Nuclear units were abandoned, but loss deduction must await claims

Plain-English summary

A regulated public utility permanently retired two nuclear generating units after a steam leak revealed extensive wear in replacement generators. It removed the fuel, made regulatory filings preventing further operation, reduced staff, changed insurance, and wrote down the assets. The IRS ruled that these acts established an abandonment loss under § 165, excluding assets set aside for recovery, but the utility could not claim the deduction until its arbitration claim against the generator manufacturer and its insurance claims were resolved. Potential recovery through utility rates did not require the same deferral. The IRS also ruled that decommissioning and remediation costs that merely restore the site to its pre-contamination condition are deductible business expenses under § 162 rather than capital expenditures under § 263(a). A contested, contingent claim against the manufacturer does not postpone those expense deductions, although any later recovery must be included in income, and the IRS gave no opinion on § 263A inventory capitalization.

Ruling snapshot

• Question: When could the utility deduct its nuclear-unit abandonment loss, and could it currently deduct qualifying decommissioning expenses despite possible recoveries?
• Outcome: Mixed, abandonment established but the loss deduction deferred; qualifying remediation expenses are currently deductible
• Key authorities: IRC §§ 162, 165, 263(a), 263A, and 451; Treas. Reg. §§ 1.165-1, 1.165-2, and 1.167(a)-8; Rev. Ruls. 87-117 and 94-38

Full text (IRS public release)

Internal Revenue Service Department of the Treasury
Washington, DC 20224

Number: 201451014 Third Party Communication: None
Release Date: 12/19/2014 Date of Communication: Not Applicable
Index Number: 165.00-00
162.00-00 Person To Contact:
-----------------------, ID No. -------------------
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------------------------------------------------------------ Telephone Number:
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---------------------------------------------- Refer Reply To:
CC:ITA:B02
PLR-111988-14
Date: August 22, 2014

              TY: ---------

Legend

Taxpayer = ---------------------------------------------------
A= --------------------
B= --------------------
C= ---------------
D= ----------------------------------------------------------
E= ----------------------------
F= ----------
G= ------------------------------------------------------------------------

H= --------------
I= -----
J= -----------------------------------------------------------
K= ---------
L= ------------------------------------------------------------------------

Date 1 = -------
Date 2 = -------
Date 3 = -------
Date 4 = --------------------------
Date 5 = -------
Date 6 = ---------------------------
Date 7 = --------------
Date 8 = ---------------------
Date 9 = -------------------
Date 10 = -------------------
Date 11 = -------------------
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Date 12 = --------------
Date 13 = ------------------
Date 14 = --------------------
Date 15 = -------------------
Date 16 = -------------------
Date 17 = ----------------------
Date 18 = --------------------
a= -----------------
b= -------------------
c= ---------------

Dear ------:

   This is in response to the letter dated March 18, 2014, submitted on your behalf

by your authorized representative. In the letter you request two rulings. First, a ruling
that the Taxpayer abandoned A and B in Date 1 within the meaning of section 165 of
the Internal Revenue Code but that it is not entitled to claim the loss until its claims
against C and D are resolved. Second, a ruling that it is entitled to claim its ordinary
and necessary business expenses under section 162 regardless of the contingent
possibility of recovery of these expenses from C.
FACTS – Abandonment Loss
Taxpayer represents the facts and information related to its request for rulings as
follows:
Taxpayer, a corporation, is a wholly-owned subsidiary of E E and its affiliated group
of corporations, including Taxpayer, electronically file a consolidated federal income tax
return on a calendar year basis using the accrual method of accounting.
Taxpayer is a regulated public utility. It owns a F percent interest in A and B.
The G comprised three large pressurized water nuclear generating facilities. H was
abandoned and decommissioned commencing in Date 2.
A was placed in service in Date 3 and its operating license was scheduled to expire
on Date 4. B was placed in service in Date 5 and its operating license was scheduled to
expire on Date 6.
Two replacement steam generators were installed and placed in service in each of A
and B in Date 7 and in Date 8, respectively. C designed and manufactured the
replacement steam generators.
In Date 9, a steam leak occurred in one of the heat transfer tubes in one of the B
steam generators and B was safely taken off-line. All four steam generators were
inspected and areas of significant, unexpected and excessive wear were found
throughout. As a result, since Date 9, A and B have remained offline through the
announced retirement of G on Date 10.
PLR-111988-14 3

Taxpayer undertook an analysis of possible causes of the extraordinary wear and

explored potential remedial actions. In Date 11, after months of analysis and tests,
Taxpayer submitted a restart plan to the Nuclear Regulatory Commission (NRC). The
NRC conducted public hearings and studied the merits of the restart application. In
Date 12, the NRC ruled that restart would require amendments to the operating license
of A. Faced with mounting costs and uncertainties, Taxpayer determined that continued
efforts to repair or restart A and B were not feasible.
On Date 13, Taxpayer filed a Form I with the Securities and Exchange Commission
announcing that it was going to issue a press release on Date 10 announcing that it was
going to permanently retire G. On Date 14, the Taxpayer formally notified the NRC that
it had permanently ceased operation of A and B effective Date 10. The defueling of A
was completed on Date 15, and the Taxpayer sent a letter to the NRC on Date 16,
certifying that the fuel had been removed from A. The defueling of B was completed on
Date 17, and a letter certifying the nuclear fuel removal for B was sent to the NRC on
Date 18. It is anticipated that the decommissioning process will take several decades.
Taxpayer severed a substantial number of operational employees who will not be
engaged in the decommissioning of G. It sought and received a reduction in its state
property tax base to reflect the impairment.
The Taxpayer wrote down its investment in G for financial purposes in the second
quarter of Date 1.
Not all of the assets at G will be abandoned in connection with the permanent
retirement of G. The Taxpayer set up the J to recover a portion of its investment in
assets and inventory as a result of the decommissioning of G. The Taxpayer has
represented that none of the property included in the J will be treated as abandoned
property subject to this ruling request.
On Date 15, the Taxpayer submitted a Notice of Dispute to C for all damages
caused by C’s failed design and manufacture of the replacement steam generators that
led to the shutdown and permanent retirement of A and B. The dispute resolution
process initiated by the Notice of Dispute was unsuccessful so the Taxpayer initiated
binding arbitration proceedings against C to recover damages. The arbitration
proceedings were ongoing at the time the ruling request was filed.
G carries accidental property damage and carried accidental outage insurance
issued by D. The accidental outage insurance was cancelled due to the permanent
retirement of G. D has been placed on notice of potential claims for loss recovery under
both policies.
There are also pending proceedings before the K to determine how otherwise
unrecovered costs are addressed in the ratemaking process.
LAW AND ANALYSIS – Abandonment Loss
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Section 165(a) of the Internal Revenue Code provides that there shall be allowed as
a deduction any loss sustained during the taxable year and not compensated for by
insurance or otherwise.
Section 1.165-1(d)(2)(i) of the Income Tax Regulations provides that if a casualty or
other event occurs which may result in a loss and, in the year of such casualty or event,
there exists a claim for reimbursement with respect to which there is a reasonable
prospect of recovery, no portion of the loss with respect to such reimbursement may be
received is sustained, for purposes of section 165, until it can be ascertained with
reasonable certainty whether or not such reimbursement will be received. Whether or
not such reimbursement will be received may be ascertained with reasonable certainty,
for example, by a settlement of the claim, by an adjudication of the claim, or by an
abandonment of the claim.
A reasonable prospect of recovery exists when a taxpayer has bona fide claims for
recoupment from third parties and when there is a substantial possibility that such
claims will be decided in his favor. Estate of Scofield v. Commissioner, 266 F.2d 154,
159 (6th Cir. 1959).
If a taxpayer’s claim is not speculative or wholly without merit, and if the taxpayer
believes that the chance of recovering the loss is sufficiently probable to warrant
bringing a lawsuit and prosecuting it with reasonable diligence to a conclusion, the
deduction should be deferred until the conclusion of the lawsuit. Jeppsen v.
Commissioner, 128 F.3d 1410, 1414 (10th Cir. 1997).
Section 1.165-2(c) provides that for the allowance under section 165(a) of losses
arising from the permanent withdrawal of depreciable property from use in the trade or
business or in the production of income, see section 1.167(a)-8.
Section 1.167(a)-8(a)(4) provides that in order to qualify for the recognition of loss
from physical abandonment, the intent of the taxpayer must be irrevocably to discard
the asset so that it will neither be used again by him nor retrieved by him for sale,
exchange or other disposition.
Rev. Rul. 87-117, 1987-2 C.B. 61, holds that for purposes of section 165(a), the fact
that a public utility company that has abandoned a partially constructed nuclear power
plant obtains a rate increase that is based in part on the costs of the abandoned plant
does not cause it to have been compensated for by insurance or otherwise as that
phrase is used in section 165(a).
The abandonment of real property interests where ownership has not been
transferred has been addressed in a variety of circumstances. An abandonment was
found where the taxpayer filled and sealed a water well excavation in Rev. Rul. 56-599,
1956-2 C.B. 122; dismantled an asphalt plant, moved it to another location and did not
reassemble it, Seminole Rock & Sand Co. v. Commissioner, 19 T.C. 259 (1952), acq.,
1953-1 C.B. 6; stopped working on a mine, reduced the work force and budget to
maintain it, sold the mine equipment for salvage, decided to abandon the mine by vote
of board of directors, and wrote the mine off the company books, A.J. Industries, Inc. v.
PLR-111988-14 5

United States, 503 F.2d 660 (9th Cir. 1974); and locked and boarded hotel, placed
barricades around it, cut off utilities, terminated insurance, discontinued maintenance,
and made no efforts to sell or lease it, Hanover v. Commissioner, T.C. Memo. 1979-
332.
Legal restrictions upon the physical disposition of property such as a nuclear plant
will not in themselves preclude a finding of abandonment if all other facts and
circumstances demonstrate an intention to irrevocably retire property from use and the
requisite overt acts related to abandonment have occurred. The acts necessary to
evidence the intent to abandon property need only be appropriate to the particular
circumstances. A nuclear power plant is a heavily regulated asset, and one which
Taxpayer cannot simply walk away from, board up, or dismantle.
In the present case, Taxpayer has indicated that it intended to abandon A and B. It
has taken steps to abandon the units by removing the nuclear fuel from the units. It has
submitted documents to the NRC that prevent it from operating G. It altered its
insurance for the unit to a level indicative of its nonoperational status. Finally, it issued
press releases concerning the abandonment of the plant, wrote-off the assets on its
books and included statements about the abandonment in its financial statements.
The Taxpayer has taken actions to render A and B nonoperational. It has
announced its intention to permanently shut down G. The nuclear generators have
been shut down since the leak at B was discovered. It has commenced the initial
activity phase of radiological decommissioning with the appropriate filing with the NRC.
Taxpayer severed a substantial number of operational employees who will not be
engaged in the decommissioning of G. It sought and received a reduction in its state
property tax base to reflect the impairment.
Based on the above, it is held that Taxpayer sustained an abandonment loss within
the meaning of section 165(a) of the Internal Revenue Code with respect to A and B
(exclusive of the assets in the J) in Date 1. It demonstrated the requisite intent to
abandon A and B, it effectuated that intent through numerous acts of abandonment and
it has placed both units in a state of disability.
This holding is limited to the issue of whether an abandonment of A and B occurred
and does not consider which specific assets are abandoned or the amount properly
allocated thereto.
However, pursuant to section 165(a), even though Taxpayer abandoned A and B, it
will not be entitled to claim a deduction for the loss incurred if the loss is compensated
for by insurance or otherwise. See also section 1.165-1(d)(2).
The Taxpayer is pursuing its claims against C in an arbitration proceeding. It has
represented that it has a valid claim against C and a reasonable prospect of recovery
against C.
The Taxpayer has filed separate proof of loss claims under the D outage policy and
may pursue claims under the property accident policy. It has represented that it has a
reasonable prospect of recovering damages from D.
PLR-111988-14 6

The Taxpayer is also seeking recovery of costs that might not be recoverable from C
or D in rate proceedings before K.
Given that the Taxpayer has a reasonable prospect of recovering damages from
both C and D, the deduction of the abandonment loss should be deferred until the
arbitration proceeding is concluded and the D insurance claims are resolved. Any
recovery in rates before the K does not constitute a reasonable prospect of recovery by
insurance or otherwise sufficient to require deferral of the abandonment loss deduction
under section 165. Rev. Rul. 87-117, 1987-2 C.B. 61.
FACTS – Ordinary and necessary business expenses
In addition to the facts set forth above, Taxpayer represented the following:
Taxpayer has incurred and will continue to incur a variety of expenses associated
with the decontamination, dismantlement, removal, disposal of the structures, systems
and components, and the decommissioning of A and B. The contamination being
remediated all occurred while Taxpayer owned and operated A and B. The vast
majority of the expenses will merely restore the facility to its pre-contaminated state and
will not adapt the property to a new or different use, increase its value beyond its pre-
contaminated state, or prolong its useful life.
Taxpayer is the majority owner and operator of G, but is a minority owner of L and is
the only common owner of L and G. Each nuclear generating station is separately
licensed by the NRC and the decommissioning of each unit is separately regulated by
the NRC. There is no commingling of operations or decommissioning between the two
stations. Each joint venture has the power to select its own UNICAP method.
LAW AND ANALYSIS – Ordinary and necessary business expenses
Section 162 generally allows a deduction for the ordinary and necessary expenses
paid or incurred during the taxable year in carrying on any trade or business.
In Rev. Rul. 94-38, 1994-1 C.B. 55, the Service ruled that costs incurred to clean up
land and treat groundwater that the taxpayer had contaminated with hazardous waste
from its business were deductible under § 162 and not required to be capitalized under
§ 263, except for the cost of constructing groundwater treatment facilities. The Service
explained that the appropriate test under § 263 for determining whether the
expenditures increased the value of property is to compare the status of the asset after
the expenditure is made with the status of the asset before the condition arose that
necessitated the expenditure. The environmental remediation costs did not materially
add to the value of the land, appreciably prolong its life, or adapt it to a new or different
use.
In Rev. Rul. 2004-18, 2004-1 C.B. 509, the Service clarified Rev. Rul. 94-38,
explaining that otherwise deductible amounts may be subject to inventory capitalization
under § 263A.
In Rev. Rul. 98-25, 1998-1 C.B. 998, the Service ruled that costs incurred to replace
underground storage tanks containing waste by-products, including the costs of
PLR-111988-14 7

removing, cleaning and disposing of the old tanks, and the costs of acquiring, installing
and filling the new tanks, were deductible as ordinary and necessary business
expenses under § 162.
In Rev. Rul. 2005-42, 2005-2 C.B. 67, the Service addressed five situations involving
environmental remediation costs of taxpayers that manufactured inventory and
concluded in each situation that remediation costs otherwise deductible under § 162
were nevertheless properly capitalizable as inventory costs under § 263A. In situation
4, a stove manufacturer that ceased operations at one site continued to produce stoves
at another site. The Service concluded that the taxpayer’s remediation costs at the first
site were incurred by reason of its production activities within the meaning of § 1.263A-
1(e)(3)(i) and thus were properly allocable to the inventory produced by the taxpayer at
site two.
In United Dairy Farmers, Inc. v. United States, 107 F. Supp.2d 937 (S.D. Ohio 2000)
aff’d, 267 F.3d 510 (6th Cir. 2001), the court held that ta taxpayer’s expenses for
remediation of contaminated soil must be capitalized under § 263 because the
remediation permanently enhanced the properties’ value. The taxpayer had purchased
two convenience stores, each of which, unknown to the taxpayer, contained leaking
underground storage tanks that had contaminated the soil. The deduction was rejected
because the taxpayer had purchased the stores in a contaminated condition and was
not merely restoring them to their condition at the time of purchase.
Expenses for which there is a fixed right of reimbursement are not deductible under
§ 162. Burnett v. Commissioner, 356 F.2d 755 (5th Cir. 1966).
A taxpayer has a fixed right to reimbursement where a right has matured without
further substantial contingency. Charles Baloian Co. v. Commissioner, 68 T.C. 620
(1977), nonacq., 1978-2 C.B. 3.
There must be a fixed right to reimbursement so that the taxpayer’s payment are in
the nature of an advance to or payment on behalf of another. If there is no agreement
but only a contingency that at some future the claim for reimbursement will be allowed
in whole or in part, the taxpayer is entitled to deduct its expenditure. Electric
Tachometer v. Commissioner, 37 T.C. 158 (1961), acq., 1962-2 C.B. 4; Varied
Investments, Inc. v. United States, 31 F.3d 651 (8th Cir,. 1994).
Taxpayer has represented that it has incurred and will continue to incur a variety of
expenses associated with the decontamination, dismantlement, removal, disposal of the
structures, systems and components, and the decommissioning of A and B. The
contamination being remediated all occurred while Taxpayer owned and operated A and
B. The vast majority of the expenses will merely restore the facility to its pre-
contaminated state and will not adapt the property to a new or different use, increase its
value beyond its pre-contaminated state, or prolong its useful life. It has further
represented that to the extent it incurs expenditures to purchase equipment used in the
decommissioning process or to erect temporary facilities, those costs would be
capitalized under § 263(a). Similarly, it has represented that to the extent it incurs costs
to construct an independent fuel storage installation for G nuclear waste, such costs
PLR-111988-14 8

would be capitalized under § 263(a). In light of these representations, the expenses
that merely restore the facility to its pre-contaminated state and that do not adapt the
property to a new or different use or increase its value beyond its pre-contaminated
state or prolong its useful life are deductible pursuant to § 162 and are not subject to
capitalization under § 263(a).
Taxpayer has represented that it is possible that a part of any recovery against C
may represent compensation for ordinary and necessary business expenses it incurred
following the abandonment of A and B. Taxpayer does not have a fixed right to
reimbursement from C. Taxpayer has contingent claims against C that are being
contested. This contested liability does not preclude the claiming of the § 162 expenses
in the year they are incurred. Electric Tachometer, Varied Investments, Inc. Taxpayer
has represented that any recoveries will be included in its income in accordance with §
451.
No opinion is expressed about the tax treatment of the transaction under other
provisions of the Code and regulations or about the tax treatment of any conditions
existing at the time of, or effects resulting from, the transaction that are not specifically
addressed by the above ruling. Consequently, no opinion is expressed regarding the
applicability of § 263A to the decommissioning expenses at G.
The rulings contained in this letter are based upon information and representations
submitted by Taxpayer and accompanied by a penalty of perjury statement executed by
appropriate parties. While this office has not verified any of the material submitted in
support of the request for rulings, it is subject to verification on examination.
This ruling is directed only to the taxpayers requesting it. Section 6110(k)(3) of the
Code provides that it may not be used or cited as precedent.
A copy of this letter should be attached to Taxpayer’s federal income tax return for
the taxable year in which the transaction covered by this ruling took place.
In accordance with the power of attorney, we are sending copies of this letter to
Taxpayer’s authorized representatives. We are also sending a copy of this letter to the
appropriate operating division director.

                                    Sincerely,



                                    _______________________________
                                    Thomas D. Moffitt
                                    Branch Chief, Branch 2
                                    Office of the Associate Chief Counsel
                                    (Income Tax & Accounting)