Plainfield-Union Water Co. v. Comm'r of Internal Revenue, Docket No. 89513.

• Decision Date: 05 November 1962
• Docket Number: Docket No. 89513.
• Citation: 39 T.C. 333
• Parties: PLAINFIELD-UNION WATER COMPANY, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.
• Court: U.S. Tax Court

39 T.C. 333

PLAINFIELD-UNION WATER COMPANY, PETITIONER,

v.COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.

Docket No. 89513.

Tax Court of the United States.

Filed November 5, 1962.

Martin D. Ginsburg, Esq., for the petitioner.

Gerald N. Daffner, Esq., for the respondent,

Petitioner, a privately owned water company, had tar-painted cast-iron water pipes through which it supplied well water prior to 1950, at which time it connected its system to an adjacent system which used aggressive (acidic) river water. This river water caused tuberculation in petitioner's pipe nearest the connection, and petitioner eventually put cement lining in that part of its pipes. Held, cleaning out this pipe and lining it with cement is a currently deductible repair.

FORRESTER, Judge:

Respondent has determined a deficiency of $16,471.61¹ in petitioner's income tax for the calendar year 1957. The only issue remaining before us is whether a certain expenditure made for cleaning and lining of pipe is a deductible repair or a capital expenditure.²

FINDINGS OF FACT.

Some of the facts have been stipulated and are so found.

Petitioner, a New Jersey corporation incorporated in 1906, is a public utility engaged in the business of supplying water and, in connection therewith, maintaining a system of water mains and pipes used in conducting such supply of water to users in various towns in New Jersey. It filed its income tax return for the calendar year 1957 on an accrual basis with the district director of internal revenue at Newark, New Jersey.

Pipe was first installed in the Plainfield-Union water system in 1890. In 1910, petitioner installed 9,390 feet of 16-inch cast-iron pipe three-fourths of an inch in thickness (hereinafter sometimes referred to as the ‘Maple Avenue main’) at a cost of $18,804.54. At the time of the original installation of this pipe, it was painted internally with tar. Cement-lined pipe was not available in 1910. By December 31, 1957, petitioner had in its water supply system 2,825,624 feet of cast-iron pipe ranging in diameter from 2 to 24 inches, including 118,738 feet of 16-inch cast-iron pipe.

Petitioner has utilized the double declining balance method for depreciation purposes for all depreciable assets acquired after December 31, 1953. All of the assets in question are included in a single account. The composite rate of depreciation applicable is 3.5 percent.

Prior to utilization of the double declining balance method, petitioner had taken deductions on the straight line method at various composite rates. Until the close of the taxable year ending December 31, 1928, petitioner used various rates in the neighborhood of 2 percent. From January 1, 1929, through December 31, 1939, petitioner's composite rate was 2 1/4 percent. Since January 1, 1940, petitioner has utilized a composite rate of 1.75 percent for all depreciable assets acquired prior to December 31, 1953.

At the time of installation in 1910, the Maple Avenue main was assigned a useful life of 100 years. For Federal income tax purposes, this pipe had not been fully depreciated as of the end of the taxable year 1957.

Prior to 1950, petitioner used well water exclusively. In 1950, petitioner tied the Maple Avenue main into the Elizabethtown water system and thereby provided itself with an additional source of water. The Elizabethtown water herein relevant is filtered river water, which is substantially more ‘aggressive’ (acidic) than the well water which otherwise comprised petitioner's system. Tuberculation results from the attack by an aggressive water upon the metal of a pipe beneath the tar or asphalt lining. This attack often occurs at points where the lining does not completely cover the metal. The aggressive water and metal produce an iron oxide which gradually pushes up the tar or asphalt coating, resulting in what is known as tuberculation. The result of tuberculation is that the carrying capacity of the pipe is often reduced, the maximum reduction usually being 50 percent. Red water and tuberculation frequently, but not always, occur together. Red water is often caused by a high velocity in the pipeline which carries some of the iron oxide deposits along the transmission main to the consumer.

The Elizabethtown system and petitioner were tied in at one end of the Maple Avenue main. At the other end there were two lines— the first comprised a 6,038-foot line of 16-inch tar-lined cast-iron pipe, installed in 1937, and the second consisted of a 16-inch cast-iron main running under Woodland Avenue. The connection between the Maple Avenue main and the latter line was closed, except for approximately 2 weeks, at all times material. Therefore no Elizabethtown water usually ran through it. The line under Woodland Avenue was not cement lined and had been installed by 1910. There had never been a drop in the carrying capacity of that line.

After passing through the Maple Avenue main and the 6,038-foot line, the Elizabethtown water continued into a 24-inch cement-lined Raritan Road main. The Raritan Road main, which was installed subsequent to 1950, was cement lined at installation. Petitioner has been buying solely cement-lined pipe since approximately 1954. By the time the Elizabethtown water reached the end of the Raritan main, it had mixed with well water and was comparatively diluted and nonaggressive.

Petitioner did not have any tuberculation prior to 1950. The Maple Avenue main lost carrying capacity sometimes subsequent to the introduction in 1950 of the undiluted aggressive Elizabethtown river water and by 1954 there was a substantial diminution in said main's carrying capacity. Petitioner caused it to be cleaned, in 1954, in order to restore its carrying capacity to the pre-1950 level.

By 1957 the carrying capacity of the Maple Avenue main had again been substantially diminished and there was tuberculation in the relevant pipe. During the calendar years 1957 and 1958, petitioner caused the Maple Avenue main to be cleaned and lined with a cement lining three-sixteenths of an inch in thickness. During the calendar year 1957, 7,400 feet of said pipe was so cleaned and lined.

The cleaning and cement lining was commenced December 10, 1957, and completed January 8, 1958. The total contract cost was $42,003.80, of which $33,208 was allocable to 1957.

In 1960 petitioner caused the 6,038 feet of pipe between the Maple Avenue main and the Raritan Road main to be cleaned and cement lined. With the exception of the 1954 cleaning and the 1957-1958 and 1960 cleaning and cement lining, petitioner has never in its history cleaned or cement lined any of its formerly tar-lined pipe. The amount so cleaned and lined comprised approximately one-half of 1 percent of petitioner's pipes. There was no indication that further cleaning or cement lining would be needed by petitioner on any of its other lines.

The cement lining is not permanent and will wash out eventually. Cleaning and cement lining usually eliminate the problems of tuberculation and the necessity of periodic cleaning for as long as the cement lining lasts.

Of the $33,208 allocable to the 1957 cleaning and cement lining of the Maple Avenue main, petitioner capitalized $1,531.80 on its 1957 Federal income tax return and deducted $28,355.40 as an ordinary and necessary business expense, which expense respondent has disallowed. Petitioner arrived at the capitalized figure of $1,531.80 by applying a factor of 23 cents per foot to the 7,400 feet of pipe actually lined in 1957; 7,400 feet at 23 cents per foot gave a figure of $1,702 against which the usual 10 percent retainage of $170.20 was deducted, resulting in the net capitalized figure of $1,531.80. Twenty-three cents per foot represented the additional cost in 1957 for 16-inch cement-lined over tar-coated pipe three-fourths of an inch in thickness. The cost per foot, before installation, of cast-iron cement-lined pipe was $6.43, and the cost per foot of pipe painted internally with tar was $6.20.

The year 1957 was a base year for petitioner's regulated utility rate-making purposes. The accounting treatment employed by petitioner in connection with the relevant 1957 cleaning and cement lining for tax purposes was uniformly submitted to, and accepted by, the New Jersey Public Utilities Commission as a correct treatment. It would have been advantageous for petitioner to capitalize the relevant expenditures for rate-making purposes, because the rates are based on a percentage return of capital investment.

The reduction in carrying capacity of the Maple Avenue main during the 1950 through 1957 period was substantially caused by tuberculation resulting from the continued flow of aggressive Elizabethtown river water through said main.

The cleaning and cement lining of the Maple Avenue main was a repair which restored the original water carrying capacity of the pipes in question. Such pipe was previously and thereafter continued to be used in the normal course of petitioner's operations as a water company. The repair did not form a part of an overall plan of improvement. The cleaning and lining did not materially increase the useful life, value, or structural strength of the pipes involved, nor did it render those pipes suitable for any new or additional use by petitioner.

OPINION.

The issue before us is whether the cost of cleaning and cement lining the Maple Avenue main during 1957 is a deductible repair under section 162(a) /3/ and the regulations thereunder,⁴ or whether it is a capital expenditure. ⁵

The area of repair or capital expenditure is replete with innumerable decisions which struggle unsuccessfully to draw a clear and useful line of general applicability. An expenditure which returns property to the state it was in before the situation prompting the expenditure arose, and which does not make the relevant property more valuable, more useful, or longer-lived, is usually deemed a deductible repair. A capital expenditure is generally...