IRS Provides “Tangible Property Regulations” Safe Harbor for Natural Gas Pipelines

IRS Provides “Tangible Property Regulations” Safe Harbor for Natural Gas Pipelines

Treasury and the IRS have released Revenue Procedure 2023-15, providing safe harbor guidance for applying the Section 263 tangible property regulations (TPR) to costs incurred to repair, maintain, replace or improve natural gas transmission and distribution pipelines. The guidance is timely, in that the sunsetting of bonus depreciation beginning in 2023 has placed a renewed emphasis upon correctly determining whether such costs may be immediately expensed or instead must be capitalized and recovered through depreciation.

TPR Safe Harbors

The natural gas transmission and distribution property safe harbor method of accounting (NGSH) offers two separate safe harbors — one for linear equipment and another for non-linear equipment.  The linear property safe harbor can be adopted independently, but the safe harbor for non-linear property requires adopting the linear property safe harbor as well.  

Examples of linear equipment include pipes, valves, casings and fittings. Examples of non-linear property include compressors, tanks, meters and structures.

The revenue procedure further divides the universe of eligible property between transmission and distribution assets. Transmission property generally includes the equipment needed to transport natural gas between a gas processing plant and a natural gas distribution system. Distribution property includes the equipment needed to further transport the natural gas from the transmission system to the ultimate consumer.

For linear transmission property:

  • Units of property (UOPs) are defined using a point-to-point approach based on hydraulic subsystems.
  • Capitalization generally is required if the taxpayer replaces more than 10% of the length of any UOP.

For linear distribution property:

  • The UOP is not defined, with the safe harbor instead distinguishing between “distribution mains” and “distribution service lines.”
  • Capitalization generally is required if the taxpayer replaces more than four miles of a distribution main.  
  • The tax treatment of costs to replace a distribution service line generally depends on whether the project costs are “per se capital expenditures,” and if not, whether the costs are associated with distribution main replacements required to be capitalized.  
  • Total annual costs related to unidentified service line projects are allocated between current deductions and capital expenditures using a provided formula.

For non-linear property (both transmission and distribution), the new guidance provides an itemized listing of the specific UOPs and major components to be used in applying the NGSH. Costs of replacing any of the identified UOPs or major components of non-linear property must be capitalized, while the taxpayer generally may deduct costs incurred to repair or maintain – without replacing – any of those UOPs or major components.

Per se capitalization expenditures

In addition to the general rules, the new guidance includes a list of per se capitalization expenditures, largely tracking the general capitalization standards of the TPR (such as project costs to “materially” increase the capacity to one or more customers).

As a result, in determining whether the costs of a particular pipeline project must be capitalized under the NGSH, the taxpayer first considers whether the costs are per se capital expenditures, and if not, the taxpayer applies the general safe harbor rules for the specific type of pipeline property. If neither applies, the costs may be deducted under the TPR.

Other rules

As with similar TPR guidance issued for other categories of “network assets,” Rev. Proc. 2023-15 includes detailed project aggregation rules, de minimis rules for blanket work orders and a variety of exclusions and carve outs (such as for “smart pigs” and “cleaning pigs”).

Adopting the NGSH

Adopting the NGSH requires a change in accounting method, for which the new guidance provides detailed implementation procedures. Importantly, adopting the NGSH requires using general asset accounts (GAAs) for natural gas pipeline property within the scope of the new accounting method, including both existing pipeline assets as well as new acquisitions. The guidance contains the necessary procedures for doing so.

The NGSH may be adopted only by taxpayers having a depreciable interest in natural gas transmission or distribution property who pay or incur costs to maintain, repair, replace or improve that property. By design, this excludes from the scope of the new guidance pipeline property used to transport crude oil, refined products, water, or any other liquid or gas other than natural gas, as well as gathering lines used in production fields. The guidance also excludes natural gas pipeline property used at a liquified natural gas (LNG) marine terminal.

BDO Insight

Notwithstanding the guidance’s caveat that it only applies to natural gas assets specifically within its scope, given the absence of any other guidance from the IRS or Treasury regarding application of the TPR to similar types of pipeline networks, taxpayers operating pipelines transporting other forms of liquids or gasses may be tempted to apply the general principles of the NGSH to such other pipeline properties. Taxpayers considering applying the Revenue Procedure 2023-15 safe harbors to other types of pipeline properties should consult with a BDO tax professional.