Nuclear abandonment loss allowed
An abandonment loss can be claimed on a cancelled nuclear power plant, even though the utility plans to pursue recovery of its costs through a rate increase.
Section 165 of the US tax code allows any loss sustained during the year to be deducted as long as it is “not compensated for by insurance or otherwise.” Determining the year the loss occurs can sometimes be challenging. There must be an identifiable event that confirms a project has been permanently abandoned.
A utility owned an undivided interest in a nuclear power project. The project was 11 years in the making. It was beset by large cost overruns. The construction contractor went bankrupt and was likely to disavow the contract in bankruptcy, depriving the owners of the benefit of the fixed-price terms and delay penalties. Construction delays meant that the project was no longer expected to be completed in time to qualify for production tax credits the US government offers as an inducement to build new nuclear power plants.
The other owners of the plant unilaterally decided to suspend construction. The utility then announced publicly that it was cancelling the project. There was significant media coverage of the announcement.
A partly built nuclear power plant cannot simply be boarded up. Construction is heavily regulated. So is dismantling the work.
The utility informed the public utility commission, withdrew an application for a loan guarantee from the US Department of Energy, stopped work, began demobilizing the construction crews, adopted a board resolution permanently abandoning the project, cancelled its builder’s risk insurance and took a series of other steps in year 11 to cancel the project.
The IRS told the utility in a private letter ruling that that it could take an abandonment loss in year 11, notwithstanding that unwinding everything would take time.
It said the fact that the utility was seeking reimbursement for its costs through a rate increase does not mean the utility will be compensated for the loss “through insurance or otherwise.” The rates are not direct compensation for the loss. Rather, the public utility commission takes into account many factors in deciding how best to ensure the utility will be able to maintain its financial integrity and be able to earn a fair charge for its services. Amounts the utility collects through rates must be reported as taxable income. An insurance recovery would just reduce the utility’s basis in the abandoned plant.
The ruling is Private Letter Ruling 201910001.