SECTION 2. BACKGROUND

.01 Taxpayers that transmit and distribute natural gas pay or incur significant expenditures to maintain, repair, replace, and improve natural gas transmission and distribution property. Generally, whether these expenditures are allowable as deductions under § 162 for repairs or maintenance or must be capitalized under § 263(a) as improvements to property depends on whether these expenditures result in a betterment or restoration of the property or adapt it to a new or different use. See §§ 1.162-4 and 1.263(a)-3(d). Whether these expenditures are capital

ized under § 263A depends, generally, on whether these expenditures are properly allocable to property produced by the taxpayer. See § 1.263A-1(a)(3). Applying capitalization principles to natural gas transmission and distribution property can be particularly difficult, largely because the property consists of a network of interconnected assets. As a consequence, there often exists uncertainty as to whether certain costs to maintain, repair, replace, and improve parts or components of such interconnected property are capital expenditures or expenses allowable as deductions.

.02 To reduce uncertainty and associated disputes between taxpayers and the IRS regarding whether expenditures to maintain, repair, replace, or improve natural gas transmission and distribution property must be capitalized or are allowable as deductions, this revenue procedure provides a “natural gas transmission and distribution property safe harbor method of accounting” or “NGSH Method” (as defined under section 4.01 of this revenue procedure) for determining whether certain costs of maintaining, repairing, replacing, and improving natural gas transmission and distribution property are required to be capitalized under § 263(a) or § 263A, or may be treated as ordinary and necessary business expenses for which a deduction is allowable under § 162(a).

.03 To apply the NGSH Method, a taxpayer must first classify its natural gas

transmission and distribution property as either linear property (for example, pipes, fittings, and valves) or non-linear property (for example, compressors, regulators, and meters). If a taxpayer chooses to use the NGSH Method for its linear property, the taxpayer (1) must use the “safe harbor method for linear property” (as defined under section 4.02 of this revenue procedure) for all of the taxpayer’s linear transmission and distribution property and (2) may choose to apply the “safe harbor method for non-linear property” (as defined under section 4.03 of this revenue procedure) for all of the taxpayer’s non-linear transmission and distribution property. However, if a taxpayer chooses to use the NGSH Method for its non-linear property, the taxpayer must use (1) the safe harbor method for non-linear property for all of the taxpayer’s non-linear transmission and distribution property and (2) the safe harbor method for linear property for all of the taxpayer’s linear transmission and distribution property.

.04 The safe harbor method for linear property provides different rules for linear transmission property (generally, linear property that transmits natural gas from production facilities to local distribution systems) and for linear distribution property (generally, linear property that distributes natural gas to local customers). For linear transmission property, the safe harbor method for linear property defines the appropriate units of transmis

1 Unless otherwise specified, all “section” or “§” references are to sections of the Code or the Income Tax Regulations (26 CFR part 1).

Bulletin No. 2023–18 807 May 1, 2023

sion property and provides a simplified rule for determining whether the costs of replacing a portion of that unit of linear transmission property must be capitalized under §§ 263(a) and 263A. See section 5.02 of this revenue procedure. For linear distribution property, the safe harbor method does not define units of property but divides distribution property into “distribution mains” and “distribution service lines” and provides simplified rules for determining whether the costs of replacing distribution mains and the costs of repairing, maintaining, replacing, or improving distribution service lines must be capitalized under §§ 263(a) and 263A. See sections 5.03 and 5.07 of this revenue procedure. A taxpayer using the safe harbor method for linear property is required to use it for both its linear transmission property and its linear distribution property.

.05 The safe harbor method for non-linear property defines units of property and major components of non-linear transmission and distribution property and provides that a taxpayer must capitalize the costs of replacing a unit of non-linear property or a major component of a unit of non-linear property under §§ 263(a) and 263A. See section 5.04 of this revenue procedure and Appendix A of this revenue procedure (Appendix A). In addition, if a taxpayer replaces a unit of non-linear property or a major component of a unit of non-linear property, the taxpayer must also capitalize the costs of any repairs, maintenance, or replacements that directly benefit or are incurred by reason of the replacement of the unit of non-linear property or major component of the unit of non-linear property. Except as otherwise provided in section 6.04 of this revenue procedure, if a taxpayer chooses to use the safe harbor method for non-linear property, the taxpayer must use this safe harbor method for all its non-linear transmission and distribution property.

.06 This revenue procedure also provides “per se capitalization rules” that apply to both linear and non-linear property. These per se capitalization rules identify certain costs that a taxpayer must treat as capital expenditures if the taxpayer utilizes the NGSH Method. See section 5.05 of this revenue procedure. For example, in general, a taxpayer

using the NGSH Method is required to capitalize the costs of additions and replacements that materially increase capacity to one or more customers. See sections 5.05(1)(b) and (2) of this revenue procedure. Also, under the per se capitalization rules, a taxpayer using the NGSH Method must capitalize the costs of: (1) replacing all or part of property if the taxpayer deducts a loss for the replaced property (other than a casualty loss) or takes the adjusted basis of the replaced property into account in realizing gain or loss resulting from a sale or exchange of the replaced property; and (2) repairing and replacing all or part of property for which the taxpayer is required to take a basis adjustment as a result of a casualty loss or relating to a casualty event. These rules are referred to collectively as the “disposition/loss per se capitalization rules.” See section 5.05(1)(g) and (h) of this revenue procedure.

.07 Replacements of natural gas transmission and distribution property often involve dispositions of properties that are replaced. These dispositions generally require taxpayers to recognize gain or loss, or take a basis adjustment, thus triggering the disposition/loss per se capitalization rules under the NGSH Method. Accordingly, the NGSH Method would not be useful without providing a mechanism to mitigate the effects of these dispositions and the resulting application of the disposition/loss per se capitalization rules to a taxpayer utilizing this safe harbor method. Thus, a taxpayer using the NGSH Method must include costs capitalized under the NGSH Method in general asset accounts as described under § 168(i)(4) and § 1.168(i)-1(l). See section 5.08 of this revenue procedure. The use of general asset accounts limits (1) the circumstances under which a taxpayer is required to recognize a loss on the disposition of property, and (2) the circumstances under which a taxpayer is required to take a casualty loss or a basis adjustment as a result of a casualty event. Therefore, the inclusion of transmission and distribution property in general asset accounts allows a taxpayer to avoid triggering the disposition/loss per se capitalization rules. The use of general asset accounts also allows a taxpayer to continue to depreciate this property after its disposition.

In addition, to facilitate the transition to the use of general asset accounts, this revenue procedure requires a taxpayer using the NGSH Method to make a late general asset account election under §§ 168(i)(4) and § 1.168(i)-1(l) for natural gas transmission and distribution property that the taxpayer previously placed in service and owns at the beginning of its year of change. See section 5.08(2) of this revenue procedure. Moreover, to incentivize taxpayers to use the NGSH method and to encourage taxpayers to change to the NGSH method for their first taxable year ending after May 1, 2023, this revenue procedure provides a special transition rule. Under this rule, if a taxpayer changes to the NGSH Method for its first taxable year ending after May 1, 2023, the taxpayer does not have to apply certain per se capitalization rules to amounts paid or incurred to replace or repair linear property or non-linear property, as applicable, in taxable years ending on or before May 1, 2023. See section 5.08(3)(a) of this revenue procedure.

.08 The safe harbor method for linear property and the safe harbor method for non-linear property are methods of accounting under § 446. Section 446(e) and § 1.446-1(e) require taxpayers to secure the consent of the Commissioner of Internal Revenue (Commissioner) before changing a method of accounting for Federal income tax purposes. Section 1.446-1(e)(3)(ii) authorizes the Commissioner to prescribe administrative procedures setting forth the limitations, terms, and conditions necessary to permit a taxpayer to obtain consent to change a method of accounting. Section 6.05 of this revenue procedure provides the procedures by which a taxpayer may obtain automatic consent for a change in method of accounting to use the safe harbor method for linear property and the safe harbor method for non-linear property.