SECTION 5. NATURAL — Internal Revenue Bulletin 2023-18

GAS TRANSMISSION AND DISTRIBUTION PROPERTY SAFE HARBOR METHOD OF ACCOUNTING

.01 In general . (1) A taxpayer using the NGSH Method must apply the safe harbor method for linear property provided in sections 5.02 and 5.03 of this revenue procedure to the direct and indirect costs of replacing all its linear transmission and distribution main property, including any unit of property rules described therein. A taxpayer using the NGSH Method must also apply the safe

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harbor method for distribution service line costs as provided in section 5.07 of this revenue procedure. Moreover, a taxpayer using the NGSH Method may, but is not required to, apply the safe harbor method for non-linear property provided in section 5.04 of this revenue procedure to the direct and indirect costs of repairing, maintaining, replacing, and improving all its non-linear transmission and distribution property, including the application of the units of property and major components described in Appendix A. In addition, except as provided in section 5.08(3) (a) of this revenue procedure, a taxpayer using the NGSH Method must apply the per se capitalization rules provided in section 5.05 of this revenue procedure and the aggregation rules provided in section 5.06 of this revenue procedure to property subject to the NGSH Method. Finally, a taxpayer using the NGSH Method must include certain costs of natural gas transmission and distribution property in general asset accounts as provided in section 5.08 of this revenue procedure.

(2) Solely for purposes of this revenue procedure, the IRS will respect a reasonable and consistently applied designation of property by the taxpayer as either transmission or distribution property for Federal or State regulatory purposes, whichever is applicable. If the taxpayer is unregulated, the IRS will respect a reasonable and consistently applied designation that the taxpayer uses for its books and records.

(3) A taxpayer may not rely on the unit of property definitions provided in this revenue procedure for any other purpose of the Code or regulations, including for determining the unit of property under other sections of the Code or determining the asset for depreciation purposes (including placed in service, retirements, dispositions, or classification under § 168(e) or Rev. Proc. 87-56, 1987-2 C.B. 674) for the same or similar type of assets. (4) Amounts required to be capitalized under the NGSH Method are capital expenditures and must be taken into account through a charge to capital account or basis. Amounts that are paid or incurred for MACRS property and that are capitalized under this NGSH Method are accounted for in the manner described in section 5.08 of this revenue procedure.

.02 Safe harbor method for linear property—application to transmission property .

(1) Unit of property for linear trans- mission property . For purposes of this revenue procedure, the unit of property for linear natural gas transmission property is the linear property within each hydraulic subsystem as defined in section 4.12 of this revenue procedure. If a transmission segment is composed of two or more parallel lines, each line between each compressor station or other connection point is a separate unit of property. A lateral line on a transmission line is not a separate unit of property unless there is a compressor station or regulator at the junction point between the lateral line and the main transmission line. If a lateral line can be treated as part of a unit of property with more than one main transmission line, the taxpayer should designate the main line with which the lateral line is associated and follow that designation consistently.

(2) Simplified rule for replacements of linear transmission property . Whether a taxpayer using the safe harbor method for linear property must capitalize the cost of a replacement of linear transmission property is determined by the length of the line replaced. If more than 10 percent of the length of the unit of linear transmission property is replaced, the cost of the replacement must be capitalized under §§ 263(a) and 263A. If 10 percent or less of the length of the unit of linear transmission property is replaced, the cost of the replacement is not required to be capitalized under § 263(a) or § 263A. The cost of the replacement includes the direct and indirect costs of replacing the pipe and any associated linear property, including, but not limited to, connectors, cathodic protection, valves, casing, tunnels, instrumentation and controls, and structural supports for such property.

(3) Blanket work orders . (a) Allocation . To the extent a taxpayer cannot specifically identify whether amounts charged to a blanket work order are for a replacement of linear transmission property greater than 10 percent of the unit of linear transmission property, the taxpayer may use any reasonable method to allocate costs charged to the blanket work order if the reasonable method is consistently applied by the taxpayer.

(b) De minimis charges . A taxpayer that adheres to a policy that limits perevent charges under a blanket work order to replacements of property costing $50,000 or less is not required to capitalize the costs of replacing linear transmission property charged to the blanket work order. Replacements of property qualifying under this de minimis rule are not taken into account in determining whether more than 10 percent of the length of the unit of linear transmission property is replaced under section 5.02(2) of this revenue procedure or in applying the aggregation requirement in section 5.06 of this revenue procedure. .03 Safe harbor method for linear prop- erty—application to distribution property .

(1) In general . For purposes of determining whether the costs of replacing linear distribution property must be capitalized under the NGSH Method, the unit of linear distribution property is not defined. Instead, the taxpayer must initially determine whether the costs are for the replacement of distribution mains as defined in section 4.18 of this revenue procedure or are distribution service line costs as defined in section 4.20 of this revenue procedure. To determine whether the costs of replacing distribution mains must be capitalized, the taxpayer must apply the simplified rule provided in section 5.03(2) of this revenue procedure. To determine whether distribution service line costs must be capitalized, the taxpayer must apply the simplified rules provided in section 5.07 of this revenue procedure.

(2) Simplified rule for replacements of distribution mains . Whether a taxpayer using the safe harbor method for linear property must capitalize the cost of replacing distribution mains is determined by the length of the distribution mains replaced. If more than four miles of distribution mains are replaced, the cost of the replacement must be capitalized under §§ 263(a) and 263A. If four miles or less of distribution mains are replaced, the cost of the replacement is not required to be capitalized under § 263(a) or § 263A. The cost of the replacement includes the direct and indirect costs of replacing the distribution mains and any associated linear property, including, but not limited to, connectors, cathodic protection, valves, casing, tunnels, instrumentation and con

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trols, and structural supports for such linear property.

(3) Blanket work orders . (a) Allocation . To the extent a taxpayer cannot specifically identify whether amounts charged to a blanket work order are for the replacement of distribution mains greater than four miles, the taxpayer may use any reasonable method to allocate costs charged to the blanket work order if the reasonable method is consistently applied by the taxpayer.

(b) De minimis charges . A taxpayer that adheres to a policy that limits perevent charges under a blanket work order to replacements of property costing $50,000 or less is not required to capitalize the costs of distribution mains replacements charged to the blanket work order. Replacements of property qualifying under the de minimis rule in this section 5.03(3)(b) are not taken into account in determining replacement length under section 5.03(2) of this revenue procedure or in applying the aggregation requirement in section 5.06 of this revenue procedure.

.04 Safe harbor method for non-linear property – application to transmission and distribution property .

(1) Applicability . A taxpayer may use the safe harbor method for non-linear property only if the taxpayer uses the safe harbor method for linear property. However, a taxpayer is not required to apply the safe harbor method for non-linear property if it uses the safe harbor method for linear property. If a taxpayer does not use the safe harbor method for non-linear property, then the taxpayer must apply §§ 162, 263(a), 263A, and the regulations thereunder to determine the appropriate units of property for its non-linear property and to determine whether amounts paid or incurred to repair, maintain, replace, or improve these units of property must be capitalized.

(2) Units of property under the safe harbor method for non-linear property . For purposes of applying the safe harbor method for non-linear property, the units of property and corresponding major components of non-linear property are identified in Appendix A. A taxpayer that uses a unit of property definition provided in Appendix A must also use the major component definitions provided in Appendix A for that unit of property. Similarly,

a taxpayer that uses a major component definition provided in Appendix A must also use the unit of property definition provided in Appendix A associated with that major component.

(3) Simplified rule for replacements of non-linear property . The safe harbor method for non-linear property applies to the direct and indirect costs paid or incurred to repair, maintain, replace, or improve the taxpayer’s non-linear transmission and distribution property. If the taxpayer replaces a unit of non-linear property or a major component of a unit of non-linear property as identified in Appendix A, then the taxpayer must capitalize the amounts paid to replace the unit of non-linear property or major component of the unit of non-linear property under §§ 263(a) and 263A. 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. If the taxpayer pays or incurs amounts to repair, maintain, replace, or improve non-linear transmission or distribution property, but does not replace either a unit of non-linear property or a major component of a unit of non-linear property as part of these activities, then the taxpayer is not required to capitalize the amounts paid or incurred for such activities under § 263(a) or § 263A. However, if a taxpayer pays or incurs amounts to repair, maintain, replace, or improve its non-linear transmission or distribution property, and these costs relate to per se capital expenditures described under section 5.05 of this revenue procedure, then the amounts paid or incurred must be capitalized under section 5.05 of this revenue procedure.

.05 Per se capital expenditures . (1) In general . Except as provided in section 5.08(3)(a) of this revenue procedure, a taxpayer using the NGSH Method must capitalize the direct and indirect costs described in section 5.05(1)(a) through (j) of this revenue procedure to the extent these costs are paid or incurred with respect to linear property or non-linear property subject to the NGSH Method, notwithstanding any other provision of

this revenue procedure. Per se capital expenditures include:

(a) The costs of property necessary to add one or more new customers;

(b) The costs of materially increasing capacity of the property to one or more existing or potential customers (see section 5.05(2) of this revenue procedure for the application of this rule to linear property);

(c) The costs of adding a unit of non-linear property or adding a major component of a unit of non-linear property other than as a replacement, as defined in section 4.10 of this revenue procedure, for an existing major component;

(d) The costs of property that extends a transmission or distribution system (see section 5.05(3) of this revenue procedure for the application of this rule to the costs of additional linear property required to relocate or replace an existing line);

(e) The costs of property that adds cathodic protection, protective wrapping, or protective coating to linear property;

(f) The costs of adding instrumentation and control equipment, including remote actuation or monitoring equipment, to property that did not previously have similar equipment; for these purposes, new instrumentation and control equipment is not similar if it provides additional functionality;

(g) The costs of 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;

(h) The costs of repairing or replacing all or part of property as a result of damage for which the taxpayer is required to take a basis adjustment as a result of a casualty loss under § 165, or relating to a casualty event described in § 165;

(i) The costs of easements or other rights in real property; and

(j) The costs of adapting property to a new or different use.

(2) Materially increasing capacity of linear property .

(a) Determining materiality . For purposes of applying section 5.05(1)(b) of this revenue procedure to linear transmission property or linear distribution property, an expenditure for linear prop

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erty materially increases capacity to one or more existing or potential customers if the work performed increases capacity by more than five percent to one or more existing or potential customers. In the case of transmission property, an increase in capacity is determined based on the increase in the capacity of the hydraulic subsystem, measured in terms of millions of cubic feet per day. In the case of distribution property, an increase in capacity is determined based on the increase in the throughput of gas to one or more existing or potential customers served or to be served by the added or replaced property, measured in terms of thousands of cubic feet per hour. For purposes of section 5.05(1)(b) of this revenue procedure, an increase in capacity does not include amounts paid to return linear property to its original capacity prior to any wear, tear, or other damage necessitating such expenditure.

(b) Taxpayer’s purpose . A taxpayer is not required to capitalize costs that materially increase capacity to linear property under section 5.05(2)(a) of this revenue procedure if the taxpayer can establish with reasonable certainty, through its books and records, that the principal purpose of an addition or replacement of linear property was for safety reasons, to standardize its system, or to comply with regulatory requirements, unrelated to increasing capacity. However, these costs may be subject to capitalization under sections 5.02, 5.03, or 5.07 of this revenue procedure or other per se capitalization rules under this section 5.05.

(3) Property that extends a system . For purposes of applying section 5.05(1) (d) of this revenue procedure, the cost of property that extends a transmission or distribution system does not include the cost of additional linear property required to relocate or replace an existing line that will continue to run between the same two endpoints. However, if more than 10 percent of the length of the original unit of property is replaced, in the case of a replacement of linear transmission property, the costs of the replacement must be capitalized under section 5.02(2) of this revenue procedure. If more than four miles of distribution mains is replaced, in the case of a replacement of distribution mains, the cost of the replacement must be

capitalized under section 5.03(2) of this revenue procedure.

(4) Special rule for identified distri- bution service line costs associated with distribution mains . If the taxpayer can identify with reasonable accuracy distribution service line costs associated with distribution main costs that are treated as per se capital expenditures under this section 5.05, then the identified distribution service line costs are also treated as per se capital expenditures under this section 5.05. For rules regarding identified and unidentified distribution service line costs, see section 5.07 of this revenue procedure.

(5) Coordination with other rules . Replacements of property for which the replacement costs are per se capital expenditures under this section 5.05 are not taken into account in determining whether more than 10 percent of the length of the unit of linear transmission property is replaced for purposes of applying section 5.02 of this revenue procedure, or in determining whether more than four miles of distribution mains are replaced for purposes of section 5.03 of this revenue procedure.

(6) Examples . The following examples illustrate the application of this section 5.05. In each example, it is assumed that (a) the taxpayer is a corporation and files its Federal income tax return on an accrual method and a calendar year basis, (b) the taxpayer uses the safe harbor method for linear property and the safe harbor method for non-linear property for all its natural gas transmission and distribution property, and (c) the taxpayer does not make an election under § 1.168(i)-1(e)(3)(ii) (disposition of all assets remaining in a general asset account) or § 1.168(i)-1(e)(3) (iii) (disposition of an asset in a qualifying disposition). In addition, for the following examples, it is assumed that none of the aggregation requirements of section 5.06 of this revenue procedure apply.

(a) Example 1 . (i) Z is a local natural gas distribution company that supplies gas to an industrial customer via a three-inch diameter distribution service line. Due to planned expansion of its facility, the customer will require more gas than can be supplied via the existing line. Z ’s records include correspondence with the customer indicating that Z agreed to install a second three-inch distribution service line and a second meter to meet the customer’s need for additional gas at its facility. As a result of Z ’s installation of a second three-inch distribution service line,

throughput of gas to the customer is increased by 100 percent.

(ii) The cost of installing the second distribution service line is a per se capital expenditure under section 5.05(1)(b) of this revenue procedure because it increases Z ’s capacity to its customer by more than five percent and Z ’s records reflect that the distribution service line is added for the principal purpose of increasing capacity to Z ’s customer. The cost of installing a second meter must be capitalized under the per se capitalization rule in section 5.05(1)(c) of this revenue procedure because the new meter is an addition of a unit of non-linear property defined in section 2.04 of Appendix A.

(b) Example 2 . Y is a natural gas transmission company that owns and operates a natural gas transmission pipeline that is 300 miles in length. Section A of this pipeline runs for 80 miles between two compressor stations, and is a hydraulic subsystem that is a unit of property. The pipe in Section A is 12 inches in diameter, except for a seven-mile segment that is 10 inches in diameter. Y incurs costs to replace the seven-mile 10-inch segment with 12-inch pipe in order to increase the capacity of Section A. As a result of the replacement, the capacity of Section A to Y ’s customers, as measured in terms of millions of cubic feet of gas per day, increased by more than five percent. In addition, Y ’s records do not specifically indicate a principal purpose for replacing the seven-mile segment. Accordingly, the cost of replacing the existing 10-inch transmission line with the larger 12-inch transmission line must be capitalized as a per se capital expenditure under section 5.05(1) (b) of this revenue procedure.

(c) Example 3 . X is a natural gas transmission company that owns and operates a natural gas transmission pipeline that is 300 miles in length. Section B of this transmission pipeline runs for 80 miles between two compressor stations and is a hydraulic subsystem that is a unit of property. The pipe in Section B is 10 inches in diameter. X replaces seven miles of Section B with 12-inch pipe. As a result of the replacement, the capacity of Section B to X ’s customers, as measured in terms of millions of cubic feet of gas per day, increased by two percent. Because the replacement did not result in an increase in Section B’s capacity by more than five percent, the cost of replacing the seven miles of pipe is not a per se capital expenditure under section 5.05(1) (b) of this revenue procedure and, because less than 10 percent of Section B (7 miles out of 80 miles = 8.8 percent) is replaced, the cost is not required to be capitalized under section 5.02(2) of this revenue procedure.

(d) Example 4 . (i) W is a local natural gas distribution company that supplies gas to a group of existing customers via an older three-inch diameter distribution main and individual distribution service lines. Pursuant to regulatory requirements, W performs regular safety risk assessments that take into account the age and composition of the pipeline at various locations. Based on this safety assessment, W determines it is necessary to replace three miles of distribution mains. The distribution main is replaced with four-inch diameter pipe, which is one of the standard sizes currently used by W for all distribution main replacements. W ’s books and records indicate that the principal purpose of the replacement was the

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or the locations where property will be replaced;

(ii) identifies the amount of pipe to be replaced, or total cost of the replacements; and

(iii) provides that the replacements are expected to be completed within five years after the date of the authorizing document. If the authorizing document does not provide a time period over which replacements will be completed, this requirement will be considered to be met unless it is determined upon original authorization that it will take more than five years to complete the replacements.

(2) Authorizing document . (a) For purposes of this section 5.05 of this revenue procedure, the term “authorizing document” means the following:

(i) a regulatory commission decision that requires replacements as part of an identified program aimed at a specific purpose;

(ii) a written project authorization aimed at a specific purpose;

(iii) a work order as defined under section 4.08 of this revenue procedure; or

(iv) a blanket work order as defined under section 4.09 of this revenue procedure and which is aimed at a specific purpose.

(b) A regulatory commission decision does not include a decision, whether or not designated as an “order,” that authorizes expenditures for replacements but does not require replacements to be made.

(3) General and specific authorizing documents . If replacements are described by a general authorizing document as well as one or more specific authorizing documents (for example, a regulatory commission decision and a written project authorization implementing the regulatory commission decision), aggregation is based on the most general authorizing document that meets the requirements of section 5.06(1)(c) of this revenue procedure. For example, if a general authorizing document provides that replacements are not expected to be completed within five years of this authorizing document, then aggregation of the replacements pursuant to this authorizing document is not required. However, if a subsequent more specific authorizing document implementing that same program or project provides that certain replacements are expected

result of the safety risk assessment. W can identify with reasonable accuracy the distribution service line costs that are associated with the distribution mains replacement.

(ii) Pursuant to section 5.05(2)(b) of this revenue procedure, the cost to replace the distribution main is not a per se capital expenditure under section 5.05(1) (b) of this revenue procedure because the taxpayer’s books and records indicate that the principal purpose of the distribution main replacement was to reduce safety risk. Additionally, because the length of the distribution main replacement is less than four miles, the cost of the distribution main replacement is not required to be capitalized under section 5.03(2) of this revenue procedure. Similarly, because W can identify the costs of replacing the distribution service lines with the distribution main replacement, the cost of replacing the associated distribution service lines is not a per se capital expenditure under section 5.05(1)(b) of this revenue procedure and is not required to be capitalized under section 5.07(2)(b)(ii) of this revenue procedure.

(e) Example 5 . (i) V is a local natural gas distribution company that supplies natural gas to a group of existing customers at the edge of its service area via three miles of three-inch diameter distribution main, and individual distribution service lines. V ’s records reflect that certain customers were experiencing gas delivery issues. Consequently, V replaces the entire three-mile segment with four-inch diameter pipe, as well as the associated service lines. V ’s books and records do not indicate any principal purpose of replacing the three-mile segment of distribution main other than to address its customer’s gas delivery issues. V ’s replacement of the three-mile segment of distribution main increased the throughput of gas to its existing customers by seven percent.

(ii) Because the replacement of the distribution main results in an increase in the throughput of gas to the customers served by the distribution main of more than five percent, the cost to replace the three miles of distribution mains is a per se capital expenditure under section 5.05(1)(b) of this revenue procedure. Additionally, because the cost of the distribution main replacement is a per se capital expenditure, the cost of replacing the associated distribution service lines is a per se capital expenditure under sections 5.05(4) and 5.07(2)(a) of this revenue procedure.

(f) Example 6 . (i) U is a local natural gas distribution company that owns and operates 160 miles of distribution mains. U ’s distribution mains currently include one-, two-, three-, and four-inch diameter pipe. The diameters and materials vary depending on the year of installation. U is currently standardizing its distribution mains by using pipe in two-inch and four-inch diameters. Any distribution main pipe that is replaced is replaced with one of these two standard sizes. U replaces 875 feet of three-inch diameter pipe with four-inch diameter pipe, which had the effect of increasing its throughput to one or more existing or potential customers by more than five percent. U ’s books and records indicate that its use of the larger diameter pipe was necessary to standardize its system with currently available sizes of pipe.

(ii) Because U ’s books and records indicate that the replacement is made to standardize its system, pursuant to section 5.05(2)(b) of this revenue pro

cedure, the cost of the replacement is not a per se capital expenditure under section 5.05(1)(b) of this revenue procedure. Finally, because less than four miles of the distribution main pipe is replaced, the cost of the replacement is not required to be capitalized under section 5.03(2) of this revenue procedure.

(g) Example 7 . (i) T is a local natural gas distribution company that owns and operates 160 miles of natural gas distribution mains. T ’s distribution mains include iron pipe and polyethylene pipe. T is currently using polyethylene pipe when it needs to replace pipe in its distribution mains because it considers polyethylene pipe to be better pipe for several reasons. T replaces three miles of four-inch diameter iron pipe in its distribution mains with four-inch diameter polyethylene pipe. There is no change in the throughput of gas to customers served by the distribution main as a result of this replacement.

(ii) The cost of the replacement is not a per se capital expenditure under section 5.05(1)(b) of this revenue procedure because the replacement does not materially increase capacity to one or more existing or potential customers. Additionally, because the distribution main replacement is for four miles or less, the cost of the replacement is not required to be capitalized under section 5.03(2) of this revenue procedure.

(h) Example 8 . S, a local natural gas distribution company, is required to relocate a distribution main to accommodate construction of a road. In order to reroute its distribution main around the construction site, S replaces one mile of pipe and also adds 1,000 feet of pipe to the distribution system. Notwithstanding the addition of pipe to the distribution system, the cost of the relocation is not a per se capital expenditure under section 5.05(1)(d) of this revenue procedure because the pipeline continues to run between the same two endpoints. Additionally, the cost of the relocation is not required to be capitalized under section 5.03(2) of this revenue procedure because the replacement of distribution main pipe is four miles or less.

.06 Aggregation requirements . (1) General rule . For purposes of determining whether the applicable thresholds for capitalization of property provided in sections 5.02, 5.03, and 5.04 of this revenue procedure are met, a taxpayer must aggregate multiple replacements if all of the following requirements are met:

(a) The replacements are within – (i) the same unit of property, for non-linear property and linear transmission property, or

(ii) the same five-digit United States Postal Service ZIP Code delivery area, for linear distribution property;

(b) The replacements are described in one authorizing document, as defined in section 5.06(2) of this revenue procedure; and

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to be completed within five years of this subsequent authorizing document, then aggregation of the replacements described in the subsequent authorizing document is required, provided that the other requirements described in section 5.06(1) of this revenue procedure are met.

(4) Aggregation of replacements across multiple years . Multiple replacements that meet the requirements described in section 5.06(1) of this revenue procedure are aggregated without regard to whether they are performed in one year or multiple years.

(5) Modifications . Modifications to an authorizing document, or to the work done pursuant to an authorizing document, that occur within the taxable year are taken into account in determining whether to aggregate replacements, and whether to capitalize the expenditures, in that taxable year, but do not affect the aggregation of replacements pursuant to that authorizing document in a prior taxable year.

(6) Anti-abuse rule . If a taxpayer acts (a) to divide closely related transmission or distribution property replacement projects into multiple written project authorizations, work orders, or blanket work orders or (b) to mischaracterize the intended or expected scope of a project, in order to avoid the application of the aggregation rules under this section 5.06, rather than for non-tax business reasons, appropriate adjustments will be made by the Commissioner to carry out the purposes of this revenue procedure.

(7) Examples . The following examples illustrate the application of this section 5.06. In each example, it is assumed that (a) the taxpayer is a corporation and files its Federal income tax return on an accrual method and a calendar year basis, (b) the taxpayer uses the safe harbor method for linear property and the safe harbor method for non-linear property for all its natural gas transmission and distribution property, and (c) the taxpayer does not make an election under § 1.168(i)-1(e)(3)(ii) (disposition of all assets remaining in a general asset account) or § 1.168(i)-1(e) (3)(iii) (disposition of an asset in a qualifying disposition).

(a) Example 1 . (i) R is a natural gas distribution company in State A . The Public Utility Commission (Regulator) of State A sets the rates and approves tariffs for R . Regulator issues Rate Order 12345 as a result of certain rate proceedings. Rate Order 12345

allows for the incremental recovery of up to an additional $30 million annually in revenue through rates and tariffs. Rate Order 12345 states that these dollars are for the recovery of incremental operating expense, maintenance expense, and return on investment related to the replacement of distribution mains in its natural gas distribution system; however, no specific replacements are required, and Rate Order 12345 does not provide a time period over which replacements will be completed. R makes annual filings documenting such costs, which match revenue billed to incremental expense and include R ’s allowed return on investment. The specific distribution main replacements are determined by R based on known conditions and risk analysis.

(ii) For purposes of determining whether the replacement costs are capitalized under section 5.03 of this revenue procedure, aggregation of pipeline replacements is not required under this section 5.06 because Rate Order 12345 (A) does not identify a program aimed at a specific purpose for the replacements; (B) does not require specific replacements to be made; (C) does not identify the property with respect to which the replacements will occur or the locations for the replacements; (D) does not identify the amount of pipe or the total cost of the replacements; and (E) does not specify that the replacements are within the same Zip Code. All these criteria must be satisfied for the aggregation requirement of this section 5.06 to apply to replacements performed under Rate Order 12345.

(b) Example 2 . Q is a local natural gas distribution company. Based on estimated general maintenance and upgrade costs and anticipated revenues through its rates and tariffs, Q budgets $100 million during Year 1 for replacements within its distribution system. For purposes of determining whether the distribution main replacement costs are capitalized under section 5.03 of this revenue procedure, an aggregation of pipeline replacements is not required under this section 5.06 because Q ’s budget document is not a written project authorization aimed at a specific purpose.

(c) Example 3 . P is a local natural gas distribution company. P issues a blanket work order for replacements of less than 2,000 feet of distribution mains. The blanket work order is used predominantly for the repair of leaks, but does not establish a project aimed at a specific purpose. P performs several replacements under the blanket work order to repair leaks. For purposes of determining whether the replacement costs are capitalized under section 5.03 of this revenue procedure, an aggregation of distribution main replacements under the blanket work order is not required under this section 5.06 because the blanket work order is not an authorizing document under section 5.06(2) of this revenue procedure.

(d) Example 4 . (i) O is a natural gas distribution company in State B . Following an explosion near a population center in State B that may be attributable to Type L pipe deteriorating faster than anticipated, Regulator issues an order in Year 1 requiring all Type L pipe used in the transmission or distribution of natural gas or other combustible material in State B to be replaced within five years to eliminate a safety risk to State B citizens. The order also specifies procedures for applying for a special tariff to support replacements of Type L pipe. In response to

this order, O ’s management instructs its engineering department to initiate a project to identify all Type L pipe in its distribution system in State B . O issues a written project authorization that will involve a review of its purchases of Type L pipe, physical identification of the pipe, and inspection of sections of pipeline. As the locations of Type L pipe are identified, O prepares work orders to replace the Type L pipe. In one ZIP Code delivery area, O identifies six sections of Type L distribution mains, totaling eight miles, and each of these sections are replaced under six separate work orders, as they are identified. Each work order identifies the location and the amount of the distribution mains to be replaced. Each work order is for a replacement of less than four miles of distribution mains.

(ii) For purposes of determining whether the replacement costs are capitalized under section 5.03 of this revenue procedure, the replacements are not aggregated under this section 5.06 under the Regulator’s order because, although the order is an authorizing document within the meaning of section 5.06(2) of this revenue procedure, the order does not identify the amount or costs of the distribution mains to be replaced, as required by section 5.06(1)(c)(ii) of this revenue procedure. Similarly, the replacements are not aggregated under the written project authorization issued by O because the authorization does not identify the amount or the costs of the distribution mains to be replaced. See section 5.06(1) (c)(ii) of this revenue procedure. Rather, each of the six work orders qualify as separate authorizing documents under section 5.06(2) of this revenue procedure and provides the information required in section 5.06(1)(c). Because neither the Regulator’s order nor the written project authorization meets the requirements for aggregation under this section 5.06, and each work order constitutes a separate authorizing document for the replacement of less than four miles of distribution mains, the costs of the replacements are not required to be capitalized under section 5.03 of this revenue procedure. (e) Example 5 . (i) The facts are the same as in Example 4, except that in response to the Regulator’s order, in Year 1, O ’s management issues a written project authorization for the replacement of all Type L pipe in County Z in State B, identifying the quantity and location of all Type L pipe in County Z, and authorizing $2 million for this purpose. County Z falls within two ZIP Code delivery areas, Area F and Area G . The project authorization does not provide a time period in which the replacements will be completed but there is no reason to expect that the project will take longer than five years.

(ii) For purposes of determining whether the replacement costs are capitalized under section 5.03 of this revenue procedure, the replacements are aggregated under this section 5.06 pursuant to O ’s written project authorization, which authorizes the replacement of distribution mains for a specific purpose and identifies the location of the replacements and the amount of distribution mains to be replaced. Accordingly, for each of the ZIP Code delivery areas affected by the written project authorization, replacements within that ZIP Code delivery area that are covered by the written project authorization are aggregated, even though the replacements may be noncontiguous, may occur over more than a sin

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gle year, and may involve several work orders. The aggregate replacements in Area F total seven miles, and the aggregate replacements in Area G total three miles. Accordingly, under section 5.03 of this revenue procedure, the replacement costs of distribution mains in Area F are capitalized and the replacement costs of distribution mains in Area G are not required to be capitalized.

(f) Example 6 . (i) The facts are the same as in Example 4 except O knows that it also has Type L pipe in its distribution systems in State Y . In response to Regulator’s order, O issues a written project authorization authorizing its crews in State Y to replace all Type L pipe that is more than 10 years old as Type L pipe is encountered in the normal course of operations. It is reasonable to expect that the replacements under this project authorization would not be completed within five years. During Year 2, O exceeds its capital maintenance budget in State Y by $1 million. A review of the work orders charged to the project authorization during Year 2 indicates that O spent $2 million on replacing 12 miles of functional Type L distribution mains. One work order authorized the replacement of six miles of distribution mains at different locations within ZIP Code delivery Area H at a cost of $ 1.2 million. The remaining three work orders each authorized the replacement of two miles of distribution mains at different locations within ZIP Code delivery Area J .

(ii) For purposes of determining whether the replacement costs are capitalized under section 5.03 of this revenue procedure, the replacements of Type L distribution mains in State Y in Year 2 are not aggregated under this section 5.06 under O ’s written project authorization, because the written project authorization does not specify the amount of mains or the total cost of replacements, or the period over which the replacements are to occur and it is reasonable to expect that the replacements will not be completed within five years. However, the replacement of six miles of distribution mains pursuant to the work order charged in Year 2 authorizing the replacement of six miles of distribution mains at specified locations within ZIP Code delivery Area H is aggregated under this section 5.06 because this work order meets the requirements of section 5.06(1) of this revenue procedure and constitutes an authorizing document. See section 5.06(3) of this revenue procedure. Although the other three work orders are for replacements of distribution mains within the same ZIP Code delivery area, these work orders are not aggregated because they constitute separate authorizing documents. Because each of these three work orders is for the replacement of less than four miles of distribution mains, the costs of these distribution main replacements are not required to be capitalized under section 5.03 of this revenue procedure.

(g) Example 7 . (i) M is a natural gas distribution company. M budgets $10 million for the replacement of distribution mains that run through subdivisions A and B, which are in ZIP code delivery area H . The budget directs the work to be done through a written project authorization, which is issued in Year 1. The work under the written project authorization is reasonably expected to be completed in late Year 2 or early Year 3. The priority of replacements will be determined based on risk assessments, but the

written project authorization calls for the eventual replacement of five miles of distribution mains in ZIP code delivery area H .

(ii) For purposes of determining whether the replacement costs are capitalized under section 5.03 of this revenue procedure, aggregation is not required by the general budget because the budget does not qualify as an authorizing document under section 5.06(2) of this revenue procedure. However, the replacements done pursuant to the written project authorization are aggregated under this section 5.06 because the document is aimed at a specific purpose, authorizes the replacement of a known amount of distribution mains in a certain location and, although it does not specify the time period over which replacements will be completed, there is no reason to expect that completing the replacements will take longer than five years. Because the aggregate replacements of distribution mains within ZIP Code area H total more than four miles, the costs to replace the five miles of distribution mains are capitalized under section 5.03 of this revenue procedure.

(h) Example 8 . (i) L is a natural gas transmission company that operates a natural gas transmission line in State C . In Year 1, L conducts an internal inspection of a 100-mile section of the transmission line, a hydraulic subsystem that is a separate unit of property under section 5.02(1) of this revenue procedure. An analysis of the survey indicates that 11 miles (11 percent) of the pipe in this section should be removed and replaced due to deterioration. In a written project authorization issued in January of Year 1, L ’s management authorized $22 million to replace the 11 miles of pipe and directed that the work commence as soon as practicable. The project is expected to be completed in Year 1. Based on a study of actual deterioration in removed pipe versus the deterioration shown by the inspection device, L ’s engineers determine in November of Year 1 that the replacement of only nine miles (9 percent) is warranted. The replacement of the nine miles, which was performed under two separate work orders, is completed in December of Year 1.

(ii) For purposes of determining whether the replacement costs are capitalized under section 5.02 of this revenue procedure, the replacements are required to be aggregated under this section 5.06 pursuant to the January, Year 1, authorization, which meets the requirements of section 5.06(1) and (2) of this revenue procedure. Under section 5.06(5) of this revenue procedure, the aggregation determination is based on the status of the written project authorization and the work done, or to be done, at the end of each taxable year. As of the end of Year 1, it was known that only nine miles of the transmission line were replaced. Because the aggregated replacements total less than 10 percent of the unit of linear transmission property, the cost of the replacements is not required to be capitalized under section 5.02 of this revenue procedure.

(i) Example 9 . (i) The facts are the same as in Example 8, except that the January Year 1 project authorization required the replacement of only nine miles (9 percent) of L ’s 100-mile hydraulic subsystem. In November of Year 1, L ’s engineers then determined that a total of 11 miles (11 percent) had to be replaced, and the replacement of 11 miles was completed in December of Year 1.

(ii) For purposes of determining whether the replacement costs are capitalized under section 5.02 of this revenue procedure, the replacement work is aggregated pursuant to the January Year 1 project authorization, which meets the requirements of section 5.06(1) and (2) of this revenue procedure. Under section 5.06(5) of this revenue procedure, the aggregation determination is based on the status of the written project authorization and the work done, or to be done, at the end of each taxable year. It was known as of the end of Year 1 that more than 10 percent of the unit of property was replaced, as aggregated under this section 5.06 pursuant to the January Year 1 project authorization. Accordingly, the cost of the replacements in Year 1 must be capitalized under section 5.02 of this revenue procedure.

(j) Example 10 . (i) The facts are the same as in Example 8, except that when the January Year 1 written project authorization is issued, L ’s management expects that the work will not be completed until Year 3. The work commences in Year 1 and continues in Years 2 and 3. In Year 3, based on a study of actual deterioration in removed pipe versus that shown by the inspection device, L ’s engineers determine that the replacement of only nine miles (9 percent) of the 100-mile section is warranted, rather than the 11 miles (11 percent) originally anticipated. In December of Year 3, L ’s engineers issue the final work order, authorizing the replacement of two additional miles of pipe, and the work is completed. In aggregate, only nine total miles of pipe are replaced under the written project authorization.

(ii) For purposes of determining whether the replacement costs are capitalized under section 5.02 of this revenue procedure, the replacement work expected to be performed in Year 1, Year 2, and Year 3 is aggregated pursuant to the January Year 1 project authorization, which meets the requirements of sections 5.06(1) and (2) of this revenue procedure. Because the replacement of more than 10 percent of the unit of property was authorized in January of Year 1, the costs of the replacements that are incurred in Year 1 and Year 2 are capitalized. Under section 5.06(5) of this revenue procedure, the aggregation determination is based on the status of the written project authorization and the work done, or to be done, as of the close of each taxable year, and modifications do not affect the aggregation of replacements in prior taxable years. Therefore, the fact that only a total of nine miles (nine percent of the 100-mile unit of property) was eventually replaced does not affect the tax treatment of the replacement costs incurred in Year 1 and Year 2. However, the costs incurred in Year 3 are not required to be capitalized because, at the end of Year 3, L knows that only nine percent of the unit of property was replaced under the Year 1 project authorization.

(k) Example 11 . (i) The facts are the same as in Example 10, except that pursuant to L ’s initial survey, the January Year 1 written project authorization requires the replacement of only nine miles of pipe (nine percent of the 100-mile unit of property). Eight miles are replaced in Years 1 and 2. In Year 3, L ’s engineers determine that five additional miles of pipe should be replaced for a total of 13 miles and request that management modify the project and authorize additional funds to complete the 13-mile replacement. The project authorization is modified

May 1, 2023 816 Bulletin No. 2023–18

year are reduced by the identified distribution service line costs described in section 5.07(2) of this revenue procedure. (b) Step 2 . Determine total distri- bution main replacement costs not associated with identified distribution service line costs (denominator of cap- italization ratio) . To determine the total distribution main replacement costs not associated with identified distribution service line costs for purposes of the denominator in the capitalization ratio, the taxpayer’s total distribution main replacement costs, including distribution main replacement costs qualifying under the de minimis rule for blanket orders under section 5.03(3)(b) of this revenue procedure, paid or incurred in the taxable year are decreased by the following:

(i) Distribution main replacement costs that are required to be capitalized as per se capital expenditures under section 5.05 of this revenue procedure;

(ii) Distribution main replacement costs associated with identified distribution service line costs required to be capitalized under section 5.07(2)(b)(i) of this revenue procedure; and

(iii) Distribution main replacement costs associated with identified distribution service line costs not required to be capitalized under section 5.07(2)(b)(ii) of this revenue procedure.

(c) Step 3 . Determine capitalized distribution main replacement costs not associated with identified distribu- tion service line costs (numerator of capitalization ratio) . To determine the capitalized distribution main replacement costs not associated with identified distribution service line costs for purposes of the numerator in the capitalization ratio, the taxpayer’s total costs of distribution main replacements that are required to be capitalized under section 5.03(2) of this revenue procedure are decreased by any amount of distribution main replacement costs associated with identified distribution service line costs required to be capitalized under section 5.07(2)(b) (i) of this revenue procedure (the amount determined in section 5.07(3)(b)(ii) of this revenue procedure).

(d) Step 4 . Determine capitalization ratio . To determine the capitalization ratio, divide the taxpayer’s capitalized distribution main replacement costs not

accordingly, and replacement of the remaining five miles is completed by December of Year 3.

(ii) For purposes of determining whether the replacement costs are capitalized under section 5.02 of this revenue procedure, the costs of the replacements expected to be performed in Years 1 through 3 were aggregated under this section 5.06 pursuant to the Year 1 project authorization, which meets the requirements of sections 5.06(1) and (2). Under section 5.06(5) of this revenue procedure, the aggregation determination was based on the status of the written project authorization and the work done, or to be done, as of the close of each taxable year, and modifications would not affect the aggregation of replacements in prior taxable years. Accordingly, the costs incurred in Years 1 and 2 are not required to be capitalized because, as of the end of each of those taxable years, the total replacements required by the project authorization were not expected to exceed 10 percent of the unit of property. Pursuant to section 5.06(5) of this revenue procedure, however, the cost of the five miles replaced in Year 3 is required to be capitalized, because, as of the end of Year 3, it was known that a total of 13 miles (13 percent of the unit of property) were replaced pursuant to the Year 1 project authorization.

.07 Safe harbor method for linear property – rules for distribution service line costs .

(1) In general . A taxpayer using the safe harbor method for linear property must determine the amount of distribution service line costs that must be capitalized using the rules described in sections 5.07(2) and 5.07(3) of this revenue procedure. The rules in section 5.07(2) of this revenue procedure determine the treatment of distribution service line costs that a taxpayer can identify with reasonable accuracy as paid or incurred for a project described in section 5.07(2) of this revenue procedure. The rules in section 5.07(3) of this revenue procedure determine the treatment of distribution service line costs that the taxpayer is unable to identify with reasonable accuracy as paid or incurred for a project described in section 5.07(2) of this revenue procedure.

(2) Rules for identified distribution service line costs . To the extent that a taxpayer can identify, with reasonable accuracy, distribution service line costs, the following treatment applies to the identified costs:

(a) Identified costs that are per se cap- ital expenditures . Identified distribution service line costs that are per se capital expenditures described under section 5.05 of this revenue procedure, including distribution service line costs associated with distribution main costs that are per

se capital expenditures described under section 5.05 of this revenue procedure, are required to be capitalized.

(b) Identified costs other than per se capital expenditures .

(i) Identified distribution service line costs, other than per se capital expenditures described in section 5.07(2)(a) of this revenue procedure, associated with distribution main replacements that are required to be capitalized under section 5.03(2) of this revenue procedure (that is, associated with distribution main replacements that are more than four miles), are required to be capitalized;

(ii) Identified distribution service line costs, other than per se capital expenditures described in section 5.07(2)(a) of this revenue procedure, associated with distribution main replacements that are not required to be capitalized under section 5.03(2) of this revenue procedure (that is, associated with distribution main replacements that are four miles or less), are not required to be capitalized; and

(iii) Identified distribution service line costs, other than per se capital expenditures described in section 5.07(2)(a) of this revenue procedure, not associated with distribution main replacements (for example, the replacement of a customer’s service line only) are not required to be capitalized.

(3) Simplified rules for unidentifiied dis- tribution service line costs. To the extent a taxpayer cannot identify distribution service line costs with reasonable accuracy as provided under section 5.07(2) of this revenue procedure, the simplified rules in this section 5.07(3) apply to determine the amount of such costs to be capitalized under §§ 263(a) and 263A. Step 1 determines the total amount of unidentified distribution service line costs. Steps 2 through 4 determine the capitalization ratio that applies to such costs. In Step 5, the taxpayer multiplies the total amount of unidentified distribution line costs determined in Step 1 by the capitalization ratio to determine the amount of its unidentified distribution service line costs that are required to be capitalized.

(a) Step 1 . Determine total unidentified distribution service line costs . To determine the total unidentified distribution service line costs, the taxpayer’s total distribution service line costs for the taxable

Bulletin No. 2023–18 817 May 1, 2023

associated with identified distribution service line costs that were capitalized, as determined under Step 3, by the taxpayer’s total distribution main replacement costs not associated with distribution service line costs, as determined under Step 2.

(e) Step 5 . Determine the portion of unidentified distribution service line costs that must be capitalized . To determine the portion of unidentified distribution service line costs that must be capitalized, multiply the taxpayer’s capitalization ratio, as

determined under Step 4, by the taxpayer’s total unidentified distribution service line costs determined under Step 1.

(f) Formula . The following formula reflects the rule provided in this section 5.07(3):

Total unidentified distribution service

line costs ( Step 1 )

Capitalized distribution main replacement costs not associated with identified distribution service line costs ( Step 3 )

service line costs

ply the taxpayer’s capitalization ratio, as 5.07(3):

Capitalized distribution main replacement costs not associated with

Capitalized

identified distribution service line costs ( Step 3 )

unidentified

= distribution

Total distribution main replacement

service line

costs not associated with identified distribution

costs ( Step 5 )

service line costs

( Step 2 )