Condemned utility assets' deferred tax reserves had to be removed

Plain-English summary

A city condemned the regulated utility assets of two subsidiaries, and the taxpayer deferred gain under section 1033 by investing the proceeds in replacement utility property. After the condemnation, the two subsidiaries became nonoperating, held no public utility property, served no customers, and were no longer subject to rate-of-return regulation. A ratemaking dispute arose over whether accumulated deferred income taxes tied to the condemned assets could remain on the former utilities' books or be carried to other regulated utilities and deducted from their rate base. The IRS treated the condemnation as the functional equivalent of retiring the property and concluded that the normalization consistency rule required removing the associated deferred tax reserves. Section 168's carryover rule did not preserve the reserves because a section 1033 transaction produces substituted basis rather than a listed carryover-basis transfer. The IRS ruled that failing to eliminate the deferred taxes would violate the normalization rules and that the other regulated utilities could not record the old reserves.

Ruling snapshot

• Question: Must deferred tax reserves associated with condemned utility assets be eliminated rather than carried to replacement assets or other regulated utilities?
• Outcome: Yes, the reserves had to be removed to comply with the normalization rules
• Key authorities: IRC §§ 167, 168(i)(7), 168(i)(9), 168(i)(10), 1033; Treas. Reg. §§ 1.167(l)-1(h), 1.168(i)-8

Full text (IRS public release)

 Internal Revenue Service                                       Department of the Treasury
                                                                Washington, DC 20224

 Number: 202350001                                              Third Party Communication:
 Release Date: 12/15/2023                                       Date of Communication: Not Applicable
 Index Number: 168.24-01, 1033.01-00
                                                                Person To Contact:
 --------------------------                                     -----------------------, ID No. ------------
 ------------------------------                                 Telephone Number:
 ----------------------------------------------                 -------------------
 -------------------------------------                          Refer Reply To:
 --------------------------                                     CC:PSI:B6
 ---------------------------                                    PLR-101888-23
                                                                Date:
 In Re: Request for rulings under section                       09/19/23
 168(l)(9) regarding the proper treatment of
 accumulated deferred income taxes ("ADIT")
 under the depreciation normalization
 provisions of the Internal Revenue Code




LEGEND:

Taxpayer                   =        ----------------------------------------
-------------------------
Subsidiary A               =         --------------------------
-----------------------------------------------------------

Subsidiary B                =       -----------------------------------------
-------------------------
Subsidiary C                =       ------------------------------------------
-------------------------
Subsidiary D                =       --------------------------------------------------
-------------------------
Regulated Utility A         =       -----------------------------------------------------------------
                                    ---------------------------
Regulated Utility B =               ---------------------------------------------------------------
                                    ---------------------------
Regulated Utility C =               ---------------------------------------------------------------------------------
------------
PLR-101888-23                                   2

Regulated Utility D =     -------------------------------------------------------------
                          ---------------------------
Regulated Utility E =      -------------------------------------------------------------
                          ------------------------

Regulated Utility F =      ------------------------------------------------------------
                          ------------------------

Regulated Utility G =      --------------------------------------------------------------------
                          ------------------------

Regulated Utility H =      ---------------------------------------------------------------------
                          ------------------------

Regulated Utility I   =    ---------------------------------------------------------------
                          ------------------------

Regulated Utility J =      ----------------------------------------------------------------
                          ------------------------

Regulated Utility K =      -------------------------------------------------------------------
                          ------------------------

City                  =   ------------------------

State                 =   ----------

Year 1                =   -------

Resource A            =   -------

Resource B            =   ---------------

Resource C            =   -------------------

Resource D            =   --------

Management            =   ------------------------------

Commission A          =   ---------------------------------------------

Organization          =   -----------------------------------------------

Decision              =   ----------------------------
PLR-101888-23                                            3

System                    =        ----------------------------------------

Association               =        ---------------------------------------------------------------------------------
                          ------------------------------------------------------------------------------------------
                          -------------------

Court                     =        -------------------------------------------

a                         =        ---

b                         =        ---------

c                         =        -------------

d                         =        -------------

e                         =        -----

f                         =        -----


Dear -----------------:

      This letter responds to a request for a private letter ruling dated November 23,
2022, submitted on behalf of Taxpayer, Subsidiary A, Subsidiary B, Subsidiary C, and
Subsidiary D, regarding the proper treatment of accumulated deferred income taxes
(“ADIT”) under § 168(i)(9) of the Code following the condemnation of Subsidiary C’s and
Subsidiary D’s utility assets by City in Year 1 (the "Condemnation").

                                                    FACTS

        Taxpayer represents that the facts are as follows:

       Taxpayer is a Resource A management company that owns, operates, and
manages Resource A, Resource B, and Resource C facilities through its a utility
operating subsidiaries, serving approximately b active service connections in State.
Subsidiary A is a wholly-owned utility holding company subsidiary of Taxpayer.
Subsidiary B is a wholly-owned utility holding company subsidiary of Subsidiary A.
Subsidiary C is a wholly-owned subsidiary of Subsidiary B. Prior to the Condemnation,
Subsidiary C was a regulated Resource A and Resource B public utility serving
residents of City. Following the Condemnation, and currently, Subsidiary C is a non-
operating entity. Subsidiary D also is a wholly-owned subsidiary of Subsidiary B.
Subsidiary D was a regulated Resource A utility serving residents of the greater City
area. Prior to the Condemnation, its assets were transferred to Subsidiary C; it was
PLR-101888-23                                4

included in the Condemnation at the request of the City. Following the Condemnation,
Subsidiary D remains a non-operating entity.

        As members of the Taxpayer affiliated group, Subsidiaries C and D join in the
filing of a consolidated return with other Taxpayer operating companies. Prior to, and at
the time of the Condemnation, Subsidiary C was subject to the ratemaking jurisdiction of
Commission A, as was Subsidiary D prior to the transfer of its assets to Subsidiary C.
Following the Condemnation, however, neither Subsidiary C nor Subsidiary D had any
remaining public utility property subject to cost of service/rate of return ratemaking.
Taxpayer owns and operates other Resource A and Resource B public utilities that are
subject to the jurisdiction of Commission A ("State Regulated Utilities").

       The most recent rate case before Commission A involved the following
Regulated Utilities: Regulated Utility A, Regulated Utility B, Regulated Utility C,
Regulated Utility D, Regulated Utility E, Regulated Utility F, Regulated Utility G,
Regulated Utility H, Regulated Utility I, Regulated Utility J, and Regulated Utility K. All
of these State Regulated Utilities are wholly-owned by Taxpayer or a subsidiary holding
company of Taxpayer. All of the State Regulated Utilities participate in the consolidated
federal income tax return of Taxpayer. For purposes of maintaining their accounting
records and for State ratemaking purposes, the State Regulated Utilities are treated as
separate entities. For ratemaking purposes, income taxes are calculated on a stand-
alone basis.

       Taxpayer and each of its subsidiaries are accrual basis taxpayers. Taxpayer is
the common parent of an affiliated group of corporations filing a consolidated return on
a calendar-year basis. Taxpayer, as the common parent of the affiliated group, serves
as the agent of Subsidiary C and Subsidiary D and of the State Regulated Utilities for
purposes of this private letter ruling request pursuant to § 1.1502-77(a) of the Income
Tax Regulations.

        “Staff” refers to the employees of Commission A who participated in the rate
proceeding culminating in the rate order at issue in this private letter ruling request.
“Organization” refers to the organization established by the State Legislature to
represent the interests of residential utility ratepayers in rate-related proceedings
involving public service corporations before Commission A. “Decision” refers to
Commission A decision addressing the issue presented herein and directing Taxpayer
to seek this private letter ruling request. System is the System prescribed by the
Association for Resource A and Resource D.
        Taxpayer invested condemnation proceeds from the Subsidiary D condemnation
into the utility plant assets of the State Regulated Utilities and recorded ADIT on the
books of the State Regulated Utilities. The State Regulated Utilities are required to
follow the System prescribed by Association. All amounts of ADIT recorded on the
books of the State Regulated Utilities were recorded pursuant to their obligation to apply
the accounting set forth in the Association System.
PLR-101888-23                                             5

        Other than Regulated Utility I, Regulated Utility F, and Regulated Utility C, the
balance of companies are utilities where the revenue requirement in the rate cases
listed above is determined by using a cost of service/rate of return basis. An income tax
allowance is provided for the utilities using standard ratemaking methods employed by
the Commission A and ADIT is subtracted (or added) to rate base. The State
Regulated Utilities and specifically Regulated Utility J and Regulated Utility A record an
ADIT Liability for method and life differences between the amounts of accelerated
federal income tax depreciation that they would claim on a stand-alone basis and book
depreciation. The ADIT liability for those method/life depreciation differences is
recorded in accounts e/f. Their recording of those ADIT liability amounts on their books
is in accordance with the System prescribed by Association, which they are required to
follow. The System does not provide guidance on the treatment of ADIT upon the
condemnation of assets previously included in rate base.

       Thus, the issue of the amount of ADIT that is reflected in rate base primarily
affects two utilities, Regulated Utility J and Regulated Utility A. The other utilities in the
above-noted rate cases have their revenue requirement determined by a different
method, such as their operating margin, where the rate base does not have an impact
on each of those utility's revenue requirement.

Background of the Condemnation of Subsidiary C and Subsidiary D Assets

        In Year 1, City condemned public utility property of Subsidiary C and Subsidiary
D and, pursuant to an order of the Court, the City paid Taxpayer approximately c as
"just compensation" for the condemned assets. Taxpayer used the condemnation
proceeds to, inter alia, acquire additional new Resource A and Resource B uses, and to
construct or improve other Resource A and Resource B-related facilities. Taxpayer
realized an approximately $d pre-tax gain upon receipt of the condemnation proceeds,
and it properly elected to defer the recognition of the gain attributable to public utility
property under § 1033(a)(2). Following the Condemnation, neither Subsidiary D,
Subsidiary C, nor any other Taxpayer Resource A subsidiary, had any continuing
relationship with the former Subsidiary C customers who become customers of City.
Similarly, none of the former customers of Subsidiary D or Subsidiary C became
customers of any other Taxpayer Resource A subsidiary absent their relocation to the
service territory of another Taxpayer operating subsidiary. Finally, neither the
condemned assets nor the cost to operate such assets, including depreciation, were
included in the rate case filings of any Taxpayer Resource A subsidiary following the
Condemnation. In summary, all the assets and the customer relationships were
transferred from Subsidiary D and Subsidiary C to City upon the Condemnation.

         Taxpayer ----------------------------------------------------------------------------------------------
---------------------------------------------------------------------------------------------------------------------
---------------------------------------------------------------------------------------------------------------------
---------------------------------------------------------------------------------------------------------------------
------------------------------------------------------------------------------------------ --------------------------
PLR-101888-23                                             6

-------------------------------------------------------------------------------------------------------------------.
In addition, Taxpayer reduced the basis of the replacement assets by the amount of
deferred gain in accordance with § 1033(b). Following the Condemnation, Subsidiary D
and Subsidiary C became non-operating utilities, owned no operational assets or any
public utility property, served no customers within those utilities, and were no longer rate
regulated by Commission A.

        Staff and Taxpayer agreed that Taxpayer, as the common parent of the affiliated
group, was entitled to the proceeds of the Condemnation. Taxpayer represents that
Taxpayer, not Taxpayer group's operating Resource A companies or their customers,
would bear the cost of any tax ultimately triggered upon a disposition of the replacement
assets. Thus, Taxpayer received the tax benefit of the deferral. Section 1.1502-6
provides that members of a consolidated group have joint and several liability for the
federal income taxes. Taxpayer represents, however, that as the common parent of the
consolidated group, Taxpayer will be responsible for the tax liability, and will bear the
entire liability for the tax on the deferred gain when it is recognized.

         Amongst the issues presented in Taxpayer’s most recent general rate case for its
Resource A and Resource B subsidiaries was whether the ADIT on the regulatory
books of Subsidiary C and Subsidiary D at the time of the Condemnation must be
retired, along with the deemed retirement of the condemned assets or whether the ADIT
can carry over to the replacement assets acquired with the condemnation proceeds.
Among the other issues presented in Taxpayer’s most recent general rate case for its
State Regulated Utilities is whether the ADIT that was recorded on the books of each of
the State Regulated Utilities pursuant to instructions in the Association System can be
deducted from utility rate base. This issue specifically focuses on the ADIT liability
amounts that the State Regulated Utilities recorded on their books in accounts e/f
related to the State Regulated Utilities claiming accelerated federal income tax
depreciation on the amounts of utility plant in service that is included in their respective
rate base, and recording the differences between their book and tax depreciation as
liability amounts of ADIT under the System.

        The method and life differences between book and tax depreciation are recorded
in accounts e/f as ADIT liabilities, recognizing the amounts of income taxes that are
being deferred due to the tax deductions for depreciation being based on an
accelerated method (known as "method" differences) and using shorter depreciable
lives (known as "life" differences) versus book depreciation.

       It is not disputed that a tax deferral has occurred and is continuing. Also, it is not
disputed that for accounting purposes, the State Regulated Utilities recorded the impact
of the deferral on the utility's books in the ADIT liability account.

       In its Decision, Commission A ordered Taxpayer to seek a private letter ruling to
resolve the specific question whether the failure to eliminate the deferred taxes
PLR-101888-23                                   7

attributable to assets condemned in a transaction governed by § 1033 would violate the
normalization provisions of § 168(i)(9).

       In this rate case, Taxpayer maintained that, for federal income tax purposes, the
Condemnation was a "retirement" of the Subsidiary C and Subsidiary D assets and that,
as such, the ADIT attributable to those assets must be eliminated under § 1.167(I)-
1(h)(2) and cannot be used by any other regulated public utility in the Taxpayer network
as a reduction to rate base or as a form of zero-cost capital. Moreover, Taxpayer
maintained that under various portions of the regulations under §§ 1.168(i)-8 and
1.167(a)-8, condemnations are simply another form of retirement, representing the
permanent withdrawal of depreciable public utility property from Subsidiary C’s and
Subsidiary D’s regulated trade or business. Taxpayer notes that following the
Condemnation, Subsidiary C and Subsidiary D became non-operating entities, no
longer rate regulated by Commission A.

         The State Regulated Utilities have recorded ADIT on their books pursuant to the
instructions in the Association System, which state that ADIT generally can be deducted
from utility rate base. This issue specifically focuses on the ADIT liability amounts that
the State Regulated Utilities recorded on their books in accounts e/f related to the State
Regulated Utilities claiming accelerated federal income tax depreciation on the amounts
of utility plant in service that is included in their respective rate base as of the time of the
Condemnation, and recording the differences between their book and tax depreciation
as liability amounts of ADIT under the System. The method and life differences
between book and tax depreciation are recorded in accounts e/f as ADIT liabilities,
recognizing the amounts of income taxes that are being deferred due to the tax
deductions for depreciation being based on an accelerated method (known as "method"
differences) and using shorter depreciable lives (known as "life" differences) versus
book depreciation.

        It is normal in utility rate proceedings for the regulatory commission to be able to
rely upon the utilities that it regulates following the Association System. These State
Regulated Utilities are required to follow the Association System for their accounting.
Pursuant to their following the Association System accounting for ADIT on their books,
the State Regulated Utilities have recorded ADIT liability amounts related to the
method/life differences between their book and tax depreciation. The ADIT liability
amounts that have been recorded by the State Regulated Utilities would be reflected as
deductions from utility rate base under normal circumstances. In Commission A Staff's
view, the pertinent question is whether the source of funds for the investment by
Taxpayer in the utility plant of the State Regulated Utilities would prohibit Commission A
for ratemaking purposes from relying upon the recorded ADIT liability amounts that the
State Regulated Utilities have recorded on their books pursuant to the requirements of
the Association System. Taxpayer represents that a tax deferral has occurred and is
continuing, for accounting purposes, the State Regulated Utilities recorded the impact of
the deferral on the utility's books in the ADIT liability account, and the federal Income
tax normalization rules do not prohibit adjustments related to book/tax basis differences.
PLR-101888-23                                  8


                                  RULING REQUESTED

      The failure to eliminate the deferred taxes, including ADIT and the deferred tax
reserves on the regulated books of Subsidiary C and Subsidiary D as of the date of the
Condemnation, attributable to public utility property condemned in a transaction
governed by § 1033 would violate the normalization provisions of § 168(i)(9).

                                   LAW AND ANALYSIS

       Section 168(f)(2) provides that the depreciation deduction determined under
§ 168 shall not apply to any public utility property (within the meaning of § 168(i)(10)) if
the taxpayer does not use a normalization method of accounting.

       Section 168(i)(10) defines, in part, public utility property as property used
predominantly in the trade or business of the furnishing or sale of electrical energy,
water, or sewage disposal services, if the rates for such furnishing or sale, as the case
may be, have been established or approved by a State or political subdivision thereof.

        Prior to the Revenue Reconciliation Act of 1990, the definition of public utility
property was contained in § 167(l)(3)(A) and § 168(i)(10), which defined public utility
property by means of a cross reference to § 167(l)(3)(A). The definition of public utility
property is unchanged. Section 1.167(l)-1(b) provides that under § 167(l)(3)(A),
property is public utility property during any period in which it is used predominantly in a
§ 167(l) public utility activity. The term “section 167(l) public utility activity” means, in
part, the trade or business of the furnishing or sale of electrical energy, water, or
sewage disposal services, if the rates for such furnishing or sale, as the case may be,
are regulated, i.e., have been established or approved by a regulatory body described in
§ 167(l)(3)(A). The term “regulatory body described in § 167(l)(3)(A)” means a State
(including the District of Columbia) or political subdivision thereof, any agency or
instrumentality of the United States or a public service or public utility commission or
other body of any State or political subdivision thereof similar to such a commission.
The term “established or approved” includes the filing of a schedule of rates with a
regulatory body which has the power to approve such rates, though such body has
taken no action on the filed schedule or generally leaves undisturbed rates filed by the
taxpayer.

        The definitions of public utility property contained in § 168(i)(10) and former
§ 46(f)(5) are essentially identical. Section 1.167(l)-1(b) restates the statutory definition
providing that property will be considered public utility property if it is used
predominantly in a public utility activity and the rates are regulated. Section 1.167(l)-
1(b)(1) provides that rates are regulated for such purposes if they are established or
approved by a regulatory body. The terms established or approved are further defined
to include the filing of a schedule of rates with the regulatory body that has the power to
PLR-101888-23                                 9

approve such rates, even if the regulatory body has taken no action on the filed
schedule or generally leaves undisturbed rates filed.

        The regulations under former § 46, specifically § 1.46-3(g)(2), expand the
definition of regulated rates. The expanded definition embodies the notion of rates
established or approved on a rate of return basis. This notion is not specifically
provided for in the regulations under former § 167. Nevertheless, there is an expressed
reference to rate of return in § 1.167(l)-1(h)(6)(i). The operative rules for normalizing
timing differences relating to use of different methods and periods of depreciation are
only logical in the context of rate of return regulation. The normalization method, which
must be used for public utility property to be eligible for the depreciation allowance
available under § 168, is defined in terms of the method the taxpayer uses in computing
its tax expense for purposes of establishing its cost of service for ratemaking purposes
and reflecting operating results in its regulated books of account. Thus, for purposes of
applying the normalization rules, the definition of public utility property is the same for
purposes of the investment tax credit and depreciation.

       In order to use a normalization method of accounting, § 168(i)(9)(A)(i) requires a
taxpayer, in computing its tax expense for establishing its cost of service for ratemaking
purposes and reflecting operating results in its regulated books of account, to use a
method of depreciation for property that is the same as, and a depreciation period for
such property that is not shorter than, the method and period used to compute its
depreciation expense for such purposes. Under § 168(i)(9)(A)(ii), if the amount
allowable as a deduction under § 168 differs from the amount that would be allowable
as a deduction under § 167 using the method, period, first and last year convention, and
salvage value used to compute regulated tax expense under § 168(i)(9)(A)(i), then the
taxpayer must make adjustments to a reserve to reflect the deferral of taxes resulting
from such difference.

        Section 168(i)(9)(B)(i) provides that one way the requirements of § 168(i)(9)(A)
will not be satisfied is if the taxpayer, for ratemaking purposes, uses a procedure or
adjustment which is inconsistent with such requirements. Under § 168(i)(9)(B)(ii), such
inconsistent procedures and adjustments include the use of an estimate or projection of
the taxpayer's tax expense, depreciation expense, or reserve for deferred taxes under
§ 168(i)(9)(A)(ii), unless such estimate or projection is also used, for ratemaking
purposes, with respect to all three of these items and with respect to the rate base
(hereinafter referred to as the “Consistency Rule”).

       Former § 167(l) generally provided that public utilities were entitled to use
accelerated methods for depreciation if they used a “normalization method of
accounting.” A normalization method of accounting was defined in former § 167(l)(3)(G)
in a manner consistent with the definition in § 168(i)(9)(A). Section 1.167(l)-1(a)(1)
provides that the normalization requirements for public utility property pertain only to the
deferral of federal income tax liability resulting from the use of an accelerated method of
depreciation for computing the allowance for depreciation under § 167 and the use of
PLR-101888-23                                  10

straight-line depreciation for computing tax expense and depreciation expense for
purposes of establishing cost of services and for reflecting operating results in regulated
books of account. These regulations do not pertain to other book-tax timing differences
with respect to state income taxes, F.I.C.A. taxes, construction costs, or any other taxes
and items.

        Section 1.167(l)-1(h)(1)(i) provides that the reserve established for public utility
property should reflect the total amount of the deferral of federal income tax liability
resulting from the taxpayer's use of different depreciation methods for tax and
ratemaking purposes.

         Section 1.167(l)-1(h)(1)(iii) provides that the amount of federal income tax liability
deferred as a result of the use of different depreciation methods for tax and ratemaking
purposes is the excess (computed without regard to credits) of the amount the tax
liability would have been had the depreciation method for ratemaking purposes been
used over the amount of the actual tax liability. This amount shall be taken into account
for the taxable year in which the different methods of depreciation are used.

       Section 1.167(l)-1(h)(2)(i) provides that the taxpayer must credit this amount of
deferred taxes to a reserve for deferred taxes, a depreciation reserve, or other reserve
account. This regulation further provides that the aggregate amount allocable to
deferred taxes may be reduced to reflect the amount for any taxable year by which
federal income taxes are greater by reason of the prior use of different methods of
depreciation under section 1.167(1)-1(h)(1)(i) or to reflect asset retirements or the
expiration of the period for depreciation used for determining the allowance for
depreciation under section 167(a).

        Section 1.167(l)-1(h)(6)(i) provides that, notwithstanding the provisions of
subparagraph (1) of that paragraph, a taxpayer does not use a normalization method of
regulated accounting if, for ratemaking purposes, the amount of the reserve for deferred
taxes under § 167(l) which is excluded from the base to which the taxpayer's rate of
return is applied, or which is treated as no-cost capital in those rate cases in which the
rate of return is based upon the cost of capital, exceeds the amount of such reserve for
deferred taxes for the period used in determining the taxpayer's expense in computing
cost of service in such ratemaking.

       Section 1.167(l)-1(h)(6)(ii) provides that for the purpose of determining the
maximum amount of the reserve to be excluded from the rate base (or to be included as
no-cost capital) under § 1.167(l)-1(h)(6)(i), if solely an historical test period is used to
determine depreciation for federal income tax expense for ratemaking purposes, then
the amount of the reserve account for the period is the amount of the reserve
(determined under § 1.167(l)-1(h)(2)) at the end of the historical period. Section
1.167(l)-1(h)(6)(ii) provides that if solely a future period is used for such determination,
the amount of the reserve account for the period is the amount of the reserve at the
PLR-101888-23                                   11

beginning of the period and a pro rata portion of the amount of any projected increase to
be credited or decrease to be charged to the account during such period.

        Section 1.167(l)-1(h)(6)(ii) provides if, in determining depreciation for ratemaking
tax expense, the test period used is part historical and part future, then the amount of
the reserve account for this period is the amount of the reserve at the end of the
historical portion of the period and a pro rata amount of any projected increase to be
credited to the account during the future portion of the period. The pro rata amount of
any increase during the future portion of the period is determined by multiplying the
increase by a fraction, the numerator of which is the number of days remaining in the
period at the time the increase is to accrue, and the denominator of which is the total
number of days in the future portion of the period.

       Section 1.168-6(a) provides, in part, that the section includes the rules for
determining the depreciation allowance for MACRS property acquired in a like-kind
exchange or an involuntary conversion, including a like-kind exchange or an involuntary
conversion of MACRS property that is exchanged or replaced with other MACRS
property in a transaction between members of the same affiliated group. Section
1.168(i)-6(a) generally provides identical rules for determining the depreciation
allowance for MACRS property acquired in a like-kind exchange or an involuntary
conversion.

       Section 1.168(i)-8(b)(2) provides that, for purposes of § 1.168(i)-8, a disposition
occurs when ownership of the asset is transferred or when the asset is permanently
withdrawn from use either in the taxpayer's trade or business or in the production of
income. A disposition includes the sale, exchange, retirement, physical abandonment,
or destruction of an asset.

        Section 1.168(i)-8(c)(1) provides that the manner of disposition (for example,
normal retirement, abnormal retirement, ordinary retirement, or extraordinary retirement)
is not taken into account in determining whether a disposition occurs or gain or loss is
recognized.

       Section 1.168(i)-8(h)(1) provides that depreciation ends for an asset at the time
of the asset's disposition, as determined under the applicable convention for the asset.

       Section 1033 provides the rules for involuntary conversions. Section 1033(a)(1)
provides that if property (as a result of its destruction in whole or in part, theft, seizure,
or requisition or condemnation or threat or imminence thereof) is compulsorily or
involuntarily converted into property similar or related in service or use to the property
so converted, no gain shall be recognized. Section 1033(a)(2)(A) provides that if
property (as a result of its destruction in whole or in part, theft, seizure, or requisition or
condemnation or threat or imminence thereof) is compulsorily or involuntarily converted
into money or into property not similar or related in service or use to the converted
property, the gain (if any) shall be recognized except to the extent provided in
PLR-101888-23                                 12

§ 1033(a)(2)(A). Thus, § 1033 allows for deferral of gain where property is compulsorily
or involuntarily converted into property similar or related in service or use to the
converted property.

        The key factors in determining whether property is public utility property are that
1) the property must be used predominantly in the trade or business of the furnishing or
sale of, inter alia, Resource A and Resource B; 2) the rates for such furnishing or sale
must be established or approved by a State or political subdivision thereof, any agency
or instrumentality of the United States, or by a public service or public utility commission
or similar body of any State or political subdivision thereof; and 3) the rates so
established or approved must be determined on a rate-of-return basis. Based on the
facts and representations submitted by Taxpayer, following the Condemnation,
Subsidiary C and Subsidiary D became non-operating entities, and were no longer rate-
regulated by Commission A. Therefore, other assets of Subsidiary C and Subsidiary
were no longer public utility property.

       Additionally, the removal of public utility property from the rate base necessitated
the removal of the associated ADIT under the Consistency Rule of § 168(i)(9)(B). That
rule requires that any estimate or projection used to determine a taxpayer's tax
expense, depreciation expense, rate base or the reserve for deferred taxes under
§ 168(i)(9)(A)(ii) must also be used for the other normalization elements for ratemaking
purposes.

       Under § 168(i)(7), various "carryover basis" transactions allow for the transfer of
ADIT and the associated deferred tax reserve accompanying the transferred property to
carry over in the hands of the transferee. However, transactions such as those
governed by § 1033 involving substituted basis are not included in this provision.
Similarly, the regulations under § 46 provide that in the case of regulated public utility
property which becomes deregulated, the property is removed from the rate base and
the ADIT attributable to an unamortized investment tax credit related to the deregulated
property must be removed.

       The ADIT at issue was created by the deferral of federal taxes attributable to
Taxpayer's claiming accelerated depreciation with respect to the condemned property
as required by § 1.167(I)-1(h)(2). The disposition of the condemned property in the
Condemnation is the functional equivalent of a retirement of such property in the hands
of Subsidiary C and Subsidiary D. Following the Condemnation, both Subsidiary C and
Subsidiary D became non-operating entities, ceased to hold any "public utility property,"
and were no longer subject to the cost of service/rate of return ratemaking jurisdiction of
Commission A. Sections 1.167(a)-8(a), 1.168(i)-8(b)(2)) and 1. 167(I)-1(h)(2) provide
that the accumulated ADIT balance must be adjusted to reflect dispositions such as the
Condemnation. Accordingly, since all of Subsidiary C’s assets and Subsidiary D’s
assets were disposed of in the Condemnation, the entire ADIT balance attributable
thereto must be removed as well and may not be transferred to the new owners of the
condemned property. Therefore, Subsidiary C and Subsidiary D correctly removed from
PLR-101888-23                                    13

its regulated books of account the entire ADFIT reserve balance associated with the
Subsidiary C and Subsidiary D Assets that were Condemned. State Regulated Utilities
may not record on their regulated books of account any of the ADFIT associated with
the pre-Condemnation properties.

                                          RULING

      The failure to eliminate the deferred taxes, including ADIT and the deferred tax
reserves on the regulated books of Subsidiary C and Subsidiary D as of the date of the
Condemnation, attributable to public utility property condemned in a transaction
governed by § 1033 would violate the normalization provisions of § 168(i)(9).

       Except as specifically set forth above, no opinion is expressed or implied
concerning the federal income tax consequences of the above-described facts under
any other provision of the Code or regulations.

      This ruling is directed only to the taxpayer requesting it. Section 6110(k)(3) of
the Code provides that it may not be used or cited as precedent.

        This ruling is based upon information and representations submitted by Taxpayer
and accompanied by a penalty of perjury statement executed by an appropriate party.
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.

         In accordance with the power of attorney on file with this office, a copy of this
letter is being sent to your authorized representatives.

      This letter is being issued electronically in accordance with Rev. Proc. 2020-29,
2020-21 I.R.B. 859. A paper copy will not be mailed to Taxpayer.

                                        Sincerely,

                                           /S/

                                        David A. Selig
                                        Senior Counsel, Branch 6
                                        Office of the Associate Chief Counsel
                                        (Passthroughs and Special Industries)


Enclosure: Copy for § 6110 purposes


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