrapolation year. Booktax basis adjustments for property placed in service in the extrapolation year may be accounted for by multiplying the tentative repair deduction amount for an extrapolation year by the taxpayer’s book-to-tax adjustment percentage for the extrapolation year. Tax adjustments that must be accounted for include, but are not limited to, the following types of adjustments:

(i) adjustments resulting from a change in accounting method permitted under Rev. Proc. 2000-7, 2000-1 C.B. 712, involving the treatment of the costs incurred in removing retired assets;

(ii) 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;

(iii) adjustments arising from casualty loss deductions recognized under § 165; and

(iv) adjustments resulting from research and experimental expenditures deducted under § 174.

(4) Repair allowance adjustment and repair deduction amount . Fourth, for each extrapolation year in which the repair allowance election under § 1.167(a)-11(d) (2) (ADR repair allowance) was made, the tentative repair deduction amount must be reduced by the cost of repairs to natural gas transmission property or natural gas distribution property attributable to ADR repair allowance property. To determine the reduction where a prior ADR repair allowance election was made for the natural gas transmission property or natural gas distribution property, 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) for the 1997 taxable year a taxpayer determined that 73 percent of its 1997 qualified repair expenditures for natural gas transmission and natural gas distribution property were attributable to repair allowance property, then that same percentage (73 percent) must be applied to determine the reduction to the repair deduction amount otherwise calculated under section 2.02(3) of this Appendix B. The amount determined after reducing the tentative repair deduction amount by the cost of repairs attributable to CLADR repair allowance property is the repair deduction amount for the extrapolation year.

(5) Tentative extrapolation year § 481(a) adjustment amount . Fifth, the tentative § 481(a) adjustment amount for each extrapolation year is determined. The tentative § 481(a) adjustment for each extrapolation year is calculated by subtracting the repair deduction amount for that year, as determined under sections 2.02(1) through 2.02(4) of this Appendix B, from the amount of repair expenses the taxpayer deducted for that year under its prior method of accounting, including § 481(a) adjustments resulting from any prior change in method of accounting. The difference, whether positive or negative, is the tentative § 481(a) adjustment amount for the extrapolation year.

(6) Extrapolation year § 481(a) adjust- ment amount . Sixth, the tentative § 481(a) adjustment amount for each extrapolation year must be adjusted to account for any differences in depreciation, credits, or any other cumulative differences in deductions between the extrapolation year and the year of change resulting from the taxpayer’s proposed method of accounting. For instance, if under the proposed method a taxpayer’s repair deduction for an extrapolation year would be tentatively increased by $1,000, such that the unadjusted basis of the property placed in service would be correspondingly decreased by $1,000, the $1,000 tentative repair deduction increase for the extrapolation year must be reduced by the portion of the $1,000 in unadjusted basis that the taxpayer had recovered prior to the year of change.

(7) Total § 481(a) adjustment . Finally, the total § 481(a) adjustment attributable to the change to the taxpayer’s proposed method of accounting is determined. The

total § 481(a) adjustment for the year of change is calculated by combining the § 481(a) adjustment amounts for all extrapolation years, as described in this section 2.02 of this Appendix B, with the adjustment amounts, after taking into account book-tax basis adjustments, for years determined under § 481(a) in the normal manner.

.03 Example. In 2023, W, a calendar year taxpayer, changes its method of accounting to the NGSH Method. W uses the extrapolation methodology provided in section 2 of this Appendix B to determine the amount of its § 481(a) adjustment attributable to taxable years 2003 through 2019. Following the general rule in section 2.02(1) of this Appendix B, W uses as its testing period 2020, 2021, and 2022, the three consecutive taxable years ending with 2022, the year preceding the year of change. Assume that each of 2020, 2021, and 2022 are representative of all years included in W ’s § 481(a) adjustment.

W ’s book capital additions for 2020, 2021, and 2022 are $3,000, $3,000, and $4,000, respectively, for a total of $10,000. Of these amounts, the portions that are properly treated as repair expenses allowable as deductions resulting from the application of W ’s proposed method of accounting for 2020, 2021, and 2022, before taking into account book-tax basis adjustments, are $300, $400, and $300, respectively, for a total of $1,000.

For its 2014 extrapolation year, W ’s book capital additions were $3,333. W ’s book-to-tax adjustment percentage for 2014 is 90 percent. In 2013, W elected to apply the ADR repair allowance under § 1.167(a)-11(d)(2), which applied to 25 percent of W ’s natural gas transmission and natural gas distribution property. Under W ’s prior method of accounting (prior to application of the NGSH Method), W deducted $150 in repair expenses in 2014.

W determines its § 481(a) adjustment for 2014 as follows:

Step 1 . W determines that it will use taxable years 2020, 2021, and 2022 as the testing years in its testing period.

Step 2 . W calculates its repair deduction percentage for each extrapolation year. First, a tentative repair deduction percentage is calculated using data from

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the testing period (taxable years 2020, 2021, and 2022). Book capital additions that are properly treated as repair expenses allowable as deductions resulting from the application of the proposed method of accounting, before taking into account book-tax basis adjustments, for 2020, 2021, and 2022, the testing years

that comprise the testing period, equal $1,000 ($300 + $400 + $300). Total book capital additions for the testing period are $10,000 ($3,000 + $3,000 + $4,000). W ’s tentative repair deduction percentage is 10 percent ($1,000 / $10,000).

Next, W calculates the reduction percentage for each extrapolation year using

the formula (1 - (0.10 * ( X/Y ))), where X equals the number of years the extrapolation year precedes 2022, the final year of the testing period, and Y equals 3, the number of years in the testing period (2020-2022). The reduction percentage for each extrapolation year is calculated as follows:

tion amount for 2014 ($165) from the amount of repair expenses W deducted for 2014 under its prior method of accounting (as adjusted for purposes of computing any prior § 481(a) adjustment) ($150). Therefore, W ’s § 481(a) adjustment amount for 2014 is negative $15. Step 6 . To determine its § 481(a) adjustment amount for 2014, W must account for its decreased depreciation deductions resulting from the additional $15 of repair expenditures allowable as deductions under the proposed method of accounting. Assuming that the additional $15 of repair expenditures allowable as deductions for 2014 results in a $4.50 of reduction in cumulative depreciation expense through January 1, 2023, the beginning of the year of change, that is attributable to the assets placed in service in 2014, W ’s § 481(a) adjustment amount for the increased

Finally, W multiplies the tentative repair deduction percentage for each extrapolation year by the reduction percentage for each extrapolation year to calculate the repair deduction percentage for each extrapolation year. Accordingly, for 2014, W ’s repair deduction percentage is 7.33 percent (10 percent X 73.33 percent = 7.33 percent).

Step 3 . Next, W calculates a tentative repair deduction amount for each extrapolation year. For its 2014 extrapolation year, W multiplies its book capital additions for 2014 ($3,333) by its repair deduction percentage (7.33 percent), resulting in an initial tentative repair deduction amount of $244. Next, W accounts for any book-tax basis adjustments for property placed in service in 2014 by multiplying the initial tentative repair deduction amount ($244) for 2014 by W ’s book-to-tax adjustment

percentage for 2014 (90 percent), resulting in a tentative repair deduction amount of $220.

Step 4 . W must reduce its tentative repair deduction amount for 2014 to exclude repairs attributable to natural gas transmission property and natural gas distribution property for which W elected to apply the ADR repair allowance. In 2014, W determined that 25 percent of its 2014 qualified repair expenditures for natural gas transmission and natural gas distribution property were attributable to repair allowance property. Therefore, W reduces the repair deduction amount for 2014 ($220) by 25 percent ($55), yielding a repair deduction amount for 2014 of $165.

Step 5 . W determines its tentative § 481(a) adjustment amount for 2014. W subtracts the adjusted gross repair deduc

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repair deductions that would have been permitted in 2014 under the proposed method of accounting is negative $10.50 (-$15.00 + $4.50).

Step 7 . To determine its total § 481(a) adjustment, W combines the adjustments

attributable to its extrapolation years 2003 through 2019, computed using the extrapolation method in this Appendix B (as described above for 2014), with the § 481(a) adjustments attributable to 2020 through 2022, determined

using the actual data from those years and taking into account book-tax basis adjustments. W must take the entire § 481(a) adjustment (whether positive or negative) into account in 2023, W ’s year of change.

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