An abandonment loss can be claimed on a power plant that was shut down, but not until an arbitration against the manufacturer and pending insurance claims have been resolved.
The IRS explained why in a private letter ruling in December. The ruling is Private Letter Ruling 201451014.
An electric utility owns interests in two large pressurized-water nuclear power plants. Two new steam generators were installed in each of the plants, but a steam leak developed in a heat transfer tube in one of the new generators. This led to discovery of excessive wear and tear in both plants after an inspection of all four steam generators and eventually caused the utility to decide to shut down both power plants permanently. The utility made a public announcement that it was retiring both plants and told the US Nuclear Regulatory Commission that the decommissioning process will take several decades. It laid off a substantial number of employees, got a reduction in its state property tax base to reflect the impairment, and wrote off its remaining investment in the plants on its books.
The utility then commenced an arbitration against the manufacturer of the defective steam generators and sent a notice of potential claims to its insurer. There are also ongoing proceedings before the state public utility commission to determine how the utility’s unrecovered investment should be addressed in the rates it charges customers.
Section 165 of the US tax code allows a company abandoning assets to claim an abandonment loss to the extent the loss is “not compensated by insurance or otherwise.” The taxpayer must intend irrevocably to discard an asset so that the asset will never be used again. However, no part of the loss can be claimed as long as there is a reasonable prospect of a recovery.
The IRS said in the ruling: “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, [then] the deduction should be deferred until the conclusion of the lawsuit.”
In this case, the IRS said the tax deduction should be deferred until the arbitration and insurance claims have been resolved. However, it saw no need to wait for the rate proceedings before the public utility commission since any increase in rates to compensate the utility will not cause the utility to be considered to have been “compensated for by insurance or otherwise.”
The IRS also told the utility it can deduct the amounts it spends on decommissioning without waiting. Such spending is deductible under section 162 of the US tax code as an ordinary and necessary business expense. The possibility that the utility might recover some of these costs in the arbitration does not bar it from deducting amounts spent on decommissioning now. Any future recoveries for decommissioning costs should be reported as income.
Keith Martin in Washington