Internal Revenue Bulletin 2008-18 (PDF rendition): IRS Revenue Rulings

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Bulletin No. 200
8-18
May 5, 2008
HIGHLIGHTS
OF THIS ISSUE
These synopses are intended only as aids to the reader in
identifying the subject matter covered. They may not be
relied upon as authoritative interpretations.
INCOME TAX
Rev. Rul. 2008–23, page 852.
Employee leasing arrangements.This ruling addresses
which party is subject to the Code section 274(n) limitation
when a trucking company leases truck drivers from a leasing
company and the leasing company reimburses the drivers for
meal and incidental expenses they incur in the course of per-
forming services.
Rev. Rul. 2008–24, page 861.
Federal rates; adjusted federal rates; adjusted federal
long-term rate and the long-term exempt rate.For pur-
poses of sections 382, 642, 1274, 1288, and other sections
of the Code, tables set forth the rates for May 2008.
REG–168745–03, page 871.
Proposed regulations explain how section 263(a) of the Code
applies to amounts paid to acquire, produce, or improve tan-
gible property. The regulations clarify what amounts must be
capitalized, rather than deducted currently, and how those cap-
italized amounts should be treated. The regulations withdraw
and replace the proposed regulations issued in August 2006
under section 263(a). A public hearing is scheduled for June
24, 2008.
Notice 2008–46, page 868.
This notice provides guidance regarding implementation of the
tax return preparer penalty provisions under section 6694 of
the Code. Notice 2008–13 supplemented.
Notice 2008–47, page 869.
The Department of Treasury and the Service invite public com-
ments on recommendations for items that should be included
on the 2008–2009 Guidance Priority List. Taxpayers may sub-
mit recommendations for guidance at any time during the year.
Recommendations submitted by May 31, 2008, will be re-
viewed for possible inclusion on the original 2008–2009 Guid-
ance Priority List. Recommendations received after May 31,
2008, will be reviewed for inclusion in the next periodic up-
date.
EMPLOYEE PLANS
Notice 2008–46, page 868.
This notice provides guidance regarding implementation of the
tax return preparer penalty provisions under section 6694 of
the Code. Notice 2008–13 supplemented.
Notice 2008–47, page 869.
The Department of Treasury and the Service invite public com-
ments on recommendations for items that should be included
on the 2008–2009 Guidance Priority List. Taxpayers may sub-
mit recommendations for guidance at any time during the year.
Recommendations submitted by May 31, 2008, will be re-
viewed for possible inclusion on the original 2008–2009 Guid-
ance Priority List. Recommendations received after May 31,
2008, will be reviewed for inclusion in the next periodic up-
date.
(Continued on the next page)
Finding Lists begin on page ii.

EXEMPT ORGANIZATIONS
T.D. 9390, page 855.
Final regulations amend the existing regulations under sections
501(c)(3) and 4958 of the Code and clarify the relationship be-
tween the substantive requirements for tax exemption for pub-
lic charities described in section 501(c)(3) and the imposition
of section 4958 excise taxes on excess benefit transactions
between public charities and their insiders. Specifically, the
regulations set forth a non-exhaustive list of factors the IRS will
consider in deciding whether to revoke the tax-exempt status
of organizations that have engaged in excess benefit transac-
tion(s). The regulations also add several examples to illustrate
the requirement that an organization serve a public rather than
a private interest. Furthermore, the regulations clarify that sec-
tion 4958 does not apply at the time of the initial determination
of exempt status.
Notice 2008–46, page 868.
This notice provides guidance regarding implementation of the
tax return preparer penalty provisions under section 6694 of
the Code. Notice 2008–13 supplemented.
Notice 2008–47, page 869.
The Department of Treasury and the Service invite public com-
ments on recommendations for items that should be included
on the 2008–2009 Guidance Priority List. Taxpayers may sub-
mit recommendations for guidance at any time during the year.
Recommendations submitted by May 31, 2008, will be re-
viewed for possible inclusion on the original 2008–2009 Guid-
ance Priority List. Recommendations received after May 31,
2008, will be reviewed for inclusion in the next periodic up-
date.
ESTATE TAX
Notice 2008–46, page 868.
This notice provides guidance regarding implementation of the
tax return preparer penalty provisions under section 6694 of
the Code. Notice 2008–13 supplemented.
Notice 2008–47, page 869.
The Department of Treasury and the Service invite public com-
ments on recommendations for items that should be included
on the 2008–2009 Guidance Priority List. Taxpayers may sub-
mit recommendations for guidance at any time during the year.
Recommendations submitted by May 31, 2008, will be re-
viewed for possible inclusion on the original 2008–2009 Guid-
ance Priority List. Recommendations received after May 31,
2008, will be reviewed for inclusion in the next periodic up-
date.
GIFT TAX
Notice 2008–46, page 868.
This notice provides guidance regarding implementation of the
tax return preparer penalty provisions under section 6694 of
the Code. Notice 2008–13 supplemented.
Notice 2008–47, page 869.
The Department of Treasury and the Service invite public com-
ments on recommendations for items that should be included
on the 2008–2009 Guidance Priority List. Taxpayers may sub-
mit recommendations for guidance at any time during the year.
Recommendations submitted by May 31, 2008, will be re-
viewed for possible inclusion on the original 2008–2009 Guid-
ance Priority List. Recommendations received after May 31,
2008, will be reviewed for inclusion in the next periodic up-
date.
EMPLOYMENT TAX
Notice 2008–46, page 868.
This notice provides guidance regarding implementation of the
tax return preparer penalty provisions under section 6694 of
the Code. Notice 2008–13 supplemented.
Notice 2008–47, page 869.
The Department of Treasury and the Service invite public com-
ments on recommendations for items that should be included
on the 2008–2009 Guidance Priority List. Taxpayers may sub-
mit recommendations for guidance at any time during the year.
Recommendations submitted by May 31, 2008, will be re-
viewed for possible inclusion on the original 2008–2009 Guid-
ance Priority List. Recommendations received after May 31,
2008, will be reviewed for inclusion in the next periodic up-
date.
SELF-EMPLOYMENT TAX
Notice 2008–46, page 868.
This notice provides guidance regarding implementation of the
tax return preparer penalty provisions under section 6694 of
the Code. Notice 2008–13 supplemented.
(Continued on the next page)
May 5, 20082008–18 I.R.B.

EXCISE TAX
T.D. 9390, page 855.
Final regulations amend the existing regulations under sections
501(c)(3) and 4958 of the Code and clarify the relationship be-
tween the substantive requirements for tax exemption for pub-
lic charities described in section 501(c)(3) and the imposition
of section 4958 excise taxes on excess benefit transactions
between public charities and their insiders. Specifically, the
regulations set forth a non-exhaustive list of factors the IRS will
consider in deciding whether to revoke the tax-exempt status
of organizations that have engaged in excess benefit transac-
tion(s). The regulations also add several examples to illustrate
the requirement that an organization serve a public rather than
a private interest. Furthermore, the regulations clarify that sec-
tion 4958 does not apply at the time of the initial determination
of exempt status.
Notice 2008–46, page 868.
This notice provides guidance regarding implementation of the
tax return preparer penalty provisions under section 6694 of
the Code. Notice 2008–13 supplemented.
Notice 2008–47, page 869.
The Department of Treasury and the Service invite public com-
ments on recommendations for items that should be included
on the 2008–2009 Guidance Priority List. Taxpayers may sub-
mit recommendations for guidance at any time during the year.
Recommendations submitted by May 31, 2008, will be re-
viewed for possible inclusion on the original 2008–2009 Guid-
ance Priority List. Recommendations received after May 31,
2008, will be reviewed for inclusion in the next periodic up-
date.
TAX CONVENTIONS
Announcement 2008–39, page 867.
This announcement provides interim guidance concerning the
“commencement date” for Mutual Agreement Procedure (MAP)
cases eligible for arbitration under the December 28, 2007,
Protocol to the U.S.-Germany Tax Treaty.
ADMINISTRATIVE
T.D. 9389, page 863.
REG–114942–07, page 901.
Temporary and proposed regulations under section 6103 of
the Code describe the circumstances by which officers and
employees of the Treasury Department may disclose return in-
formation to whistleblowers and, if applicable, their legal rep-
resentatives in connection with written contracts for services
relating to the detection of violations of the internal revenue
laws or related statutes.
Notice 2008–47, page 869.
The Department of Treasury and the Service invite public com-
ments on recommendations for items that should be included
on the 2008–2009 Guidance Priority List. Taxpayers may sub-
mit recommendations for guidance at any time during the year.
Recommendations submitted by May 31, 2008, will be re-
viewed for possible inclusion on the original 2008–2009 Guid-
ance Priority List. Recommendations received after May 31,
2008, will be reviewed for inclusion in the next periodic up-
date.
2008–18 I.R.B.May 5, 2008

The IRS Mission
Provide Americ
a’s taxpayers top quality service by helping them
understand an
d meet their tax responsibilities and by applying
the tax law with
integrity and fairness to all.
Introduction
The Internal Revenue Bulletin is the authoritative instrument of
the Commissioner of Internal Revenue for announcing official
rulings and procedures of the Internal Revenue Service and for
publishing Treasury Decisions, Executive Orders, Tax Conven-
tions, legislation, court decisions, and other items of general
interest. It is published weekly and may be obtained from the
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contents are compiled semiannually into Cumulative Bulletins,
which are sold on a single-copy basis.
It is the policy of the Service to publish in the Bulletin all sub-
stantive rulings necessary to promote a uniform application of
the tax laws, including all rulings that supersede, revoke, mod-
ify, or amend any of those previously published in the Bulletin.
All published rulings apply retroactively unless otherwise indi-
cated. Procedures relating solely to matters of internal man-
agement are not published; however, statements of internal
practices and procedures that affect the rights and duties of
taxpayers are published.
Revenue rulings represent the conclusions of the Service on the
application of the law to the pivotal facts stated in the revenue
ruling. In those based on positions taken in rulings to taxpayers
or technical advice to Service field offices, identifying details
and information of a confidential nature are deleted to prevent
unwarranted invasions of privacy and to comply with statutory
requirements.
Rulings and procedures reported in the Bulletin do not have the
force and effect of Treasury Department Regulations, but they
may be used as precedents. Unpublished rulings will not be
relied on, used, or cited as precedents by Service personnel in
the disposition of other cases. In applying published rulings and
procedures, the effect of subsequent legislation, regulations,
court decisions, rulings, and procedures must be considered,
and Service personnel and others concerned are cautioned
against reaching the same conclusions in other cases unless
the facts and circumstances are substantially the same.
The Bulletin is divided into four parts as follows:
Part I.—19
86 Code.
This part i
ncludes rulings and decisions based on provisions of
the Intern
al Revenue Code of 1986.
Part II.—Treaties and Tax Legislation.
This part is divided into two subparts as follows: Subpart A,
Tax Conventions and Other Related Items, and Subpart B, Leg-
islation and Related Committee Reports.
Part III.—Administrative, Procedural, and Miscellaneous.
To the extent practicable, pertinent cross references to these
subjects are contained in the other Parts and Subparts. Also
included in this part are Bank Secrecy Act Administrative Rul-
ings. Bank Secrecy Act Administrative Rulings are issued by
the Department of the Treasury’s Office of the Assistant Secre-
tary (Enforcement).
Part IV
.—Items of General Interest.
This par
t includes notices of proposed rulemakings, disbar-
ment an
d suspension lists, and announcements.
The last Bulletin for each month includes a cumulative index
for the matters published during the preceding months. These
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The c
ontents of this publication are not copyrighted and may be reprinted freely. A citation of the Internal Revenue Bulletin as the source would be appropriate.
For sale by the Superintendent of Documents, U.S.Government Printing Office, Washington, DC 20402.
May 5, 20082008–18 I.R.B.

Part I. Rulings
and Decisions Under the Internal Revenue Code
of 1986
Section 42.—L
ow-Income
Housing Credi
t
The adjusted a
pplicable federal short-term, mid-
term, and long
-term rates are set forth for the month
of May 2008. Se
e Rev. Rul. 2008-24, page 861.
Section 62.—Adjusted
Gross Income Defined
26 CFR 1.62–
2: Reimbursements and other expense
allowance a
rrangements.
A revenue ru
ling addresses which party is subject
to the secti
on 274(n) limitation when a trucking com-
pany leases
truck drivers from a leasing company and
the leasin
g company reimburses the drivers for meal
and incide
ntal expenses they incur in the course of
performin
g services. See Rev. Rul. 2008-23, page
852.
Section 274.—Disallowance
of Certain Entertainment,
etc., Expenses
26 CFR 1.274–2: Disallowance of deductions for
certain expenses for entertainment, amusement,
recreation, or travel.
(Also §§ 62, 1.62–2.)
Employee leasing arrangements.
This ruling addresses which party is sub-
ject to the Code section 274(n) limitation
when a trucking company leases truck
drivers from a leasing company and the
leasing company reimburses the drivers
for meal and incidental expenses they in-
cur in the course of performing services.
Rev. Rul. 2008–23
ISSUE
If a Client leases employees from
a Leasing Company, and the Leasing
Company reimburses the employees for
meal and incidental expenses (M&IE)
they incur in the course of performing
services, which party’s deduction for re-
imbursement of the M&IE is subject to the
limitation under § 274(n) of the Internal
Revenue Code?
FACTS
Leas
ing Company and Client, who are
unr
elated parties, enter into a written em-
ployee leasin
g contract under which Leas-
ing Company le
ases drivers to Client to
haul products
in exchange for Client’s pe-
riodic payme
nts to Leasing Company. The
employee lea
sing contract provides that
Leasing Comp
any will calculate Client’s
periodic pay
ments to cover Leasing Com-
pany’s expe
nditures (wages due to drivers,
payments of
the M&IE to drivers under
a reimburse
ment arrangement between
Leasing Com
pany and the drivers, and
other expen
ses) plus a profit.
Each driver
(Driver) performs services
as an emplo
yee in the trucking indus-
try. Drive
r incurs M&IE while traveling
overnight
away from home in connection
with Drive
r’s employment. In addition
to receivi
ng wages, Driver receives a
separate
ly stated reimbursement at the
M&IE rate
from Leasing Company. All
the reimb
ursements paid to Driver are
paid unde
r a “reimbursement or other ex-
pense all
owance arrangement,” within the
meaning
of § 274(e)(3), between Leasing
Company
and Driver.
Neither
Leasing Company nor Client
deducts
the M&IE amounts as compen-
sation o
n its originally filed income tax
return,
nor does either treat the M&IE
amount
s as wages for purposes of with-
holdin
g under Chapter 24. The employee
leasin
g contract does not address which
party r
eimburses the drivers’ M&IE for
purpos
es of applying the § 274(n) limita-
tion.
In each situation described below,
eithe
r Leasing Company or Client may
be the
Driver’s employer under the usual
commo
n law rules applicable to determin-
ing th
e employer-employee relationship.
See§
31.3121(d)–1 of the Employment
Tax R
egulations.
Situ
ation 1. Driver adequately accounts
to Le
asing Company for the M&IE to
sati
sfy the substantiation requirements of
§274
(d) pursuant to an annually updated
reve
nue procedure, Rev. Proc. 2007–63,
2007
–42 I.R.B. 809 (or any successor).
Aft
er calculating Driver’s wages and any
M&I
E payments that may be due, Leasing
Com
pany sends Client a billing invoice
for
a periodic payment due. The invoice
is f
or a lump-sum and does not itemize
fo
r the amount of any M&IE reimburse-
me
nt. Client pays Leasing Company the
lump-sum peri
odic payment. Upon receiv-
ing Client’s p
eriodic payment, Leasing
Company pays b
oth Driver’s wages and
M&IE reimbur
sement.
Situation 2.D
river adequately accounts
to Leasing Co
mpany for the M&IE to
satisfy the s
ubstantiation requirements of
§ 274(d) purs
uant to Rev. Proc. 2007–63
(or any succe
ssor). After Driver accounts
to Leasing C
ompany for M&IE, Leasing
Company cal
culates Driver’s wages and
any M&IE pay
ments that may be due.
Leasing Com
pany sends Client a billing
invoice fo
r a periodic payment due. The
invoice is
for a lump-sum and does not
itemize fo
r the amount of any M&IE reim-
bursement
. Client pays Leasing Company
the lump-s
um periodic payment. Upon
receivin
g Client’s periodic payment, Leas-
ing Compa
ny pays both Driver’s wages
and M&IE r
eimbursement. Immediately
after Lea
sing Company pays Driver, Leas-
ing Compa
ny sends Client a statement
indicat
ing the amount paid to Driver as a
reimbur
sement of Driver’s M&IE. Leasing
Company
also accounts for that amount
by deliv
ering to Client a copy of all of the
substa
ntiation that Driver had originally
submit
ted to Leasing Company. Client
accept
s the substantiation submitted by
Leasin
g Company and acknowledges that
the por
tion of its periodic payment equal to
the am
ount that Leasing Company paid to
reimb
urse Driver’s M&IE is paid under a
reimb
ursement arrangement with Leasing
Compa
ny and is subject to the § 274(n)
limit
ation.
Situa
tion 3.Driver is paid an allowance
at the
applicable M&IE rate by Leasing
Comp
any, but substantiates the expenses
to Cl
ient. Client then immediately deliv-
ers t
oLeasingCompanyacopyofallof
the i
nformation that Driver had originally
subm
itted to Client to substantiate Driver’s
expe
nses, and Client informs Driver that
it h
as done so. Leasing Company accepts
the
substantiation. Driver adequately ac-
cou
nts for the M&IE to satisfy the substan-
tia
tion requirements of § 274(d) pursuant
to R
ev. Proc. 2007–63 (or any successor).
Aft
er receiving Driver’s substantiation,
Lea
sing Company calculates Driver’s
wa
ges and any M&IE reimbursements
th
at may be due. Leasing Company sends
2008–18 I.R.B.852May 5, 2008

Client a billing invoice for a periodic pay-
ment due. The invoice is for a lump-sum
and does not itemize for the amount of
any M&IE reimbursement. Client pays
Leasing Company the lump-sum periodic
payment. Upon receiving Client’s periodic
payment, Leasing Company pays both
Driver’s wages and M&IE reimbursement.
Immediately after Leasing Company pays
Driver, Leasing Company sends Client
a statement indicating the amount paid
to Driver as a reimbursement of Driver’s
M&IE. Leasing Company also accounts
to Client by referring to the substantiation
Client had received from Driver and had
submitted (via a copy) to Leasing Com-
pany. Client accepts the substantiation
submitted by Leasing Company and ac-
knowledges that the portion of its periodic
payment equal to the amount that Leas-
ing Company paid to reimburse Driver’s
M&IE is paid under a reimbursement ar-
rangement with Leasing Company and is
subject to the § 274(n) limitation.
LAW
Section 162(a)(2) allows a deduction
for all the ordinary and necessary expenses
paid or incurred during the taxable year in
carrying on any trade or business, includ-
ing traveling expenses (such as M&IE)
while away from home in the pursuit of a
trade or business.
In general, § 274(d)(1) provides that
no deduction is allowed under § 162 to a
taxpayer for traveling expenses (including
M&IE) unless the taxpayer substanti-
ates the expenses. If the taxpayer is an
employee and is reimbursed for M&IE
by a payor (whether the employer, the
employer’s agent, or a third party), the
employee satisfies§ 274(d) by account-
ing to the payor with adequate records
substantiating the amount of the expense,
the time and place of the expense, and
the business purpose of the expense. Sec-
tion 1.274–5(f)(4)(i) (last sentence) and
(f)(4)(iii) of the Income Tax Regulations.
With some exceptions, an employee who
adequately accounts for the M&IE is
not again required to substantiate the ex-
penses. Section 1.274–5T(f)(5) of the
temporary Income Tax Regulations. If
the payor and employee use the annually
updated revenue procedure to substantiate
the expenses, the M&IE amount (to the
extent reimbursed and substantiated) is
treated as an expense for food or beverages
and is subject to § 274(n).Seesection 6.05
of Rev. Proc. 2007–63. If the taxpayer is
an independent contractor and receives a
payment for M&IE under a reimbursement
or other expense allowance arrangement
from a client, § 274(d) requires that the in-
dependent contractor account to the client
with adequate records, or other sufficient
evidence corroborating the independent
contractor’s own statement, substantiat-
ing the amount of the expense, the time
and place of the expense, and the busi-
ness purpose of the expense. Section
1.274–5T(h)(3). Unlike an employee,
however, an independent contractor must
maintain a copy of the records, or other
sufficient evidence, to substantiate the ex-
penses. Section 274(d); § 1.274–5T(h)(2).
Section 274(n)(1) generally limits the
amount allowed as a deduction for any
expense for food or beverages to 50 per-
cent of the expense, although § 274(n)(3)
generally imposes a lesser limitation on
deductions for truck drivers’ expenses.
However, § 274(n)(2) excepts expenses
described in § 274(e)(3) from the limita-
tion imposed by § 274(n)(1).
Section 274(e)(3) expenses are those
paid or incurred by a taxpayer in con-
nection with the performance of services
for another person (whether or not that
other person is the taxpayer’s employer)
under a reimbursement or other expense
allowance arrangement with that other per-
son. If the payment is made to an em-
ployee, the § 274(e)(3)(A) exception ap-
plies to the employee only to the extent the
employer does not report the payment as
compensation to the employee on the em-
ployer’s originally filed income tax return
and as wages to the employee for purposes
of withholding under Chapter 24. Sec-
tion 1.274–2(f)(2)(iv)(b). If the payment
is made to an independent contractor, the
§ 274(e)(3)(B) exception applies to the in-
dependent contractor to the extent the in-
dependent contractor accounts for the ex-
penses to the payor in a manner satisfying
§ 274(d). Section 1.274–2(f)(2)(iv)(c).
For purposes of § 274(e)(3), a
“reimbursement or other expense al-
lowance arrangement” includes, but is
not limited to, an “accountable plan”
as that term is defined for purposes of
§62(c).See§ 1.62–2(c)(1). Since 1963,
§ 1.274–2(f)(2)(iv)(a) has provided that
the term “reimbursement or other expense
allowance arrangement” in § 274(e)(3)
has the same meaning it has “in section
62(2)(A), but without regard to whether
the taxpayer is the employee of a person
for whom services are performed.” T.D.
6659, 1963–2 C.B. 113. The subsequent
addition of § 62(c) in 1988 and its ac-
companying regulations did not change
the meaning of “reimbursement or other
expense allowance arrangement” for pur-
poses of § 274(e)(3). Thus, the application
of § 274(e)(3) does not require the exis-
tence of an accountable plan within the
meaning of § 62(c) and the regulations
under that section.
Section 274(n)(1) limits certain de-
ductions allowable under § 162. If an
employee or independent contractor incurs
M&IE in connection with the performance
of services for another person and is not re-
imbursed, § 274(n) limits any § 162(a)(2)
deduction claimed by the employee or
independent contractor. If an employee
accounts for the expenses under § 274(d)
to the payor, is reimbursed under a re-
imbursement or other expense allowance
arrangement, and the payment is not
treated both as additional compensation
and as wages for income tax withholding
purposes, then under § 274(e)(3)(A), the
employee is not subject to § 274(n).See
§ 274(n)(2)(A) and § 1.274–2(f)(2)(iv)(a).
The party initially making the reim-
bursement (“initial payor”) bears the
expenses, and § 274(n) limits that
party’s § 162(a)(2) deduction, unless
that party also satisfies § 274(e)(3)(B).
Sections1.274–2(f)(2)(iv)(b)and
1.274–5(f)(4)(iii). If the initial payor,
in connection with its performance of
services for a third party, is reimbursed
under a reimbursement or other expense
allowance arrangement with the third
party, and the initial payor accounts
to the third party in the same manner
that the employee accounted for the ex-
penses to the initial payor, then the initial
payor satisfies § 274(e)(3)(B). Section
1.274–2(f)(2)(iv)(c)(1). In that case,
the third party bears the expenses, and
§ 274(n) limits the § 162(a)(2) deduction
that the third party claims for those ex-
penses.
InTransport Labor Contract/Leasing,
Inc. v. Commissioner, 461 F.3d 1030 (8
th
Cir. 2006),rev’g123 T.C. 154 (2004)
(TLC), the question was the application
of § 274(n) for taxable years ending in
May 5, 20088532008–18 I.R.B.

1993 through 1996 to an employee leasing
arrangement that provided for the pay-
ment to employees ofper diemallowances
for M&IE. The Court of Appeals for the
Eighth Circuit found that the trucking
company clients, not the leasing company
(TLC), actually bore theper diemexpenses
under the reimbursement arrangement be-
tween the parties. The appellate court held
that TLC qualified for the exception in
§ 274(e)(3)(B) and, therefore, that TLC’s
§ 162(a)(2) deduction for theper diem
expenses was not limited by § 274(n).
The appellate court reversed the Tax
Court, which had held that § 274(n) lim-
ited TLC’s § 162(a)(2) deduction because
TLC was the drivers’ common law em-
ployer. Under the Tax Court’s analysis,
the § 274(n) limitation necessarily applies
to the employees’ common law employer.
CompareBeechTruckingCo.v.Commis-
sioner, 118 T.C. 428, 443 (2002) (relying
on common law employer factor and iden-
tity of party ultimately bearing the expense
to determine incidence of § 274(n) limita-
tion). The appellate court opined that the
TaxCourthaderroneouslyfailedtoexam-
ine whether TLC qualified for the excep-
tion in § 274(e)(3)(B).
InTLC, the Court of Appeals for the
Eighth Circuit determined that TLC’s
§ 162 deduction ultimately was not lim-
ited by § 274(n) because TLC was not
the party that ultimately bore theper diem
expenses. The appellate court concluded
that status as a common law employer is
not dispositive in the § 274(n) analysis,
but did not explicitly reject that status as
a relevant factor. The Internal Revenue
Service acquiesces in the result inTLCand
agrees with the appellate court’s opinion
that the § 274(n) limitation should apply to
the party that ultimately bears theper diem
expenses. However, the Internal Revenue
Service does not agree with the opinion to
theextentthatitcouldbereadtoimply
that status as a common law employer is
relevant to the § 274(n) analysis.
ANALYSIS
In each situation below, Driver is an
employee who incurs M&IE in connec-
tion with the performance of services for
another person, receives a reimbursement
at the M&IE rate, and accounts for the
reimbursement under a “reimbursement
or other expense allowance arrangement”
within the meaning of § 274(e)(3). Nei-
ther Leasing Company nor Client deducts
the M&IE amounts as compensation paid
to Driver on its originally filed income
tax return, nor treats the M&IE amounts
as wages paid to Driver for purposes of
withholding under Chapter 24. Therefore,
under § 274(e)(3)(A), Driver is not subject
to § 274(n).
Situation 1. Leasing Company, as
payor of the substantiated M&IE reim-
bursement to Driver, must determine if its
deduction of the expenses under § 162(a)
is subject to the § 274(n) limitation. Al-
though Leasing Company pays the M&IE
of each driver in connection with its per-
formance of services for Client, Leasing
Company has provided Client only an
invoice for a lump-sum periodic pay-
ment due. Therefore, Leasing Company
does not satisfy § 274(e)(3)(B) because it
has not accounted to Client in a manner
satisfying § 274(d) and does not have a re-
imbursement or other expense allowance
arrangement with Client. Under these
circumstances, Leasing Company bears
the expense of the M&IE, and § 274(n)
limits Leasing Company’s § 162(a)(2)
deduction for the M&IE, regardless of
whether Leasing Company or Client is
Driver’s employer under the usual com-
mon law rules. Even if Leasing Com-
pany had provided an itemized invoice
to Client designating a portion of the pe-
riodic payment as a reimbursement of
Driver’s M&IE, Leasing Company still
does not satisfy § 274(e)(3)(B) because it
has not accounted to Client in a manner
satisfying § 274(d) and does not have a re-
imbursement or other expense allowance
arrangement with Client.
Situation 2. Leasing Company, as
payor of the substantiated M&IE reim-
bursement to Driver, must determine if its
deduction of the expenses under § 162(a) is
subject to the § 274(n) limitation. Leasing
Company has the information Driver orig-
inally submitted to account for Driver’s
M&IE. Immediately after Leasing Com-
pany pays Driver, Leasing Company sends
Client a statement indicating the amount
paid to Driver that was a reimbursement
of Driver’s M&IE. Leasing Company also
accounts to Client by delivering to Client
a copy of the substantiation that Driver
had originally provided to Leasing Com-
pany. Client accepts the substantiation
submitted by Leasing Company and ac-
knowledges that the portion of its periodic
payment equal to the amount that Leas-
ing Company paid to reimburse Driver’s
M&IE is paid under a reimbursement ar-
rangement and is subject to the § 274(n)
limitation. Leasing Company meets the
requirements of § 274(e)(3)(B) because
(1) under the employee leasing contract
and as indicated by their course of dealing,
Leasing Company can prove that it has
established a reimbursement or other ex-
pense allowance arrangement with Client
within the meaning of § 274(e)(3), and (2)
Leasing Company accounts to Client by
delivering a copy of the substantiation that
DriverhadprovidedtoLeasingCompany
(i.e., in a manner satisfying § 274(d)).
Therefore, Leasing Company is not sub-
ject to § 274(n), Client bears the expense
of the M&IE, and § 274(n) limits Client’s
§ 162(a)(2) deduction for the M&IE, re-
gardless of whether Leasing Company
or Client is Driver’s employer under the
usual common law rules.
Situation 3. Leasing Company has a
copy of the information Driver originally
submitted to Client to account for Driver’s
M&IE. Leasing Company, as payor of
the substantiated M&IE reimbursement to
Driver, must determine if its deduction of
the expenses under § 162(a) is subject to
the § 274(n) limitation. Immediately after
Leasing Company pays Driver, Leasing
Company sends Client a statement indi-
cating the amount paid to Driver that was
a reimbursement of Driver’s M&IE. Leas-
ing Company also accounts to Client by
referring to the substantiation Client had
received from Driver and had submitted
(via a copy) to Leasing Company. Client
accepts the substantiation submitted by
Leasing Company, and acknowledges that
the portion of its periodic payment equal
to the amount that Leasing Company paid
to reimburse Driver’s M&IE is paid un-
der a reimbursement arrangement and is
subject to the § 274(n) limitation. Leas-
ing Company meets the requirements of
§ 274(e)(3)(B) because (1) under the em-
ployee leasing contract and as indicated by
their course of dealing, Leasing Company
can prove that it has established a reim-
bursement or other expense allowance ar-
rangement with Client within the meaning
of § 274(e)(3), and (2) Leasing Company
accounts to Client by referring to the sub-
stantiation that Driver originally submitted
to Client (i.e., in a manner satisfying
2008–18 I.R.B.854May 5, 2008

§ 274(d)). Therefore, Leasing Company
is not subject to § 274(n), Client bears
the expense of the M&IE, and § 274(n)
limits Client’s § 162(a)(2) deduction for
the M&IE, regardless of whether Leasing
Company or Client is Driver’s employer
under the usual common law rules.
HOLDINGS
(1) InSituation 1, Leasing Company’s
deduction for reimbursement of the M&IE
to Driver is subject to the § 274(n) limita-
tion.
(2) InSituation 2, Client’s deduction
for reimbursement of the M&IE to Leasing
Company is subject to the § 274(n) limita-
tion.
(3) InSituation 3, Client’s deduction
for reimbursement of the M&IE to Leasing
Company is subject to the § 274(n) limita-
tion.
DRAFTING INFORMATION
The principal author of this revenue
ruling is Jeffrey T. Rodrick of the Office
of Associate Chief Counsel (Income Tax
& Accounting). For further information
regarding this revenue ruling, contact
Mr. Rodrick at (202) 622–4930 (not a
toll-free call).
Section 280G.—Golden
Parachute Payments
Federal short-term, mid-term, and long-term rates
aresetforthforthemonthofMay2008. SeeRev.
Rul. 2008-24, page 861.
Section 382.—Limitation
on Net Operating Loss
Carryforwards and Certain
Built-In Losses Following
Ownership Change
The adjusted applicable federal long-term rate is
set forth for the month of May 2008. See Rev. Rul.
2008-24, page 861.
Section 412.—Minimum
Funding Standards
The adjusted applicable federal short-term, mid-
term, and long-term rates are set forth for the month
of May 2008. See Rev. Rul. 2008-24, page 861.
Section 467.—Certain
Payments for the Use of
Property or Se
rvices
The adjusted a
pplicable federal short-term, mid-
term, and long
-term rates are set forth for the month
of May 2008. Se
e Rev. Rul. 2008-24, page 861.
Section 468.—Special
Rules for Mining and Solid
Waste Reclamation and
Closing Costs
The adjusted applicable federal short-term, mid-
term, and long-term rates are set forth for the month
of May 2008. See Rev. Rul. 2008-24, page 861.
Section 482.—Allocation
of Income and Deductions
Among Taxpayers
Federal short-term, mid-term, and long-term rates
are set forth for the month of May 2008. See Rev.
Rul. 2008-24, page 861.
Section 483.—Interest on
Certain Deferred Payments
The adjusted applicable federal short-term, mid-
term, and long-term rates are set forth for the month
of May 2008. See Rev. Rul. 2008-24, page 861.
Section 501.—Exemption
From Tax on Corporations,
Certain Trusts, etc.
26 CFR 1.501(c)(3)–1: Organizations organized and
operated for religious, charitable, scientific, testing
for public safety, literary, or educational purposes, or
for the prevention of cruelty to children or animals.
T.D. 9390
DEPARTMENT OF THE
TREASURY
Internal Revenue Service
26 CFR Parts 1 and 53
Standards for Recognition
of Tax-Exempt Status if
Private Benefit Exists or if
an Applicable Tax-Exempt
Organization Has Engaged in
Excess Benefit Transaction(s)
AGENCY: Internal Revenue Service
(IRS), Treasury.
ACTION: Final regulations.
SUMMARY: This document contains fi-
nal regulations that clarify the substan-
tive requirements for tax exemption under
section 501(c)(3) of the Internal Revenue
Code (Code). This document also contains
provisions that clarify the relationship be-
tween the substantiverequirements for tax
exemption under section 501(c)(3) and the
imposition of section 4958 excise taxes on
excess benefit transactions. These regula-
tions affect organizations described in sec-
tion 501(c)(3) of theCode and organiza-
tions applying for exemption as organiza-
tions described in section 501(c)(3) of the
Code.
DATES: Effective Date: These regulations
are effective March 28, 2008.
FOR FURTHER INFORMATION
CONTACT: Galina Kolomietz, (202)
622–7971 (not a toll-free number).
SUPPLEMENTARY INFORMATION:
Background
On September 9, 2005, a notice of
proposed rulemaking (REG–111257–05,
2005–2 C.B. 759) clarifying the sub-
stantive requirements for tax exemption
under section 501(c)(3) of the Code, and
the relationship between the substantive
requirements for tax exemption under
section 501(c)(3) and the imposition of
section 4958 excise taxes was published in
theFederal Register(70 FR 53599). The
IRS received several written comments
responding to this notice. After consider-
ation of all comments received, the pro-
posed regulations under sections 501(c)(3)
and 4958 are revised and published in final
form. The major areas of comments and
revisions are discussed in the following
preamble. See §601.601(d)(2)(ii)(b)).
Explanation and Summary of
Comments
Private Benefit
The proposed regulations added several
examples to illustrate the requirement in
§1.501(c)(3)–1(d)(1)(ii) that an organiza-
tion serve a public rather than a private
interest. The purpose of the examples is
May 5, 20088552008–18 I.R.B.

to illustrate that prohibited private bene-
fit may involve non-economic benefits as
well as economic benefits and that prohib-
ited private benefit may arise regardless of
whether payments made to private inter-
ests are reasonable or excessive.
One comment suggested that, rather
than add three isolated examples on pri-
vate benefit to the regulations, the IRS
consider a broader revision of the regula-
tions under section 501(c)(3) to provide a
more detailed discussion of the underlying
principles of the private benefit doctrine.
In particular, this comment suggested that
the regulations address the relative quan-
tity of private benefit that could preclude
exemption. The IRS and the Treasury
Department are not revising the existing
regulations under section 501(c)(3) at this
time. The new examples in the proposed
regulations clarify the principles of the
private benefit doctrine under current law.
In §1.501(c)(3)–1(d)(1)(iii),Example 1
illustrates that private benefit may in-
volve non-economic benefits.Example 2
illustrates that private benefit is inconsis-
tent with tax-exemptstatus under section
501(c)(3) if it is substantial and not merely
incidental to the accomplishment of the
organization’s exempt purposes.Example
3illustrates that private benefit may exist
even though the transaction is at fair mar-
ket value. Moreover, these examples are
intended to illustrate the principle that pri-
vate benefit remains an independent basis
for revocation even if it does not involve
economic benefit or raise fair market value
issues. Accordingly, these examples are
adopted in final form without revision.
Revocation Standards
The proposed regulations provided
guidance on certain factors that the IRS
will consider in determining whether an
applicable tax-exempt organization de-
scribed in section 501(c)(3) that engages
in one or more excess benefit transac-
tions continues to be described in section
501(c)(3). The comments received in
response to the proposed regulations are
discussed below. Overall, the commen-
tators reacted favorably to the factors set
forth in the proposed regulations. The fac-
tors described in the proposed regulations
are finalized without major revisions. The
application of the factorsisrefinedbythe
addition of a new example to the final
regulations.
a.Interaction with determination of
existence of excess benefit transaction
Two comments suggested that the final
regulations clarify the interaction between
the determination of the organization’s tax-
exempt status and thedetermination of the
existence of an excess benefit transaction.
One of these comments specifically re-
quested that the final regulations state that
the IRS will not take any action to re-
move an organization’s tax exemption on
excess benefit transaction grounds while
the IRS’s determination of the existence of
an excess benefit transaction is itself being
contested in court. The final regulations do
not adopt this comment. The determina-
tion of an organization’s tax-exempt status
and the determination of the existence of
an excess benefit transaction are separate
determinations, involving distinct parties,
different legal elements, and separate pro-
cesses, even though they may relate to the
same facts.
b.Clarification of terms
Two comments voiced the need to clar-
ify the terms “significant” and “de min-
imis” as they are used in the proposed
regulations. One of these comments sug-
gested adding an example of a safe harbor
based on specific amounts the IRS would
consider clearly insignificant, perhaps as
a percentage of overall expenditures. Be-
cause the determination of whether an ac-
tivity or an amount is “significant” or “de
minimis” depends on the facts and circum-
stances, the final regulations do not adopt
this comment.
One comment suggested adding exam-
ples combining potentialde minimisval-
ues with other abating or negative factors
and/or examples containing values that are
notde miminis. The final regulations con-
tain a new example that illustrates the ap-
plication of the revocation factors to an
excess benefit transaction that is neither
significant in comparison to the size and
scope of the organization’s exempt activi-
ties norde minimis.
One comment requested clarification of
the term “repeated” as used inExample 3
of §1.501(c)(3)–1(g) of the proposed reg-
ulations. The term was used in that ex-
ample to correspond to the third factor
in the proposed regulations, which looked
to “whether the organization has been in-
volved in repeated excess benefit transac-
tions.” In response to this comment, the
third factor of the proposed regulations is
revised to substitute the term “multiple”
for the word “repeated.” The term “multi-
ple” refers to both (1) repeated instances of
the same (or substantially similar) excess
benefit transaction, regardless of whether
the transaction involves the same or dif-
ferent persons; and (2) the presence of
more than one excess benefit transaction,
regardless of whether the transactions are
the same or substantially similar and re-
gardless of whether they involve the same
or different persons.
Another comment requested guidance
regarding when the IRS would consider
the presence of a single excess benefit
transaction to jeopardize an organization’s
tax-exempt status. Because such a deter-
mination would depend on the facts and
circumstances, the final regulations do not
adopt the comment.
c.Due diligence and safeguards
One comment requested that evidence
that an organization’s board of directors
conducted appropriate due diligence or
followed certain safeguards in connec-
tion with the excess benefit transaction
be treated as a factor weighing in favor
of continuing to recognize exemption.
The IRS and the Treasury Department
agree that the organization’s reliance on
objectively reasonable internal controls
and procedures, such as the procedures for
establishing a rebuttable presumption of
reasonableness, in approving a transaction
that is later determined to be an excess
benefit transaction, should be treated as
a factor weighing in favor of continuing
to recognize exemption. Accordingly, the
fourth factor under the proposed regula-
tions is revised to make clear that imple-
mentation by an organization of safeguards
that are reasonably calculated to prevent
excess benefit transactions will be treated
as a factor weighing in favor of continu-
ing to recognize exemption regardless of
whether such safeguards are implemented
in direct response to the excess bene-
fit transaction(s) at issue or as a general
matter of corporate governance or fiscal
management. Thus, an organization may
be treated as having implemented safe-
2008–18 I.R.B.856May 5, 2008

guards reasonably calculated to prevent
excess benefit transactions even though
the organization is contesting the exis-
tence of the excess benefit transaction(s)
at issue. An example is added to illus-
trate how implementation of safeguards,
including preexisting safeguards, will be
taken into account in determining whether
to continue to recognize an organization’s
tax-exempt status.
One comment suggested that an organ-
ization’s good faith attempt to establish
a rebuttable presumption of reasonable-
ness within the meaning of §53.4958–6
be treated as a factor weighing in favor
of continuing to recognize exemption.
Another comment suggested that a good
faith attempt by an organization’s board
of directors to determine fair market value
be treated as a factor precluding revoca-
tion even if the IRS disagrees with the
board’s fair market value analysis. The
fourth factor, as revised in these final reg-
ulations, takes into account whether the
organization has implemented safeguards
that are reasonably calculated to prevent
excess benefit transactions. This factor
takes safeguards into account, regardless
of whether they were implemented before
or after an excess benefit transaction oc-
curred. The comments raise the question
of how this factor will apply where steps
have been taken to avoid an excess benefit
transaction, but nonetheless have failed
to prevent the excess benefit transaction.
The weight afforded to this particular cir-
cumstance will depend upon the specific
facts and circumstances.
d.Requests for additional examples
Two comments suggested adding to the
proposed regulationsan example specifi-
cally addressing reasonable compensation.
In response to these comments, the new ex-
ample added by these final regulations ad-
dresses reasonable compensation.
One comment suggested that the regu-
lations include examples involving health
care organizations. The IRS and the Trea-
sury Department note that the application
of sections 501(c)(3) and 4958 to health
care organizations is not unique. The
examples in these regulations, although
not specifically involving health care
organizations, apply to health care organi-
zations in the same manner as they apply
to other organizations described in section
501(c)(3).
One comment criticized the examples
in the proposed regulations as too “black-
and-white” and suggested that the regula-
tions be supplemented with examples that
discuss less clear facts. Specifically, this
comment requested guidance on situations
involving more thande minimisamounts
in which an applicable tax-exempt organ-
ization does not seek correction from the
disqualified person involved. The new ex-
ample added by these final regulations il-
lustrates that, in some situations, even in
the absence of correction of non-de min-
imisexcess benefit transactions, an organ-
ization may retain its tax-exempt status if
the other factors, in combination, warrant
continued exemption. Under the fifth fac-
tor, the IRS will take into account the or-
ganization’s good faith with respect to cor-
rection. Accordingly, the reasons behind
the organization’s failure to seek correc-
tion will be examined.
One comment suggested adding an ex-
ample that would illustrate what factors, in
addition to post-audit correction, would be
sufficient to avoid revocation. The exam-
ple that has been added illustrates a case
where factors other than correction support
continued exemption. The IRS and the
Treasury Department may consider publi-
cation of future guidance on the applica-
tion of the factors based on other specific
fact patterns that the IRS encounters in the
course of tax administration.
One comment requested adding an ex-
ample discussing the effect of “automatic
excess benefit transactions” that are not
de minimison the organization’s tax-ex-
empt status. The term “automatic excess
benefit transaction” refers to a transaction
in which a disqualified person provides
services to an organization and receives
economic benefits from the organization
that are not substantiated, contempora-
neously and in writing, as compensation
within the meaning of §53.4958–4(c). Af-
ter the enactment of the Pension Protection
Act of 2006, Public Law 109–280 (120
Stat. 780 (2006)), the term “automatic ex-
cess benefit transaction” also refers to any
grant, loan, compensation or other similar
payment from a donor advised fund to
a donor or donor advisor with respect to
such fund and from a supporting organi-
zation to any of its disqualified persons.
See section 4958(c)(2) and (3). Although
not in the context of an automatic excess
benefit transaction, the new example in
the final regulationsinvolves an excess
benefit transaction that is notde minimis.
e.Removal of disqualified person
One comment suggested that the reg-
ulations address whether and under what
circumstances removal of a disqualified
person may be necessary to avoid revo-
cation. The new example added by these
final regulations illustrates that removal
of a disqualified person is not a neces-
sary condition for continued exemption.
In the example, the organization imple-
mented safeguards designed to prevent fu-
ture excess benefit transactions involving
the same disqualified persons.
f.Best practices
One comment described specific ac-
tions that boards of applicable tax-exempt
organizations should be required to take
to improve governance and to prevent
excess benefit transactions at their orga-
nizations. This comment was not adopted
because the purpose of these regulations
is to set forth an analytical framework for
determining whether to revoke tax-exempt
status if an organization engages in one or
more excess benefit transactions.
Special Analyses
It has been determined that this regu-
lation is not a significant regulatory ac-
tion as defined in Executive Order 12866.
Therefore, a regulatory assessment is not
required. It also has been determined that
section 553(b) of the Administrative Pro-
cedure Act (5 U.S.C. chapter 5) does not
apply to this regulation, and because this
regulation does not impose a collection of
information on small entities, the Regula-
tory Flexibility Act (5 U.S.C. chapter 6)
does not apply. Pursuant to section 7805(f)
of the Code, the notice of proposed rule-
making preceding this regulation was sub-
mitted to the Chief Counsel for Advocacy
of the Small Business Administration for
comment on its impact on small business.
Drafting Information
The principal authors of these reg-
ulations are Galina Kolomietz and
Phyllis Haney, Office of Division
Counsel/Associate Chief Counsel (Tax
May 5, 20088572008–18 I.R.B.

Exempt and Government Entities).
However, other personnel from the IRS
and the Treasury Department participated
in their development.
*****
Amendments to the Regulations
Accordingly, 26 CFR parts 1 and 53 are
amended as follows:
PART 1—INCOME TAXES
Paragraph 1. The authority citation for
part 1 continues to read, in part, as follows:
Authority: 26 U.S.C. 7805 * * *
Par. 2. Section 1.501(c)(3)–1 is revised
by:
1. Redesignating paragraph (d)(1)(iii)
as paragraph (d)(1)(iv) and adding a new
paragraph (d)(1)(iii).
2. Redesignating paragraph (f) as para-
graph (g) and adding a new paragraph (f).
The additions read as follows:
§1.501(c)(3)–1 Organizations organized
and operated for religious, charitable,
scientific, testing for public safety,
literary, or educational purposes, or for
the prevention of cruelty to children or
animals.
*****
(d) * * *
(1) * * *
(iii)Examples. The following exam-
ples illustrate the requirement of paragraph
(d)(1)(ii) of this section that an organiza-
tion serve a public rather than a private in-
terest:
Example 1. (i) O is an educational organization
the purpose of which is to study history and immi-
gration. O’s educational activities include sponsor-
ing lectures and publishing a journal. The focus of
O’s historical studies is the genealogy of one fam-
ily, tracing the descent of its present members. O ac-
tively solicits for membership only individuals who
are members of that one family. O’s research is di-
rected toward publishing a history of that family that
will document the pedigrees of family members. A
major objective of O’s research is to identify and lo-
cate living descendants of that family to enable those
descendants to become acquainted with each other.
(ii) O’s educational activities primarily serve the
private interests of members of a single family rather
than a public interest. Therefore, O is operated for the
benefit of private interests in violation of the restric-
tion on private benefit in paragraph (d)(1)(ii) of this
section. Based on these facts and circumstances, O
is not operated exclusively for exempt purposes and,
therefore, is not described in section 501(c)(3).
Example 2.(i)Oisanartmuseum.O’sprin-
cipal activity is exhibiting art created by a group of
unknown but promising local artists. O’s activity, in-
cluding organized tours of its art collection, promotes
the arts. O is governed by a board of trustees un-
related to the artists whose work O exhibits. All of
the art exhibited is offered for sale at prices set by
the artist. Each artist whose work is exhibited has
a consignment arrangement with O. Under this ar-
rangement, when art is sold, the museum retains 10
percent of the selling price to cover the costs of oper-
ating the museum and gives the artist 90 percent.
(ii) The artists in this situation directly benefit
from the exhibition and sale of their art. As a result,
the principal activity of O serves the private interests
of these artists. Because O gives 90 percent of the
proceeds from its sole activity to the individual artists,
the direct benefits to the artists are substantial and O’s
provision of these benefits to the artists is more than
incidental to its other purposes and activities. This
arrangement causes O to be operated for the benefit
of private interests in violation of the restriction on
private benefit in paragraph (d)(1)(ii) of this section.
Based on these facts and circumstances, O is not oper-
ated exclusively for exempt purposes and, therefore,
is not described in section 501(c)(3).
Example 3. (i) O is an educational organization
the purpose of which is to train individuals in a pro-
gram developed by P, O’s president. The program is
of interest to academics and professionals, represen-
tatives of whom serve on an advisory panel to O. All
of the rights to the program are owned by Company
K, a for-profit corporation owned by P. Prior to the
existence of O, the teaching of the program was con-
ducted by Company K. O licenses, from Company K,
the right to conduct seminars and lectures on the pro-
gram and to use the name of the program as part of O’s
name, in exchange for specified royalty payments.
Under the license agreement, Company K provides O
with the services of trainers and with course materials
on the program. O may develop and copyright new
course materials on the program but all such materials
must be assigned to Company K without considera-
tion if and when the license agreement is terminated.
Company K sets the tuition for the seminars and lec-
tures on the program conducted by O. O has agreed
not to become involved in any activity resembling the
program or its implementation for 2 years after the
termination of O’s license agreement.
(ii) O’s sole activity is conducting seminars and
lectures on the program. This arrangement causes O
to be operated for the benefit of P and Company K in
violation of the restriction on private benefit in para-
graph (d)(1)(ii) of this section, regardless of whether
the royalty payments from O to Company K for the
right to teach the program are reasonable. Based on
these facts and circumstances, O is not operated ex-
clusively for exempt purposes and, therefore, is not
described in section 501(c)(3).
*****
(f)Interaction with section 4958—(1)
Application process. An organization that
applies for recognition of exemption un-
der section 501(a) as an organization de-
scribed in section 501(c)(3) must establish
its eligibility under this section. The Com-
missioner may deny an application for ex-
emption for failure to establish any of sec-
tion 501(c)(3)’s requirements for exemp-
tion.Section4958doesnotapplytotrans-
actions with an organization that has failed
to establish that it satisfies all of the re-
quirements for exemption under section
501(c)(3). See §53.4958–2.
(2)Substantive requirements for ex-
emption still apply to applicable tax-ex-
empt organizations described in section
501(c)(3)—(i)In general. Regardless of
whether a particular transaction is subject
to excise taxes under section 4958, the sub-
stantive requirements for tax exemption
under section 501(c)(3) still apply to an
applicable tax-exempt organization (as de-
fined in section 4958(e) and §53.4958–2)
described in section 501(c)(3) whose
disqualified persons or organization man-
agers are subject to excise taxes under sec-
tion 4958. Accordingly, an organization
will no longer meet the requirements for
tax-exempt status under section 501(c)(3)
if the organization fails to satisfy the re-
quirements of paragraph (b), (c) or (d) of
this section. See §53.4958–8(a).
(ii)Determination of whether revoca-
tion of tax-exempt status is appropriate
when section 4958 excise taxes also ap-
ply. In determining whether to continue
to recognize the tax-exempt status of an
applicable tax-exempt organization (as de-
fined in section 4958(e) and §53.4958–2)
described in section 501(c)(3) that engages
in one or more excess benefit transac-
tions (as defined in section 4958(c) and
§53.4958–4) that violate the prohibition
on inurement under section 501(c)(3), the
Commissioner will consider all relevant
facts and circumstances, including, but not
limited to, the following—
(A) The size and scope of the organi-
zation’s regular and ongoing activities that
further exempt purposes before and after
the excess benefit transaction or transac-
tions occurred;
(B) The size and scope of the excess
benefit transaction or transactions (collec-
tively, if more than one) in relation to the
size and scope of the organization’s regular
and ongoing activities that further exempt
purposes;
(C) Whether the organization has been
involved in multiple excess benefit trans-
actions with one or more persons;
(D) Whether the organization has im-
plemented safeguards that are reasonably
calculated to prevent excess benefit trans-
actions; and
2008–18 I.R.B.858May 5, 2008

(E) Whether the excess benefit transac-
tion has been corrected (within the mean-
ing of section 4958(f)(6) and §53.4958–7),
or the organization has made good faith ef-
forts to seek correction from the disquali-
fied person(s) who benefited from the ex-
cess benefit transaction.
(iii) All factors will be considered in
combination with each other. Depending
on the particular situation, the Commis-
sioner may assign greater or lesser weight
to some factors than to others. The factors
listed in paragraphs (f)(2)(ii)(D) and (E)
of this section will weigh more heavily in
favor of continuing to recognize exemp-
tion where the organization discovers the
excess benefit transaction or transactions
and takes action before the Commissioner
discovers the excess benefit transaction
or transactions. Further, with respect to
the factor listed in paragraph (f)(2)(ii)(E)
of this section, correction after the excess
benefit transaction or transactions are dis-
covered by the Commissioner, by itself, is
never a sufficient basis for continuing to
recognize exemption.
(iv)Examples. The following exam-
ples illustrate the principles of paragraph
(f)(2)(ii) of this section. For purposes of
each example, assume that O is an appli-
cable tax-exempt organization (as defined
in section 4958(e) and §53.4958–2) de-
scribed in section 501(c)(3). The examples
read as follows:
Example 1. (i) O was created as a museum for
the purpose of exhibiting art to the general public. In
Years 1 and 2, O engages in fundraising and in se-
lecting, leasing, and preparing an appropriate facility
for a museum. In Year 3, a new board of trustees is
elected. All of the new trustees are local art dealers.
Beginning in Year 3 and continuing to the present, O
uses a substantial portion of its revenues to purchase
art solely from its trustees at prices that exceed fair
market value. O exhibits and offers for sale all of
the art it purchases. O’s Form 1023, “Application for
Recognition of Exemption Under Section 501(c)(3) of
the Internal Revenue Code,” did not disclose the pos-
sibility that O would purchase art from its trustees.
(ii) O’s purchases of art from its trustees at
more than fair market value constitute excess ben-
efit transactions between an applicable tax-exempt
organization and disqualified persons under section
4958. Therefore, these transactions are subject to
the applicable excise taxes provided in that section.
In addition, O’s purchases of art from its trustees at
more than fair market value violate the proscription
against inurement under section 501(c)(3) and para-
graph (c)(2) of this section.
(iii) The application of the factors in paragraph
(f)(2)(ii) of this section to these facts is as follows.
Beginning in Year 3, O does not engage primarily
in regular and ongoing activities that further exempt
purposes because a substantial portion of O’s activ-
ities consists of purchasing art from its trustees and
dealing in such art in a manner similar to a commer-
cial art gallery. The size and scope of the excess bene-
fit transactions collectively are significant in relation
to the size and scope of any of O’s ongoing activities
that further exempt purposes. O has been involved
in multiple excess benefit transactions, namely, pur-
chases of art from its trustees at more than fair mar-
ket value. O has not implemented safeguards that
are reasonably calculated to prevent such improper
purchases in the future. The excess benefit transac-
tions have not been corrected, nor has O made good
faith efforts to seek correction from the disqualified
persons who benefited from the excess benefit trans-
actions (the trustees). The trustees continue to con-
trol O’s Board. Based on the application of the fac-
tors to these facts, O is no longer described in section
501(c)(3) effective in Year 3.
Example 2. (i)ThefactsarethesameasinEx-
ample 1, except that in Year 4, O’s entire board of
trustees resigns, and O no longer offers all exhibited
art for sale. The former board is replaced with mem-
bers of the community who are not in the business of
buying or selling art and who have skills and expe-
rience running charitable and educational programs
and institutions. O promptly discontinues the prac-
tice of purchasing art from current or former trustees,
adopts a written conflicts of interest policy, adopts
written art valuation guidelines, hires legal counsel
to recover the excess amounts O had paid its former
trustees, and implements a new program of activities
to further the public’s appreciation of the arts.
(ii) O’s purchases of art from its former trustees
at more than fair market value constitute excess ben-
efit transactions between an applicable tax-exempt
organization and disqualified persons under section
4958. Therefore, these transactions are subject to
the applicable excise taxes provided in that section.
In addition, O’s purchases of art from its trustees at
more than fair market value violate the proscription
against inurement under section 501(c)(3) and para-
graph (c)(2) of this section.
(iii) The application of the factors in paragraph
(f)(2)(ii) of this section to these facts is as follows. In
Year 3, O does not engage primarily in regular and on-
going activities that further exempt purposes. How-
ever, in Year 4, O elects a new board of trustees com-
prised of individuals who have skills and experience
running charitable and educational programs and im-
plements a new program of activities to further the
public’s appreciation of the arts. As a result of these
actions, beginning in Year 4, O engages in regular
and ongoing activities that further exempt purposes.
The size and scope of the excess benefit transactions
that occurred in Year 3, taken collectively, are sig-
nificant in relation to the size and scope of O’s regu-
lar and ongoing exempt function activities that were
conducted in Year 3. Beginning in Year 4, however,
as O’s exempt function activities grow, the size and
scope of the excess benefit transactions that occurred
in Year 3 become less and less significant as com-
pared to the size and scope of O’s regular and ongoing
exempt function activities. O was involved in multi-
ple excess benefit transactions in Year 3. However,
by discontinuing its practice of purchasing art from
its current and former trustees, by replacing its former
board with independent members of the community,
and by adopting a conflicts of interest policy and art
valuation guidelines, O has implemented safeguards
that are reasonably calculated to prevent future vio-
lations. In addition, O has made a good faith effort
to seek correction from the disqualified persons who
benefited from the excess benefit transactions (its for-
mer trustees). Based on the application of the factors
to these facts, O continues to meet the requirements
for tax exemption under section 501(c)(3).
Example 3. (i) O conducts educational programs
for the benefit of the general public. Since its forma-
tion, O has employed its founder, C, as its Chief Exec-
utive Officer. Beginning in Year 5 of O’s operations
and continuing to the present, C caused O to divert
significant portions of O’s funds to pay C’s personal
expenses. The diversions by C significantly reduced
the funds available to conduct O’s ongoing educa-
tional programs. The board of trustees never autho-
rized C to cause O to pay C’s personal expenses from
O’s funds. Certain members of the board were aware
that O was paying C’s personal expenses. However,
the board did not terminate C’s employment and did
not take any action to seek repayment from C or to
prevent C from continuing to divert O’s funds to pay
C’s personal expenses. C claimed that O’s payments
of C’s personal expenses represented loans from O to
C. However, no contemporaneous loan documenta-
tion exists, and C never made any payments of prin-
cipal or interest.
(ii)ThediversionsofO’sfundstopayC’sper-
sonal expenses constitute excess benefit transactions
between an applicable tax-exempt organization and
a disqualified person under section 4958. Therefore,
these transactions are subject to the applicable excise
taxes provided in that section. In addition, these
transactions violate the proscription against inure-
ment under section 501(c)(3) and paragraph (c)(2) of
this section.
(iii) The application of the factors in paragraph
(f)(2)(ii) of this section to these facts is as follows. O
has engaged in regular and ongoing activities that fur-
ther exempt purposes both before and after the excess
benefit transactions occurred. However, the size and
scope of the excess benefittransactions engaged in
by O beginning in Year 5, collectively, are significant
in relation to the size and scope of O’s activities that
further exempt purposes. Moreover, O has been in-
volved in multiple excess benefit transactions. O has
not implemented any safeguards that are reasonably
calculated to prevent future diversions. The excess
benefit transactions have not been corrected, nor has
O made good faith efforts to seek correction from C,
the disqualified person who benefited from the excess
benefit transactions. Based on the application of the
factors to these facts, O is no longer described in sec-
tion 501(c)(3) effective in Year 5.
Example 4. (i) O conducts activities that further
exempt purposes. O uses several buildings in the con-
duct of its exempt activities. In Year 1, O sold one
of the buildings to Company K for an amount that
was substantially below fair market value. The sale
was a significant event in relation to O’s other ac-
tivities. C, O’s Chief Executive Officer, owns all of
the voting stock of Company K. When O’s board of
trustees approved the transaction with Company K,
the board did not perform due diligence that could
have made it aware that the price paid by Company K
to acquire the building was below fair market value.
Subsequently, but before the IRS commences an ex-
amination of O, O’s board of trustees determines that
May 5, 20088592008–18 I.R.B.

Company K paid less than the fair market value for
the building. Thus, O concludes that an excess ben-
efit transaction occurred. After the board makes this
determination, it promptly removes C as Chief Ex-
ecutive Officer, terminates C’s employment with O,
and hires legal counsel to recover the excess benefit
from Company K. In addition, O promptly adopts a
conflicts of interest policy and new contract review
procedures designed to prevent future recurrences of
this problem.
(ii) The sale of the building by O to Company K
at less than fair market value constitutes an excess
benefit transaction between an applicable tax-exempt
organization and a disqualified person under section
4958 in Year 1. Therefore, this transaction is subject
to the applicable excise taxes provided in that section.
In addition, this transaction violates the proscription
against inurement under section 501(c)(3) and para-
graph (c)(2) of this section.
(iii) The application of the factors in paragraph
(f)(2)(ii) of this section to these facts is as follows.
O has engaged in regular and ongoing activities that
further exempt purposes both before and after the ex-
cess benefit transaction occurred. Although the size
and scope of the excess benefit transaction were sig-
nificant in relation to the size and scope of O’s activi-
ties that further exempt purposes, the transaction with
Company K was a one-time occurrence. By adopting
a conflicts of interest policy and new contract review
procedures and by terminating C, O has implemented
safeguards that are reasonably calculated to prevent
future violations. Moreover, O took corrective ac-
tions before the IRS commenced an examination of
O. In addition, O has made a good faith effort to seek
correction from Company K, the disqualified person
who benefited from the excess benefit transaction.
Based on the application of the factors to these facts,
O continues to be described in section 501(c)(3).
Example 5. (i) O is a large organization with
substantial assets and revenues. O conducts activities
that further its exempt purposes. O employs C as
its Chief Financial Officer. During Year 1, O pays
$2,500 of C’s personal expenses. O does not make
these payments pursuant to an accountable plan, as
described in §53.4958–4(a)(4)(ii). In addition, O
does not report any of these payments on C’s Form
W–2, “Wage and Tax Statement,” or on a Form
1099–MISC, “Miscellaneous Income,”forCforYear
1, and O does not report these payments as com-
pensation on its Form 990, “Return of Organization
Exempt From Income Tax,” for Year 1. Moreover,
none of these payments can be disregarded as non-
taxable fringe benefits under §53.4958–4(c)(2) and
none consisted of fixed payments under an initial
contract under §53.4958–4(a)(3). C does not report
the $2,500 of payments as income on his individual
Federal income tax return for Year 1. O does not
repeat this reporting omission in subsequent years
and, instead, reports all payments of C’s personal
expenses not made under an accountable plan as
income to C.
(ii) O’s payment in Year 1 of $2,500 of C’s per-
sonal expenses constitutes an excess benefit trans-
action between an applicable tax-exempt organiza-
tion and a disqualified person under section 4958.
Therefore, this transaction is subject to the applica-
ble excise taxes provided in that section. In addition,
this transaction violates the proscription against in-
urement in section 501(c)(3) and paragraph (c)(2) of
this section.
(iii) The application of the factors in paragraph
(f)(2)(ii) of this section to these facts is as follows.
O engages in regular and ongoing activities that fur-
ther exempt purposes. The payment of $2,500 of C’s
personal expenses represented only ade minimispor-
tion of O’s assets and revenues; thus, the size and
scope of the excess benefit transaction were not sig-
nificant in relation to the size and scope of O’s ac-
tivities that further exempt purposes. The reporting
omission that resulted in the excess benefit transac-
tion in Year 1 occurred onlyonce and is not repeated
in subsequent years. Based on the application of the
factors to these facts, O continues to be described in
section 501(c)(3).
Example 6.(i) O is a large organization with
substantial assets and revenues. O furthers its ex-
empt purposes by providing social services to the
population of a specific geographic area. O has a
sizeable workforce of employees and volunteers to
conduct its work. In Year 1, O’s board of directors
adopted written procedures for setting executive
compensation at O. O’s executive compensation
procedures were modeled on the procedures for
establishing a rebuttable presumption of reasonable-
ness under §53.4958–6. In accordance with these
procedures, the board appointed a compensation
committee to gather data on compensation levels
paid by similarly situated organizations for func-
tionally comparable positions. The members of the
compensation committee were disinterested within
the meaning of §53.4958–6(c)(1)(iii). Based on its
research, the compensation committee recommended
a range of reasonable compensation for several of
O’s existing top executives (the Top Executives).
On the basis of the committee’s recommendations,
the board approved new compensation packages
for the Top Executives and timely documented the
basis for its decision in board minutes. The board
members were all disinterested within the meaning
of §53.4958–6(c)(1)(iii). The Top Executives were
not involved in setting their own compensation. In
Year 1, even though payroll expenses represented a
significant portion of O’s total operating expenses,
the total compensation paid to O’s Top Executives
represented only an insubstantial portion of O’s total
payroll expenses. During a subsequent examination,
the IRS found that the compensation committee
relied exclusively on compensation data from or-
ganizations that perform similar social services to
O. The IRS concluded, however, that the organi-
zations were not similarly situated because they
served substantially larger geographic regions with
more diverse populations and were larger than O
in terms of annual revenues, total operating budget,
number of employees, and number of beneficiaries
served. Accordingly, the IRS concluded that the
compensation committee did not rely on “appropri-
ate data as to comparability” within the meaning
of §53.4958–6(c)(2) and, thus, failed to establish
the rebuttable presumption of reasonableness under
§53.4958–6. Taking O’s size and the nature of the
geographic area and population it serves into ac-
count, the IRS concluded that the Top Executives’
compensation packages for Year 1 were excessive.
As a result of the examination, O’s board added new
members to the compensation committee who have
expertise in compensation matters and also amended
its written procedures to require the compensation
committee to evaluate a number of specific factors,
including size, geographic area, and population
covered by the organization, in assessing the compa-
rability of compensation data. O’s board renegotiated
the Top Executives’ contracts in accordance with the
recommendations of the newly constituted compen-
sation committee on a going forward basis. To avoid
potential liability for damages under state contract
law, O did not seek to void the Top Executives’
employment contracts retroactively to Year 1 and did
not seek correction of the excess benefit amounts
from the Top Executives. O did not terminate any of
the Top Executives.
(ii) O’s payments of excessive compensation to
the Top Executives in Year 1 constituted excess ben-
efit transactions between an applicable tax-exempt
organization and disqualified persons under section
4958. Therefore, these payments are subject to the
applicable excise taxes provided under that section,
including second-tier taxesif there is no correction by
the disqualified persons. In addition, these payments
violate the proscription against inurement under sec-
tion 501(c)(3) and paragraph (c)(2) of this section.
(iii) The application of the factors in paragraph
(f)(2)(ii) of this section to these facts is as follows. O
has engaged in regular and ongoing activities that fur-
ther exempt purposes both before and after the excess
benefit transactions occurred. The size and scope of
the excess benefit transactions, in the aggregate, were
not significant in relation to the size and scope of
O’s activities that further exempt purposes. O en-
gaged in multiple excess benefit transactions. Nev-
ertheless, prior to entering into these excess benefit
transactions, O had implemented written procedures
for setting the compensation of its top management
that were reasonably calculated to prevent the occur-
rence of excess benefit transactions. O followed these
written procedures in setting the compensation of the
Top Executives for Year 1. Despite the board’s fail-
ure to rely on appropriate comparability data, the fact
that O implemented and followed these written pro-
cedures in setting the compensation of the Top Execu-
tives for Year 1 is a factor favoring continued exemp-
tion. The fact that O amended its written procedures
to ensure the use of appropriate comparability data
and renegotiated the Top Executives’ compensation
packages on a going forward basis are also factors fa-
voring continued exemption, even though O did not
void the Top Executives’ existing contracts and did
not seek correction from the Top Executives. Based
on the application of the factors to these facts, O con-
tinues to be described in section 501(c)(3).
(3)Applicability. The rules in para-
graph (f) of this section will apply with re-
spect to excess benefit transactions occur-
ring after March 28, 2008.
*****
PART 53—FOUNDATION AND
SIMILAR EXCISE TAXES
Par. 3. The authority citation for part
53 continues to read, in part, as follows:
2008–18 I.R.B.860May 5, 2008

Authority: 26 U.S.C. 7805 * * *
Par. 4. In §53.4958–2, paragraph (a)(6)
is added to read as follows:
§53.4958–2 Definition of applicable
tax-exempt organization.
(a) * * *
(6)Examples. The following exam-
ples illustrate the principles of this section,
which defines an applicable tax-exempt or-
ganization for purposes of section 4958:
Example 1. O is a nonprofit corporation formed
under state law. O filed its application for recognition
of exemption under section 501(c)(3) within the time
prescribed under section 508(a). In its application,
O described its plans for purchasing property from
some of its directors at prices that would exceed fair
market value. After reviewing the application, the
IRS determined that because of the proposed prop-
erty purchase transactions, O failed to establish that
it met the requirements for an organization described
in section 501(c)(3). Accordingly, the IRS denied
O’s application. While O’s application was pending,
O engaged in the purchase transactions described in
its application at prices that exceeded the fair mar-
ket values of the properties. Although these transac-
tions would constitute excess benefit transactions un-
der section 4958, because the IRS never recognized
O as an organization described in section 501(c)(3),
O was never an applicable tax-exempt organization
under section 4958. Therefore, these transactions are
not subject to the excise taxes provided in section
4958.
Example 2. O is a nonprofit corporation formed
under state law. O files its application for recogni-
tion of exemption under section 501(c)(3) within the
time prescribed under section 508(a). The IRS is-
sues a favorable determination letter in Year 1 that
recognizes O as an organization described in section
501(c)(3). Subsequently, in Year 5 of O’s operations,
O engages in certain transactions that constitute ex-
cess benefit transactions under section 4958 and vio-
late the proscription against inurement under section
501(c)(3) and §1.501(c)(3)–1(c)(2). The IRS exam-
ines the Form 990, “Return of Organization Exempt
From Income Tax”, that O filed for Year 5. After con-
sidering all the relevant facts and circumstances in ac-
cordance with §1.501(c)(3)–1(f), the IRS concludes
that O is no longer described in section 501(c)(3) ef-
fective in Year 5. The IRS does not examine the
Forms 990 that O filed for its first four years of op-
erations and, accordingly, does not revoke O’s ex-
empt status for those years. Although O’s tax-ex-
empt status is revoked effective in Year 5, under the
lookbackrules in paragraph (a)(1) of this section and
§53.4958–3(a)(1) of this chapter, during the five-year
period prior to the excess benefit transactions that oc-
curred in Year 5, O was an applicable tax-exempt or-
ganization and O’s directors were disqualified per-
sons as to O. Therefore, the transactions between O
and its directors during Year 5 are subject to the ap-
plicable excise taxes provided in section 4958.
*****
Linda E. Stiff,
Deputy Commissioner for
Services and Enforcement.
Approved March 19, 2008.
Eric Solomon,
Assistant Secretary of
the Treasury (Tax Policy).
(Filed by the Office of the Federal Register on March 27,
2008, 8:45 a.m., and published in the issue of the Federal
Register for March 28, 2008, 73 F.R. 16519)
Section 642.—Special
Rules for Credits and
Deductions
Federal short-term, mid-term, and long-term rates
are set forth for the month of May 2008. See Rev.
Rul. 2008-24, page 861.
Section 807.—Rules for
Certain Reserves
The adjusted applicable federal short-term, mid-
term, and long-term rates are set forth for the month
of May 2008. See Rev. Rul. 2008-24, page 861.
Section 846.—Discounted
Unpaid Losses Defined
The adjusted applicable federal short-term, mid-
term, and long-term rates are set forth for the month
of May 2008. See Rev. Rul. 2008-24, page 861.
Section 1274.—Determi-
nation of Issue Price in the
Case of Certain Debt Instru-
ments Issued for Property
(Also Sections 42, 280G, 382, 412, 467, 468, 482,
483, 642, 807, 846, 1288, 7520, 7872.)
Federal rates; adjusted federal rates;
adjusted federal long-term rate and the
long-term exempt rate.For purposes of
sections 382, 642, 1274, 1288, and other
sections of the Code, tables set forth the
rates for May 2008.
Rev. Rul. 2008–24
This revenue ruling provides vari-
ous prescribed rates for federal income
tax purposes for May 2008 (the current
month). Table 1 contains the short-term,
mid-term, and long-term applicable fed-
eral rates (AFR) for the current month
for purposes of section 1274(d) of the
Internal Revenue Code. Table 2 contains
the short-term, mid-term, and long-term
adjusted applicable federal rates (adjusted
AFR) for the current month for purposes
of section 1288(b). Table 3 sets forth the
adjusted federal long-term rate and the
long-term tax-exempt rate described in
section 382(f). Table 4 contains the ap-
propriate percentages for determining the
low-income housing credit described in
section 42(b)(2) for buildings placed in
service during the current month. Finally,
Table 5 contains the federal rate for deter-
mining the present value of an annuity, an
interest for life or for a term of years, or
a remainder or a reversionary interest for
purposes of section 7520.
May 5, 20088612008–18 I.R.B.

REV. RUL. 2008–24 TABLE 1
Applicable Federal Rates (AFR) for May 2008
Period for Compounding
AnnualSemiannualQuarterlyMonthly
Short-term
AFR1.64%1.63%1.63%1.62%
110% AFR1.80%1.79%1.79%1.78%
120% AFR1.97%1.96%1.96%
1.95%
130% AFR2.13%2.12%2.11%2.11%
Mid-term
AFR2.74%2.72%2.71%2.70%
110% AFR3.01%2.99%2.98%2.97%
120% AFR3.29%3.26%
3.25%
3.24%
130% AFR
3.57%3.54%3.52%3.51%
150% AFR
4.12%4.08%4.06%
4.05%
175% AFR
4.82%4.76%4.73%4.71%
Long-term
AFR4.21%4.17%
4.15%
4.13%
110% AFR4.64%
4.59%4.56%4.55%
120% AFR
5.06%5.00%
4.97%
4.95%
130% AFR
5.49%5.42%5.38%5.36%
REV. RUL. 2008–24 TABLE 2
Adjusted AFR for May 2008
Period for Compounding
AnnualSemiannualQuarterlyMonthly
Short-ter
madjusted
AFR
2.07%2.06%
2.05%2.05%
Mid-term adjusted AFR3.17%
3.15%
3.14%3.13%
Long-term adjusted
AFR
4.71%4.66%4.63%4.62%
REV. RUL.
2008–24 TABLE 3
Rates Under Section 382 for May 2008
Adjusted federal long-term rate for the current month4.71%
Long-term tax-exempt rate for ownership changes during the current month (the highest of the adjusted
federal long-term rates for the current month and the prior two months.)4.71%
REV. RUL. 2008–24 TABLE 4
Appropriate Percentages Under Section 42(b)(2) for May 2008
Appropriate percentage for the 70% present value low-income housing credit7.80%
Appropriate percentage for the 30% present value low-income housing credit3.34%
2008–18 I.R.B.862May 5, 2008

REV. RUL. 2008–24 TABLE 5
Rate Under Section 7520 for May 2008
Applicable federal rate for determining the present value of an annuity, an interest for life or a term of years,
or a remainder or reversionary interest3.2%
Section 1288.—Treatment
of Original Issue Discount
on Tax-Exempt Obligations
The adjusted applicable federal short-term, mid-
term, and long-term rates are set forth for the month
of May 2008. See Rev. Rul. 2008-24, page 861.
Section 6103.—Confi-
dentiality and Disclosure
of Returns and Return
Information
26 CFR 301.6103(n)–2T: Disclosure of return infor-
mation in connection with written contracts among
the IRS, whistleblowers, and legal representatives of
whistleblowers (temporary).
T.D. 9389
DEPARTMENT OF THE
TREASURY
Internal Revenue Service
26 CFR Part 301
Disclosure of Return
InformationinConnection
With Written Contracts Among
the IRS, Whistleblowers, and
Legal Representatives of
Whistleblowers
AGENCY: Internal Revenue Service
(IRS), Treasury.
ACTION: Temporary regulations.
SUMMARY: This document contains tem-
porary regulations relating to the disclo-
sure of return information, pursuant to sec-
tion 6103(n) of the Internal Revenue Code
(Code), by an officer or employee of the
Treasury Department, to a whistleblower
and, if applicable, the legal representative
of the whistleblower, to the extent nec-
essary in connection with a written con-
tract among the IRS, the whistleblower
and, if applicable, the legal representative
of the whistleblower, for services relat-
ing to the detection of violations of the
internal revenue laws or related statutes.
The temporary regulations will affect of-
ficers and employees of the Treasury De-
partment who disclose return information
to whistleblowers, or their legal represen-
tatives, in connection with written con-
tracts among the IRS, whistleblowers and,
if applicable, their legal representatives,
for services relating to the detection of vi-
olations of the internal revenue laws or re-
lated statutes. The temporary regulations
will also affect any whistleblower, or le-
gal representative of a whistleblower, who
receives return information in connection
with a written contract among the IRS, the
whistleblower and, if applicable, the le-
gal representative of the whistleblower, for
services relating to the detection of viola-
tions of the internal revenue laws or related
statutes. The text of the temporary regula-
tions also serves as the text of the proposed
regulations (REG–114942–07) set forth in
the notice of proposed rulemaking on this
subject in this issue of the Bulletin.
DATES:Effective Date:These temporary
regulations are effective on March 25,
2008.
Applicability Date:For dates of appli-
cability, see §301.6103(n)–2T(f).
FOR FURTHER INFORMATION
CONTACT: Helene R. Newsome,
202–622–7950 (not a toll-free number).
SUPPLEMENTARY INFORMATION:
Background
This document contains amendments to
the Procedure and Administration Regu-
lations (26 CFR part 301) under section
6103(n) relating to the disclosure of re-
turn information in connection with writ-
ten contracts among the IRS, whistleblow-
ers and, if applicable, their legal represen-
tatives.
The Tax Relief and Health Care Act
of 2006, Public Law 109–432 (120 Stat.
2958), (the Act) was enacted on December
20, 2006. Section 406 of the Act amends
section 7623, concerning the payment of
awards to whistleblowers, and establishes
a Whistleblower Office within the IRS
that has responsibility for the adminis-
tration of a whistleblower program. The
Whistleblower Office, in connection with
administering a whistleblower program,
will analyze information provided by a
whistleblower, and either investigate the
matter itself or assign it to the appropriate
IRS office for investigation. In analyzing
information provided by a whistleblower,
or investigating a matter, the Whistle-
blower Office may determine that it re-
quires the assistance of the whistleblower,
or the legal representative of the whistle-
blower. The legislative history of section
406 of the Act states that “[t]o the extent
the disclosure of returns or return infor-
mationisrequired[forthewhistleblower
or his or her legal representative] to ren-
der such assistance, the disclosure must
be pursuant to an IRS tax administration
contract.” Joint Committee on Taxation,
Technical Explanation of H.R. 6408, The
“Tax Relief and Health Care Act of 2006,”
as Introduced in the House on December
7, 2006, at 89 (JCX–50–06), December 7,
2006. The legislative history further states
that “[i]t is expected that such disclosures
will be infrequent and will be made only
when the assigned task cannot be properly
or timely completed without the return
information to be disclosed.”Id.
Under section 6103(a), returns and re-
turn information are confidential unless
the Internal Revenue Code (Code) au-
thorizes disclosure. Section 6103(n) is
the authority by which returns and return
information may be disclosed pursuant
to a tax administration contract. Section
6103(n) authorizes, pursuant to regula-
tions prescribed by the Secretary, returns
and return information to be disclosed
to any person, including any person de-
scribedinsection7513(a),forpurposesof
tax administration, to the extent necessary
in connection with: (1) the processing,
storage, transmission, and reproduction
of returns and return information; (2) the
May 5, 20088632008–18 I.R.B.

programming, maintenance, repair, test-
ing, and procurement of equipment; and
(3) the providing of other services. These
temporary regulations describe the cir-
cumstances, pursuant to section 6103(n),
under which officers and employees of
the Treasury Department may disclose
return information to whistleblowers and,
if applicable, their legal representatives,
in connection with written contracts for
services relating to the detection of vi-
olations of the internal revenue laws or
related statutes.
Explanation of Provisions
General Rule
The temporary regulations, at
§301.6103(n)–2T(a)(1), provide that an
officer or employee of the Treasury
Department may, pursuant to sections
6103(n) and 7623, disclose return informa-
tion to a whistleblower and, if applicable,
the legal representative of the whistle-
blower, to the extent necessary in connec-
tion with a written contract among the IRS,
the whistleblower and, if applicable, the
legal representative of the whistleblower,
for services relating to the detection of
violations of the internal revenue laws or
related statutes. If a whistleblower has
retained the services of a legal representa-
tive, then, in addition to the whistleblower,
the whistleblower’s legal representative
must be a party to the written contract with
the IRS. These temporary regulations do
not provide for the disclosure of returns to
whistleblowers or their legal representa-
tives.
The temporary regulations, at
§301.6103(n)–2T(a)(2), provide that the
Commissioner has the discretion to de-
termine whether to enter into a written
contract with the whistleblower and, if
applicable, the legal representative of the
whistleblower, for services as described in
§301.6103(n)–2T(a)(1). The IRS expects
to enter into these contracts only infre-
quently, and any contract that is entered
into, and any disclosures made pursuant
to this type of contract, will be carefully
tailored to the specific facts of the case.
Limitations
The temporary regulations, at
§301.6103(n)–2T(b)(1), set forth the
condition that the disclosure of return
informationinconnectionwithawrit-
ten contract for services described in
§301.6103(n)–2T(a)(1) may be made only
to the extent the IRS deems it necessary in
connection with the reasonable or proper
performance of the contract. In this re-
gard, disclosures should relate to relevant
taxable years and types of tax. The tempo-
rary regulations, at §301.6103–2T(b)(2),
set forth the additional condition that if
the IRS determines that the services of
a whistleblower and, if applicable, the
legal representative of the whistleblower
as described in §301.6103(n)–2T(a)(1)
can be performed reasonably or properly
by disclosure of only parts or portions of
return information, then only the parts or
portions of the return information are to
be disclosed.
The temporary regulations, at
§301.6103(n)–2T(b)(3), provide that,
upon written request by a whistleblower,
or a legal representative of a whistle-
blower, with whom the IRS has entered
into a written contract for services as
described in §301.6103(n)–2T(a)(1), the
Director of the Whistleblower Office, or
designee of the Director, may inform the
whistleblower and, if applicable, the le-
gal representative of the whistleblower,
of the status of the whistleblower’s claim
for award under section 7623, including
whether the claim is being evaluated for
potential investigative action, or is pend-
ing due to an ongoing examination, appeal,
collection action, or litigation. This in-
formationmaybedisclosedonlyifthe
Commissioner determines that the disclo-
sure would not seriously impair Federal
tax administration.
The temporary regulations, at
§301.6103(n)–2T(b)(4), impose the con-
dition that return information disclosed
to a whistleblower and, if applicable, a
legal representative of a whistleblower,
may not be disclosed or otherwise used by
the whistleblower or a legal representative
of a whistleblower, except as expressly
authorized by the IRS.
Penalties
The temporary regulations, at
§301.6103(n)–2T(c), set forth the civil
and criminal penalties to which whistle-
blowers and their legal representatives are
subject for unauthorized inspection or dis-
closure of return information by operation
of sections 7431(a)(2), 7213(a)(1), and
7213A(a)(1)(B).
Safeguards
The temporary regulations, at
§301.6103(n)–2T(d)(1), provide that
whistleblowers and their legal representa-
tives who receive return information under
these regulations must comply with all
applicable conditionsand requirements as
the IRS may prescribe from time to time
(prescribed requirements) for the purposes
of protecting the confidentiality of the
return information and preventing unau-
thorized disclosures and inspections of
the return information (e.g.,requirements
pertaining to computer security, physical
security of return information, methods of
destruction of return information).
The temporary regulations, at
§301.6103(n)–2T(d)(2), provide that any
written contract for services as described
in §301.6103(n)–2T(a)(1) must provide
that any whistleblowerand, if applicable,
the legal representative of a whistleblower,
who has access to return information un-
der these regulations shall comply with
the prescribed requirements.
The temporary regulations, at
§301.6103(n)–2T(d)(3), impose the re-
quirement that whistleblowers, and their
legal representatives who receive return
information under these regulations, must
agree in writing, before any disclosure
of return information is made, to permit
an inspection of their premises by the
IRS relative to the maintenance of the re-
turn information disclosed to them under
these regulations and, upon completion
of services as described in the written
contract with the IRS, to dispose of all
return information by returning the return
information, including any and all copies
or notes made, to the IRS, or to the extent
that it cannot be returned, by destroying
the information in a manner consistent
with security guidelines and other safe-
guards for protecting return information in
guidance published by the IRS.
The temporary regulations, at
§301.6103(n)–2T(d)(4), provide that if the
IRS determines that any whistleblower, or
the legal representative of a whistleblower,
who has access to return information un-
der these regulations, has failed to, or does
not, satisfy the prescribed requirements,
the IRS, using the procedures described in
2008–18 I.R.B.864May 5, 2008

the regulations under section 6103(p)(7),
may take any action it deems necessary
to ensure that the prescribed requirements
are or will be satisfied.
Special Analyses
It has been determined that this Trea-
sury decision is not a significant regula-
tory action as defined in Executive Order
12866. Therefore, a regulatory assessment
is not required. It also has been deter-
mined that section 553(b) of the Admin-
istrative Procedure Act (5 U.S.C. chapter
5) does not apply to these regulations. For
the applicability of the Regulatory Flexi-
bility Act (5 U.S.C. chapter 6) refer to the
Special Analyses section of the preamble
to the cross-reference notice of proposed
rulemaking published in this issue of the
Bulletin. Pursuant to section 7805(f) of
the Code, these regulations have been sub-
mitted to the Chief Counsel for Advocacy
of the Small BusinessAdministration for
comment on its impact on small business.
Drafting Information
The principal author of these regula-
tions is Helene R. Newsome, Office of
the Associate Chief Counsel (Procedure &
Administration).
*****
Amendments to the Regulations
Accordingly, 26 CFR part 301 is
amended as follows:
PART 301—PROCEDURE AND
ADMINISTRATION
Paragraph 1. The authority citation for
part 301 is amended by adding an entry in
numerical order to read as follows:
Authority: 26 U.S.C. 7805 * * *
Section 301.6103(n)–2T also issued un-
der 26 U.S.C. 6103(n); * * *
Par. 2. Section 301.6103(n)–2T is
added to read as follows:
§301.6103(n)–2T Disclosure of
return information in connection with
written contracts among the IRS,
whistleblowers, and legal representatives
of whistleblowers (temporary).
(a)General rule. (1) Pursuant to the
provisions of sections 6103(n) and 7623
of the Internal Revenue Code and subject
to the conditions of this section, an offi-
cer or employee of the Treasury Depart-
ment is authorized to disclose return infor-
mation (as defined in section 6103(b)(2))
to a whistleblower and, if applicable, the
legal representative of the whistleblower,
to the extent necessary in connection with
a written contract among the Internal Rev-
enue Service (IRS), the whistleblower and,
if applicable, the legal representative of the
whistleblower, for services relating to the
detection of violations of the internal rev-
enue laws or related statutes.
(2) The Commissioner shall have the
discretion to determine whether to enter
into a written contract pursuant to section
7623 with the whistleblower and, if ap-
plicable, the legal representative of the
whistleblower for services described in
paragraph (a)(1) of this section.
(b)Limitations. (1) Disclosure of re-
turn information in connection with a writ-
ten contract for services described in para-
graph (a)(1) of this section shall be made
only to the extent the IRS deems it neces-
sary in connection with the reasonable or
proper performance of the contract. Dis-
closures may include, but are not limited
to, disclosures to accomplish properly any
purpose or activity of the nature described
in section 6103(k)(6) and the regulations
thereunder.
(2)IftheIRSdeterminesthattheser-
vices of a whistleblower and, if applica-
ble, the legal representative of the whistle-
blower, as described in paragraph (a)(1) of
this section can be performed reasonably
or properly by disclosure of only parts or
portions of return information, then only
the parts or portions of the return informa-
tion shall be disclosed.
(3) Upon written request by a whistle-
blower, or a legal representative of a
whistleblower, with whom the IRS has
entered into a written contract for ser-
vices as described in paragraph (a)(1) of
this section, the Director of the Whistle-
blower Office, or designee of the Director,
may inform the whistleblower and, if ap-
plicable, the legal representative of the
whistleblower, of the status of the whistle-
blower’s claim for award under section
7623, including whether the claim is be-
ing evaluated for potential investigative
action, or is pending due to an ongoing ex-
amination, appeal, collection action, or lit-
igation. The information may be disclosed
only if the Commissioner determines that
the disclosure would not seriously impair
Federal tax administration.
(4) Return information disclosed to a
whistleblower and, if applicable, a legal
representative of a whistleblower, under
this section, shall not be disclosed or other-
wise used by the whistleblower or a legal
representative of a whistleblower, except
as expressly authorized in writing by the
Director of the Whistleblower Office.
(c)Penalties. Any whistleblower, or le-
gal representative of a whistleblower, who
receives return information under this sec-
tion, is subject to the civil and criminal
penalty provisions of sections 7431, 7213,
and 7213A for the unauthorized inspection
or disclosure of the return information.
(d)Safeguards. (1) Any whistleblower,
or the legal representative of a whistle-
blower, who receives return information
under this section, shall comply with all
applicable conditionsand requirements as
the IRS may prescribe from time to time
(prescribed requirements) for the purposes
of protecting the confidentiality of the re-
turn information and preventing any dis-
closure or inspection of the return informa-
tion in a manner not authorized by this sec-
tion.
(2) Any written contract for services as
described in paragraph (a)(1) of this sec-
tion shall provide that any whistleblower
and, if applicable, the legal representative
of a whistleblower, who has access to re-
turn information under this section, shall
comply with the prescribed requirements.
(3) Any whistleblower, or the legal rep-
resentative of a whistleblower, who may
receive return information under this sec-
tion, shall agree in writing, before any dis-
closure of return information is made, to
permit an inspection of his or her premises
by the IRS relative to the maintenance
of the return information disclosed under
these regulations and, upon completion of
services as described in the written con-
tract with the IRS, to dispose of all re-
turn information by returning the return in-
formation, including any and all copies or
notes made, to the IRS, or to the extent that
it cannot be returned, by destroying the in-
formation in a manner consistent with se-
curity guidelines and other safeguards for
protecting return information in guidance
published by the IRS.
(4)IftheIRSdeterminesthatany
whistleblower, or the legal representa-
tive of a whistleblower, who has access
May 5, 20088652008–18 I.R.B.

to return information under this section,
has failed to, or does not, satisfy the pre-
scribed requirements,theIRS,usingthe
procedures described in the regulations
under section 6103(p)(7), may take any
action it deems necessary to ensure that
the prescribed requirements are or will be
satisfied, including—
(i) Suspension of further disclosures
of return information by the IRS to the
whistleblower and, if applicable, the legal
representative of the whistleblower, until
the IRS determines that the conditions and
requirements have been or will be satis-
fied; and
(ii) Suspension or termination of any
duty or obligation arising under a contract
with the IRS.
(e)Definitions. For purposes of this
section—
(1) The termTreasury Departmentin-
cludes the IRS and the Office of the Chief
Counsel for the IRS.
(2) The termwhistleblowermeans an
individual who provides information to the
IRS regarding violations of the tax laws or
related statutes and submits a claim for an
award under section 7623 with respect to
the information.
(3) The termlegal representativemeans
any individual who is a member in good
standing in the bar of the highest court of
any state, possession, territory, common-
wealth, or the District of Columbia, and
who has a written power of attorney exe-
cutedbythewhistleblower.
(f)Effective/applicability date.This
section is applicable on March 25, 2008.
(g)Expiration date. This section will
expire on March 23, 2011.
Linda E. Stiff,
Deputy Commissioner for
Services and Enforcement.
Approved March 12, 2008.
Eric Solomon,
Assistant Secretary of
theTreasury(TaxPolicy).
(Filed by the Office of the Federal Register on March 24,
2008, 8:45 a.m., and published in the issue of the Federal
Register for March 25, 2008, 73 F.R. 15668)
Section 7520.—Valuation
Tables
The adjusted applicable federal short-term, mid-
term, and long-term rates are set forth for the month
of May 2008. See Rev. Rul. 2008-24, page 861.
Section 7872.—Treatment
of Loans With Below-Market
Interest Rates
The adjusted applicable federal short-term, mid-
term, and long-term rates are set forth for the month
of May 2008. See Rev. Rul. 2008-24, page 861.
2008–18 I.R.B.866May 5, 2008

Part II. Treaties and Tax Legislation
Subpart A.—Tax Conventions and Other Related Items
German Mutual Agreement
Procedure Arbitration
Announcement
Announcement 2008–39
Following is a copy of the announce-
ment posted by the LMSB Deputy Com-
missioner (International) on the Internal
Revenue Service LMSB Website on April
3, 2008.
1
Announcement Concerning Mutual
Agreement Procedure Arbitration
under the Recent Protocol Between
the United States and Germany
Background
On December 28, 2007, the Protocol
Amending the Convention Between the
United States and the Federal Republic
of Germany for the Avoidance of Dou-
ble Taxation and the Prevention of Fiscal
Evasion With Respect to Taxes on Income
and Capital and to Certain Other Taxes
(the 2006 Protocol) entered into force.
The 2006 Protocol modified certain pro-
visions of the Convention between the
United States and the Federal Republic
of Germany for the Avoidance of Dou-
ble Taxation and the Prevention of Fiscal
Evasion With Respect to Taxes on In-
come and Capital and to Certain Other
Taxes (the Convention). Among other
things, the 2006 Protocol revises Article
25 (Mutual Agreement Procedure) of the
Convention to provide for mandatory ar-
bitration of certain cases in the mutual
agreement procedure (MAP). The com-
petent authorities of the United States
and Germany are jointly developing pro-
cedures for implementing the arbitration
process. Information regarding the rele-
vant procedures will be incorporated into
a mutual agreement at a future date. This
Announcement provides interim guidance
concerning the “commencement date” for
MAP cases for purposes of the arbitration
process until a formal mutual agreement
is published.
Commencement date
New paragraph 6(c)(aa) of Article 25
of the Convention provides that arbitra-
tion proceedings generally shall begin two
years after the commencement date of a
MAP case. Under paragraph 4 of Article
XVII of the 2006 Protocol, the commence-
ment date for a MAP case that was already
under consideration by the competent au-
thorities as of December 28, 2007, shall be
December 28, 2007.
For requests for competent authority as-
sistance received on or after December 28,
2007, new paragraph 6(b) of Article 25
of the Convention provides that the com-
mencement date of such a MAP case is the
earliest date on which the information nec-
essary to undertake substantive considera-
tion for a mutual agreement has been re-
ceived by both competent authorities. For
purposes of a competent authority request
in the United States, the information nec-
essary to undertake substantive consider-
ation for a mutual agreement is the infor-
mation required to be submitted to the U.S.
competent authorityunder Revenue Proce-
dure 2006–54, Section 4.05. For purposes
of a competent authority request in Ger-
many, the information necessary to under-
take substantive consideration for a mu-
tual agreement is the information required
to be submitted to the German competent
authority under Memorandum IV B 6 – B
1300- 340/06. See paragraph 22(p) of Ar-
ticle XVI of the 2006 Protocol.
The competent authorities of the United
States and Germany agree that, within 45
days after receipt of a request for compe-
tent authority assistance, each competent
authority shall determine whether the tax-
payer’s request provides information nec-
essary to undertake substantive considera-
tion. The agreement will also provide that,
if the necessary information has been pro-
vided, then the relevant competent author-
ity will advise the taxpayer and the other
competent authority that the information
submitted with the taxpayer’s request is
sufficient to undertake substantive consid-
eration of the request.
If the necessary information is not
provided, the relevant competent author-
ity will inform the taxpayer and other
competent authority of what additional
information is needed. After the relevant
competent authority has determined that
it has the necessary information it will in-
form the taxpayer and the other competent
authority of its determination.
The agreement will also provide that the
competent authorities shall inform taxpay-
ers in writing of the commencement date
consistent with new paragraph 6(b) of Ar-
ticle 25 of the Convention.
A case initially submitted to the compe-
tent authorities as a request for an Advance
Pricing Agreement (APA) is eligible for ar-
bitration, but only to the extent tax returns
have been filed with respect to all taxable
years at issue. For purposes of establishing
a commencement date for cases initially
submitted as a request for an APA, para-
graph 22(p)(aa) of Article XVI of the 2006
Protocol provides that the information nec-
essary to undertake substantive considera-
tion for a mutual agreement is the informa-
tion required to be submitted to the Inter-
nal Revenue Service under Revenue Pro-
cedure 2006–9, section 4 (or any applica-
ble successor provisions). The competent
authorities agree that they will modify this
rule pursuant to paragraph 22(q) of Arti-
cle XVI of the 2006 Protocol to take into
account the procedures related to process-
ing APA requests. Such agreement will
indicate that the commencement date for
cases initially submitted as a request for
an APA shall be the earlier of, the date
the countries exchange position papers, or
two years from the date the taxpayer sub-
mits the information required by Revenue
Procedure 2006–9, section 4. The compe-
tent authorities shall inform the taxpayers
in writing of the commencement date.
1
http://www.irs.gov/businesses/international/article/0,,id=181003,00.html
May 5, 20088672008–18 I.R.B.

Part III. Administrative, Procedural, and Miscellaneous
Supplemental Guidance
Under the Preparer
Penalty Provisions of the
Small Business and Work
Opportunity Tax Act of 2007
Notice 2008–46
This notice provides guidance regard-
ingimplementationofthetaxreturnpre-
parer penalty provisions under section
6694 of the Internal Revenue Code, as
amended by the Small Business and Work
Opportunity Tax Act of 2007, Pub. L.
No. 110–28, 121 Stat. 190, by adding cer-
tain returns and documents supplementing
Exhibits 1, 2, and 3 of Notice 2008–13,
2008–3 I.R.B. 282.
A.Returns and Claims for Refund Subject
to 6694 Penalty
Notice 2008–13 describes categories of
returns and other documents to which sec-
tion 6694 could apply. Notice 2008–13
provides that, solely for purposes of sec-
tion 6694, a return or claim for refund in-
cludes the tax returns listed in Exhibit 1 or
a claim for refund with respect to any such
return. The notice further provides that a
person who for compensation prepares all
or a substantial portion of any of the tax
returns listed on Exhibit 1 is a tax return
preparer who is subject to section 6694.
Notice 2008–13 also provides that
solely for purposes of section 6694, an
information return or document listed on
Exhibit 2 that includesinformation that is
or may be reported on a taxpayer’s tax re-
turn or claim for refund is a return to which
section 6694 could apply if the information
reported constitutes asubstantial portion
of that taxpayer’s tax return or claim for
refund. A person who for compensation
prepares any of the information returns
or documents listed on Exhibit 2, which
return or document does not report a tax
liability but affects an entry or entries on
a tax return and constitutes a substantial
portion of the tax return or claim for re-
fund that does report a tax liability, is a tax
return preparer who is subject to section
6694.
Notice 2008–13 also provides that
solely for purposes of section 6694, a doc-
ument listed on Exhibit 3 that includes
information that is or may be reported on
a taxpayer’s tax return or claim for refund
(and that constitutes a substantial portion
of such tax return or claim for refund) will
not subject the preparer to a penalty under
section 6694(a). A document listed on Ex-
hibit 3, however, may subject the preparer
to a willful or reckless conduct penalty
under section 6694(b) if the information
reported on the document constitutes a
substantial portion of the tax return or
claim for refund and is prepared willfully
in any manner to understate the liability of
taxonataxreturnorclaimforrefund,or
in reckless or intentional disregard of rules
or regulations. A person who for compen-
sation prepares all or a substantial portion
of any of the documents listed on Exhibit
3 is not a tax return preparer subject to
section 6694(a) unless the document was
prepared willfullyin any manner to un-
derstate the liability of tax on a tax return
or claim for refund or in reckless or inten-
tional disregard of rules or regulations.
Notice 2008–13 also provides that the
Treasury Department and the Internal Rev-
enue Service may add or remove forms or
documents from any of the categories or
exhibits to Notice 2008–13 in future guid-
ance. Accordingly, the following returns
and documents are added to Exhibits 1, 2,
and 3 of Notice 2008–13:
Exhibit 1 — Tax Returns Reporting Tax Liability
(1) Form 1040–C,U.S. Departing Alien Income Tax Return;
(2) Form 1040NR,U.S. Nonresident Alien Income Tax Return;
(3) Form 1040NR–EZ,U.S. Income Tax Return for Certain Nonresident Aliens With No Dependents;
(4) Form 1041–N,U.S. Income Tax Return for Electing Alaska Native Settlement Trusts;
(5) Form 1041–QFT,U.S. Income Tax Return for Qualified Funeral Trusts;
(6) Form 1120–FSC,U.S. Income Tax Return of a Foreign Sales Corporation;
(7) Form 1120–H,U.S. Income Tax Return for Homeowners Associations;
(8) Form 1120–L,U.S. Life Insurance Company Income Tax Return;
(9) Form 1120–ND,Return for Nuclear Decommissioning Funds and Certain Related Persons;
(10) Form 1120–PC,U.S. Property and Casualty Insurance Company Income Tax Return;
(11) Form 1120–POL,U.S. Income Tax Return for Certain Political Organizations;
(12) Form 1120–REIT,U.S. Income Tax Return for Real Estate Investment Trusts;
(13) Form 1120–RIC,U.S. Income Tax Return for Regulated Investment Companies;
(14) Form 1120–SF,U.S. Income Tax Return for Settlement Funds (Under Section 468B);
(15) Form 1040–SS,U.S. Self-Employment Tax Return (Incuding the Additional Child Tax Credit for Bona Fide Residents of
Puerto Rico);
2008–18 I.R.B.868May 5, 2008

(16) Form 2438,Undistributed Capital Gains Tax Return;
(17) Form 8288,U.S. Withholding Tax Return for Dispositions by Foreign Persons of U.S. Real Property Interests;
(18) Form 8752,Required Payment or Refund Under Section 7519;and
(19) Form 8804,Annual Return for Partnership Withholding Tax (Section 1446).
Exhibit 2 — Information Returns That Report Information That is or May be Reported on Another Tax Return That
May Subject a Tax Return Preparer to the Section 6694(a) Penalty if the Information Reported Constitutes a Substantial
Portion of the Other Tax Return
(1) Form 3520,Annual Return To Report Transactions With Foreign Trusts and Receipt of Certain Foreign Gifts;
(2) Form 3520–A,Annual Information Return of Foreign Trust With a U.S. Owner (Under section 6048(b));
(3) Form 5471,Information Return of U.S. Persons With Respect To Certain Foreign Corporations;
(4) Form 5472,Information Return of a 25% Foreign-Owned U.S. Corporation or a Foreign Corporation Engaged in a U.S.
Trade or Business (Under Sections 6038A and 6038C of the Internal Revenue Code);
(5) Form 8805,Foreign Partner’s Information Statement of Section 1446 Withholding Tax;
(6) Form 8858,Information Return of U.S. Persons WithRespect To Foreign Disregarded Entities;and
(7) Form 8865,Return of U.S. Persons With Respect to Certain Foreign Partnerships.
Exhibit 3 — Forms That Would Not Subject a Tax Return Preparer to the Section 6694(a) Penalty Unless Prepared
Willfully in any Manner to Understate the Liability of Tax on a Return or Claim for Refund or in Reckless or Intentional
Disregard of Rules or Regulations
(1) Form 8288–A,Statement of Withholding on Dispositions by Foreign Persons of U.S. Real Property Interests;and
(2) Form 8288–B,Application for Withholding Certificate for Dispositions by Foreign Persons of U.S. Real Property Interests.
EFFECTIVE DATE
This notice is effective as of April 16,
2008.
EFFECT ON OTHER DOCUMENTS
Notice 2008–13, 2008–3 I.R.B. 282, is
supplemented.
CONTACT INFORMATION
The principal authors of this notice are
Matthew S. Cooper and Michael E. Hara
of the Office of Associate Chief Coun-
sel (Procedure and Administration). For
further information regarding this notice,
contact Mr. Cooper at (202) 622–4940 or
Mr. Hara at (202) 622–4910 (not toll-free
calls).
Public Comment Invited
on Recommendations for
2008–2009 Guidance Priority
List
Notice 2008–47
The Department of Treasury and Inter-
nal Revenue Service invite public com-
ment on recommendations for items that
should be included on the 2008–2009
Guidance Priority List.
The Treasury Department’s Office of
Tax Policy and the Service use the Guid-
ance Priority List each year to identify
and prioritize the tax issues that should
be addressed through regulations, revenue
rulings, revenue procedures, notices, and
other published administrative guidance.
The 2008–2009 Guidance Priority List
will establish the guidance that the Trea-
sury Department and the Service intend to
issue from July 1, 2008, through June 30,
2009. The Treasury Department and the
Service recognize the importance of pub-
lic input to formulate a Guidance Priority
List that focuses resources on guidance
items that are most important to taxpayers
and tax administration. Published guid-
ance plays an important role in increasing
voluntary compliance by helping to clarify
ambiguous areas of the tax law.
As is the case whenever significant
legislation is enacted, the Treasury De-
partment and the Service have continued
to dedicate substantial resources during
the current plan year to published guid-
ance projects necessary to implement the
provisions of the American Jobs Creation
Act of 2004, Pub. L. No. 108–357, 118
Stat. 1418, which was enacted on Oc-
tober 22, 2004; the Energy Policy Act
of 2005, Pub. L. No. 109–58, 119 Stat.
594, which was enacted on August 8,
2005; the Gulf Opportunity Zone Act of
2005, Pub. L. No. 109–135, 119 Stat.
2577, which was enacted on December
21, 2005; the Tax Increase Prevention
and Reconciliation Act of 2005, Pub. L.
No. 109–222, 120 Stat. 345, which was
enacted on May 17, 2006; the Pension
Protection Act of 2006, Pub. L. No.
109–280, 120 Stat. 780, which was
enacted on August 17, 2006; the Tax Relief
May 5, 20088692008–18 I.R.B.

and Health Care Act of 2006, Pub. L.
No. 109–432, 120 Stat. 2921, which
was enacted on December 20, 2006; the
Mortgage Forgiveness Debt Relief Act of
2007, Pub. L. No. 110–142, 121 Stat.
1803, which was enacted on December
20, 2007; and the Economic Stimulus
Act of 2008, Pub. L. No. 110–185, 122
Stat. 613, which was enacted on February
13, 2008. The Treasury Department and
the Service will continue to evaluate the
priority of each guidance project in light
of the above-mentioned tax legislation and
other developments occurring during the
2008–2009 plan year.
In reviewing recommendations and
selecting projects for inclusion on the
2008–2009 Guidance Priority List, the
Treasury Department and the Service will
consider the following:
1. Whether the recommended guidance
resolves significant issues relevant to
many taxpayers;
2. Whether the guidance may be appro-
priate for enhanced public involve-
ment through the process described in
Notice 2007–17, 2007–12 I.R.B. 748;
3. Whether the recommended guidance
promotes sound tax administration;
4. Whether the recommended guidance
can be drafted in a manner that will
enable taxpayers to easily understand
and apply the guidance;
5. Whether the Service can administer
the recommended guidance on a uni-
form basis; and
6. Whether the recommended guidance
reduces controversy and lessens the
burden on taxpayers or the Service.
Taxpayers may submit recommenda-
tions for guidance at any time during the
year. Please submit recommendations by
May 31, 2008, for possible inclusion on
the original 2008–2009 Guidance Prior-
ity List. The Treasury Department and
the Service plan to update the 2008–2009
Guidance Priority List periodically to re-
flect additional guidance that the Treasury
Department and the Service intend to pub-
lish during the plan year. The periodic
updates allow the Treasury Department
and the Service to respond to the need for
additional guidance that may arise during
the plan year. Recommendations for guid-
ance received after May 31, 2008, will be
reviewed for inclusion in the next periodic
update.
Taxpayers are not required to submit
recommendations for guidance in any par-
ticular format. Taxpayers should, how-
ever, briefly describe the recommended
guidance and explain the need for the guid-
ance. In addition, taxpayers may include
an analysis of how the issue should be re-
solved. It would be helpful if taxpayers
suggesting more than one guidance project
prioritize the projects by order of impor-
tance. If a large number of projects are be-
ing suggested, it also would be helpful if
the projects were grouped in terms of high,
medium or low priority.
Taxpayers should send written com-
ments to:
Internal Revenue Service
Attn: CC:PA:LPD:PR
(Notice 2008–47)
Room 5203
P.O. Box 7604
Ben Franklin Station
Washington, D.C. 20044
or hand deliver comments Monday
through Friday between the hours of
8a.m.and4p.m.to:
Courier’s Desk
Internal Revenue Service
Attn: CC:PA:LPD:PR
(Notice 2008–47)
1111 Constitution Avenue, N.W.
Washington, D.C. 20224
Alternatively, taxpayers may sub-
mit comments electronically via
e-mail to the following address:
Notice.Comments@irscounsel.treas.gov.
Taxpayers should include “Notice
2008–47” in the subject line. All
comments will be available for public
inspection and copying in their entirety.
For further information regarding this
notice, contact Henry Schneiderman of
the Office of Associate Chief Counsel
(Procedure and Administration) at (202)
622–3400 (not a toll-free call).
2008–18 I.R.B.870May 5, 2008

Part IV. Items o
fGeneralInterest
Notice of Prop
osed
Rulemaking, a
Notice
of Public Hear
ing, and
Withdrawal o
fPreviously
Proposed Reg
ulations
Guidance Reg
arding
Deduction a
nd Capitalization
of Expendit
ures Related to
Tangible P
roperty
REG–16874
5–03
AGENCY: In
ternal Revenue Service
(IRS), Tre
asury.
ACTION: No
tice of proposed rulemaking,
anoticeof
public hearing, and withdrawal
of previou
sly proposed regulations.
SUMMARY:
This document contains
proposed
regulations that explain how
section 2
63(a) of the Internal Revenue
Code (Cod
e) applies to amounts paid to
acquire,
produce, or improve tangible
propert
y. The proposed regulations clarify
and expa
nd the standards in the current
regulat
ions under section 263(a), as well
as provi
de some bright-line tests (for ex-
ample, a
de minimisrule for acquisitions).
The pro
posed regulations will affect all
taxpay
ers that acquire, produce, or im-
prove t
angible property. This document
also pr
ovidesanoticeofpublichearingon
the pro
posed regulations and withdraws
the pr
oposed regulations published in the
Feder
al Registeron August 21, 2006
(71 FR
161).
DATES
: Written or electronic comments
must b
e received by June 9, 2008. Out-
lines
of topics to be discussed at the pub-
lic h
earing scheduled for June 24, 2008, at
10 a.
m., must be received by June 3, 2008.
ADDR
ESSES: Send submissions to:
CC:P
A:LPD:PR (REG–168745–03), room
5203
, Internal Revenue Service, PO Box
7604
, Ben Franklin Station, Washington,
DC 20
044. Submissions may be hand-de-
liv
ered Monday through Friday between
the
hours of 8:00 a.m. and 4:00 p.m.
to C
C:PA:LPD:PR (REG–168745–03),
Cou
rier’s Desk, Internal Revenue Ser-
vic
e, 1111 Constitution Avenue, NW,
Washington, D
C 20224, or sent elec-
tronically, v
ia the Federal eRulemak-
ing Portal atw
ww.regulations.gov(IRS
REG–168745–0
3). The public hearing
will be held in
the auditorium of the Inter-
nal Revenue B
uilding, 1111 Constitution
Avenue, NW, W
ashington, DC.
FOR FURTHER INFORMATION
CONTACT: Concerning the proposed
regulations, Merrill D. Feldstein or
Mon L. Lam, (202) 622–4950; concerning
submission of comments, the hearing,
and/or to be placed on the building
access list to attend the hearing,
Richard.A.Hurst@irscounsel.treas.gov.
SUPPLEMENTARY INFORMATION:
Background
On August 21, 2006, the IRS and Trea-
sury Department published in the
Federal
Register(71 FR 161) proposed amend-
ments to the regulations under section
263(a) (2006 proposed regulations) relat-
ing to amounts paid to acquire, produce,
or improve tangible property. The IRS
and Treasury Department received numer-
ous written comments. A public hearing
was held on December 19, 2006. After
considering the comment letters and the
statements at the public hearing, the IRS
and Treasury Department are withdrawing
the 2006 proposed regulations and are
proposing new regulations.
Summary of Comments and
Explanation of Provisions
I.Overview
These
new proposed regulations in-
clude
many of the provisions contained in
the 20
06 proposed regulations, including
the pr
oposed format changes in which
§1.26
3(a)–1 provides general rules for
capi
tal expenditures, §1.263(a)–2 provides
rule
s for amounts paid for the acquisition
or pr
oduction of tangible property, and
§1.2
63(a)–3 provides rules for amounts
paid
for the improvement of tangible
prop
erty. However, these new proposed
reg
ulations provide many additional rules
tha
t were not included in the 2006 pro-
pos
ed regulations. For example, these new
pro
posed regulations provide a definition
of materials a
nd supplies under §1.162–3
(including a s
pecial 12-month rule and
a $100de minim
isrule), a book confor-
mityde minimi
srule for acquisitions of
units of prope
rty under §1.263(a)–2, a
safe harbor f
or routine maintenance under
§1.263(a)–3
, and an optional simplified
method for re
gulated taxpayers under
§1.263(a)–3
. Additionally, these new
proposed re
gulations provide significant
changes to t
he rules relating to unit of
property an
d restorations, and allow for
industry-s
pecific repair allowance meth-
ods in futu
re Internal Revenue Bulletin
guidance.
These new proposed regula-
tions gene
rally will apply to taxable years
beginning
on or after the date that final
regulatio
ns are published in theFederal
Register
.
II.Withd
rawal and Re-Proposal of
Regulati
ons
In additio
ntoprovidingspecificcom-
ments, ma
ny commentators suggested
that, giv
en the broad scope and effect of
the regul
ations and the numerous com-
ments rec
eived on the 2006 proposed
regulat
ions, consideration should be given
to re-pr
oposing the regulations in their
entiret
y. This suggestion has been adopted
and the 2
006 proposed regulations are
withdra
wn and replaced with these new
propos
ed regulations.
III.Mat
erials and Supplies under
§1.162–
3
Various
commentators thought that the
2006 pro
posed regulations failed to fully
addres
s the relationship between the rules
for cap
italization of tangible property un-
der sec
tion 263(a) and the materials and
suppli
es rules provided in §1.162–3 of the
curren
t regulations because the 2006 pro-
posed
regulations did not provide special
rules
for the interaction between the two
provi
sions. Specifically, commentators
noted
that under the 2006 proposed reg-
ulati
ons, tangible property with a useful
life
of 12 months or less was not treated
as a m
aterial and supply, which treatment
was i
nconsistent with existing authorities,
part
icularly with regard to the timing of
when
to deduct amounts paid to acquire
the p
roperty with a useful life of 12 months
May 5, 20088712008–18 I.R.B.

or less. Commentators pointed out that
the 2006 proposed regulations were incon-
sistentwith§1.162–3andwouldcreate
uncertainty with regard to which provision
should be applied to which property. In
response, the IRS and Treasury Depart-
ment decided to revise §§1.162–3 and
1.263(a)–2 to provide clear and consistent
treatment for those items that traditionally
have been considered to be materials and
supplies and to provide distinct, but co-
ordinated, treatment for those items that
should be addressed under section 263(a).
The new proposed regulations provide
additional guidance under §1.162–3 with
respect to the definition of materials and
supplies. Specifically, the proposed rules
define a material and supply as tangible
property that (a) is not a unit of property,
(b) is a unit of property with an economic
useful life of 12 months or less, (c) is a unit
of property that costs $100 or less, or (d) is
identified as a material and supply in future
guidance.
Under the existing regulations, the
costs of non-incidental materials and sup-
plies are deducted as the materials and
supplies are used or consumed, and the
costs of incidental materials and supplies
are deducted as the costs are incurred.
These new proposed regulations retain
this treatment of materials and supplies,
except with respect to rotable and tem-
porary spare parts. These new proposed
regulations provide that rotable or tem-
porary spare parts treated as materials
andsupplieswillbeconsideredusedor
consumed in the taxable year in which
the taxpayer disposes of the parts. This
rule prevents taxpayers from prematurely
deducting the cost of a unit of property by
systematically replacing components with
rotable spare parts. The IRS and Treasury
Department anticipate that taxpayers with
rotable or temporary spare parts that are
not discarded after their original use gen-
erally will prefer to capitalize their costs
and treat those parts as depreciable assets.
These new proposed regulations provide
for an election to capitalize these costs.
Taxpayers should recognize that the
used or consumed standard for non-in-
cidental materials and supplies generally
is met later than the placed in service
standard used for depreciation. In addi-
tion, taxpayers are reminded that after a
material or supply is used or consumed,
capitalization of the material or supply
cost to another property may be required.
For example, amounts paid for materials
and supplies used in the production of
inventory or a self-constructed asset gen-
erally are required to be capitalized under
section 263A. Similarly, amounts paid to
produce materials and supplies generally
are required to be capitalized as part of
the production costs of the materials and
supplies. Nothing in these new proposed
regulations is intended to change this treat-
ment.
First, these new proposed regulations
provide that property that is not a unit of
property as defined in §1.263(a)–3 will be
considered a material and supply. In gen-
eral, this definition is intended to describe
spare and replacement parts and is con-
sistent with the current characterization of
these items.
Second, these new proposed regula-
tions provide that property that has an
economic useful life of 12 months or less
will be considered a material and supply.
Commentators requested clarification con-
cerning the application of the 12-month
rule provided in the 2006 proposed reg-
ulations. For purposes of applying the
12-month rule, these new proposed reg-
ulations generally adopt the economic
useful life definition in §1.167(a)–1(b)
and provide that, for purposes of these
new proposed materials and supplies
regulations, the measurement period for
economic useful life begins when the item
is first used or consumed in the taxpayer’s
trade or business. Therefore, the time
priortowhenanitemisusedorconsumed
is not taken into consideration in deter-
mining the economic useful life of the
asset for purposes of these new proposed
regulations, notwithstanding the fact that
the item may have been placed in service
(ready and available for its intended use)
for depreciation.
In addition, these new proposed reg-
ulations provide a special economic use-
ful life test under the 12-month rule for
taxpayers with applicable financial state-
ments (AFS). Under this rule, taxpayers
with AFS are required to determine the
economic useful life in a manner consis-
tent with the economic useful life used
for purposes of determining deprecia-
tion in the books and records supporting
their AFS. An exception is provided if a
taxpayer does not assign a useful life to
certain property in its AFS (for example,
the item is currently expensed in the tax-
payer’s AFS because it is consideredde
minimis).
The 2006 proposed regulations did not
provide ade minimisrule for the acqui-
sition or production of property but re-
quested comments on whether ade min-
imisrule should be adopted. Commenta-
tors generally agreed that the regulations
should include ade minimisrule but var-
ied on how that rule should be structured.
Third, these new proposed regulations
provide a $100de minimisrule within the
definition of materials and supplies. Mate-
rials and supplies include a unit of property
that has a production or acquisition cost of
$100 or less, without regard to the treat-
ment of the item in the taxpayer’s financial
statements. Allowing small items to be
treated as materials and supplies resolves
uncertainty with respect to whether those
items represent a depreciable asset or a ma-
terial and supply, and $100 is a low enough
threshold to alleviate concerns about the
potential distortion of income. However,
treating a small unit of property as a ma-
terial and supply may affect the timing of
the deduction for the material and supply
cost because expensing an amount paid for
a non-incidental material and supply will
only occur in the period in which the item
is used or consumed.
Various commentators pointed out that
taxpayer burden may be reduced by al-
lowing taxpayers to capitalize amounts
paid for items that otherwise would qual-
ify as materials and supplies and treat
the items as depreciable assets. For ex-
ample, many taxpayers currently treat
rotable spare parts as capital expenditures
depreciable over the life of the unit of
property in which the rotables are used.
See Rev. Rul. 69–200, 1969–1 C.B. 60.
See §601.601(d)(2)(ii)(b).
Under these new proposed regulations,
taxpayers may elect to treat an amount paid
for a material and supply as a capital ex-
penditure. In general, the election is made
separately for each material and supply
and is revocable only with the consent of
the Commissioner. The election is made
by capitalizing the cost of the material and
supply in the year the cost is incurred and
beginning depreciation of the item in the
year it is placed in service.
2008–18 I.R.B.872May 5, 2008

IV.Repairs under §1.162–4
The 2006 proposed regulations revised
§1.162–4 (the repair rules), to provide
rules consistent with the improvement
rules under §1.263(a)–3 of the 2006 pro-
posed regulations. Commentators ex-
pressed concern that the proposed changes
would result in challenges to the de-
ductibility of costs that the IRS has long
agreed with taxpayers are deductible. The
IRS and Treasury Department do not think
that the proposed change to §1.162–4 cre-
ates a burden of proof higher than that
which exists under current law or requires
capitalization of costs that are not required
to be capitalized under current law. There-
fore, these new proposed regulations do
not propose any specific changes to the
rules proposed in the 2006 proposed reg-
ulations. However, a routine maintenance
safe harbor is provided in these new pro-
posed regulations in §1.263(a)–3.
V.Professional Expenses under §1.162–6
The existing regulations under
§1.162–6 provide rules for professional
expenses. These new proposed regula-
tions propose to remove §1.162–6. In
general, the treatment of the items listed in
§1.162–6 is adequately addressed in these
new proposed regulations and other exist-
ing regulations. The proposed removal of
§1.162–6 is not intended to result in any
substantive changes in the treatment of
professional expenses.
VI. Capital Expenditures
A.Amounts Paid to Sell Property
The 2006 proposed regulations pro-
vided rules for the capitalization of selling
expenses, except in the case of dealers,
under §1.263(a)–1. The 2006 proposed
regulations included an example that re-
quired the capitalization of advertising
costs as a selling expense that must be
offset against the sale proceeds. Various
commentators questioned this treatment
of advertising costs. In general, adver-
tising costs are not capital expenditures.
Therefore, these newproposed regulations
retain the general rule but remove the ref-
erences to advertising costs provided in
the 2006 proposed regulations and update
the examples accordingly.
B. Interests in Land
The 2006 proposed regulations did not
provide a specific capitalization rule for
amounts paid to acquire or create intangi-
ble interests in land. The 2006 proposed
regulations specifically requested com-
ments on this issue, but no comments
were received. These new proposed reg-
ulations provide that amounts paid to
acquire or create interests in land, such as
easements, life estates, mineral interests,
timber rights, zoning variances, or other
interests in land, are examples of capital
expenditures. Comments are specifically
requested on this proposed rule.
VII.Amounts Paid to Acquire or Produce
Tangible Property
The 2006 proposed regulations pro-
vided rules for the capitalization of
amounts paid to acquire or produce tan-
gible property under §1.263(a)–2. These
new proposed regulations generally retain
the same format, but make some modifica-
tions to the 2006 proposed regulations. For
example, modifications have been made
to clarify the interaction of §1.263(a)–2
of these new proposed regulations with
the materials and supplies rules under
§1.162–3. Significant modifications and
clarifications are discussed further in this
preamble.
A.Definition of Produce
Commentators asked whether the term
“produce” as used in the 2006 proposed
regulations had the same meaning as the
term “produce” under section 263A. These
new proposed regulations clarify that the
definition of the term produce for purposes
of §1.162–3 and §1.263(a)–2 generally is
the same as the definition of the term pro-
duce for section 263A purposes. The sole
difference is that the term “improve” is
not included in §1.162–3 and §1.263(a)–2
because “improve” under section 263A
is specifically defined in §1.263(a)–3 of
these new proposed regulations, relating
to the improvement of tangible property.
B.Transaction Costs
The 2006 proposed regulations gen-
erally required a taxpayer to capitalize
amounts paid to facilitate the acquisition
of real or personal property, and included
a list of typical transaction costs. Com-
mentators suggested that with respect to
the rules requiring the capitalization of
facilitative transaction costs, an excep-
tion should be provided for transaction
costs for pre-decisional investigatory
costs, similar to the exception provided
with respect to certain intangibles in
§1.263(a)–4(e)(1)(iii) (creation of certain
contract rights) and §1.263(a)–5(e) (acqui-
sition of a trade or business). These new
proposed regulations provide a general
rule similar to the rules in the intangibles
regulations requiring that taxpayers capi-
talize all costs that facilitate an acquisition
of tangible property, including the costs
of investigating the acquisition, but adopt
the commentators’ suggestion in part by
providing an exception for certain costs in-
curred in the investigation of real property
acquisitions. The IRS and Treasury De-
partment think it is appropriate to provide
an exception for real property acquisitions
because these types of transactions most
often raise the issue of whether the in-
vestigatory costs are deductible business
expansion costs rather than capital expen-
ditures to acquire a specific asset. The
exception provides that costs relating to
activities performed in the process of de-
termining whether to acquire real property
and which real property to acquire gen-
erally are deductible pre-decisional costs.
Under this exception,capitalization will
not be required for certain pre-decisional
investigative activities, such as marketing
studies, that are not specifically identified
in these regulations asbeing inherently fa-
cilitative. These new proposed regulations
provide that inherently facilitative costs
must be capitalized and list the costs, such
as transportation and shipping costs, that
are inherently facilitative.
A commentator pointed out that sec-
tion 263A does not apply to acquisitions
of property that are not intended for re-
sale, and thus, taxpayers should not be re-
quired to capitalize overhead costs to this
type of property. These new proposed reg-
ulations address this comment by provid-
ing a simplifying convention for employee
compensation and overhead costs similar
to the rules provided for intangible prop-
erty. However, the new proposed regula-
tions reiterate that section 263A does apply
to the production of real or personal prop-
erty. Section 263A contains rules for cer-
tain costs incurred prior to production.
May 5, 20088732008–18 I.R.B.

Under current law, if a taxpayer en-
gages in multiple separate and distinct
transactions, the taxpayer may allocate
transaction costs to the separate trans-
actions and recover the allocable trans-
action costs as each distinct transaction
is abandoned.Sibley, Lindsay & Curr
Co.v.Commissioner, 15 T.C. 106,
110 (1950), acq., 1951–1 C.B. 3. See
§601.601(d)(2)(ii)(b). However, if the
transactions are viewed as alternatives,
only one of which the taxpayer can com-
plete, the courts have held that the tax-
payer must capitalize all the transaction
costs to the one transaction ultimately
completed.United Dairy Farmers, Inc.
v. United States, 267 F.3d 510 (6th Cir.
2001);Nicolazzi v. Commissioner,79T.C.
109 (1982), aff’d, 722 F.2d 324 (6th Cir.
1983). To avoid the difficulty inherent
in administering this rule, including as-
certaining the intent of the taxpayer, the
new proposed regulations provide a more
objective rule. This rule allows taxpay-
ers to allocate inherently facilitative costs
among the separate and distinct properties
considered, regardless of the taxpayer’s
ultimate intent or plan. The taxpayer cap-
italizes the allocable transaction costs to
each property, including properties not
acquired, and recovers the costs as ap-
propriate under the applicable provision
of the Code (for example, section 165,
167, or 168). Examples are provided to
demonstrate the application of these rules.
In addition, a commentator noted that
the rule contained in the 2006 proposed
regulations with respect to costs incurred
prior to placing property in service is really
a rule for acquisition costs, not improve-
ment costs. The IRS and Treasury Depart-
ment agree that activities occurring prior to
placing the property in service are concep-
tually more related to the acquisition of the
property than to the improvement of prop-
erty. Therefore, these new proposed reg-
ulations move to the acquisition cost sec-
tion of these regulations the requirement
to capitalize amounts paid for work per-
formed prior to placing property in service.
C.De Minimis Rule
The 2006 proposed regulations did not
provide a specificde minimisrule for the
acquisition or production of property, but
the preamble provided a detailed proposal
of what might be an appropriatede min-
imisrule and requested comments from
taxpayers on this issue. Numerous com-
ments supported the adoption of ade min-
imisrule to the extent such a proposal
would not alter the current understandings
between taxpayers and examining agents
with respect to what type of transactions
are consideredde minimison examination
for purposes of evaluating risk. Therefore,
to reduce burden and provide simplifica-
tion, these new proposed regulations pro-
vide ade minimisrule. With respect to the
concerns raised by commentators as to the
adoption of ade minimisrule, the IRS and
Treasury Department want to make clear
that the adoption of such a rule is not in-
tended to alter the general risk analysis
currently employed by examining agents.
Therefore, thede minimisrule proposed
in these regulations should not affect any
current understandings between examin-
ing agents and taxpayers with respect to
the size and character of transactions that
will be the focus of examinations.
The proposedde minimisrule is based
primarily on a qualifying taxpayer’s finan-
cial statement standards. A qualifying tax-
payer is a taxpayer that: (a) has an AFS,
(b) has written accounting procedures for
the expensing ofde minimisitems, and (c)
recognizesde minimiscostsasexpenses
on its AFS. Under the rule provided in
these new proposed regulations, a qualify-
ing taxpayer can use thede minimisstan-
dardadoptedinitsAFStotheextentthe
AFSde minimisstandard does not result in
a distortion of income. Although commen-
tators varied regarding whether it is appro-
priate to require conformity with AFS to
qualify for ade minimisrule, the IRS and
Treasury Department think that it provides
simplification and reduces burden only to
allow deductions forde minimisamounts
paid for property (other than the $100 rule
for materials and supplies) that are already
being deducted for AFS purposes.
The primary concern with the adoption
of ade minimisrule is that expensing items
under ade minimisrule may not clearly
reflect income under section 446, partic-
ularly for aggregate or bulk purchases of
de minimisitems. In general, the IRS
and Treasury Department recognize that
accounting for an item using generally
accepted accounting principles will not
result in a distortion of income. Nonethe-
less, a distortion of income standard has
been adopted in an effort to avoid inten-
tional manipulations of thede minimis
rule. These new proposed regulations pro-
vide a safe harbor in which the use of an
AFSde minimisstandard will be deemed
not to distort income. Specifically, the
safe harbor provides that an amount de-
ducted under the AFSde minimisrule for
the taxable year will be deemed not to
distort income if that amount, added to the
amounts deducted in the taxable year as
materials and supplies for units of property
costing $100 or less, is less than or equal
to the lesser of (i) 0.1 percent of the tax-
payer’s gross receipts for the taxable year,
or (ii) 2 percent of the taxpayer’s total de-
preciation and amortization for the taxable
year as determined in its AFS. The safe
harbor provided in these new proposed
regulations is based upon percentages and
comparisons provided in case law. See
Alacare Home Health Services, Inc. v.
Commissioner, T.C. Memo. 2001–149;
Cincinnati, New Orleans & Tex. Pac. Ry.
Co. v. United States, 424 F.2d 563 (Ct. Cl.
1970). This safe harbor is not intended to
be used in other contexts as a bright-line
rule of an amount that distorts income.
Whether amounts above the safe harbor
result in a distortion of income depends
upon the taxpayer’s facts and circum-
stances.
These new proposed regulations also
provide that gain on the sale or disposi-
tion of property accounted for under thede
minimisrule is not treated as gain resulting
from the sale or disposition of a capital as-
set under section 1221 or as property used
in the trade or business under section 1231.
These new proposed regulations also clar-
ify that property accounted for under the
de minimisrule is not a material or supply
under §1.162–3.
Moreover, these new proposed regula-
tions provide that taxpayers may elect to
capitalize items that might otherwise be
within the scope of thede minimisrule. In
general, this election to capitalize is made
separately for each asset by treating the
amount paid as a capital expenditure on the
tax return.
These new proposed regulations also
make a conforming change to the regu-
lations under section 263A to ensure that
amounts paid for property produced by the
taxpayer also qualify under thede minimis
rule, because there is no basis for distin-
guishing between acquired and produced
property for this purpose. This change
2008–18 I.R.B.874May 5, 2008

is provided in §1.263A–1(b)(14) of these
new proposed regulations. The rule pro-
vides that the cost of property to which
a taxpayer properly applies thede min-
imisrule contained in §1.263(a)–2(d)(4) of
these new proposed regulations (including
the requirement that it not distort income)
is not required to be capitalized under sec-
tion 263A as a separate unit of property,
but may be required to be capitalized as a
cost incurred by reason of the production
of other property. This change is neces-
sary because without aconforming change
to section 263A, property produced by the
taxpayer that qualified under thede min-
imisrule would be capitalized under sec-
tion 263A despite thede minimisrule un-
der section 263(a).
These new proposed regulations do
not impose any specific record keeping
requirements for the use of thede min-
imisrule. However, under section 6001,
taxpayers are required to keep books
and records sufficient to establish their
eligibility to use thede minimisrule.
Specifically, taxpayers must maintain
books and records reasonably sufficient
to determine (1) the total amounts paid
and deducted as materials and supplies
pursuant to §1.162–3(d)(1)(iii) of these
new proposed regulations; (2) the total
amounts paid and not capitalized pursuant
to §1.263(a)–2(d)(4)(i) of these new pro-
posed regulations; (3) the computation
of the safe harbor amount provided by
§1.263(a)–2(d)(4)(iii) of these new pro-
posed regulations; (4) that income has
not been distorted by the aggregate of
the deductions under §§1.162–3(d)(1)(iii)
and 1.263(a)–2(d)(4)(i) of these new
proposed regulations if the aggre-
gate amount exceeds the safe har-
bor amount determined pursuant to
§1.263(a)–2(d)(4)(iii) of these new pro-
posed regulations; and (5) that the require-
ments of §1.263(a)–2(d)(4)(i)(A)–(C) of
these new proposed regulations have been
met.
VIII.Improvements
In general, these proposed regula-
tions are intended to reduce controversy
and provide clarity on how to determine
whether an amount paid must be capital-
ized under section 263(a) as an improve-
ment cost. Consistent with that intent, the
2006 proposed regulations contained rules
with respect to improvements, including
rules to determine whether an amount paid
results in a material increase in value or
prolonged useful life. As described below,
these regulations modify the rules set forth
in the 2006 proposed regulations to reflect
comments received. While these pro-
posed regulations attempt to provide more
certainty in an area of law that currently
requires a subjective analysis, the IRS and
Treasury Department request comments
on whether the improvement rules in these
regulations are consistent with the overrid-
ing goal of providing clarity and certainty
in this area.
The IRS and Treasury Department re-
ceived numerous comments regarding the
improvement rules provided in the 2006
proposed regulations. Many of the com-
ments received included a general request
that consideration be given to providing
more bright-line rules and clarifying def-
initions as well as providing greater con-
sistency with other provisions of the Code.
The rules contained in these new proposed
regulations attempt to address these con-
cerns.
Section 1.263(a)–3 of the 2006 pro-
posed regulations provided that taxpayers
are required to capitalize amounts paid
to improve a unit of property. Under the
general rule in the 2006 proposed regula-
tions, a unit of property is improved if the
amounts paid (i) materially increase the
value of the unit of property; or (ii) restore
the unit of property. Under the 2006 pro-
posed regulations, amounts paid to adapt
a unit of property to a new or different
use were considered to materially increase
the value of a unit of property. The 2006
proposed regulations also contained rules
for determining the appropriate unit of
property.
These new proposed regulations re-
move the new or different use standard
from the material increase in value rules
and provide a separate category for new
or different use. Additionally, the material
increase in value standard has been re-
named the “betterment” standard because
the betterment standard more closely re-
flects the manner in which section 263(a)
has been interpreted and applied under
current law. Therefore, these new pro-
posed regulations identify three categories
of costs that result in an improvement to
property. Taxpayers under the new pro-
posed regulations must capitalize amounts
paid that:
(i) Result in a betterment to a unit of
property;
(ii) Restore a unit of property; or
(iii) Adapt a unit of property to a new or
different use.
These new proposed regulations continue
to include rules for defining the unit of
property to be used in making these deter-
minations.
The 2006 proposed regulations did not
prescribe a plan of rehabilitation doctrine
as traditionally described in the case law.
That judicially-created doctrine provides
that a taxpayer must capitalize otherwise
deductible repair costs if they are incurred
as part of a general plan of rehabilitation
to the property. SeeNorwest Corp. v.
Commissioner, 108 T.C. 265 (1997);Moss
v. Commissioner, 831 F.2d 833 (9
th
Cir.
1987);United States v. Wehrli,400F.2d
686 (10
th
Cir. 1968). Commentators re-
quested that the regulations specifically
state that the plan of rehabilitation doctrine
either is eradicated or is limited to clearly
defined circumstances.
Section 263A requires that all direct
costs of an improvement and all indirect
costs that directly benefit or are incurred
by reason of the improvement must be
capitalized. See section 263A(b)(1),
which states that section 263A applies to
real or tangible property produced by the
taxpayer, and section 263A(g)(1), which
states that the definition of “produce” in-
cludes improve. See also §1.263A–1(e),
which requires the capitalization of direct
costs and of all indirect costs that directly
benefit or are incurred by reason of the
performance of production activities. Sec-
tion 263A, therefore, requires a taxpayer
to capitalize otherwise deductible repair
costs as part of an improvement if the tax-
payer improves a unit of property and the
otherwise deductible repair costs directly
benefit or are incurred by reason of the im-
provement to the property. Thus, section
263A has eliminated the need for a plan
of rehabilitation doctrine to determine the
allocable costs that must be capitalized as
part of an improvement. Although some
commentators requested that the circum-
stances in which otherwise deductible
repair costs must be capitalized as part of
an improvement be limited, for example,
to property that is totally dysfunctional
and unsuitable for its intended purpose,
May 5, 20088752008–18 I.R.B.

there is no authority for doing so because
section 263A specifically applies to im-
provements. The legislative history to
the Tax Reform Act of 1986, P.L. 99–514
(100 Stat. 2085) also indicates that Con-
gress intended section 263A to apply to
improvements to property. See, for exam-
ple, S. Rep. No. 99–313, 99
th
Cong., 2d
Sess. 133–152 (1986), which states that
the uniform capitalization rules will apply
to assets or improvements to assets con-
structed by a taxpayer for its own use in a
trade or business or in an activity engaged
in for profit, and that the rules are not
intended to apply to expenditures properly
treated as repair costs under present law
that do not relate to the manufacture, re-
manufacture, or production of property.
Section 263A does not require other-
wise deductible repair costs to be capital-
ized if the repairs do not directly benefit or
are not incurred by reason of a production
activity (for example, an improvement).
The judicially-created plan of rehabili-
tation doctrine, however, has been cited
to require capitalization of otherwise de-
ductible repair costs solely because the
taxpayer has a plan (written or otherwise)
to perform periodic repairs or mainte-
nance, or solely because the taxpayer
performs several repairs to the same prop-
erty at one time even though the property
is not improved. As stated in the preamble
to the 2006 proposed regulations, the IRS
and Treasury Department do not think this
characterization is appropriate. These new
proposed regulations specifically provide
that repairs that are made at the same time
as an improvement, butthat do not directly
benefit or are not incurred by reason of
the improvement, are not required to be
capitalized under section 263(a). These
new proposed regulations do not prescribe
a plan of rehabilitation doctrine. There-
fore, when these new proposed regulations
are finalized, the judicially-created plan
of rehabilitation doctrine will be obsolete,
particularly with regard to the assertion
that the doctrine transforms otherwise
deductible repair costs into capital im-
provement costs solely because the repairs
are performed at the same time as an
improvement, or are pursuant to a mainte-
nance plan, even though the repairs do not
improve the property under §1.263(a)–3.
However, section 263A continues to re-
quire a taxpayer to capitalize otherwise
deductible repair costs if the taxpayer im-
proves a unit of property and the otherwise
deductible repair costs directly benefit or
are incurred by reason of the improvement
to the property.
A.Unit of Property
The 2006 proposed regulations began
with an initial unit of property determina-
tion of all components that are function-
ally interdependent to define the largest
unit of property as a starting point for the
analysis. Special rules applied to build-
ings and their structural components and
to property used in certain regulated indus-
tries. Network assets were excluded from
the definition of unit of property. The unit
of property determination for other per-
sonal property employed a facts and cir-
cumstances test basedontheapplication
of four exclusive factors—(1) marketplace
treatment; (2) industry practice and finan-
cial accounting; (3) treatment as a rotable
spare part; and (4) functional use. An over-
riding rule required taxpayers to treat prop-
erty as a unit of property for purposes of
section 263 if the taxpayer did so for any
other Federal income tax purpose.
The IRS and Treasury Department
received multiple comments on the defini-
tion of a unit of property provided in the
2006 proposed regulations. The commen-
tators generally expressed dissatisfaction
with the unit of property rules provided
in the 2006 proposed regulations, particu-
larly with respect to the regulated industry
rules and the rule for rotable spare parts.
Commentators generally agreed with the
unit of property rules for a building, but
raised objections that the remaining rules
provided in the 2006 proposed regulations
were overly complex and ambiguous.
Many commentators recommended that
the determination of a unit of property
be based primarily on the functional in-
terdependence test, similar to that used
for depreciation and section 263A pur-
poses, with no further factors, while other
commentators recommended that the de-
termination be based on the factors used
inFedEx Corp. v. United States,291
F. Supp. 2d 699 (W.D. Tenn. 2003), aff’d,
412 F.3d 617 (6th Cir. 2005).
The IRS and Treasury Department
think that most of the factors listed in the
2006 proposed regulations were the same
as the factors used inFedEx. However,
commentators generally criticized the
manner in which the 2006 proposed regu-
lations applied these factors. Nonetheless,
the IRS and Treasury Department agree
that some factors, such as the rotable spare
parts factor, may be overly burdensome,
particularly for taxpayers that use small
components in their businesses. Addition-
ally, although some taxpayers in regulated
industries favored the ability to conform
to regulatory reporting, many that are not
subject to regulatory accounting for all
assets objected to the conformity rule as
inappropriate and a potential source for
uncertainty and controversy. Therefore,
these new proposed regulations substan-
tially modify the unit of property definition
containedinthe2006proposedregula-
tions.
These new proposed regulations pro-
vide unit of property rules that generally
are based on the functional interdepen-
dence standard, and include special rules
for buildings, plant property, and network
assets. Additional rules are provided that
may require a smaller unit of property
characterization in certain circumstances.
Generally, improvements to a unit of prop-
erty are not considered separate units of
property even though the improvements
are treated as separate assets for deprecia-
tion purposes.
These new proposed regulations gener-
ally provide the same rule for buildings as
the 2006 proposed regulations. A building
and its structural components are treated as
a single unit of property. However, a spe-
cial rule for condominiums and coopera-
tives is provided. Additionally, a leasehold
improvement that is section 1250 property
and is made by a lessee is a separate unit
of property.
For property other than a building, these
new proposed regulations provide that, in
general, a single unit of property includes
all components that are functionally inter-
dependent. However, a number of spe-
cial rules are provided that may require a
smaller unit of property to be considered.
The IRS and Treasury Department do not
think that applying solely a functional in-
terdependence test results in the appropri-
ate unit for all types of property. For some
types of property, such as machinery and
equipment in a manufacturing plant, the
functional interdependence test often re-
sults in a very expansive unit of property.
The IRS and Treasury Department think
it is inappropriate to use such a large unit
2008–18 I.R.B.876May 5, 2008

of property for making a determination re-
garding improvements.
These new proposed regulations pro-
vide a special rule for plant property, which
is defined as “functionally interdependent
machinery or equipment . . . used to per-
form an industrial process . . . .” This
definition is not intended to include all
types of property used in a taxpayer’s trade
or business, but is intended only to cap-
ture the functionally interdependent ma-
chinery and equipment used in industrial
processes like manufacturing, electric gen-
eration, distribution,warehousing, as well
as equipment used in providing industrial
services such as automated materials han-
dling equipment. This special rule requires
that the functionally interdependent ma-
chinery and equipment be separated into a
component or a group of components that
performs a discrete and major function or
operation. These new proposed regula-
tions provide various examples to illustrate
activities that will constitute a discrete and
major function.
These new proposed regulations pro-
vide the same definition of network assets
as the 2006 proposed regulations and con-
tinue to reserve on providing a special rule
for networks assets. The IRS and Trea-
sury Department think that in many sit-
uations, the unit of property for network
assets should be smaller than the unit of
property determined under the functional
interdependence test. The IRS and Trea-
sury Department generally think that the
unit of property rules for network assets
should be addressed on an industry by in-
dustry basis in Internal Revenue Bulletin
guidance. Industries are invited to submit
requests for guidance under the Industry
Issue Resolution (IIR) program after these
regulations are finalized.
These new proposed regulations also
provide two additional rules that may
require a smaller unit of property deter-
mination than that provided under the
general rule. The first rule is triggered if
the taxpayer has assigned different eco-
nomic useful lives for financial statement
or regulatory purposes to components of
a single unit of property at the time the
unit of property is placed in service by the
taxpayer. Simply accounting for compo-
nents separately (for example, recording
the property separately in depreciation or
other asset-tracking books and records)
does not trigger this rule. However, as-
signing a different economic useful life to
components will require that the unit of
property determination be limited to those
components that have been assigned the
same useful life for financial statement
purposes. The second rule applies when
components of a single unit of property are
depreciated by the taxpayer under differ-
ent MACRS classes (including a different
MACRS class that results from a change
in method of accounting). This second
rule also applies if components of a single
unit of property are depreciated by the
taxpayer using different recovery methods
(for example, double-declining balance
versus unit-of-production). Again, simply
recording various components separately
in the taxpayer’s depreciation books and
records will not trigger the rule.
These rules are intended to prevent
overly broad unit of property determi-
nations that are inconsistent with the
taxpayer’s characterization of the unit of
property for depreciation purposes. In
general, the IRS and Treasury Department
anticipate that these limiting rules will
apply only in unique circumstances. The
IRS and Treasury Department encourage
taxpayers to provide comments on the
application of these limiting rules and to
identify situations (if any) in which the
limiting rules may not operate as intended.
B.Routine Maintenance Safe Harbor
The 2006 proposed regulations did not
contain a routine maintenance safe harbor.
Various commentators requested that the
regulations provide guidance to clarify
when the cost of a routine maintenance
activity will be considered a deductible
expense. In addition, commentators ex-
pressed concern that under the rules pro-
vided in the 2006 proposed regulations,
routine maintenance activities are required
to be capitalized if performed near the end
of the economic useful life of the property,
regardless that identical activities were
considered deductible if performed earlier
in the useful life.
To address this concern, these new pro-
posed regulations provide a routine main-
tenance safe harbor under which qualify-
ing activities will be deemed to not im-
prove the unit of property. Under this safe
harbor, routine maintenance activities in-
clude recurring activities that a taxpayer
expects to perform more than once over the
class life of the unit of property as a result
of the taxpayer’s use of the unit of property
to keep the unit of property in its ordinar-
ily efficient operating condition. Amounts
paid for betterments do not keep the unit
of property in an ordinarily efficient oper-
ating condition; however, the replacement
of minor parts with improved but compara-
ble parts generally does not result in a bet-
terment. Thus, for example, the safe har-
bor includes amounts paid for replacement
parts that the taxpayer expects to replace
more than once during the class life of the
unit of property, even if the replacement
part is an improved but comparable part.
As part of the safe harbor provisions, these
new proposed regulations provide a list of
relevant considerations to be taken into ac-
count in determining whether an amount
is paid for routine maintenance. These
considerations include the recurring nature
of the activity, industry practice, manufac-
turer recommendations, taxpayer experi-
ence and the treatment of the activity on
the taxpayer’s AFS. The safe harbor main-
tenance rule specifically applies to main-
tenance activities performed on rotable or
temporary spare parts, but reminds tax-
payers that under the rules proposed in
§1.162–3(b) of these new proposed regula-
tions, the capitalized costs associated with
rotable and temporary spare parts (that is,
acquisition costs) may be deducted only
in the taxable year in which the rotable or
temporary spare part is discarded.
One concern with establishing a main-
tenance safe harbor that includes the costs
of replacement parts is creating an incen-
tive for taxpayers to componentize assets
in an effort to recover basis upon the re-
moval of a component while deducting the
replacement cost as a repair or mainte-
nance expense. Therefore, the safe harbor
does not apply to the cost of replacement
components in situations in which the tax-
payer has taken into account the basis of
the component being replaced in determin-
ing gain or loss resulting from a sale or
exchange of the replacement component,
has taken a loss related to the retirement
of the component, or has taken a basis ad-
justment related to a casualty event under
section 165.
The safe harbor is intended to operate
only as a safe harbor in which qualify-
ing costs will be deemed not to consti-
tute an improvement. The IRS and Trea-
sury Department recognize that many ac-
May 5, 20088772008–18 I.R.B.

tivities that do not qualify for the safe har-
bor nonetheless may be activities that do
not give rise to capitalization of costs un-
der section 263(a). Additionally, costs de-
ductible under the maintenance safe har-
bor may be required to be capitalized under
section 263A to otherproperty produced or
acquired for resale.
C.Betterments
1.Overview
The 2006 proposed regulations used
the term “material increase in value” to
generally describe the concept of a better-
ment. In general, commentators agreed
with the standards outlined in the 2006
proposed regulations to determine whether
an amount paid materially increases the
value of property. However, commenta-
tors differed on whether taxpayers should
be allowed to override the material in-
crease in value test by proving that the
activity did not actually increase fair mar-
ket value. Consistent with the preamble
to the 2006 proposed regulations, the
IRS and Treasury Department continue to
think that whether an amount paid should
be capitalized as a betterment to a unit
of property depends upon the purpose,
the physical nature, and the effect of the
work for which the amounts were paid,
and not upon an analysis of the fair market
value of the property before and after the
work. Therefore, to clarify this distinction,
these new proposed regulations change the
name of the material increase in value test
to the betterment test. The general rule
focuses on betterments to the condition of
the property, the costs of which should be
capitalized as an improvement if the bet-
terment is material, regardless of whether
the betterment increases the fair market
value.
Commentators noted that the general
concept of a betterment is difficult to apply
and suggested that the language in the reg-
ulations better define what types of events
would give rise to a betterment. Addition-
ally, commentators pointed out that some
of the betterment tests were redundant.
The IRS and Treasury Department agree
that the general concept of a betterment
or improvement can be difficult to apply.
In developing these new proposed regula-
tions, consideration was given to retaining
the rules provided in the current regula-
tions without providing clarification of
material increase in value, prolong useful
life, and new or different use. The prin-
cipal concern in providing detailed rules
on the concept of an improvement is the
potential to create controversy in areas
where none currently exists, which would
undermine one of the primary purposes of
the project.
Nonetheless, because commentators
generally did not oppose the tests pro-
vided for material increase in value under
the 2006 proposed regulations, these new
proposed regulations continue to provide
an exclusive list of tests that determine
whether an amount paid results in a bet-
terment in an attempt to further solicit
comments in this area. The IRS and
Treasury Department specifically request
comments as to whether the exclusive list
of tests with respect to improvements pro-
vides additional certainty in this area and
if not, why. Given the continuing eval-
uation of this area, taxpayers should be
particularly aware that no reliance should
be placed on the rules provided in these
new proposed regulations until such rules
are finalized.
The tests included in the original pro-
posed regulations have been reorganized in
these new proposed regulations in an at-
tempt to provide additional clarification.
Under these new proposed regulations, an
amount paid results in a betterment if it:
(i) Ameliorates a material condition or
material defect that existed prior to the ac-
quisition or arose during the production of
the property,
(ii) Results in a material addition to the
unit of property (including a physical en-
largement, expansion, or extension), or
(iii) Results in a material increase in the
capacity, productivity, efficiency, strength,
or quality of the unit of property or its out-
put.
2.Ameliorates a Material Condition or
Defect
This rule generally follows the rule con-
tained in the 2006 proposed regulations
but clarifies, in response to comments re-
ceived, that capitalization is only required
to the extent the condition or defect is con-
sidered material. Commentators noted that
a taxpayer may not know of a condition or
defect that exists at the time property is ac-
quired and that requiring capitalization of
costs in this situation would create a hard-
ship for those taxpayers. Although taxpay-
ers may not be aware of defects that exist
at the time of acquisition, the remedial ac-
tivity being performed necessarily results
in a betterment, regardless of whether the
activity actually increases the fair market
value of the property. The rule provided
in these proposed regulations is consis-
tent with established case law. SeeUnited
Dairy Farmers, Inc. v. United States,267
F.3d 510 (6
th
Cir. 2001);Dominion Re-
sources, Inc. v. United States,219F.3d
359 (4
th
Cir. 2000).
Moreover, adopting a rule based on a
taxpayer’s knowledge at the time of acqui-
sition or production would be difficult to
administer. The IRS and Treasury Depart-
ment recognize that application of this rule
to used property acquired by a taxpayer
will result in some costs that would oth-
erwise be deductible as repair costs being
capitalized the first time the repairs are per-
formed (if the condition or defect is ma-
terial) if the nature of the activities is to
correct the effects of wear and tear that
was not caused by the taxpayer’s use of
the property. This result is consistent with
the routine maintenance safe harbor, which
requires the activities under that safe har-
bor to be performed as a result of the tax-
payer’s own use of the property.
The IRS and Treasury Department un-
derstand that certain cases exist in which
a taxpayer contaminates property during
its operations, the taxpayer disposes of the
property, and the taxpayer reacquires the
property to clean up the contamination.
Under the proposed rule, a taxpayer would
be required to capitalize the costs incurred
to clean up the property even though it was
the taxpayer’s own activities that contam-
inated the property. The IRS and Treasury
Department request comments regarding
the appropriate treatment of environmental
remediation costs in these circumstances,
considering that the remediation is per-
formed as a result of the taxpayer’s own
use of the property. The IRS and Trea-
sury Department also request comments
regarding how to determine whether the
contamination was due solely to the tax-
payer’s prior operations or, if an interim
owner may have added to the contami-
nation, how to determine the appropriate
treatment of remediation costs in that cir-
cumstance.
2008–18 I.R.B.878May 5, 2008

3.Results in a Material Increase in the
Capacity, etc.
This rule applies both to material
increases in the capacity, efficiency,
strength, or quality of the unit of property
itself as well as to material increases in the
capacity, efficiency, strength, or quality of
the output of the unit of property.
4.Application of Betterments Rule
Commentators requested that, to the ex-
tent possible, additional guidance be pro-
vided with respect to how the betterments
rules, including materiality, should be ap-
plied. The IRS and Treasury Department
considered various possible bright-line
rules with respect to materiality, but de-
termined that each rule was inappropriate
under certain circumstances. For example,
the IRS and Treasury Department con-
sidered a rule that presumed materiality
if the amounts paid are capitalized in the
taxpayer’s financial statements as a perma-
nent improvement, that is, the betterment
is capitalized in the taxpayer’s financial
statements over the remaining economic
useful life of the unit of property or longer.
The IRS and Treasury Department think
that financial statement treatment is an im-
portant factor in determining materiality,
because if the activity is material enough
to treat as an improvement for financial
statements, then generally it should be a
material improvement for tax purposes.
However, this bright-line rule was not
adopted because the IRS and Treasury
Department recognize that the standards
used for financial statement purposes for
capitalization of improvements do not co-
incide with the rules for capitalization of
improvements in these proposed regula-
tions. For example, some taxpayers may
defer major maintenance expenses and
amortize the expenses over the period until
the next maintenance cycle rather than im-
mediately expensing the costs for financial
statement purposes. The taxpayer’s reason
for not immediately expensing the cost
for financial statement purposes (that is,
treating the cost as a deferred expense or
as a material capital expenditure) may not
be readily apparent to the IRS, creating ad-
ministrative burden and a potential source
of controversy. Therefore, under these
new proposed regulations, materiality will
be based upon the facts and circumstances
in each case. Examples are provided to
illustrate to the application of materiality.
5.Appropriate Comparison for
Betterments
The 2006 proposed regulations specif-
ically provided that the appropriate
comparison for determining whether an
amount paid results in a betterment is made
by comparing the condition of the unit
of property immediately after the expen-
diture with the condition of the property
prior to the circumstances necessitating
the expenditure. These new proposed reg-
ulations retain the same comparison test.
D.Restorations
1.Overview
The 2006 proposed regulations pro-
vided that, consistent with section
263(a)(2), a taxpayer must capitalize
amounts paid that restore a unit of prop-
erty. The 2006 proposed regulations
provided that amounts paid restore a unit
of property only if they substantially pro-
long the economic useful life of the unit
of property, and provided four rules for
making that determination. The restora-
tion of property rules contained in the
2006 proposed regulations were criticized
by commentators as being overbroad and
difficult to apply. In particular, the AFS
definition of economic useful life and the
bright-line one-year rule were denounced
as providing inappropriate results. In re-
sponse, these new proposed regulations
make numerous modifications to the 2006
proposed regulations.
These new proposed regulations con-
tinue to require a taxpayer to capitalize
amounts paid to restore a unit of property.
However, the one-year rule and the AFS
conformity requirement for economic use-
ful life have been removed. These new
proposed regulations provide a series of
bright-line rules to determine when an
amount paid is deemed to restore property.
Although some commentators criticized
rules that deem the cost of certain activ-
ities to be capitalized as restorations, the
IRS and Treasury Department think that
bright lines under this test will reduce
controversy and help ease administration.
These rules also expand on the rules pro-
vided in the 2006 proposed regulations
with regard to the restoration of property
after a casualty loss.
Section 263(a)(2) states that no deduc-
tion is allowed for any amount paid in
restoring property or in making good the
exhaustion thereof for which an allowance
is or has been made. The IRS and Trea-
sury Department think that this language
requires capitalization of a replacement
component if the taxpayer removes the
basis of the replaced component from its
books and records and takes the basis of
the replaced component into account in its
tax return. If a taxpayer takes into account
the basis of a replaced component in its
tax return, then the replacement of that
component “makes good the exhaustion
thereof for which an allowance has been
made.” Therefore, these new proposed
regulations provide that if the taxpayer has
properly taken a portion of the existing
adjusted basis of the restored asset into ac-
count in the computation of gain or loss on
a sale or exchange, or as a retirement loss
or other loss under the Code, the replace-
ment of that component will be deemed to
restore the unit of property.
2.Restoration of Property Destroyed in a
Casualty
The 2006 proposed regulations required
a taxpayer to capitalize amounts paid to re-
pair property if the taxpayer properly de-
ducted a casualty loss under section 165
with respect to a unit of property and the
amounts paid restore the unit of property
to a condition that is the same or better
than before the casualty. The casualty loss
rule provided in the 2006 proposed reg-
ulations was criticized. In general, com-
mentators thought there should be no link
between the recognition of a casualty loss
under section 165 and the determination
of whether the cost to replace the prop-
erty destroyed (in part or in whole) after
a casualty event constitutes a capital ex-
penditure. However, significant authority
implies that a casualty-type event gener-
ally may only be characterized either as an
extraordinary event (thus giving rise to a
“loss” under section 165), or as an ordi-
nary and necessary event in the operation
of a trade or business (thus giving rise to
an ordinary and necessary deduction un-
der section 162). See,e.g.,R. R. Hensler,
Inc. v. Commissioner, 73 T.C. 168, 179
(1979), acq., (1980–2 C.B. 1);Hubinger
May 5, 20088792008–18 I.R.B.

v. Commissioner, 36 F.2d 724, 726 (2d
Cir. 1929), cert. denied, 281 U.S. 741
(1930). Thus, a casualty is not an ordinary
event, and the cost to repair property dam-
aged by a casualty is not an ordinary ex-
pense. Stated differently, a loss under sec-
tion 165 represents a destruction of prop-
erty necessitating a replacement, which is
capital, while an ordinary event generally
represents damage to property necessitat-
ing a repair, which may or may not be cap-
ital. Because the restoration cost resulting
from a loss is not ordinary, it is not allowed
as an ordinary and necessary expense un-
der section 162, but is treated as a capi-
tal expenditure under section 263(a). Al-
though it is clear that a casualty event gen-
erally results in two economic costs to the
taxpayer (the destruction of the previously
invested capital and the costs to replace the
destruction), the event giving rise to both
of these costs is the same.
These new proposed regulations gen-
erally require consistent characterization
of all costs arising from a single event.
Therefore, under the rules provided in
these new proposed regulations, a tax-
payer that experiences an extraordinary
loss event sufficiently destructive to in-
voke the provisions of section 165 will be
required to treat the resulting restoration
costs as a capitalized replacement of the
destroyed property. This rule is required
to ensure consistency in tax treatment
among similarly situated taxpayers. For
example, a taxpayer whose property is
completely destroyed by a casualty event
is required to capitalize the restoration of
the loss because the restoration results in
the replacement of the destroyed prop-
erty with an entirely new unit of property.
However, without a consistency rule, a
taxpayer who experiences the same casu-
alty event but only has part of a unit of
property destroyed might argue that the
cost to replace the destroyed portion of
the unit of property is deductible because
it simply returns the unit of property as
a whole to its pre-casualty state. Allow-
ing this type of disparity in tax treatment
would provide an incentive to characterize
destructions of property as partial destruc-
tions in order to leave open the position
that a deduction may be taken for both
the destruction of property resulting from
the casualty event, as well as the ordinary
and necessary expense of replacing the de-
stroyed property. This rule also eliminates
the dual characterization of minor costs
incurred for items such as broken windows
or blown-off shingles as both a casualty
loss under section 165 and an ordinary and
necessary expense under section 162.
Commentators noted that a rule requir-
ing the capitalization of restoration costs
following the recognition of a casualty
loss would unfairly burden taxpayers that
routinely experienceextraordinary loss
events in their trade or business. However,
it should be noted that under these new
proposed regulations, capitalization is re-
quired only if a loss or basis adjustment to
the property is recognized by the taxpayer
with respect to the event.
Various judicial authorities have held
that events that generally are viewed as ex-
traordinary loss events may nonetheless be
considered ordinary occurrences in a par-
ticular industry. SeeAtlantic Greyhound
Corp.v.UnitedStates, 111 F. Supp. 953
(Ct. Cl. 1953). In this situation, the
costs to replace property destroyed in what
would normally be characterized as a ca-
sualty event may result in an ordinary and
necessary expenditure under section 162
rather than a loss under section 165. In this
regard, the IRS and Treasury Department
will consider providing guidance on what
types of events may be considered ordi-
nary in a particular industry. Taxpayers are
encouraged to provide comments on this
issue.
Commentators also noted that the rule
provided in the 2006 proposed regulations
created a disparity between taxpayers that
recognized a loss under section 165 and
taxpayers that received untaxed insurance
proceeds as a result of a casualty event
and adjusted the basis of the damaged asset
accordingly. These new proposed regula-
tions eliminate this disparity.
3.Other Restorations
Similar to the 2006 proposed regula-
tions, these new proposed regulations pro-
vide additional circumstances in which a
restoration is deemed to occur. Capitaliza-
tion is required for amounts paid to return
a unit of property to its ordinarily efficient
operating condition if the property has de-
teriorated to a stateof disrepair and can no
longer function for its intended purpose.
The IRS and Treasury Department antic-
ipate that these types of restorations will
occur either as a result of lack of mainte-
nance by the taxpayer or after the end of
the property’s useful life. A unit of prop-
erty that is damaged by a casualty is not
considered to be deteriorated to a state of
disrepair.
These new proposed regulations also
require capitalization of amounts paid to
rebuild a unit of property to a like-new
condition after the end of its economic use-
ful life. The IRS and Treasury Department
anticipate that this standard will apply to
the traditional rebuilding of a unit of prop-
erty to return it to a like-new condition. In
general, a restoration under this rule will
not result from routine maintenance activ-
ities, even if performed near the end of the
useful life of the property, but instead rep-
resents a fundamental renewal of the eco-
nomicusefullifeoftheasset.
Similar to the 2006 proposed regula-
tions, the new proposed regulations require
capitalization of amounts paid to replace a
major component or substantial structural
part of a unit of property. In response to
comments regarding the uncertainty in ap-
plying this standard, these new proposed
regulations define the term “major compo-
nent or substantial structural part.” Specif-
ically, these new proposed regulations pro-
vide that the replacement of a major com-
ponent or substantial structural part will be
deemed to occur only if (a) the replace-
ment costs constitute 50 percent or more
of the replacement cost of the unit of prop-
erty or (b) the replacement part or parts
constitute 50 percent or more of the physi-
cal structure of the unit of property. These
50 percent thresholds apply solely for pur-
poses of the restoration rules and are not
intended to be applied to the betterment or
new or different use rules.
E.New or Different Use
In general, these new proposed regu-
lations contain the rules set forth in the
2006 proposed regulations with respect
to the capitalization of amounts paid to
adapt property to a new or different use.
However, these new proposed regula-
tions remove the parenthetical contained
in the 2006 proposed regulations relat-
ing to “structural alterations to the unit
of property.” Commentators noted that,
although permanent structural alterations
mayresultinadaptingpropertytoanewor
different use, those alterations also could
result in betterments to the unit of prop-
2008–18 I.R.B.880May 5, 2008

erty and, in certain circumstances, could
constitute routine maintenance. Commen-
tators also noted that adapting property to
a new or different use does not necessarily
make the property better or increase its
value, but nevertheless is a capital expen-
diture. Therefore, the new or different
use rules are provided separately from the
betterment rules in these new proposed
regulations.
These new proposed regulations also
clarify that amounts paid will be deemed
to adapt property to a new or different use
only if the new use is not consistent with
the taxpayer’s intended use of the property
at the time the property is placed in service
by the taxpayer. Additional examples have
been added to clarify the application of this
rule.
F.Repair Allowance
The 2006 proposed regulations pro-
vided a repair allowance similar to the
CLADR repair allowance, but did not
specify different repair allowance percent-
ages for different industries. Commenta-
tors generally favored the idea of a repair
allowance; however, they widely criti-
cized the lack of percentages tailored to
specific industries. Some commentators
in regulated industries requested that they
be allowed to determine their deductible
repair costs and theircapital improvement
costs for tax purposes based on conformity
with regulatory accounting reporting.
These new proposed regulations adopt
the request by certain regulated industries
to conform the tax treatment of amounts
paid to maintain, repair, or improve tan-
gible property to their regulatory account-
ing treatment. An optional regulatory ac-
counting method is proposed for amounts
paid to maintain, repair, or improve tangi-
ble property subject to regulatory account-
ing. For purposes of this method, regu-
lated accounting industries include indus-
tries regulated by the Federal Energy Reg-
ulatory Commission (FERC), the Federal
Communications Commission (FCC), and
the Surface Transportation Board (STB).
The IRS and Treasury Department recog-
nize that conformity with the regulatory
accounting rules in these industries fre-
quently may result in the overcapitaliza-
tion of costs, and sometimes the undercap-
italization of costs, as compared to the gen-
eral rules for improvements under these
new proposed regulations. The regulatory
accounting method is not intended to be
used as a definitive test of what should be
capitalized for taxpayers that do not elect
to use the method.
These new proposed regulations do not
propose a detailed repair allowance like
the one that was provided in the 2006 pro-
posed regulations. Some commentators
stated that very large taxpayers will want
to have a repair allowance, because apply-
ing the general rules asset-by-asset is too
burdensome because of their numerous as-
sets. The commentators made clear, how-
ever, that taxpayers would not widely use
a one-size-fits-all approach and that any
repair allowance must be tailored to in-
dividual industries. Therefore, these new
proposed regulations provide authority for
issuing industry-specific repair allowance
guidance in the future.
IX.Accounting Method Changes
These new proposed regulations do not
provide any specific rules for changes in
method of accounting. Because these pro-
posed regulations are not effective until
they are published as final regulations,
taxpayers may not change their account-
ing method to conform to a method of
accounting provided in these proposed
regulations. Generally, a taxpayer’s treat-
ment of an amount paid to conform with
these proposed regulations will be a
change in method of accounting under
section 446(e). For example, a change
to the routine maintenance safe harbor
in §1.263(a)–3(e) of these proposed reg-
ulations or to the optional regulatory
accounting method in§1.263(a)–3(i) of
these proposed regulations is a change
in method of accounting. The IRS and
Treasury Department request comments
on whether a change to or from the use of
thede minimisrule in §1.263(a)–2(d)(4)
of these proposed regulations is a change
in method of accounting under section
446(e).
Proposed Effective Date
These regulations are proposed to ap-
ply to taxable years beginning on or af-
ter the date the final regulations are pub-
lished in theFederal Register.Thefinal
regulations will provide rules applicable to
taxpayers that seek to change a method of
accounting to comply with the rules con-
tained in the final regulations. Taxpay-
ers may not change a method of account-
ing in reliance upon the rules contained in
these new proposed regulations until the
rules are published as final regulations in
theFederal Register.
Special Analyses
It has been determined that this notice
of proposed rulemaking is not a significant
regulatory action as defined in Executive
Order 12866. Therefore, a regulatory
assessment is not required. It also has
been determined that section 553(b) of the
Administrative Procedure Act (5 U.S.C.
chapter 5) does not apply to these regu-
lations, and, because the regulation does
not impose a collection of information on
small entities, the Regulatory Flexibility
Act (5 U.S.C. chapter 6) does not apply.
Pursuant to section 7805(f), this notice of
proposed rulemaking will be submitted
to the Chief Counsel for Advocacy of
the Small Business Administration for
comment on its impact on small business.
Comments and Public Hearing
Before the proposed regulations are
adopted as final regulations, consideration
will be given to any written comments (a
signed original and eight (8) copies) or
electronic comments that are submitted
timely to the IRS. Comments are requested
on all aspects of the proposed regulations.
In addition, the IRS and Treasury Depart-
ment specifically request comments on
the clarity of the proposed rules and how
they may be made easier to understand.
All comments will be available for public
inspection and copying.
A public hearing has been scheduled
for June 24, 2008, at 10 a.m. in the Audi-
torium, Internal Revenue Building, 1111
Constitution Avenue, NW, Washington,
DC. Due to building security procedures,
visitors must enter at the Constitution Av-
enue entrance. In addition, all visitors
must present photo identification to enter
the building. Because of access restric-
tions, visitors will not be admitted beyond
the immediate entrance area more than 30
minutes before the hearing starts. For in-
formation about having your name placed
on the building access list to attend the
hearing, see the “FOR FURTHER IN-
FORMATION CONTACT” section of this
preamble.
May 5, 20088812008–18 I.R.B.

The rules of 26 CFR 601.601(a)(3) ap-
ply to the hearing. Persons who wish to
present oral comments at the hearing must
submit electronic or written comments by
June 9, 2008 and an outline of the topics
tobediscussedandthetimetobedevoted
to each topic (signed original and eight (8)
copies) by June 3, 2008. A period of 10
minutes will be allotted to each person for
making comments. An agenda showing
the scheduling of the speakers will be pre-
pared after the deadline for receiving out-
lines has passed. Copies of the agenda will
be available free of charge at the hearing.
Drafting Information
The principal author of these regula-
tions is Merrill D. Feldstein, Office of the
Associate Chief Counsel (Income Tax and
Accounting). However, other personnel
from the IRS and Treasury Department
participated in their development.
Withdrawal of Proposed Amendments
to the Regulations
Accordingly, under the authority of 26
U.S.C. 7805, the notice of proposed rule-
making (REG–168745–03) published in
theFederal Registeron August 21, 2006,
(71 FR 161) is withdrawn.
*****
Proposed Amendments to the
Regulations
Accordingly, 26 CFR part 1 is proposed
to be amended as follows:
PART 1—INCOME TAXES
Paragraph 1. The authority citation for
part 1 continues to read in part as follows:
Authority: 26 U.S.C. 7805 * * *
Par. 2. Section 1.162–3 is revised to
read as follows:
§1.162–3 Materials and supplies.
(a)In general—(1)Non-incidental ma-
terials and supplies. Amounts paid to ac-
quire or produce materials and supplies are
deductible in the taxable year in which the
materials and supplies are used or con-
sumed in the taxpayer’s operations.
(2)Incidental materials and supplies.
Amounts paid to acquire or produce inci-
dental materials and supplies that are car-
ried on hand and for which no record of
consumption is kept or physical invento-
ries at the beginning and end of the year
are not taken, are deductible in the taxable
year in which these amounts are paid, pro-
vided taxable income is clearly reflected.
(b)Rotable and temporary spare parts.
For purposes of this section, rotable spare
parts are parts that are removable from
the unit of property, generally repaired or
improved, and either reinstalled on other
property, or stored for later installation.
Temporary spare parts are parts that are
used temporarily until a new or repaired
part can be installed, and then removed and
stored for later (emergency or temporary)
installation. For purposes of paragraph
(a)(1) of this section, rotable and tempo-
rary spare parts are used or consumed in
the taxpayer’s business in the taxable year
in which the taxpayer disposes of the parts.
(c)Coordination with other provisions
of the Internal Revenue Code. Nothing in
this section changes the treatment of any
amount that is specifically provided for un-
der any provision of the Internal Revenue
Code (Code) or regulations other than sec-
tion 162(a) or section 212 and the regula-
tions under those sections. For example,
see §1.263(a)–3, which requires taxpayers
to capitalize amounts paid to improve units
of property and section 263A and the regu-
lations under section 263A, which require
taxpayers to capitalize the direct and al-
locable indirect costs, including the cost
of materials and supplies, to property pro-
duced or to property acquired for resale.
(d)Definitions—(1)Materials and sup-
plies. For purposes of this section,materi-
als and suppliesmeans tangible property
that is used or consumed in the taxpayer’s
operations and that—
(i) Is not a unit of property (as deter-
mined under §1.263(a)–3(d)(2)) and is not
acquired as part of a single unit of prop-
erty;
(ii) Is a unit of property (as determined
under §1.263(a)–3(d)(2)) that has an eco-
nomic useful life of 12 months or less, be-
ginning when the property is used or con-
sumed in the taxpayer’s operations;
(iii) Is a unit of property (as determined
under §1.263(a)–3(d)(2)) that has an ac-
quisition cost or production cost (as deter-
mined under section 263A) of $100 or less;
or
(iv) Is identified in published guid-
ance in theFederal Registeror in
the Internal Revenue Bulletin (see
§601.601(d)(2)(ii)(b)ofthischapter)as
materials and supplies for which treatment
is permitted under this section.
(2)Economic useful life—(i)General
rule. The economic useful life of a unit of
property is not necessarily the useful life
inherent in the property but is the period
over which the property may reasonably be
expected to be useful to the taxpayer or, if
the taxpayer is engaged in a trade or busi-
ness or an activity for the production of in-
come, the period over which the property
may reasonably be expected to be useful
to the taxpayer in its trade or business or
for the production of income, as applica-
ble. See §1.167(a)–1(b) for the factors to
be considered in determining this period.
(ii)Taxpayers with an applicable finan-
cial statement. For taxpayers with an ap-
plicable financial statement (as defined in
paragraph (d)(2)(iii) of this section), the
economic useful life of a unit of property,
solely for the purposes of applying the pro-
visions of paragraph (d)(1)(ii) of this sec-
tion, is the useful life initially used by the
taxpayer for purposes of determining de-
preciation in its applicable financial state-
ment, regardless of any salvage value of
the property. If a taxpayer does not have an
applicable financial statement for the tax-
able year in which the property was origi-
nally acquired or produced, the economic
useful life of the unit of property must
be determined under paragraph (d)(2)(i) of
this section. Further, if a taxpayer treats
amounts paid for a unit of property as an
expense in its applicable financial state-
ment on a basis other than the useful life
of the property or if a taxpayer does not de-
preciate the unit of property on its applica-
ble financial statement, the economic use-
ful life of the unit of property must be de-
termined under paragraph (d)(2)(i) of this
section. For example, if a taxpayer has a
policy of treating as an expense on its ap-
plicable financial statement amounts paid
for property costing less than a certain dol-
lar amount, notwithstanding that the prop-
erty has a useful life of more than one
year, the economic useful life of the prop-
erty must be determined under paragraph
(d)(2)(i) of this section.
(iii)Definition of applicable finan-
cial statement. The taxpayer’s applicable
financial statement is the taxpayer’s fi-
nancial statement listed in paragraphs
(d)(2)(iii)(A) through (C) of this section
that has the highest priority (including
2008–18 I.R.B.882May 5, 2008

within paragraph (d)(2)(iii)(B) of this sec-
tion). The financial statements are, in
descending priority—
(A) A financial statement required to
be filed with the Securities and Exchange
Commission(SEC)(the10-KortheAn-
nual Statement to Shareholders);
(B) A certified audited financial state-
ment that is accompanied by the report of
an independent CPA (or in the case of a
foreign entity, by the report of a similarly
qualified independent professional), that is
used for—
(1) Credit purposes;
(2) Reporting to shareholders, partners,
or similar persons; or
(3) Any other substantial non-tax pur-
pose; or
(C) A financial statement (other than
a tax return) required to be provided to
the Federal or a state government or any
Federal or state agencies (other than the
SEC or the Internal Revenue Service).
(3)Amount paid. For purposes of this
section, in the case of a taxpayer using
an accrual method of accounting, the
termsamount paidandpaymentmean a
liability incurred (within the meaning of
§1.446–1(c)(1)(ii)). A liability may not
be taken into account under this section
prior to the taxable year during which the
liability is incurred.
(4)Produce. For purposes of this
section,producemeans construct, build,
install, manufacture, develop, create, raise
or grow. See also §1.263(a)–2(b)(4).
This definition is intended to have the
same meaning as the definition used
for purposes of section 263A(g)(1) and
§1.263A–2(a)(1)(i), exceptthatimprove-
ments are excluded from the definition in
this paragraph (d)(4) and are separately
defined and addressed in §1.263(a)–3.
Amounts paid to produce materials and
supplies must be capitalized under section
263A.
(e)Election to capitalize. A taxpayer
may elect to treat as acapital expenditure
the cost of any material or supply as de-
fined in paragraph (d)(1) of this section,
unless the material or supply is a com-
ponent of a unit of property as described
in paragraph (d)(1)(i) of this section, and
the unit of property is a material or sup-
ply under paragraph (d)(1)(ii)–(iv) of this
section, rather than a capital expenditure.
An election made under this paragraph (e)
applies to amounts paid during the tax-
able year to acquire or produce any ma-
terial or supply to which paragraph (a)
of this section would apply (but for the
election under this paragraph (e)). A tax-
payer makes the election by capitalizing
the amounts paid to acquire or produce a
material or supply in the taxable year the
amounts are paid and by recovering the
costs when the material or supply is placed
in service by the taxpayer for the purposes
of determining depreciation under the ap-
plicable Code and regulation provisions.
A taxpayer must make this election in its
timely filed original Federal income tax re-
turn (including extensions) for the taxable
year the material or supply is placed in ser-
vice by the taxpayer for purposes of deter-
mining depreciation. See §1.263(a)–2 for
the treatment of amounts paid to acquire or
produce real or personal tangible property.
In the case of a pass-through entity, the
election is made by the pass-through entity,
and not by the shareholders, partners, etc.
An election must be made for each mate-
rial and/or supply. A taxpayer may revoke
an election made under this paragraph (e)
with respect to a material or supply only
by filing a request for a private letter ruling
and obtaining the Commissioner’s consent
to revoke the election. An election may
not be made or revoked through the filing
of an application forchange in accounting
method or by an amended Federal income
tax return. A taxpayer that revokes an elec-
tion may not re-elect to capitalize the ma-
terial or supply for a period of at least 60
months, beginning with the taxable year of
revocation.
(f)Examples. Therulesofthissection
areillustratedbythefollowingexamples,
in which it is assumed (unless otherwise
stated) that the property is not an inciden-
tal material or supply, that the taxpayer is
a calendar year, accrual method taxpayer,
and that the taxpayer has not elected to
capitalize under paragraph (e) of this sec-
tion.
Example 1.Not a unit of property; component
of personal property. X operates a fleet of aircraft.
In 2008, X purchases a stock of spare parts, which
it uses to maintain and repair its aircraft. The spare
parts are not units of property as determined under
§1.263(a)–3(d)(2) and are not rotable or temporary
spare parts. In 2009, X uses the spare parts in a repair
and maintenance activity that does not improve the
property under §1.263(a)–3. Under paragraph (a)(1)
of this section, the amounts paid for the spare parts
are deductible as materials and supplies in 2009, the
taxable year in which the spare parts are used to repair
and maintain the aircraft.
Example 2.Not a unit of property; rotable spare
parts. X operates a fleet of specialized vehicles that
it uses in its service business. At the time that it ac-
quires a new type of vehicle, X also acquires a sub-
stantial number of rotable spare parts that will be kept
on hand to quickly replace similar parts in X’s vehi-
cles as those parts break down or wear out. These
rotable replacement parts are not units of property as
determined under §1.263(a)–3(d)(2), are removable
from the vehicles, and are repaired or reconditioned,
so that they can be reinstalled on the same or simi-
lar vehicles. In 2008, X acquires several vehicles and
associated rotable spare parts. In 2009, X makes re-
pairs to several vehicles by using these rotable spare
parts to replace worn or damaged parts. In 2010, X
removes these rotable spare parts from its vehicles,
repairs them and reinstalls them on other similar ve-
hicles. In 2012, X can no longer use the rotable parts
it acquired in 2008 and disposes of them as scrap.
Under paragraph (d)(1) of this section, the rotable
spare parts acquired in 2008 are materials and sup-
plies. However, under paragraph (b) of this section,
these parts are not used orconsumed until the taxable
year in which X disposes of the parts. Therefore, un-
der paragraph (a)(1) of this section, X may deduct the
amounts paid for the rotable spare parts in 2012, the
taxable year in which X disposes of the parts.
Example 3.Not a unit of property; part of a single
unit of real property. X owns an apartment building
and discovers that a window in one of the apartments
is broken. In 2008, X pays for the acquisition, de-
livery, and installation of a new window to replace
the broken window. In the same year, the new win-
dow is installed. The window is not a unit of property
as determined under §1.263(a)–3(d)(2), and the re-
placement of the window does not improve the prop-
erty under §1.263(a)–3. Under paragraph (a)(1) of
this section, the amounts paid for the acquisition, de-
livery, and installation of the window are deductible
as materials and supplies in 2008, the taxable year in
which the window is installed in the apartment build-
ing.
Example 4.Economic useful life of 12 months
or less. X operates a fleet of aircraft that carries
freight for its customers.X owns a storage tank on
its premises, which can hold a one-month supply of
jet fuel for its aircraft. On December 31, 2008, X
purchases a one-month supply of jet fuel. In 2009, X
uses the jet fuel purchased on December 31, 2008, to
fuel the aircraft used in its business. Under paragraph
(a)(1) of this section, the amounts paid for the jet fuel
are deductible as materials and supplies in 2009, the
taxable year in which the jet fuel is used or consumed
in the operation of X’s aircraft.
Example 5.Unit of property that costs $100 or
less. X operates a rental business that rents out a va-
riety of small individual items to customers (rental
items). X maintains a supply of rental items on hand
to replace worn or damaged items. In 2008, X pur-
chases a large quantity of rental items to use in its
rental business. Each of these rental items is a unit
of property that costs $100 or less. In 2009, X be-
gins using all of the rental items purchased in 2008
by providing them to customers of its rental business.
X does not sell or exchange these items on established
retail markets at any time after the items are used in
the rental business. Under paragraph (a)(1) of this
section, the amounts paid for the rental items are de-
ductible as materials and supplies in 2009, the taxable
May 5, 20088832008–18 I.R.B.

year in which the rental items are used in X’s busi-
ness.
Example 6.Unit of property that costs $100 or
less. X provides billing services to its customers. In
2008, X incurs costs to purchase 50 facsimile ma-
chines to be used by its employees. Each facsimile
machine is a unit of property that costs less than $100.
In 2008, X’s employees begin using 35 of the facsim-
ile machines, and X stores the remaining 15 machines
for use in a later taxable year. Under paragraph (a)(1)
of this section, the amounts paid for 35 of the fac-
simile machines are deductible as materials and sup-
plies in 2008, the taxable year in which X uses those
machines. The amounts paid for each of the remain-
ing 15 machines are deductible in the taxable year in
which each machine is used.
Example 7.Materials and supplies used in im-
provements; coordination with §1.263(a)–3.Xowns
various machines that are used in its business. In
2008, X purchases a supply of spare parts for its ma-
chines. The spare parts are not units of property as de-
termined under §1.263(a)–3(d)(2) and are not rotable
or temporary spare parts. The spare parts may be used
by X in the repair or maintenance of a machine under
§1.162–4 or in the improvement of a machine under
§1.263(a)–3. In 2009, X uses all of these spare parts
in an activity that improves the unit of property under
§1.263(a)–3. Under paragraph (d)(1)(i) of this sec-
tion, the spare parts purchased by X in 2008 are ma-
terials and supplies. Under paragraph (a)(1) of this
section, the amounts paid for the spare parts are oth-
erwise deductible as materials and supplies in 2009,
the taxable year in which Xuses those parts. How-
ever, because these materials and supplies are used to
improve X’s property, X is required to capitalize the
amounts paid for those spare parts under §1.263(a)–3.
See also section 263A requiring taxpayers to capital-
ize the direct and allocable indirect costs of property
produced or acquired for resale.
Example 8.Cost of producing materials and sup-
plies; coordination with section 263A.Xisamanu-
facturer that produces liquid waste as part of its oper-
ations. X determines that its current liquid waste dis-
posal process is inadequate. To remedy the problem,
in 2008, X constructs a leaching pit to provide a drain-
ing area for the liquid waste. The leaching pit has an
economic useful life of less than 12 months, starting
on the date that X begins to use the leaching pit as
a draining area. At the end of this period, X’s fac-
tory will be connected to the local sewer system. In
2009, X starts using the leaching pit in its operations.
The amounts paid to construct the leaching pit (in-
cluding the direct and allocable indirect costs of prop-
erty produced under section 263A) are amounts paid
for a material or supply under paragraph (d)(1)(ii) of
this section. Under paragraph (a)(1) of this section,
the amounts paid for the leaching pit are otherwise
deductible as materials and supplies in 2009, the tax-
able year in which X uses the leaching pit. However,
because the amounts paid to construct the leaching
pit are incurred by reason of X’s manufacturing oper-
ations, X is required to capitalize the amounts paid to
construct the leaching pit to X’s property produced.
See §1.263A–1(e)(3)(ii)(E).
Example 9.Costs of acquiring materials and sup-
plies for production of property; coordination with
section 263A. In 2008, X purchases jigs, dies, molds,
and patterns for use in the manufacture of X’s prod-
ucts. The economic useful life of each jig, die, mold,
and pattern is 12 months or less, beginning when
each item is used in the manufacturing process. X
begins using the purchased items in 2009 to manu-
facture its products. These items are materials and
supplies under paragraph (d)(1)(ii) of this section.
Under paragraph (a)(1) of this section, the amounts
paid for the items are otherwise deductible as mate-
rials and supplies in 2009, the taxable year in which
X uses those items. However, because the amounts
paid for these materials and supplies directly benefit
or are incurred by reason of the taxpayer’s produc-
tion activities, X is required to capitalize the amounts
paid for these items to X’s property produced. See
§1.263A–1(e)(3)(ii)(E).
Example 10.Election to capitalize. X operates
a rental business that rents out a variety of items
(rental items) to its customers, each of which is
a separate unit of property as determined under
§1.263(a)–3(d)(2). X does not sell or exchange these
items on established retail markets at any time after
the items are used in the rental business. In 2008,
X incurs costs to purchase various rental items, all
ofwhichcostlessthan$100orhaveaneconomic
useful life of less than 12 months, beginning when
used or consumed. X begins using the rental items
in its business in 2008. Under paragraph (a)(1) of
this section, the amounts paid for each rental item
purchased in 2008 are deductible as a material or
supply in the taxable year in which the item is used.
However, for administrative reasons, X would prefer
to treat all of its rental items as capital expenditures
subject to depreciation. Under paragraph (e) of this
section, X may elect not to apply the rule contained
in paragraph (a)(1) of this section to the rental items.
X makes this election by capitalizing the amounts
paid for each rental item in the taxable year the costs
are incurred and by beginning to recover the costs
of each item on its timely filed Federal income tax
return for the taxable year that the item is placed
in service by X for purposes of determining depre-
ciation under the applicable Code and regulation
provisions. See §1.263(a)–2(e) for the treatment of
capital expenditures.
Example 11.Election to capitalize. X is an elec-
tric utility. In 2008, X acquires certain temporary
spare parts, which it keeps on hand to avoid opera-
tional time loss in the event it must make emergency
repairs to a unit of property that is subject to depre-
ciation. These parts are not units of property as de-
termined under §1.263(a)–3(d)(2) and are not used
to improve property under §1.263(a)–3(d)(1). These
temporary spare parts are used until a new or repaired
part can be installed, and then removed and stored
for later emergency installation. Under paragraphs
(a)(1) and (b) of this section, the amounts paid for
the temporary spare parts are deductible as materi-
als and supplies in the taxable year in which they are
disposed of by the taxpayer. However, because it is
unlikely that the temporary spare parts will be dis-
posed of in the near future, X would prefer to treat the
spare parts as capital expenditures subject to depreci-
ation. Accordingly, X may elect under paragraph (e)
of this section not to apply the rule contained in para-
graph (a)(1) of this section to each of its temporary
spare parts. X makes this election by capitalizing the
amounts paid for each spare part in the taxable year
the costs are incurred and by beginning to recover the
costs of each part on its timely filed Federal income
tax return for the taxable year that the part is placed
in service by X for purposes of determining depreci-
ation under the applicable Code and regulation pro-
visions. See §1.263(a)–2(e) for the treatment of cap-
ital expenditures and section 263A requiring taxpay-
ers to capitalize the direct and allocable indirect costs
of property produced or acquired for resale.
Par. 3. Section 1.162–4 is revised to
read as follows:
§1.162–4 Repairs.
Amounts paid for repairs and mainte-
nance to tangible property are deductible
iftheamountspaidarenotrequiredtobe
capitalized under §1.263(a)–3.
§1.162–6 [Removed]
Par. 4. Section 1.162–6 is removed.
Par. 5. Section 1.263(a)–0 is amended
by revising the entries for §§1.263(a)–1,
1.263(a)–2 and 1.263(a)–3 to read as fol-
lows:
§1.263(a)–0 Table of contents.
*****
§1.263(a)–1 Capital expenditures; in
general.
(a) General rule for capital expendi-
tures.
(b) Coordination with section 263A.
(c) Examples of capital expenditures.
(d) Amounts paid to sell property.
(1) In general.
(2) Treatment of capitalized amount.
(3) Examples.
(e) Amount paid.
(f) [Reserved]
(g) Effective/applicability date.
§1.263(a)–2 Amounts paid to acquire or
produce tangible property.
(a) Overview.
(b) Definitions.
(1) Amount paid.
(2) Personal property.
(3) Real property.
(4) Produce.
(c) Coordination with other provisions
of the Internal Revenue Code.
(1) In general.
(2) Materials and supplies.
(d) Acquired or produced tangible prop-
erty.
(1) In general.
(i) Requirement of capitalization.
(ii) Examples.
2008–18 I.R.B.884May 5, 2008

(2) Defense or perfection of title to
property.
(i) In general.
(ii) Examples.
(3) Transaction costs.
(i) In general.
(ii) Scope of facilitate.
(A) In general.
(B) Inherently facilitative amounts.
(C) Special rule for acquisitions of real
property.
(D) Employee compensation and over-
head costs.
(1) In general.
(2) Election to capitalize.
(iii) Treatment of transaction costs.
(iv) Examples.
(4)De minimisrule.
(i) In general.
(ii) Exceptions tode minimisrule.
(iii) Safe harbor.
(iv) Additional rules.
(v) Election to capitalize.
(vi) Definition of applicable financial
statement.
(vii) Examples.
(e) Treatment of capital expenditures.
(f) Recovery of capitalized amounts.
(1) In general.
(2) Examples.
(g) [Reserved]
(h) Effective/applicability date.
§1.263(a)–3 Amounts paid to improve
tangible property.
(a) Overview.
(b) Definitions.
(1) Amount paid.
(2) Personal property.
(3) Real property.
(4) Applicable financial statement.
(c) Coordination with other provisions
of the Internal Revenue Code.
(1) In general.
(2) Example.
(d) Improved property.
(1) Capitalization rule.
(2) Determining the unit of property.
(i) In general.
(ii) Building and structural compo-
nents.
(iii) Property other than buildings.
(A) In general.
(B) Plant property.
(1) Definition.
(2) Unit of property for plant property.
(C) Network assets.
(1) Definition.
(2)[Reserved]
(D) Additional rules.
(iv) Examples.
(3) Compliance with regulatory re-
quirements.
(4) Repairs and maintenance performed
during an improvement.
(i) In general.
(ii) Exception for individuals.
(5) Aggregate of related amounts.
(e) Safe harbor for routine maintenance.
(1) In general.
(2) Exceptions.
(3) Rotable or temporary spare parts.
(4) Class life.
(5) Examples.
(f) Capitalization of betterments.
(1) In general.
(2) Application of general rule.
(i) Facts and circumstances.
(ii) Unavailability of replacement parts.
(iii) Appropriate comparison.
(A) In general.
(B) Normal wear and tear.
(C) Particular event.
(3) Examples.
(g) Capitalization of restorations.
(1) In general.
(2) Rebuild to like-new condition.
(i) In general.
(A) Like-new condition.
(B) Economic useful life.
(ii) Exception.
(3) Replacement of a major component
or substantial structural part.
(i) In general.
(ii) Exception.
(4) Examples.
(h) Capitalization of amounts to adapt
property to a new or different use.
(1) In general.
(2) Examples.
(i) Optional regulatory accounting
method.
(1) In general.
(2) Eligibility for regulatory accounting
method.
(3) Description of regulatory account-
ing method.
(4) [Reserved]
(5) Examples.
(j) Repair allowance.
(k) Treatment of capital expenditures.
(l) Recovery of capitalized amounts.
(m) [Reserved]
(n) Effective/applicability date.
Par. 6. Section 1.263(a)–1 is revised to
read as follows:
§1.263(a)–1 Capital expenditures; in
general.
(a)General rule for capital expendi-
tures. Except as provided in chapter 1 of
the Internal Revenue Code (Code), no de-
duction is allowed for—
(1) Any amount paid for new buildings
or for permanent improvements or better-
mentsmadetoincreasethevalueofany
property or estate, or
(2) Any amount paid in restoring prop-
erty or in making good the exhaustion
thereof for which an allowance is or has
been made.
(b)Coordination with section 263A.
Section 263(a) generally requires taxpay-
ers to capitalize an amount paid to acquire,
produce, or improve real or personal tan-
gible property. Section 263A generally
prescribes the direct and indirect costs that
must be capitalized to property produced
or improved by the taxpayer and property
acquired for resale.
(c)Examples of capital expenditures.
The following amounts paid are examples
of capital expenditures:
(1) An amount paid to acquire or pro-
duce real or personal tangible property.
See §1.263(a)–2.
(2) An amount paid to improve real
or personal tangible property.See
§1.263(a)–3.
(3) An amount paid to acquire or create
intangibles. See §1.263(a)–4.
(4)Anamountpaidorincurredtofacil-
itate an acquisition of a trade or business,
a change in capital structure of a business
entity, and certain other transactions. See
§1.263(a)–5.
(5) An amount paid to acquire or create
interests in land, such as easements, life es-
tates, mineral interests, timber rights, zon-
ing variances, or other interests in land.
(6) An amount assessed and paid un-
der an agreement between bondholders or
shareholders of a corporation to be used in
a reorganization of the corporation or vol-
untary contributions by shareholders to the
capital of the corporation for any corporate
purpose. See section 118 and §1.118–1.
(7)Anamountpaidbyaholdingcom-
pany to carry out a guaranty of dividends
at a specified rate on the stock of a sub-
sidiary corporation for the purpose of se-
May 5, 20088852008–18 I.R.B.

curing new capital for the subsidiary and
increasing the value of its stockholdings in
the subsidiary. This amount must be added
to the cost of the stock in the subsidiary.
(d)Amounts paid to sell property—(1)
In general. Except in the case of dealers in
property, commissions and other transac-
tion costs paid to facilitate the sale of prop-
erty generally must be capitalized. How-
ever, in the case of dealers in property,
amounts paid to facilitate the sale of prop-
erty are treated as ordinary and necessary
business expenses. See §1.263(a)–5(g) for
the treatment of amounts paid to facilitate
the disposition of assets that constitute a
trade or business.
(2)Treatment of capitalized amount.
Amounts capitalized under paragraph
(d)(1) of this section are treated as a reduc-
tion in the amount realized and generally
are taken into account either in the taxable
year in which the sale occurs or in the
taxable year in which the sale is aban-
doned if a loss deduction is permissible.
The capitalized amount is not added to the
basis of the property and is not treated as
an intangible under §1.263(a)–4.
(3)Examples. The following examples,
which assume the sale is not an installment
sale under section 453, illustrate the rules
of this paragraph (d):
Example 1.Sales costs of real property.Xowns
a parcel of real estate. X sells the real estate and pays
legal fees, recording fees, and sales commissions to
facilitate the sale. X must capitalize the fees and com-
missions and, in the taxable year of the sale, offset
the fees and commissions against the amount realized
from the sale of the real estate.
Example 2.Sales costs of dealers. Assume the
samefactsasinExample 1, except that X is a dealer
in real estate. The commissions and fees paid to facil-
itate the sale of the real estate are treated as ordinary
and necessary business expenses under section 162.
Example 3.Sales costs of personal property used
in a trade or business. X owns a truck for use in
X’s trade or business. X decides to sell the truck and
on November 15, 2008, X pays for an appraisal to
determine a reasonable asking price. On February 15,
2009, X sells the truck to Y. X is required to capitalize
in 2008 the amount paid to appraise the truck and, in
2009, is required to offset the amount paid against the
amount realized from the sale of the truck.
Example 4.Costs of abandoned sale of personal
property used in a trade or business. Assume the
samefactsasinExample 3, except that, instead of
selling the truck on February 15, 2009, X decides on
that date not to sell the truck and takes the truck off
the market. X is required to capitalize in 2008 the
amount paid to appraise the truck. However, X may
treat the amount paid to appraise the truck as a loss
under section 165 in 2009 when the sale is abandoned.
Example 5.Sales costs of personal property not
used in a trade or business. Assume the same facts as
inExample 3, except that X does not use the truck in
X’s trade or business, but instead uses it for personal
purposes. X decides to sell the truck and on Novem-
ber 15, 2008, X pays for an appraisal to determine
a reasonable asking price. On February 15, 2009, X
sells the truck to Y. X is required to capitalize in 2008
the amount paid to appraise the truck and, in 2009, is
required to offset the amount paid against the amount
realized from the sale of the truck.
Example 6.Costs of abandoned sale of personal
property not used in a trade or business. Assume the
same facts as inExample 5, except that, instead of
selling the truck on February 15, 2009, X decides on
that date not to sell the truck and takes the truck off
the market. X is required to capitalize in 2008 the
amount paid to appraise the truck. Although the sale
is abandoned in 2009, X may not treat the amount
paid to appraise the truck as a loss under section 165
because the truck was not used in X’s trade or busi-
ness or in a transaction entered into for profit.
(e)Amount paid. In the case of a tax-
payer using an accrual method of account-
ing, the termsamount paidandpayment
mean a liability incurred (within the mean-
ing of §1.446–1(c)(1)(ii)). A liability may
not be taken into account under this section
prior to the taxable year during which the
liability is incurred.
(f) [Reserved]
(g)Effective/applicability date.The
rules in this section apply to taxable years
beginning on or after the date of publi-
cation of the Treasury decision adopting
these rules as final regulations in theFed-
eral Register.
Par. 7. Section 1.263(a)–2 is revised to
read as follows:
§1.263(a)–2 Amounts paid to acquire or
produce tangible property.
(a)Overview. This section provides
rules for applying section 263(a) to
amounts paid to acquire or produce a unit
of real or personal property. Paragraph
(b) of this section contains definitions.
Paragraph (c) of this section contains the
rules for coordinating this section with
other provisions of the Internal Revenue
Code (Code). Paragraph (d) of this sec-
tion provides the rules for determining the
treatment of amounts paid to acquire or
produce a unit of real or personal property,
including amounts paid to defend or per-
fect title to real or personal property and
amounts paid to facilitate the acquisition
of property. Paragraph (d) also provides a
de minimisrule.
(b)Definitions. For purposes of this
section, the following definitions apply:
(1)Amount paid. In the case of a tax-
payer using an accrual method of account-
ing, the termsamount paidandpayment
mean a liability incurred (within the mean-
ing of §1.446–1(c)(1)(ii)). A liability may
not be taken into account under this section
prior to the taxable year during which the
liability is incurred.
(2)Personal propertymeans tangible
personal property as defined in §1.48–1(c).
(3)Real propertymeans land and im-
provements thereto,such as buildings or
other inherently permanent structures (in-
cluding items that are structural compo-
nents of the buildings or structures) that are
not personal property as defined in para-
graph (b)(2) of this section. Any property
that constitutes other tangible property un-
der §1.48–1(d) is treated as real property
for purposes of this section. Local law
is not controlling in determining whether
property is real property for purposes of
this section.
(4)Producemeans construct, build, in-
stall, manufacture, develop, create, raise,
or grow. This definition is intended to have
the same meaning as the definition used
for purposes of section 263A(g)(1) and
§1.263A–2(a)(1)(i), except that improve-
ments are excluded from the definition in
this paragraph (b)(4) and are separately de-
fined and addressed in §1.263(a)–3.
(c)Coordination with other provisions
of the Internal Revenue Code—(1)In gen-
eral. Nothing in this section changes the
treatment of any amount that is specifi-
cally provided for under any provision of
the Code or regulations other than section
162(a) or section 212 and the regulations
under those sections. For example, see
section 263A requiring taxpayers to cap-
italize the direct and certain indirect costs
of producing property or acquiring prop-
erty for resale.
(2)Materials and supplies. Nothing
in this section changes the treatment of
amounts paid to acquire or produce prop-
erty that is properly treated as materials
and supplies under §1.162–3.
(d)Acquired or produced tangible
property—(1)In general—(i)Require-
ment of capitalization. Except as pro-
vided in paragraph (d)(4) of this section
(relating to thede minimisrule) and in
§1.162–3(d)(1)(ii), (iii), and (iv) (relat-
ing to certain materials and supplies), a
taxpayer must capitalize amounts paid
to acquire or produce a unit of real or
2008–18 I.R.B.886May 5, 2008

personal property (as determined under
§1.263(a)–3(d)(2)), including leasehold
improvement property, land and land im-
provements, buildings, machinery and
equipment, and furniture and fixtures.
Amounts paid to acquire or produce a
unit of real or personal property include
the invoice price, transaction costs as de-
termined under paragraph (d)(3) of this
section, and costs for work performed
prior to the date that the unit of property
is placed in service by the taxpayer (with-
out regard to any applicable convention
under section 168(d)). A taxpayer also
must capitalize amounts paid to acquire
real or personal property for resale and
to produce real or personal property. See
section 263A for the costs required to be
capitalized to property produced by the
taxpayer or to property acquired for resale.
(ii)Examples. The rules of this section
are illustrated by the following examples,
in which it is assumed that the taxpayer
does not apply thede minimisrule under
paragraph (d)(4) of this section:
Example 1.Acquisition of personal property.In
2008, X purchases new cash registers for use in its re-
tail store located in leased space in a shopping mall.
Assume each cash register is a unit of property as de-
termined under §1.263(a)–3(d)(2), and is not a mate-
rial or supply under §1.162–3. X must capitalize un-
der this paragraph (d)(1) the amount paid to purchase
each cash register.
Example 2.Relocation of personal property.As-
sumethesamefactsasinExample 1,exceptthatX’s
lease expires in 2009 and X decides to relocate its re-
tail store to a different building. In addition to various
other costs, X pays $5,000 to move the cash registers.
X is not required to capitalize under this paragraph
(d)(1) the $5,000 amount paid for moving the cash
registers.
Example 3.Acquisition of personal property
that is not a unit of property; coordination with
§1.162–3. X operates a fleet of aircraft. In 2008,
X purchases a stock of spare parts, which it uses to
maintain and repair its aircraft. Assume that the spare
parts are not units of property as determined under
§1.263(a)–3(d)(2). X does not make elections under
§1.162–3(e) to treat the materials and supplies as
capital expenditures. In 2009, X uses the spare parts
in a repair and maintenance activity that does not
improve the property under §1.263(a)–3. Because
the parts are not units of property, X is not required
to capitalize the amountspaid for the parts under
this paragraph (d)(1). Rather, X must apply the rules
in §1.162–3, governing the treatment of materials
and supplies, to determine the treatment of these
amounts.
Example 4.Acquisition of unit of personal prop-
erty; coordination with §1.162–3. X operates a rental
business that rents out a variety of small individual
items to customers (rental items). X maintains a
supply of rental items on hand to replace worn or
damaged items. In 2008, X purchases a large quan-
tity of rental items to be used in its business. Assume
that each of these items is a unit of property under
§1.263(a)–3(d)(2) and that several of these rental
items are materials and supplies under the definition
provided in §1.162–3(d). Therefore, X must apply
the rules in §1.162–3 to determine the treatment of
the amounts paid to acquire rental items that are
materials and supplies. Under this paragraph (d)(1),
X must capitalize the amounts paid for the rental
items that are units of property and do not otherwise
qualify as materials and supplies under §1.162–3(d).
Example 5.Acquisition or production cost.X
purchases or produces jigs, dies, molds, and patterns
for use in the manufacture of X’s products. Assume
that each of these items is a unit of property as deter-
mined under §1.263(a)–3(d)(2), and is not a material
and supply under §1.162–3(d). X is required to cap-
italize under this paragraph (d)(1) the amounts paid
to produce or purchase the jigs, dies, molds, and pat-
terns. See section 263A for the costs to be capitalized
to property produced by X.
Example 6.Acquisition of land. X purchases a
parcel of undeveloped real estate. X must capitalize
under this paragraph (d)(1) the amount paid to acquire
the real estate. See §1.263(a)–2(d)(3) for the treat-
ment of amounts paid to facilitate the acquisition of
real property.
Example 7.Acquisition of building. X purchases
a building. X must capitalize under this paragraph
(d)(1) the amount paid to acquire the building. See
§1.263(a)–2(d)(3) for the treatment of amounts paid
to facilitate the acquisition of real property.
Example 8.Acquisition of property for resale.X
purchases goods for resale. X must capitalize under
this paragraph (d)(1) the amounts paid to acquire the
goods. See section 263A for the costs to be capital-
ized to property acquired for resale.
Example 9.Production of property for sale.X
produces goods for sale. X must capitalize under
this paragraph (d)(1) the amount paid to produce the
goods. See section 263A for the costs to be capital-
ized to property produced by X.
Example 10.Production of building. X con-
structs a building. X must capitalize under this para-
graph (d)(1) the amount paid to construct the build-
ing. See section 263A for the costs to be capitalized
to real property produced by X.
Example 11
.Acquisition of assets constituting a
trade or business. Y owns tangible and intangible as-
sets that constitute a trade or business. X purchases
all the assets of Y in a taxable transaction. X must
capitalize under this paragraph (d)(1) the amount paid
for the tangible assets of Y. See §1.263(a)–4 for the
treatment of amounts paid to acquire intangibles and
§1.263(a)–5 for the treatment of amounts paid to fa-
cilitate the acquisition of assets that constitute a trade
or business. See section 1060 for special allocation
rules for certain asset acquisitions.
Example 12.Work performed prior to placing the
property in service. In 2008, X purchases a building
for use as a business office. The building is in a state
of disrepair. Prior to placing the building in service, X
incurs costs to repair cement steps, shore up parts of
the first and second floors, replace electrical wiring,
remove and replace old plumbing, and paint the out-
side and inside of the building. All the work was per-
formed on the building or its structural components.
In 2010, X places the building in service and begins
using the building as its business office. Assume the
building and its structural components is the unit of
property. The amounts paid must be capitalized as
costs of acquiring the building because they were for
work performed prior to X’s placing the building in
service.
Example 13.Work performed prior to placing the
property in service. In January 2008, X purchases a
new machine for use in an existing production line of
its manufacturing business. Assume that the machine
is a unit of property under §1.263(a)–3(d)(2). After
the machine is installed, X performs critical testing
on the machine to ensure that it is operational. On
November 1, 2008, the critical testing is complete
and X places the machine in service on the production
line. X continues to perform testing for quality con-
trol. The amounts paid for the installation and criti-
cal testing must be capitalized as costs of acquiring
the machine because they were for work performed
prior to X’s placing the machine in service. However,
amounts paid for quality control testing after the ma-
chine is placed in service by X are not required to be
capitalized as a cost of acquiring the machine.
(2)Defense or perfection of title to
property—(i)In general. Amounts paid to
defend or perfect title to real or personal
property are amounts paid to acquire or
produce property within the meaning of
this section and must be capitalized. See
section 263A for the costs required to be
capitalized to property produced by the
taxpayer or to property acquired for resale.
(ii)Examples. The following examples
illustrate the rule of this paragraph (d)(2):
Example 1.Amounts paid to contest condemna-
tion. X owns real property located in County. County
files an eminent domain complaint condemning a por-
tion of X’s property to use as a roadway. X hires an
attorney to contest the condemnation. Amounts paid
by X to the attorney must be capitalized because they
were to defend X’s title to the property.
Example 2.Amounts paid to invalidate or-
dinance. X is in the business of quarrying and
supplying for sale sand and stone in a certain munic-
ipality. Several years after X establishes its business,
the municipality in which it is located passes an or-
dinance that prohibits the operation of X’s business.
X incurs attorney’sfees in a successful prosecution
of a suit to invalidate the municipal ordinance. X
prosecutes the suit to preserve its business activities
and not to defend X’s title in the property. Therefore,
attorney’s fees paid by X are not required to be capi-
talized under this paragraph (d)(2). However, under
section 263A, all indirect costs, including otherwise
deductible costs, that directly benefit or are incurred
by reason of the taxpayer’s production activities
must be capitalized to the property produced for
sale. See §1.263A–1(e)(3)(i). Therefore, because the
amounts paid to invalidate the ordinance are incurred
by reason of X’s production activities, the amounts
paid must be capitalized under section 263A to the
property produced for sale by X.
Example 3. Amounts paid to challenge building
line. The board of public works of a municipality es-
tablishes a building line across X’s business property,
adversely affecting the value of the property. X in-
curs legal fees in unsuccessfully litigating the estab-
lishment of the building line. Amounts paid by X to
May 5, 20088872008–18 I.R.B.

the attorney must be capitalized because they were to
defend X’s title to the property.
(3)Transaction costs—(i)In general.
A taxpayer must capitalize amounts paid
to facilitate the acquisition or production
of real or personal property. See section
263A for the costs required to be capital-
ized to property produced by the taxpayer
or to property acquired for resale. See
§1.263(a)–5 for the treatment of amounts
paid to facilitate the acquisition of assets
that constitute a trade or business.
(ii)Scope of facilitate—(A)In general.
Except as otherwise provided in this sec-
tion, an amount is paid to facilitate the ac-
quisition of real or personal property if the
amount is paid in the process of investi-
gating or otherwise pursuing the acquisi-
tion. Whether an amount is paid in the
process of investigating or otherwise pur-
suing the acquisition is determined based
on all of the facts and circumstances. In
determining whether an amount is paid to
facilitate an acquisition, the fact that the
amount would (or would not) have been
paid but for the acquisition is relevant, but
is not determinative. These amounts in-
clude, but are not limited to, inherently fa-
cilitative amounts specified in paragraph
(d)(3)(ii)(B) of this section.
(B)Inherently facilitative amounts.An
amount paid in the process of investigat-
ing or otherwise pursuing the acquisition
of real or personal property facilitates the
acquisition if the amount is inherently fa-
cilitative. An amount is inherently facili-
tative if the amount is paid for—
(1) Transporting the property (for ex-
ample, shipping fees and moving costs);
(2) Securing an appraisal or determin-
ing the value or price of property;
(3) Negotiating the terms or structure of
the acquisition and obtaining tax advice on
the acquisition;
(4) Application fees, bidding costs, or
similar expenses;
(5) Preparing and reviewing the docu-
ments that effectuate the acquisition of the
property (for example, preparing the bid,
offer, sales contract, or purchase agree-
ment);
(6) Examining and evaluating the title
of property;
(7) Obtaining regulatory approval of the
acquisition or securing permits related to
the acquisition, including application fees;
(8) Conveying property between the
parties, including sales and transfer taxes,
and title registration costs;
(9) Finders’ fees or brokers’ commis-
sions, including amounts paid that are con-
tingent on the successful closing of the ac-
quisition;
(10) Architectural, geological, engi-
neering, environmental or inspection ser-
vices pertaining to particular properties;
and
(11) Services provided by a qualified
intermediary or other facilitator of an ex-
change under section 1031.
(C)Special rule for acquisitions of real
property. Except as provided in paragraph
(d)(3)(ii)(B) of this section (relating to in-
herently facilitativeamounts), an amount
paid by the taxpayer in the process of in-
vestigating or otherwise pursuing the ac-
quisition of real property does not facili-
tate the acquisition if it relates to activities
performed in the process of determining
whether to acquire real property and which
real property to acquire.
(D)Employee compensation and over-
head costs—(1)In general. For purposes
of this paragraph (d)(3), amounts paid for
employee compensation (within the mean-
ing of §1.263(a)–4(e)(4)(ii)) and overhead
are treated as amounts that do not facilitate
the acquisition of real or personal property.
See section 263A for the treatment of em-
ployee compensation and overhead costs
required to be capitalized to property pro-
duced by the taxpayer or to property ac-
quired for resale.
(2)Election to capitalize.Atax-
payer may elect to treat amounts paid
for employee compensation or overhead
as amounts that facilitate the acquisition
of property. The election is made sepa-
rately for each acquisition and applies to
employee compensation or overhead, or
both. For example, a taxpayer may elect
to treat overhead, but not employee com-
pensation, as amounts that facilitate the
acquisition of property. A taxpayer makes
the election by treating the amounts to
which the election applies as amounts that
facilitate the acquisition in the taxpayer’s
timely filed original Federal income tax
return (including extensions) for the tax-
able year during which the amounts are
paid. In the case of an S corporation or
partnership, the election is made by the
S corporation or by the partnership, and
not by the shareholders or partners. A
taxpayer may revoke an election made
under this paragraph (d)(3)(ii)(D)(2)with
respect to each acquisition only by filing
a request for a private letter ruling and
obtaining the Commissioner’s consent to
revoke the election.An election may not
be made or revoked through the filing of
an application forchange in accounting
method or by an amended Federal income
tax return.
(iii)Treatment of transaction costs.All
amounts paid to facilitate the acquisition
or production of real or personal property
are capital expenditures. Inherently facil-
itative amounts allocable to real or per-
sonal property are capital expenditures re-
lated to such property even if the property
is not eventually acquired or produced. Fa-
cilitative amounts allocable to real or per-
sonal property actually acquired or pro-
duced must be included in the basis of the
property acquired or produced. See para-
graph (f) of this section for the recovery of
capitalized amounts.
(iv)Examples. The following examples
illustrate the rules of this paragraph (d)(3):
Example 1.Broker’s fees to facilitate an acquisi-
tion. X decides to purchase a building in which to re-
locate its offices and hires a real estate broker to find
a suitable building. X pays fees to the broker to find
property for X to acquire. Under paragraph (d)(3)(i)
of this section, X must capitalize the amounts paid to
the broker because these costs are inherently facilita-
tive of the acquisition of real property.
Example 2.Inspection and survey costs to facil-
itate an acquisition. X decides to purchase build-
ing A and pays amounts to third-party contractors for
a termite inspection and an environmental survey of
building A. Under paragraph (d)(3)(i) of this section,
X must capitalize the amounts paid for the inspection
and the survey of the building because these costs are
inherently facilitative of the acquisition of real prop-
erty.
Example 3.Moving costs to facilitate an acqui-
sition. X purchases all the assets of Y and, in con-
nection with the purchase, hires a transportation com-
pany to move storage tanks from Y’s plant to X’s
plant. Under paragraph (d)(3)(i) of this section, X
must capitalize the amount paid to move the storage
tanks from Y’s plant to X’s plant because this cost is
inherently facilitative to the acquisition of personal
property.
Example 4.Scope of facilitate. X is in the busi-
ness of providing legal services to clients. X is inter-
ested in acquiring a new conference table for its of-
fice. X hires and incurs feesfor an interior designer
to shop for, evaluate, and make recommendations to
X regarding which new table to acquire. Under para-
graph (d)(3)(i) of this section, X must capitalize the
amounts paid to the interior designer to provide these
services because they are paid in the process of in-
vestigating or otherwise pursuing the acquisition of
personal property.
2008–18 I.R.B.888May 5, 2008

Example 5.Transaction costs allocable to other
property. X, a retailer, wants to acquire land for the
purpose of building a new distribution facility for its
products. X considers various properties on highway
A in state B. In evaluating the feasibility of several
sites, X incurs fees for the services of an architect
to advise and prepare preliminary plans for a facil-
ity that X is reasonably likely to construct at one of
the sites. The architect’s fees are not inherently fa-
cilitative to the acquisition of land, but are inherently
facilitative to the acquisition of a building under para-
graph (d)(3)(ii)(B)(10) of this section. In addition,
these costs are allocable as construction costs of the
building under section 263A. Therefore, X does not
capitalize these fees as amounts to acquire the build-
ing under paragraph (d)(3)(ii)(B) of this section, but
instead must capitalize these costs as indirect costs
allocable to the production of property under section
263A.
Example 6.Special rule for acquisitions of real
property. X owns several retail stores. X decides
to examine the feasibility of opening a new store in
City A. In October 2008, X hires and incurs costs
for a development consulting firm to study City A
and perform market surveys, evaluate zoning and en-
vironmental requirements, and make preliminary re-
ports and recommendations as to areas that X should
consider for purposes of locating a new store. In De-
cember 2008, X continues to consider whether to pur-
chase real property in City A and which property to
acquire. X hires, and incursfees for, an appraiser to
perform appraisals on two different sites to determine
a fair offering price for each site. In March 2009, X
decides to acquire one of these two sites for the lo-
cation of its new store. At the same time, X deter-
mines not to acquire the other site. Under paragraph
(d)(3)(ii)(C) of this section, X is not required to cap-
italize amounts paid to the development consultant
in 2008 because the amounts relate to activities per-
formed in the process of determining whether to ac-
quire real property and which real property to acquire
and the amounts are not inherently facilitative costs
under paragraph (d)(3)(ii)(B) of this section. How-
ever, X must capitalize amounts paid to the appraiser
in 2008 because the appraisal costs are inherently
facilitative costs under paragraph (d)(3)(ii)(B)(2)of
this section. In 2009, X must include the appraisal
costs allocable to property acquired in the basis of the
property acquired and may recover the appraisal costs
allocable to the propertynot acquired in accordance
with paragraph (f) of this section.
Example 7.Employee compensation and over-
head. X, a freight carrier, maintains an acquisition
department whose sole function is to arrange for the
purchase of vehicles and aircraft from manufacturers
or other parties to be used in its freight carrying busi-
ness. As provided in paragraph (d)(3)(ii)(D)(1)of
this section, X is not required to capitalize any portion
of the compensation paid to employees in its acqui-
sition department or any portion of its overhead allo-
cable to its acquisition department. However, under
paragraph (d)(3)(ii)(D)(2) of this section, X may elect
to capitalize the compensation and overhead costs al-
locable to the acquisition of a vehicle or aircraft by
treating these amounts as costs that facilitate the ac-
quisition of that property in its timely filed original
Federal income tax return for the year the amounts
are paid.
(4)De minimis rule—(i)In general.
Except as otherwise provided in this para-
graph (d)(4), a taxpayer is not required to
capitalize under paragraph (d) of this sec-
tion amounts paid for the acquisition or
production (including any amounts paid to
facilitate the acquisition or production) of
a unit of property (as determined under
§1.263(a)–3(d)(2)) if—
(A) The taxpayer has an applica-
ble financial statement (as defined in
§1.263(a)–2(d)(4)(vi));
(B) The taxpayer has at the beginning
of the taxable year, written accounting pro-
cedures treating as an expense for non-tax
purposes the amounts paid for property
costing less than a certain dollar amount;
(C) The taxpayer treats the amounts
paid during the taxable year as an expense
on its applicable financial statement in
accordance with its written accounting
procedures; and
(D) The total aggregate of amounts
paid and not capitalized under paragraphs
(d)(4)(i)(A), (B), and (C) of this section
for the taxable year do not distort the tax-
payer’s income for the taxable year.
(ii)Exceptions to de minimis rule.The
de minimisrule in paragraph (d)(4)(i) of
this section does not apply to the follow-
ing:
(A) Amounts paid to improve property
under §1.263(a)–3.
(B) Amounts paid for property that is
or is intended to be included in property
produced or acquired for resale.
(C) Amounts paid for land.
(iii)Safe harbor. The total aggregate
amount that is not required to be capital-
ized under thede minimisrule of para-
graphs (d)(4)(i)(A), (B) and (C) of this sec-
tion for the taxable year is deemed to not
distort the taxpayer’s income under para-
graph (d)(4)(i)(D) of this section if this
amount, added to the amount the taxpayer
deducts in the taxable year as materials and
supplies under the definition provided un-
der §1.162–3(d)(1)(iii) (relating to certain
property costing $100 or less), is less than
or equal to the lesser of—
(A) 0.1 percent of the taxpayer’s gross
receipts for the taxable year; or
(B) 2 percent of the taxpayer’s total
depreciation and amortization expense for
the taxable year as determined in its appli-
cable financial statement.
(iv)Additional rules.Propertytowhich
a taxpayer applies thede minimisrule
contained in paragraph (d)(4) of this sec-
tion is not treated upon sale or disposition
as a capital asset under section 1221 or
as property used in the trade or business
under section 1231. Property to which a
taxpayer applies thede minimisrule con-
tained in paragraph (d)(4) of this section is
not a material or supply under §1.162–3.
The cost of property to which a taxpayer
properly applies thede minimisrule con-
tained in paragraph (d)(4) of this section
is not required to be capitalized under sec-
tion 263A to a separate unit of property,
but may be required to be capitalized as a
cost of other property if incurred by reason
of the production of the other property.
See, for example, §1.263A–1(e)(3)(ii)(O)
requiring taxpayers to capitalize repair and
maintenance costs allocable to property
produced or acquired for resale.
(v)Election to capitalize. A taxpayer
may elect not to apply thede minimisrule
contained in paragraph(d)(4)(i) of this sec-
tion. An election made under this para-
graph (d)(4)(v) applies to any unit of prop-
erty during the taxable year to which para-
graphs (d)(4)(i)(A), (B), and (C) of this
section would apply (but for the election
under this paragraph (d)(4)(v)). A tax-
payer makes the election by treating the
amount paid as a capital expenditure in its
timely filed original Federal income tax
return (including extensions) for the tax-
able year in which the amount is paid. In
the case of an S corporation or partner-
ship, the election is made by the S cor-
poration or by the partnership, and not
by the shareholders or partners. A tax-
payer may revoke an election made un-
der this paragraph (d)(4)(v) with respect
to a unit of property only by filing a re-
quest for a private letter ruling and obtain-
ing the Commissioner’s consent to revoke
the election. An election may not be made
or revoked through the filing of an appli-
cation for change in accounting method or
by an amended Federal income tax return.
(vi)Definition of applicable financial
statement. For purposes of this paragraph
(d)(4), the taxpayer’s applicable financial
statement is the taxpayer’s financial state-
ment listed in paragraphs (d)(4)(vi)(A)
through (C) of this section that has the
highest priority (including within para-
graph (d)(4)(vi)(B) of this section). The
financial statements are, in descending
priority—
May 5, 20088892008–18 I.R.B.

(A) A financial statement required to
be filed with the Securities and Exchange
Commission(SEC)(the10-KortheAn-
nual Statement to Shareholders);
(B) A certified audited financial state-
ment that is accompanied by the report of
an independent CPA (or in the case of a
foreign entity, by the report of a similarly
qualified independent professional), that is
used for—
(1) Credit purposes;
(2) Reporting to shareholders, partners,
or similar persons; or
(3) Any other substantial non-tax pur-
pose; or
(C) A financial statement (other than
a tax return) required to be provided to
the Federal or a state government or any
Federal or state agencies (other than the
SEC or the Internal Revenue Service).
(vii)Examples. The following exam-
ples illustrate the rule of this paragraph
(d)(4):
Example 1.De minimis rule.X purchases 10
printers at $200 each for a total cost of $2000. As-
sume that each printer is a unit of property under
§1.263(a)–3(d)(2). X has an applicable financial
statement. X has a written policy at the beginning of
the taxable year to expense amounts paid for property
costing less than $500. X treats the amounts paid for
the printers as an expense on its applicable financial
statement. Assuming the total aggregate amounts
not capitalized under thede minimisrule for the
taxable year do not distort the taxpayer’s income, X
is not required to capitalize the amounts paid for the
printers.
Example 2.De minimis rule safe harbor not
met.X is a member of an affiliated group that files
a consolidated return. In 2008, X purchases 300
computers at $400 each for a total cost of $120,000.
Assume that each computer is a unit of property
under §1.263(a)–3(d)(2). X has a written policy at
the beginning of the taxable year to expense amounts
paid for property costing less than $500. X treats
the amounts paid for the computers as an expense
on its applicable financial statement. In addition,
in 2008 X purchases 300 desk chairs for $50 each
for a total cost of $15,000. X intends to deduct the
amounts paid for the desk chairs when used or con-
sumed as non-incidental materials and supplies under
§1.162–3(a)(1) and §1.162–3(d)(1)(iii) because
they are units of property costing less than $100.
For its 2008 taxable year, X has gross receipts of
$125,000,000 and reports $7,000,000 of depreciation
and amortization on its applicable financial state-
ment. Thus, in order to meet thede minimisrule safe
harbor for 2008, the sum of the amounts not required
to be capitalized under thede minimisrule for 2008
($120,000) plus the amounts X intends to deduct
as materials and supplies under §1.162–3(a)(1) and
§1.162–3(d)(1)(iii) for 2008 ($15,000), must be
less than or equal to $125,000 (0.1% of X’s total
gross receipts of $125,000,000), which is less than
$140,000 (2% of X’s total deprecation and amortiza-
tion of $7,000,000). Because $135,000($120,000 +
$15,000) exceeds $125,000, X will not meet thede
minimisrule safe harbor for its 2008 taxable year. As
a result, to apply thede minimisrule to the $120,000
paid to acquire the computers, X will have to other-
wise establish that this amount does not distort the
taxpayer’s income in 2008.
Example 3.De minimis rule safe harbor met.As-
sume the same facts as inExample 2, except X makes
an election under paragraph (d)(4)(v) of this section
to capitalize the $10,000 paid to acquire 25 of the 300
computers at $400 each. In this case, X is not required
to capitalize the $110,000 paid to acquire the remain-
ing 275 computers under paragraph (d)(4)(i) because
this amount, when added to the $15,000 that X in-
tends to deduct in 2008 as materials and supplies un-
der §1.162–3(a)(1) and §1.162–3(d)(1)(iii), does not
exceed thede minimisrule safe harbor of $125,000
for 2008.
Example 4.De minimis rule safe harbor; elec-
tion to capitalize. Assume the same facts as inEx-
ample 2, except X does not otherwise establish that
the deduction of amounts in excess of the $125,000
safe harbor do not distort X’s income in 2008. Rather,
X makes an election under §1.162–3(e) to capitalize
$10,000 paid to acquire 200 of the 300 desk chairs at
$50 each. In this case, X is not required to capital-
ize the $120,000 paid to acquire the 300 computers
under paragraph (d)(4)(i) of this section because this
amount, when added to the $5000 (the remaining 100
desk chairs at $50 each) that X intends to deduct in
2008 as materials and supplies under §1.162–3(a)(1)
and §1.162–3(d)(1)(iii), does not exceed thede min-
imisrule safe harbor of $125,000 for 2008.
(e)Treatment of capital expenditures.
Amounts required to be capitalized un-
der this section are capital expenditures
and must be taken into account through
a charge to capital account or basis, or in
the case of property that is inventory in
the hands of a taxpayer, through inclusion
in inventory costs. See section 263A for
the treatment of amounts referred to in
this section as well as other amounts paid
in connection with the production of real
property and personal property, includ-
ing films, sound recordings, video tapes,
books, or similar properties.
(f)Recovery of capitalized
amounts—(1)In general. Amounts that
are capitalized under this section are
recovered through depreciation, cost of
goods sold, or by an adjustment to basis at
the time the property is placed in service,
sold, used, or otherwise disposed of by
the taxpayer. Cost recovery is determined
by the applicable Code and regulation
provisions relating to the use, sale, or
disposition of property.
(2)Examples. The following examples
illustrate the rule of this paragraph (f)(1).
Assume that X does not apply thede min-
imisrule under paragraph (d)(4) of this
section.
Example 1.Recovery when property placed in
service. X owns a 10-unit apartment building. The
refrigerator in one of the apartments stops function-
ing and X purchases a new refrigerator to replace the
old one. X pays for the acquisition, delivery, and in-
stallation of the new refrigerator to replace the old re-
frigerator. Assume that the refrigerator is the unit of
property, as determined under §1.263(a)–3(d)(2), and
is not a material or supply under §1.162–3. Under
paragraph (d) of this section, X is required to capital-
ize the amounts paid for the acquisition, delivery, and
installation of the refrigerator. Under this paragraph
(f), the capitalized amounts are recovered through de-
preciation when the refrigerator is placed in service
by X.
Example 2.Recoverywhenpropertyusedinthe
production of property. X operates a plant where it
manufactures widgets. Xpurchases a tractor/loader
to move raw materials into and around the plant for
use in the manufacturing process. Assume that the
tractor/loader is a unit of property, as determined un-
der §1.263(a)–3(d)(2), and is not a material or sup-
ply under §1.162–3. Under paragraph (d) of this sec-
tion, X is required to capitalize the amounts paid to
acquire the tractor/loader. Under this paragraph (f),
the capitalized amounts are recovered through depre-
ciation when the tractor/loader is placed in service
by X. However, because the tractor/loader is used in
the production of property, under section 263A the
cost recovery (that is, the depreciation) on the capi-
talized amounts must be capitalized to X’s property
produced, and consequently, recovered through cost
of goods sold. See §1.263A–1(e)(3)(ii)(I).
(g) [Reserved]
(h)Effective/applicability date.The
rules in this section apply to taxable years
beginning on or after the date of publi-
cation of the Treasury decision adopting
these rules as final regulations in theFed-
eral Register.
Par. 8. Section 1.263(a)–3 is revised to
read as follows:
§1.263(a)–3 Amounts paid to improve
tangible property.
(a)Overview. This section provides
rules for applying section 263(a) to
amounts paid to improve tangible prop-
erty. Paragraph (b) of this section provides
definitions. Paragraph (c) of this section
provides rules for coordinating this sec-
tion with other provisions of the Internal
Revenue Code (Code). Paragraph (d) of
this section provides rules for determining
the treatment of amounts paid to improve
tangible property, including rules for de-
termining the appropriate unit of property.
Paragraph (e) of this section provides a
safe harbor for routine maintenance costs.
Paragraph (f) of this section provides rules
for determining whether amounts paid re-
sult in betterments to the unit of property.
2008–18 I.R.B.890May 5, 2008

Paragraph (g) of this section provides rules
for determining whether amounts paid
restore the unit of property. Paragraph (h)
of this section provides rules for amounts
paid to adapt the unit of property to a
new or different use. Paragraph (i) of this
section provides an optional regulatory
accounting method safe harbor. Paragraph
(j) of this section provides an optional
repair allowance. Paragraphs (k) through
(m) of this section provide additional rules
related to these provisions. Paragraph (n)
of this section provides the applicability
date of the rules in this section.
(b)Definitions. For purposes of this
section, the following definitions apply:
(1)Amount paid. In the case of a tax-
payer using an accrual method of account-
ing, the termsamounts paidandpayment
mean a liability incurred (within the mean-
ing of §1.446–1(c)(1)(ii)). A liability may
not be taken into account under this section
prior to the taxable year during which the
liability is incurred.
(2)Personal propertymeans tangible
personal property as defined in §1.48–1(c).
(3)Real propertymeans land and im-
provements thereto, such as buildings or
other inherently permanent structures (in-
cluding items that are structural compo-
nents of the buildings or structures) that are
not personal property as defined in para-
graph (b)(2) of this section. Any property
that constitutes other tangible property un-
der §1.48–1(d) is also treated as real prop-
erty for purposes of this section. Local law
is not controlling in determining whether
property is real property for purposes of
this section.
(4)Applicable financial statement.The
applicable financial statementis the tax-
payer’s financial statement listed in para-
graphs (b)(4)(i) through (iii) of this sec-
tion that has the highest priority (including
within paragraph (b)(4)(ii) of this section).
The financial statements are, in descend-
ing priority—
(i) A financial statement required to
be filed with the Securities and Exchange
Commission(SEC)(the10-KortheAn-
nual Statement to Shareholders);
(ii) A certified audited financial state-
ment that is accompanied by the report of
an independent CPA (or in the case of a
foreign entity, by the report of a similarly
qualified independent professional), that is
used for—
(A) Credit purposes;
(B) Reporting to shareholders, partners,
or similar persons; or
(C) Any other substantial non-tax pur-
pose; or
(iii) A financial statement (other than
a tax return) required to be provided to
the Federal or a state government or any
Federal or state agencies (other than the
SEC or the Internal Revenue Service).
(c)Coordination with other provisions
of the Internal Revenue Code—(1)In gen-
eral. Nothing in this section changes the
treatment of any amount that is specifi-
cally provided for under any provision of
the Code or regulations (other than sec-
tion 162(a) or section 212 and the regula-
tions under those sections). See, for exam-
ple, §1.263A–1(e)(3), requiring taxpayers
to capitalize costs that directly benefit or
are incurred by reason of the performance
of production or resale activities, including
repair and maintenance costs allocable to
property produced or acquired for resale.
(2)Example. The following example
illustratestherulesofthisparagraph(c):
Example.Railroad rolling stock. X is a railroad
that properly treats amounts paid for the rehabilitation
of railroad rolling stock as deductible expenses un-
der section 263(d). X is not required to capitalize the
amounts paid because nothing in this section changes
the treatment of amounts specifically provided for un-
der section 263(d).
(d)Improved property—(1)Capital-
ization rule. Except as provided in the
optional regulatory accounting method
in paragraph (i) of this section or under
any repair allowance method published
in accordance with paragraph (j) of this
section, a taxpayer must capitalize the ag-
gregate of related amounts paid to improve
a unit of property, whether the improve-
ments are made by the taxpayer or by a
third party, and whether the taxpayer is
an owner or lessee of the property. For
purposes of this section, a unit of prop-
erty includes units of property for which
the acquisition or production costs were
deducted as materials and supplies under
§1.162–3(a)(1) or under thede minimis
rule in §1.263(a)–2(d)(4). See section
263A for the costs required to be capital-
ized to property produced by the taxpayer
or to property acquired for resale; section
1016 for adding capitalized amounts to the
basis of the unit of property; and section
168 for the treatment of additions or im-
provements for depreciation purposes. For
purposes of this section, a unit of property
is improved if the amounts paid for activi-
ties performed after the property is placed
in service by the taxpayer—
(i) Result in a betterment to the unit of
property (see paragraph (f) of this section);
or
(ii) Restore the unit of property (see
paragraph (g) of this section); or
(iii) Adapt the unit of property to a new
or different use (see paragraph (h) of this
section).
(2)Determining the appropriate unit
of property—(i)In general. The unit of
property rules in this paragraph (d)(2) ap-
ply only for purposes of section 263(a) and
§§1.263(a)–1, 1.263(a)–2, 1.263(a)–3, and
1.162–3(d). In general, the unit of prop-
erty determination is based upon the func-
tional interdependence standard provided
in paragraph (d)(2)(iii)(A) of this section.
However, special rules are provided for
buildings (see paragraph (d)(2)(ii) of this
section), plant property (see paragraph
(d)(2)(iii)(B) of this section), and network
assets (see paragraph (d)(2)(iii)(C) of this
section). Additional rules are provided if
a taxpayer has assigned different finan-
cial statement economic useful lives or
MACRS classes or depreciation methods
to components of property (see paragraph
(d)(2)(iii)(D) of this section). Property
that is aggregated and subject to a general
asset account election or accounted for in
a multiple asset account (that is, pooled)
may not be treated as a single unit of prop-
erty. In addition, an improvement to a unit
of property as determined under this sec-
tion, other than a leasehold improvement,
is not a unit of property separate from the
unit of property improved.
(ii)Buildings and structural compo-
nents. In the case of a building (as de-
fined in §1.48–1(e)(1)), the building and
its structural components (as defined in
§1.48–1(e)(2)) are a single unit of property.
In the case of a leasehold improvement
made by a lessee and that is section 1250
property, the leasehold improvement is a
separate unit of property. In the case of a
taxpayer that owns or occupies an individ-
ual unit in a building with multiple units
(such as a condominium or cooperative),
the unit of property is the individual unit
owned and/or occupied by the taxpayer.
(iii)Property other than buildings—(A)
In general. Except as provided in para-
graphs (d)(2)(iii)(B), (C) and (D) of this
section, in the case of real or personal prop-
erty other than property described in para-
May 5, 20088912008–18 I.R.B.

graph(d)(2)(ii)ofthis section, all the com-
ponents that are functionally interdepen-
dent comprise a single unit of property.
Components of property are functionally
interdependent if the placing in service of
one component by the taxpayer is depen-
dent on the placing in service of the other
component by the taxpayer.
(B)Plant property—(1)Definition.For
purposes of this paragraph (d)(2) of this
section, the termplant propertymeans
functionally interdependent machinery or
equipment, other than network assets, used
to perform an industrial process, such as
manufacturing, generation, warehousing,
distribution, automated materials handling
in service industries, or other similar ac-
tivities.
(2)Unit of property for plant property.
In the case of plant property, a unit of prop-
erty is comprised of each component (or
group of components) within the unit of
property determined under the general rule
of paragraph (d)(2)(iii)(A) of this section
that performs a discreteandmajorfunction
or operation within the functionally inter-
dependent machinery or equipment.
(C)Network assets—(1)Definition.
For purposes of this paragraph (d)(2), the
termnetwork assetsmeans railroad track,
oil and gas pipelines, water and sewage
pipelines, power transmission and distri-
bution lines, and telephone and cable lines
that are owned or leased by taxpayers in
each of those respective industries. The
term includes, for example, trunk and
feeder lines, pole lines, and buried conduit.
It does not include property that would
be included as a structural component of
a building under paragraph (d)(2)(ii) of
this section, nor does it include separate
property that is adjacent to, but not part of
a network asset, such as bridges, culverts,
or tunnels.
(2)[Reserved]
(D)Additional rules. Notwithstanding
the unit of property determination under
paragraphs (d)(2)(iii)(A), (B), and (C) of
this section, a component (or a group of
components) of a unit property must be
treated as a separate unit of property if—
(1) At the time the unit of prop-
erty (as determined under paragraphs
(d)(2)(iii)(A), (B), and (C) of this section)
is placed in service by the taxpayer (with-
out regard to subsequent improvements),
the taxpayer has recorded on its books
and records for financial or regulatory
accounting purposes an economic useful
life for the component that is different
fromtheeconomicusefullifeoftheunit
of property of which the component is a
part; or
(2) The taxpayer has properly treated
the component as being within a differ-
ent class of property under section 168(e)
(MACRS classes) than the class of the unit
of property of which the component is a
part or, the taxpayer, at the time the compo-
nent was placed in service by the taxpayer,
has properly depreciated the component
using a different depreciation method un-
der section 167 or section 168 than the de-
preciation method of the unit of property
of which the component is a part.
(iv)Examples. The rules of this para-
graph (d)(2) are illustrated by the follow-
ing examples, in which it is assumed that
the taxpayer has not made a general asset
account election with regard to property or
accounted for property in a multiple asset
account.
Example 1.Buildings and structural compo-
nents; plant property. X owns a building containing
various types of manufacturing equipment that are
not structural componentsof the building. Because
the property is a building, as defined in §1.48–1(e)(1),
the unit of property for the building must be de-
termined under paragraph (d)(2)(ii) of this section.
Under the rules of that paragraph, X must treat the
building and all its structural components as a single
unit of property. In addition, because the manu-
facturing equipment contained within the building
constitutes property other than a building, the units
of property for the manufacturing equipment are
initially determined under the general rule in para-
graph (d)(2)(iii)(A) of this section and are therefore
comprised of all the components that are functionally
interdependent. Moreover, because the manufac-
turing equipment is plant property, under paragraph
(d)(2)(iii)(B) of this section, the units of property
under the general rule are further divided into smaller
units of property by determining the components
(or groups of components) that perform discrete and
major functions within the plant. Finally, X must ap-
ply the additional rules in paragraph (d)(2)(iii)(D) of
this section to determine whether any of the units of
property determined under paragraphs (d)(2)(iii)(A)
and (B) of this section contain components that must
be treated as separate units of property.
Example 2.Buildings and structural compo-
nents; property other than plants. X, a manufacturer,
owns a building adjacent to its manufacturing facil-
ity that contains office space and related facilities
for X’s employees that manage and administer X’s
manufacturing operations. The office building con-
tains equipment, such as desks, chairs, computers,
telephones, and bookshelves, that are not structural
components of the building. Because the office
building is a building, as defined in §1.48–1(e)(1), the
unit of property for the building must be determined
under paragraph (d)(2)(ii) of this section. Under the
rules of that paragraph, X must treat the office build-
ing and all its structural components as a single unit
of property. In addition, because the equipment con-
tained within the office building constitutes property
other than a building, the units of property for the
office equipment are initially determined under the
general rule in paragraph (d)(2)(iii)(A) of this section
and are comprised of the groups of components that
are functionally interdependent. X then must apply
the additional rules in paragraph (d)(2)(iii)(D) of
this section to determine whether any of the units of
property determined under paragraph (d)(2)(iii)(A)
of this section contain components that must be
treated as separate units of property.
Example 3. Plant property; discrete and major
function. X is an electric utility company that oper-
ates a power plant to generate electricity. The power
plant includes a structure that is not a building un-
der §1.48–1(e)(1), four pulverizers that grind coal,
one boiler that produces steam, one turbine that con-
verts the steam into mechanical energy, and one gen-
erator that converts mechanical energy into electrical
energy. In addition, the turbine contains a series of
blades that cause the turbine to rotate when affected
by the steam. When X placed the plant into service,
X recorded all the components of the plant as hav-
ing the same economic useful life on its books and
records for financial and regulatory accounting pur-
poses. X also treated all the components of the plant
as being within the same class of property under sec-
tion 168(e) and has depreciated all the components
using the same depreciation methods. Because the
plant is composed of real and personal tangible prop-
erty other than a building, the unit of property for
the generating equipment is initially determined un-
der the general rule in paragraph (d)(2)(iii)(A) of this
section and is comprised of all the components that
are functionally interdependent. Under this rule, the
initial unit of property is the entire plant because the
components of the plant are functionally interdepen-
dent. However, because the power plant is plant prop-
erty under paragraph (d)(2)(iii)(B) of this section, the
initial unit of property is further divided into smaller
units of property by determining the components (or
groups of components) that perform discrete and ma-
jor functions within the plant. Under this paragraph,
X must treat the structure, the boiler, the turbine, and
the generator each as a separate unit of property, and
each of the four pulverizers as a separate unit of prop-
erty because each of these components performs a
discrete and major function within the power plant.
X is not required to treat components, such as the
turbine blades, as separate units of property because
each of these components does not perform a discrete
and major function within the plant.
Example 4.Plant property; discrete and major
function. X is engaged in a uniform and linen rental
business that operates a plant to treat and launder
items used in its business. Within the plant, X utilizes
an assembly line-like process that incorporates many
different machines and equipment to launder and
prepare the items to be returned to customers. X uti-
lizes two laundering lines in its plant, each of which
can operate independently. One line is used for uni-
forms and another line is used for linens. Both lines
incorporate several sorters, boilers, washers, dryers,
ironers, folders, and wastewater treatment systems.
Because the laundering equipment contained within
the plant is personal property, the unit of property
2008–18 I.R.B.892May 5, 2008

for the laundering equipment is initially determined
under the general rule in paragraph (d)(2)(iii)(A) of
this section and is comprised of all the components
that are functionally interdependent. Under this rule,
the initial units of property are each laundering line
because each line is functionally independent and is
comprised of components that are functionally inter-
dependent. However, because each line is comprised
of plant property under paragraph (d)(2)(iii)(B) of
this section, the initial units of property are further
divided into smaller units of property by determin-
ing the components (or groups of components) that
perform discrete and major functions within the line.
Under paragraph (d)(2)(iii)(B) of this section, X
must treat each sorter, boiler, washer, dryer, ironer,
folder, and waste water treatment system in each line
as a separate unit of property because each of these
components performs a discrete and major function
within the line. Finally, X must apply the additional
rules in paragraph (d)(2)(iii)(D) of this section to
determine whether any of the units of property deter-
mined under paragraph (d)(2)(iii)(B) of this section
contain components that must be treated as separate
units of property.
Example 5.Plant property; industrial process.X
operates a restaurant that prepares and serves food to
retail customers. Within its restaurant, X has a large
piece of equipment that uses an assembly line-like
process to prepare and cook tortillas that X serves to
its customers. Because the tortilla-making equipment
is personal property, the unit of property for the equip-
ment is initially determined under the general rule in
paragraph (d)(2)(iii)(A) of this section and is com-
prised of all the components that are functionally in-
terdependent. Under this rule, the initial unit of prop-
erty is the entire tortilla-making equipment because
the various components of the equipment are func-
tionally interdependent. Although the equipment is
used to perform a manufacturing process, the equip-
ment is not being used in an industrial process, as
it performs a small-scale function as part of X’s re-
tail restaurant operations. Therefore, the equipment
is not plant property under paragraph (d)(2)(iii)(B)
of this section. Finally, X must apply the additional
rules in paragraph (d)(2)(iii)(D) of this section to de-
termine whether the equipment contains components
that must be treated as separate units of property.
Example 6.Personal property.X owns locomo-
tives that it uses in its railroad business. Each loco-
motive consists of various components, such as an en-
gine, generators, batteries and trucks. X acquired a
locomotive with all its components and recorded all
the components as having the same economic useful
life on its books and records for financial and regu-
latory accounting. X also treated all the components
of the locomotive as being within the same class of
property under section 168(e) and has depreciated all
the components using the same depreciation meth-
ods. Because X’s locomotive is property other than
a building, the initial unit of property is determined
under paragraph (d)(2)(iii)(A) of this section. Under
this paragraph, the locomotive is a single unit of prop-
erty because it consists entirely of components that
are functionally interdependent. Because the addi-
tional rules under paragraph (d)(2)(iii)(D) of this sec-
tion do not apply under these facts, the locomotive is
a single unit of property.
Example 7.Personal property. X is engaged in
the business of transporting freight throughout the
United States. To conduct its business, X owns a
fleet of tractors and trailers. Each tractor and trailer
is comprised of various components, including tires.
X purchases a truck trailer with all of its components,
including 16 tires. At the time the trailer was placed
in service by X, X treated the trailer and the tires as
being within the same class of property under sec-
tion 168(e) and has depreciated all the components
using the same depreciation methods. However, on
its books and records for financial accounting pur-
poses, X recorded economic useful lives for the tires
that were different from the economic useful life that
it recorded for the trailer. Because X’s trailer is prop-
erty other than a building, the initial units of prop-
erty for the trailer are determined under the general
rule in paragraph (d)(2)(iii)(A) of this section and are
comprised of all the components that are functionally
interdependent. Under this rule, the truck trailer, in-
cluding its 16 tires, is a single unit of property be-
cause the trailer and the tires are functionally interde-
pendent (that is, the placing in service of the tires is
dependent upon the placing in service of the trailer).
X then must apply the additional rules in paragraph
(d)(2)(iii)(D) of this section to determine whether the
initial unit of property determined under paragraph
(d)(2)(iii)(A) of this section contains components that
must be treated as separate units of property. Under
paragraph (d)(2)(iii)(D)(1) of this section, because X
recorded on its books and records economic useful
lives for the tires that are different from the economic
useful lives that it recorded for the trailer, the tires
must be treated as separate units of property.
Example 8.Personal property. X provides legal
services to customers. X purchased a laptop com-
puter and a printer to be used by its employees in pro-
viding services. When X placed the computer and
printer into service, X recorded both items and all
their components as having the same economic use-
ful life on its books and records for financial account-
ing purposes. X also treated the computer and printer
and all their components as being within the same
class of property under section 168(e) and has depre-
ciated all the components using the same depreciation
methods. Because the computer and printer are prop-
erty other than a building, the initial units of prop-
erty are determined underthe general rule in para-
graph (d)(2)(iii)(A) of this section and are comprised
of the components that are functionally interdepen-
dent. Under this paragraph (d)(2)(iii)(A), the com-
puter and the printer are separate units of property
because the computer and the printer are not compo-
nents that are functionally interdependent (that is, the
placing in service of the computer is not dependent on
the placing in service of the printer). The additional
rules in paragraph (d)(2)(iii)(D) of this section do not
apply under these facts. Accordingly, the computer
and the printer each constitute separate units of prop-
erty.
(3)Compliance with regulatory re-
quirements. For purposes of this section,
a Federal, state, or local regulator’s re-
quirement that a taxpayer perform certain
repairs or maintenance on a unit of prop-
erty to continue operating the property is
not relevant in determining whether the
amount paid improves the unit of property.
(4)Repairs and maintenance per-
formed during an improvement—(i)In
general. A taxpayer must capitalize all
the direct costs of an improvement and all
the indirect costs (including otherwise de-
ductible repair costs) that directly benefit
or are incurred by reason of an improve-
ment in accordance with the rules under
section 263A. Repairs and maintenance
that do not directly benefit or are not in-
curred by reason of an improvement are
not required to be capitalized under sec-
tion 263(a), regardless of whether they are
made at the same time as an improvement.
(ii)Exception for individuals’ resi-
dences. A taxpayer who is an individual
may capitalize amounts paid for repairs
and maintenance that are made at the same
time as substantial capital improvements
to property not used in the taxpayer’s trade
or business or for the production of in-
come if the repairs are done as part of a
remodeling of the taxpayer’s residence.
(5)Aggregate of related amounts.For
purposes of paragraph (d)(1) of this sec-
tion, the aggregate of related amounts paid
to improve a unit of property may be in-
curred over a period of more than one tax-
able year. Whether amounts are related
to the same improvement depends on the
facts and circumstances of the activities
being performed and whether the costs are
incurred by reason of a single improve-
ment or directly benefit a single improve-
ment.
(e)Safe harbor for routine mainte-
nance—(1)In general. An amount paid
for routine maintenance performed on a
unit of property is deemed to not improve
that unit of property. Routine mainte-
nance is the recurring activities that a
taxpayer expects to perform as a result of
the taxpayer’s use of the unit of property
to keep the unit of property in its ordinar-
ily efficient operating condition. Routine
maintenance activities include, for exam-
ple, the inspection,cleaning, and testing
of the unit of property, and the replace-
ment of parts of the unit of property with
comparable and commercially available
and reasonable replacement parts. The
activities are routine only if, at the time
the unit of property is placed in service
by the taxpayer, the taxpayer reasonably
expects to perform the activities more than
once during the class life (as defined in
paragraph (e)(4) of this section) of the unit
of property. Among the factors to be con-
May 5, 20088932008–18 I.R.B.

sidered in determining whether a taxpayer
is performing routine maintenance are the
recurring nature of the activity, industry
practice, manufacturers’ recommenda-
tions, the taxpayer’s experience, and the
taxpayer’s treatment of the activity on its
applicable financial statement (as defined
in paragraph (b)(4) of this section). With
respecttoataxpayerthatisalessorofa
unit of property, the taxpayer’s use of the
unit of property includes the lessee’s use
of the unit of property.
(2)Exceptions. Routine maintenance
does not include the following—
(i) Amounts paid for the replacement of
a component of a unit of property if the
taxpayer has properly deducted a loss for
that component (other than a casualty loss
under §1.165–7);
(ii) Amounts paid for the replacement
of a component of a unit of property if the
taxpayer has properly taken into account
the adjusted basis of the component in re-
alizing gain or loss resulting from the sale
or exchange of the component;
(iii) Amounts paid for the repair of dam-
age to a unit of property for which the tax-
payer has taken a basis adjustment as a re-
sult of a casualty loss under section 165
or relating to a casualty event described in
section 165; and
(iv) Amounts paid to return a unit of
property to its former ordinarily efficient
operating condition, if the property has de-
teriorated to a state of disrepair and is no
longer functional for its intended use.
(3)Rotable or temporary spare parts.
For purposes of paragraph (e)(1) of this
section, amounts paid for routine main-
tenance include routine maintenance per-
formed on (and with regard to) rotable
and temporary spare parts. But see
§1.162–3(b), which provides that rotable
and temporary spare parts are used or con-
sumed by the taxpayer in the taxable year
in which the taxpayer disposes of the part.
(4)Class life. The class life of a unit of
property is the recovery period prescribed
for the property under section 168(g)(2)
and (3) for purposes of the alternative de-
preciation system, regardless of whether
the property is depreciated under sec-
tion 168(g). For purposes of determining
class life under this paragraph (e), section
168(g)(3)(A) (relating to tax-exempt use
property subject to lease) does not apply.
(5)Examples. The following examples
illustrate the rules of this paragraph (e).
Example 1.Routine maintenance on rotable com-
ponent. (i) X is a commercial airline engaged in
the business of transporting passengers and freight
throughout the United States and abroad. To conduct
its business, X owns or leases various types of air-
craft. As a condition of maintaining its airworthiness
certification for these aircraft, X is required by the
Federal Aviation Administration (FAA) to establish
and adhere to a continuous maintenance program for
each aircraft within its fleet. These programs, which
are designed by X and the aircraft’s manufacturer and
approved by the FAA, are incorporated into each air-
craft’s maintenance manual. The maintenance man-
uals require a variety of periodic maintenance visits
at various intervals. One type of maintenance visit
is an engine shop visit (ESV), which X expects to
perform on its aircraft engines approximately every
4 years in order to keep its aircraft in its ordinarily
efficient operating condition. In 2004, X purchased
a new aircraft and four new engines to use in that
aircraft and later, in other aircraft in its fleet. The
aircraft engines are rotable spare parts because they
are removable from the aircraft, and repaired and re-
installed on other aircraft or stored for later installa-
tion on other aircraft. See §1.162–3(b) (treatment of
materials and supplies). In 2008, X performs its first
ESV on the aircraft engines. The ESV includes disas-
sembly, cleaning, inspection, repair, replacement, re-
assembly, and testing of the engine and its component
parts. During the ESV, the engine is removed from
the aircraft and shipped to an outside vendor who per-
forms the ESV. If inspection or testing discloses a dis-
crepancy in a part’s conformity to the specifications
in X’s maintenance program, the part is repaired, or
if necessary, replaced with a comparable and com-
mercially available and reasonable replacement part.
After the ESVs, the engines are returned to X to be re-
installed on another aircraft or stored for later instal-
lation. Assume the unit of property for X’s aircraft is
the entire aircraft, including the aircraft engines, and
that the class life for X’s aircraft is 12 years. Assume
that none of the exceptions set out in paragraph (e)(2)
of this section applies to the costs of performing the
ESVs.
(ii) Because the ESVs involve the recurring ac-
tivities that X expects to perform as a result of its
use of the aircraft to keep the aircraft in ordinarily
efficient operating condition, and consist of mainte-
nance activities that X expects to perform more than
once during the 12 year class life of the aircraft, X’s
ESVs are within the routine maintenance safe harbor
under paragraph (e) of this section. Accordingly,
the amounts paid by X for the ESVs are deemed not
to improve the aircraft and are not required to be
capitalized under paragraph (d)(1) of this section.
For the treatment of costs to acquire the engines, see
§1.162–3.
Example 2.Routine maintenance after economic
useful life. Assume the same facts as inExample 1,
except that X incurs costs to perform an ESV on one
of its aircraft engines in 2024, after the end of the eco-
nomic useful life that X anticipated for the aircraft.
Because this ESV involves the same routine mainte-
nance activities that were performed on aircraft en-
gines inExample 1, this ESV also is within the rou-
tine maintenance safe harbor under paragraph (e) of
this section. Accordingly, the amounts paid by X for
this ESV, even though performed after the economic
useful life of the aircraft, are deemed not to improve
the aircraft and are not required to be capitalized un-
der paragraph (d)(1) of this section.
Example 3.Routine maintenance resulting from
prior owner’s use. (i) In January 2008, X purchases
a used machine for use its manufacturing operations.
Assume that the machine is the unit of property and
has a class life of 10 years. The machine is fully op-
erational at the time it is purchased by X and is im-
mediately placed in service in X’s business. At the
time it is placed in service by X, X expects to perform
manufacturer recommended scheduled maintenance
on the machine approximately every three years. The
scheduled maintenance includes the cleaning and oil-
ing of the machine, the inspection of parts for defects,
and the replacement of minor items such as springs,
bearings, and seals with comparable and commer-
cially available and reasonable replacement parts. At
the time the machine is purchased, it is approaching
the end of a three-year scheduled maintenance pe-
riod. As a result, in February 2008, X incurs costs
to perform the manufacturer recommended scheduled
maintenance. Assume that none of the exceptions set
out in paragraph (e)(2) of this section apply to the
amounts paid for the scheduled maintenance.
(ii) The majority of the costs incurred by X do not
qualify under the routine maintenance safe harbor in
paragraph (e) of this section because the costs were
primarily incurred as a resultofthepriorowner’suse
of the property and not X’s use. The condition of the
machine at the time that it was placed in service by X
was that of a machine nearing the end of a scheduled
maintenance period. Accordingly, the amounts paid
by X for the scheduled maintenance resulting from
the prior owner’s use of the property must be capi-
talized if those amounts result in a betterment under
paragraph (f) of this section, including the ameliora-
tion of a material condition or defect, or otherwise re-
sult in an improvement under paragraph (d)(1) of this
section. See also section 263A requiring taxpayers
to capitalize the direct and allocable share of indirect
costs of property produced or acquired for resale.
Example 4.Routine maintenance resulting from
new owner’s use. Assume the same facts as inExam-
ple 3, except that after X incurs costs for the mainte-
nance in 2008, X continues to operate the machine in
its manufacturing business. In 2011, X incurs costs
to perform the next scheduled manufacturer recom-
mended maintenance on the machine. Assume that
the scheduled maintenance activities performed are
the same as those performed inExample 3and that
none of the exceptions set out in paragraph (e)(2) of
this section apply to the amounts paid for the sched-
uled maintenance. Because the scheduled mainte-
nance performed in 2011 involves the recurring ac-
tivities that X performs as a result of its use of the
machine, keeps the machine in an ordinarily efficient
operating condition, and consists of maintenance ac-
tivities that X expects to perform more than once dur-
ing the 10 year class life of the machine, X’s sched-
uled maintenance costs are within the routine main-
tenance safe harbor under paragraph (e) of this sec-
tion. Accordingly, the amounts paid by X for the
scheduled maintenance in 2011 are deemed not to im-
prove the machine and are not required to be capital-
ized under paragraph (d)(1) of this section. However,
because the amounts paid for the scheduled mainte-
nance are incurred by reason of X’s manufacturing
operations, X is required to capitalize the amounts
2008–18 I.R.B.894May 5, 2008

paid for the maintenance to products produced by X.
See §1.263A–1(e)(3)(ii).
Example 5.Routine maintenance; replacement
of substantial structural part. X is in the business of
producing commercial products for sale. As part of
the production process, X places raw materials into
lined containers in which a chemical reaction is used
to convert raw materials into the finished product.
The lining is a substantial structural part of the con-
tainer, and comprises 60% of the total physical struc-
ture of the container. Assume that each container, in-
cluding its lining, is the unit of property and that a
container has a class life of 12 years. At the time that
X placed the container into service, X was aware that
approximately every three years, X would be required
to replace the lining in the container with comparable
and commercially available and reasonable replace-
ment materials. At the end of that period, the con-
tainer will continue to function, but will become less
efficient and the replacement of the lining will be nec-
essary to keep the container in an ordinarily efficient
operating condition. In 2003, X acquired 10 new con-
tainers and placed them into service. In 2006, 2009,
2011, and 2014, X pays amounts to replace the con-
tainers’ linings with comparable and commercially
available and reasonable replacement parts. Assume
that none of the exceptions set out in paragraph (e)(2)
of this section apply to the amounts paid for the re-
placement linings. Because the replacement of the
linings involves recurring activities that X expects to
perform as a result of its use of the containers to keep
the containers in their ordinarily efficient operating
condition, and consists of maintenance activities that
X expects to perform more than once during the 12
year class lives of the containers, X’s lining replace-
ment costs are within the routine maintenance safe
harbor under paragraph (e) of this section. Accord-
ingly, the amounts paid by X for the replacement of
the container linings are deemed not to improve the
containers and are not required to be capitalized un-
der paragraph (d)(1) of this section. However, be-
cause the amounts paid to replace the container lin-
ings are incurred by reason of X’s manufacturing op-
erations, X is required to capitalize the amounts paid
for the replacements to products produced by X. See
§1.263A–1(e)(3)(ii).
Example 6.Routine maintenance once during
class life.XisaClassIrailroadthatownsafleetof
freight cars. Assume that a freight car, including all
its components, is a unit of property and has a class
life of 14 years. At the time that X places a freight car
into service, X expects to perform cyclical recondi-
tioning to the car every 8 to 10 years in order to keep
the freight car in ordinarily efficient operating con-
dition. During this reconditioning, X incurs costs to
disassemble, inspect, and recondition and/or replace
components of the freight car with comparable and
commercially available and reasonable replacement
parts. Ten years after the freight car is placed in ser-
vice by X, X incurs costs to perform a cyclical recon-
ditioning on the car. Because X expects to perform
the reconditioning only once during the 14 year class
life of the freight car, the costs incurred for recon-
ditioning do not qualify for the routine maintenance
safe harbor under paragraph (e) of this section. Ac-
cordingly, X must capitalize the amounts paid for the
reconditioning of the freight car if these amounts re-
sult in an improvement under paragraph (d)(1) of this
section.
Example 7.Routine maintenance on non-rotable
part.X is a towboat operator that owns and leases a
fleet of towboats. Each towboat is equipped with two
diesel-powered engines. Assume that each towboat,
including its engines, is the unit of property and that
a towboat has a class life of 18 years. At the time
that X places its towboats into service, X is aware
that approximately every three to four years, X will
need to perform scheduled maintenance on the two
towboat engines to keep the engines in their ordinar-
ily efficient operating condition. This maintenance
is completed while the engines are attached to the
towboat and involves the cleaning and inspecting
of the engines to determine which parts are within
acceptable operating tolerances and can continue to
be used, which parts must be reconditioned to be
brought back to acceptable tolerances, and which
parts must be replaced. Engine parts replaced during
these procedures are replaced with comparable and
commercially available and reasonable replacement
parts. Assume the towboat engines are not rotable
spare parts under §1.162–3(b). In 2005, X acquired
a new towboat, includingits two engines, and placed
the towboat into service. In 2009, X incurs amounts
to perform scheduled maintenance on both engines
in the towboat. Assume that none of the exceptions
set out in paragraph (e)(2) of this section apply to the
scheduled maintenance costs. The scheduled main-
tenance involves recurring activities that X expects
to perform more than once during the 18 year class
life of the towboat. Because this maintenance results
from X’s use of the towboat, and is performed to
keep the towboat in an ordinarily efficient operating
condition, the scheduled maintenance on X’s tow-
boat is within the routine maintenance safe harbor
under paragraph (e) of this section. Accordingly, the
amounts paid by X for the scheduled maintenance
to its towboat engines in 2009 are deemed not to
improve the towboat and are not required to be capi-
talized under paragraph (d)(1) of this section.
Example 8.Routine maintenance with better-
ments. Assume the same facts asExample 7, except
that in 2013, X’s towboat engines are due for another
scheduled maintenance visit. At this time X decides
to upgrade the engines to increase their horsepower
and propulsion, which would permit the towboats
to tow heavier loads. Accordingly, in 2013 X in-
curs costs to perform many of the same activities
that it would perform during the typical scheduled
maintenance activities such as cleaning, inspecting,
reconditioning, and replacing minor parts, but at the
same time, X incurs costs to upgrade certain engine
parts to increase the towing capacity of the boats in
excess of the capacity when the boats were placed
in service by X. Both the scheduled maintenance
procedures and the replacement of parts with new
and upgraded parts are necessary to increase the
horsepower of the engines and the towing capacity
of the boat. Thus, the work done on the engines
encompasses more than the recurring activities that
X expected to perform as a result of its use of the
towboats and did more than keep the towboat in
its ordinarily efficient operating condition. In addi-
tion, the scheduled maintenance procedures directly
benefit and are incurred by reason of the upgrades.
Therefore, the amounts paid by X in 2013 for the
maintenance and upgrade of the engines do not qual-
ify for the routine maintenance safe harbor described
under paragraph (e) of this section. These amounts
must be capitalized if they result in a betterment
under paragraph (f) of this section, including a ma-
terial increase in the capacity of the towboat, or
otherwise result in an improvement under paragraph
(d)(1) of this section. See also section 263A requir-
ing taxpayers to capitalize all the direct costs of an
improvement to property and all the indirect costs
that directly benefit or are incurred by reason of an
improvement to property.
Example 9.Exceptions to routine maintenance.
X owns and operates a farming and cattle ranch with
an irrigation system that provides water for crops.
Assume that each canal in the irrigation system is a
single unit of property and has a class life of 20 years.
When X placed the canals into service, X expected to
have to perform major maintenance on the canals ev-
ery 3 years to keep the canals in their ordinarily effi-
cient operating condition. This maintenance included
draining the canals, and then cleaning, inspecting, re-
pairing, reconditioning or replacing parts of the canal
with comparable and commercially available and rea-
sonable replacement parts. X placed the canals into
service in 2005 and did not perform any maintenance
on the canals until 2010. At that time, the canals had
fallen into a state of disrepair and no longer func-
tioned for irrigation. In 2010, X paid amounts to
drain the canals, and do extensive cleaning, repair-
ing, reconditioning and replacing parts of the canals
with comparable and commercially available and rea-
sonable replacement parts. Although the work per-
formed on X’s canals was similar to the activities that
X expected to perform, but did not perform, every
three years, the costs of these activities do not fall
within the routine maintenance safe harbor. Specifi-
cally, under paragraph (e)(2)(iv) of this section, rou-
tine maintenance does not include amounts paid to
return a unit of property to its former ordinarily effi-
cient operating condition if the property has deterio-
rated to a state of disrepair and is no longer functional
for its intended use. Accordingly, amounts paid by
X for work performed on the canals in 2010 must be
capitalized if they result in improvements under para-
graph (d)(1) of this section (for example, restorations
under paragraph (g) of this section).
(f)Capitalization of betterments—(1)
In general. A taxpayer must capitalize
amounts paid that result in the betterment
of a unit of property. An amount paid re-
sults in the betterment of a unit of property
only if it—
(i) Ameliorates a material condition or
defect that either existed prior to the tax-
payer’s acquisition of the unit of property
or arose during the production of the unit
of property, whether or not the taxpayer
was aware of the condition or defect at the
time of acquisition or production;
(ii) Results in a material addition (in-
cluding a physical enlargement, expan-
sion, or extension) to the unit of property;
or
(iii) Results in a material increase in
capacity (including additional cubic or
square space), productivity, efficiency,
May 5, 20088952008–18 I.R.B.

strength, or quality of the unit of property
or the output of the unit of property.
(2)Application of general rule—(i)
Facts and circumstances. To determine
whether an amount paid results in a better-
ment described in paragraph (f)(1) of this
section, it is appropriate to consider all the
facts and circumstances including, but not
limited to, the purpose of the expenditure,
the physical nature of the work performed,
the effect of the expenditure on the unit of
property, and the taxpayer’s treatment of
the expenditure on its applicable financial
statement (as defined in paragraph (b)(4)
of this section).
(ii)Unavailability of replacement parts.
If a taxpayer needs to replace part of a unit
of property that cannot practicably be re-
placed with the same type of part (for ex-
ample, because of technological advance-
ments or product enhancements), the re-
placement of the part with an improved but
comparable part doesnot, by itself, result
in a betterment to the unit of property.
(iii)Appropriate comparison—(A)In
general. In cases in which a particular
event necessitates an expenditure, the de-
termination of whether an expenditure re-
sults in a betterment of the unit of property
is made by comparing the condition of the
property immediately after the expenditure
with the condition of the property immedi-
ately prior to the circumstances necessitat-
ing the expenditure.
(B)Normal wear and tear.Iftheex-
penditure is made to correct the effects of
normal wear and tear to the unit of property
(including the amelioration of a condition
or defect that existed prior to the taxpayer’s
acquisition of the unit of property result-
ing from normal wear and tear), the con-
dition of the property immediately prior to
the circumstances necessitating the expen-
diture is the condition of the property af-
ter the last time the taxpayer corrected the
effects of normal wear and tear (whether
the amounts paid were for maintenance or
improvements) or, if the taxpayer has not
previously correctedthe effects of normal
wear and tear, the condition of the property
when placed in service by the taxpayer.
(C)Particular event. If the expenditure
is made as a result of a particular event,
the condition of the property immediately
prior to the circumstances necessitating the
expenditure is the condition of the property
immediately prior to the particular event.
(3)Examples. The following examples
illustrate solely the rules of this paragraph
(f). Even if capitalization is not required
in an example under this paragraph (f), the
amounts paid in the example may be sub-
ject to capitalization under a different pro-
vision of this section.
Example 1.Amelioration of pre-existing material
condition or defect. In 2008, X purchases a store lo-
cated on a parcel of land that contained underground
gasoline storage tanks left by prior occupants. As-
sume that the parcel of land is the unit of property.
The tanks had leaked, causing soil contamination. X
is not aware of the contamination at the time of pur-
chase. In 2009, X discovers the contamination and
incurs costs to remediate the soil. The remediation
costs incurred by X result in a betterment to the land
under paragraph (f)(1)(i) of this section because the
costs were incurred to ameliorate a material condition
or defect that existed prior to the taxpayer’s acquisi-
tion of the land.
Example 2.Not amelioration of pre-existing con-
dition or defect.X owned a building that was con-
structed with insulation that contained asbestos. The
health dangers of asbestos were not widely known
when the building was constructed. In 2008, X deter-
mined that certain areas of asbestos-containing insu-
lation had begun to deteriorate and could eventually
pose a health risk to employees. Therefore, X decided
to remove the asbestos-containing insulation from the
building and replace it with new insulation that was
safer to employees, but no more efficient or effective
than the asbestos insulation. Assume the building and
its structural components (including the asbestos in-
sulation) is the unit of property. The amounts paid
to remove and replace the asbestos insulation are not
required to be capitalized as a betterment under para-
graphs (f)(1)(i) and (f)(2)(i) of this section because
the asbestos, although later determined to be unsafe
under certain circumstances, was not an inherent and
material defect to the property. In addition, the re-
moval and replacement of the asbestos did not re-
sult in any material additions to the building or ma-
terial increases in capacity, productivity, efficiency,
strength or quality of the building or the output of the
building under paragraphs (f)(1)(ii) and (f)(1)(iii) of
this section.
Example 3.Not amelioration of pre-existing ma-
terial condition or defect. (i) In January 2008, X pur-
chases a used machine for use in its manufacturing
operations. Assume that the machine is a unit of prop-
erty and it has a class life of 10 years. The machine is
fully operational at the time it is purchased by X and is
immediately placed in service in X’s business. At the
time it is placed in service by X, X expects to perform
manufacturer recommended scheduled maintenance
onthemachineeverythree years. The scheduled
maintenance includes the cleaning and oiling of the
machine, the inspection of parts for defects, and the
replacement of minor items such as springs, bearings,
and seals with comparable and commercially avail-
able and reasonable replacement parts. The sched-
uled maintenance does not result in any material ad-
ditions or material increases in capacity, productiv-
ity, efficiency, strength or quality of the machine or
the output of the machine. At the time the machine
is purchased, it is approaching the end of a three-year
scheduled maintenance period. As a result, in Feb-
ruary 2008, X incurs costs to perform the manufac-
turer recommended scheduled maintenance to keep
the machine in its ordinarily efficient operating con-
dition.
(ii) The majority of the costs incurred by X do not
qualify under the routine maintenance safe harbor in
paragraph (e) of this section because the costs were
primarily incurred as a resultofthepriorowner’suse
of the property and not the taxpayer’s use. The con-
dition of the machine at the time that it was placed
in service by X was that of a machine nearing the
end of a scheduled maintenance period. Accordingly,
the amounts paid by X for the scheduled maintenance
resulting from the prior owner’s use of the property
ameliorate conditions or defects that existed prior to
X’s ownership of the machine. Nevertheless, con-
sidering the facts and circumstances under paragraph
(f)(2)(i) of this section, including the purpose and mi-
nor nature of the work performed, those amounts do
not ameliorate a material condition or defect under
paragraph (f)(1)(i) of thissection and accordingly do
not result in a betterment that must be capitalized un-
der this paragraph (f).
Example 4.Not amelioration of pre-existing ma-
terial condition or defect. In 2008, X purchases a
used ice resurfacing machine for use in the operation
of its ice skating rink. To comply with local regula-
tions, X is required to routinely monitor the air qual-
ity in the ice skating rink. One week after X places
the machine into service, during a routine air quality
check, X discovers that theoperation of the machine
is adversely affecting the air quality in the skating
rink. As a result, X incurs costs to inspect and retune
the machine, which includes replacing minor compo-
nents of the engine, which had worn out prior to X’s
acquisition of the machine. Assume the resurfacing
machine, including the engine, is the unit of property.
The routine maintenance safe harbor in paragraph (e)
of this section does not apply to the amounts paid be-
cause the activities performed do more than return the
machine to the condition that existed at the time it
was placed in service by X. The amounts paid by X
to inspect, retune, and replace minor components of
the ice resurfacing machine ameliorated a condition
or defect that existed prior to X’s acquisition of the
equipment. Nevertheless, considering the facts and
circumstances under paragraph (f)(2)(i) of this sec-
tion, including the purpose and minor nature of the
work performed, these amounts do not ameliorate a
material condition or defect under paragraph (f)(1)(i)
of this section, result in a material addition to the ma-
chine under paragraph (f)(1)(ii) of this section, or re-
sult in a material increase in the capacity, productiv-
ity, efficiency, strength or quality of the machine or
the output of the machine. Accordingly, the amounts
paid by X to inspect, retune, and replace minor com-
ponents of the machine do not result in a betterment
that must be capitalized under this paragraph (f).
Example 5.Amelioration of material condition
or defect; increase in quality. (i) In January 2009,
X acquires a building for use in its business of pro-
viding assisted living services. Before and after the
purchase, the building functions as an assisted living
facility. However, at the time of the purchase, X is
aware that the building is in a condition that is be-
low the standards that X requires for facilities used
in its business. Beginning in 2009 and over the next
two years, while X continues to use the building as
an assisted living facility, X incurs costs for repairs,
2008–18 I.R.B.896May 5, 2008

maintenance, and the acquisition of new property to
bring the facility into the high-quality condition for
which X’s facilities are known. The work includes re-
painting; replacing flooring materials, windows, and
tiling and fixtures in bathrooms; replacing window
treatments, furniture, and cabinets; and repairing or
replacing roofing materials, heating and cooling sys-
tems. On its applicable financial statements, X capi-
talizes the costs of the repairs, maintenance, and ac-
quisitions over the remaining economic useful life
recorded for the building. Assume that the building,
including its structural components, is a single unit of
property and that each section 1245 property is a sep-
arate unit of property.
(ii) Considering the facts and circumstances
under paragraph (f)(2)(i) of this section, including
the purpose of the expenditures, the effect of the
expenditures on the building, and the treatment of the
expenditures in X’s applicable financial statements,
the amounts paid by X for repairs and maintenance
to the building and its structural components ame-
liorated material conditions and defects that existed
prior to X’s acquisition of the building. In addition,
these amounts materially increased the quality of the
building as compared to the condition of the building
when it was placed in service by X. Accordingly, the
amounts paid by X for repairs and maintenance to
the building and its structural components (that is,
repainting, replacing windows, replacing bathroom
fixtures, repairing and replacing roofing materials
and heating and cooling systems) result in better-
ments that must be capitalized under this paragraph
(f). Moreover, X is required to capitalize the amounts
paid to acquire and install each section 1245 property,
including the flooring materials, tiling, each window
treatment, each item of furniture, and each cabinet,
in accordance with §1.263(a)–2(d).
Example 6.Not a betterment.(i)Xownsana-
tionwide chain of retail stores that sell a wide variety
of items. To remain competitive in the industry, X
periodically changes thelayout and appearance of its
stores. These changes include the reconfiguration of
the stores to provide better exposure of the merchan-
dise and cosmetic alterations to keep the store modern
and attractive to customers. The work is not under-
taken for the purpose of repairing damaged property
but rather to renew the appearance of the property.
X incurs costs to update 50 stores during the taxable
year. In its applicable financial statement, X capi-
talizes all the costs of the updates over a 5 year pe-
riod until which X anticipates it would have to update
again. Assume that each store building, including its
structural components, is a unit of property and that
each section 1245 property within the store is a sepa-
rate unit of property. Also assume that the work per-
formed did not ameliorate any material conditions or
defects that existed when X acquired the store build-
ings or result in any material additions to the store
buildings.
(ii) Considering the facts and circumstances un-
der paragraph (f)(2)(i) of this section, including the
purpose of the expenditure, the nature of the work
performed, and the treatment of the work on X’s
applicable financial statements, the amounts paid by
X for updates to its store buildings (including their
structural components) do not result in material in-
creases in capacity, productivity, efficiency, strength
or quality of the store buildings. Accordingly, the
amounts paid by X for the updates on the store
buildings (including their structural components)
do not result in betterments that must be capitalized
under this paragraph (f). However, X is required
to capitalize the amounts paid to acquire and in-
stall each section 1245 property in accordance with
§1.263(a)–2(d).
Example 7.Betterment; regulatory requirement.
X owns a hotel in City that includes five foot high
unreinforced terra cotta and concrete parapets with
overhanging cornices around the entire roof perime-
ter. The parapets and cornices are in good condi-
tion. In 2008, City passes an ordinance setting higher
safety standards for parapets and cornices because of
the hazardous conditions caused by earthquakes. To
comply with the ordinance, X replaces the old para-
pets and cornices with new ones made of glass fiber
reinforced concrete, which makes them lighter and
stronger than the original ones. They are attached to
the hotel using welded connections instead of wire
supports, making them more resistant to damage from
lateral movement. Assume the hotel building and its
structural components are the unit of property. The
event necessitating the expenditure was the 2008 City
ordinance. Prior to the ordinance, the old parapets
and cornices were in good condition, but were de-
termined by City to create a potential hazard. Af-
ter the expenditure, the new parapets and cornices
materially increased the structural soundness (that is,
the strength) of the hotel building. Therefore, the
amounts paid by X to replace the parapets and cor-
nices must be capitalized because they resulted in a
betterment to the hotel. City’s requirement that X cor-
rect the potential hazard to continue operating the ho-
tel is not relevant in determining whether the amount
paid improved the hotel. See paragraph (d)(3) of this
section.
Example 8.Not a betterment; regulatory require-
ment. X owns a meat processing plant. In 2008, X
discovers that oil was seeping through the concrete
walls of the plant, creating a fire hazard. Federal meat
inspectors advise X that itmust correct the seepage
problem or shut down its plant. To correct the prob-
lem, X incurs costs to add a concrete lining to the
walls from the floor to a height of about four feet and
also to add concrete to the floor of the plant. Assume
the plant building and its structural components are
the unit of property. The event necessitating the ex-
penditure was the seepage of the oil. Prior to the seep-
age, the plant did not leak and was functioning for its
intended use. The expenditure did not result in a ma-
terial addition or material increase in capacity, pro-
ductivity, efficiency, strength or quality of the plant or
its output compared to the condition of the plant prior
to the seepage of the oil. Therefore, the amounts paid
by X to correct the seepage do not result in a better-
ment to the plant. X is not required to capitalize as an
improvement under this paragraph (f) amounts paid
to correct the seepage problem. The Federal meat in-
spectors’ requirement that X correct the seepage to
continue operating the plant is not relevant in deter-
mining whether the amount paid improved the plant.
See paragraph (d)(3) of this section.
Example 9.Not a betterment; replacement with
same part. X owns a small retail shop. In 2008, a
storm damages the roof of X’s shop by displacing nu-
merous wooden shingles. Xdecides to replace all the
wooden shingles on the roof and hires a contractor to
replace all the shingles on the roof with new wooden
shingles. Assume the shop building and its structural
components are the unit of property. The event ne-
cessitating the expenditure was the storm. Prior to the
storm, the retail shop was functioning for its intended
use. The expenditure did not result in a material addi-
tion, or material increase in the capacity, productiv-
ity, efficiency, strength or quality of the shop or the
output of the shop compared to the condition of the
shop prior to the storm. Therefore, the amounts paid
by X to reshingle the roof with wooden shingles do
not result in betterment to the shop building. X is not
required to capitalize as an improvement under this
paragraph (f) amounts paid to replace the shingles.
Example 10.Not a betterment; replacement
with comparable part. Assume the same facts as
inExample 9, except that wooden shingles are not
available on the market. X decides to replace all
the wooden shingles with comparable asphalt shin-
gles. The amounts paid by X to reshingle the roof
with asphalt shingles do not result in a betterment
to the shop, even though the asphalt shingles may
be stronger than the wooden shingles. Because the
wooden shingles couldnot practicably be replaced
with new wooden shingles, the replacement of the
old shingles with comparable asphalt shingles does
not, by itself, result in an improvement to the shop.
X is not required to capitalize as an improvement
under this paragraph (f) amounts paid to replace the
shingles.
Example 11.Betterment; replacement with im-
proved parts. Assume the same facts as inExample
9, except that, instead of replacing the wooden shin-
gles with asphalt shingles, X decides to replace all the
wooden shingles with shingles made of lightweight
composite materials that are maintenance-free and do
not absorb moisture. The new shingles have a 50-year
warranty and a Class A fire rating. The expenditure
for these shingles resulted in a material increase in
the quality of the shop building as compared to the
condition of the shop building prior to the storm. X
must capitalize amounts paid to reshingle the roof as
an improvement under this paragraph (f) because they
result in a betterment to the shop.
Example 12.Material increase in capacity.X
owns a factory building with a storage area on the
second floor. In 2008, X replaces the columns and
girders supporting the second floor to permit storage
of supplies with a gross weight 50 percent greater
than the previous load-carrying capacity of the stor-
age area. Assume the factory building and its struc-
tural components are the unit of property. X must
capitalize as an improvement amounts paid for the
columns and girders because they result in a material
increase in the load-carrying capacity of the building.
The comparison rule in paragraph (f)(2)(iii) of this
section does not apply to these amounts paid because
the expenditure was not necessitated by a particular
event.
Example 13.Material increase in capacity.In
2008, X purchases harbor facilities consisting of a
slip for the loading and unloading of barges and a
channel leading from the slip to the river. At the
time of purchase, the channel is 150 feet wide, 1,000
feet long, and 10 feet deep. To allow for ingress and
egress and for the unloading of its barges, X needs
to deepen the channel to a depth of 20 feet. X hires a
contractor to dredge the channel to the required depth.
Assume the channel is the unit of property. X must
capitalize as an improvement amounts paid for the
dredging because it resulted in a material increase in
May 5, 20088972008–18 I.R.B.

the capacity of the channel. The comparison rule in
paragraph (f)(2)(iii) of this section does not apply to
these amounts paid because the expenditure was not
necessitated by a particular event.
Example 14. Not a material increase in capac-
ity. Assume the same facts as inExample 13, except
that the channel was susceptible to siltation and, by
2009, the channel depth had been reduced to 18 feet.
X hired a contractor to redredge the channel to a depth
of 20 feet. The event necessitating the expenditure
was the siltation of the channel. Both prior to the sil-
tation and after the redredging, the depth of the chan-
nel was 20 feet. Therefore, the amounts paid by X
for redredging the channel did not result in a material
addition to the unit of property or a material increase
in the capacity, productivity, efficiency, strength or
quality of the unit of property or the output of the unit
of property. X is not required to capitalize as a bet-
terment under paragraph (f) of this section amounts
paid to redredge the channel.
Example 15.Not a material increase in capacity.
X owns a building used in its trade or business. The
first floor has a drop-ceiling. X decides to remove the
drop-ceiling and repaint the original ceiling. Assume
the building and its structural components are the unit
of property. The removal of the drop-ceiling does not
create additional capacity in the building that was not
there prior to the removal. Therefore, the amounts
paid by X to remove the drop-ceiling and repaint the
original ceiling did not result in a material addition
or a material increase to the capacity, productivity,
efficiency, strength or quality of the unit of property
or output of the unit of property. X is not required
to capitalize as a betterment under this paragraph (f)
amounts paid related to removing the drop-ceiling.
The comparison rule in paragraph (f)(2)(iii) of this
section does not apply to these amounts paid because
the expenditure was not necessitated by a particular
event.
(g)Capitalization of restorations—(1)
In general. A taxpayer must capitalize
amounts paid to restore a unit of property,
includingamountspaidinmakinggood
the exhaustion for which an allowance is
or has been made. An amount is paid to
restore a unit of property if it—
(i) Is for the replacement of a compo-
nent of a unit of property and the taxpayer
has properly deducted a loss for that com-
ponent (other than a casualty loss under
§1.165–7);
(ii) Is for the replacement of a com-
ponent of a unit of property and the tax-
payer has properly taken into account the
adjusted basis of the component in realiz-
ing gain or loss resulting from the sale or
exchange of the component;
(iii) Is for the repair of damage to a
unit of property for which the taxpayer has
properly taken a basis adjustment as a re-
sult of a casualty loss under section 165,
or relating to a casualty event described in
section 165;
(iv) Returns the unit of property to its
ordinarily efficient operating condition if
the property has deteriorated to a state of
disrepair and is no longer functional for its
intended use;
(v) Results in the rebuilding of the unit
of property to a like-new condition after
theendofitseconomicusefullife(see
paragraph (g)(2) of this section); or
(vi) Is for the replacement of a ma-
jor component or a substantial structural
part of the unit of property (see paragraph
(g)(3) of this section).
(2)Rebuild to like-new condition—(i)
In general. For purposes of paragraph
(g)(1)(v) of this section, the following def-
initions apply:
(A)Like-new condition. A unit of prop-
erty is rebuilt to a like-new condition if it
is brought to the status of new, rebuilt, re-
manufactured, or similar status under the
terms of any Federal regulatory guideline
or the manufacturer’s original specifica-
tions.
(B)Economic useful life. The economic
useful life of a unit of property is not nec-
essarily the useful life inherent in the prop-
erty but is the period over which the prop-
erty may reasonably be expected to be use-
ful to the taxpayer or, if the taxpayer is en-
gaged in a trade or business or an activ-
ity for the production of income, the period
over which the property may reasonably be
expected to be useful to the taxpayer in its
trade or business or for the production of
income, as applicable. See §1.167(a)–1(b)
for the factors to be considered in deter-
mining this period.
(ii)Exception. Anamountpaidisnot
required to be capitalized under paragraph
(g)(1)(v) of this section if it is paid during
the recovery period prescribed in section
168(c) (taking intoaccount the applicable
convention) for the property, regardless of
whether the property is depreciated under
section 168(a).
(3)Replacement of a major compo-
nent or a substantial structural part—(i)
In general. For purposes of paragraph
(g)(1)(vi) of this section, the replacement
of a major component or a substantial
structural part means the replacement of—
(A) A part or a combination of parts of
the unit of property, the cost of which com-
prises 50 percent or more of the replace-
ment cost of the unit of property; or
(B) A part or a combination of parts
of the unit of property that comprise 50
percent or more of the physical structure
of the unit of property.
(ii)Exception. Anamountpaidisnot
required to be capitalized under paragraph
(g)(1)(vi) of this section if it is paid during
the recovery period prescribed in section
168(c) (taking intoaccount the applicable
convention) for the property, regardless of
whether the property is depreciated under
section 168(a).
(4)Examples. The following examples
illustrate solely the rules of this paragraph
(g). Even if capitalization is not required in
an example under the cited subparagraph
under this paragraph (g), the amounts paid
in the example may be subject to capital-
ization under a different provision of this
section, or under a different subparagraph
in this paragraph (g).
Example 1.Replacement of loss component.X
owns a manufacturing building containing various
types of manufacturing equipment. X does a cost
segregation study of the manufacturing building and
properly determines that a walk-in freezer in the man-
ufacturing equipment is section 1245 property as de-
fined in section 1245(a)(3). The freezer is not part of
the HVAC system that relates to the general operation
or maintenance of the building. The components of
the walk-in freezer cease to function and X decides
to replace them. X abandons the freezer components
and properly recognizes a loss from the abandonment
of the components. X replaces the abandoned freezer
components with new components and incurs costs
to acquire and install the new components. Under
paragraph (g)(1)(i) of this section, X must capital-
ize the amounts paid to acquire and install the new
freezer components because X replaced components
for which it had properly deducted a loss.
Example 2.Replacement of sold component.As-
sume the same facts as inExample 1except that X did
not abandon the components, but instead sold them
to another party and properly recognized a loss on
the sale. Under paragraph (g)(1)(ii) of this section,
X must capitalize the amounts paid to acquire and in-
stall the new freezer components because X replaced
components for which it had properly taken into ac-
count the adjusted basis of the components in realiz-
ing a loss from the sale of the components.
Example 3.Restoration after casualty loss.X
owns an office building that it uses in its trade or
business. A storm damages the office building at
a time when the building has an adjusted basis of
$500,000. X deducts under section 165 a casualty
loss in the amount of $50,000 and properly reduces
its basis in the office building to $450,000. X hires a
contractor to repair the damage to the building and
pays the contractor $50,000 for the work. Under
paragraph (g)(1)(iii) of this section, X must capital-
ize the $50,000 amount paid to the contractor because
X properly adjusted its basis as a result of a casualty
loss under section 165.
Example 4.Restoration after casualty event.As-
sume the same facts as inExample 3, except that X
receives insurance proceeds of $50,000 after the ca-
sualty to compensate for its loss. X cannot deduct a
2008–18 I.R.B.898May 5, 2008

casualty loss under section 165 because its loss was
compensated by insurance. However, X properly re-
duces its basis in the property by the amount of the in-
surance proceeds. Under paragraph (g)(1)(iii) of this
section, X must capitalize the $50,000 amount paid
to the contractor because X has properly taken a ba-
sis adjustment relating to a casualty event described
in section 165.
Example 5.Restoration of property in a state of
disrepair. X owns and operates a farm with several
barns and outbuildings. One of the outbuildings is not
used or maintained by X on a regular basis and falls
into a state of disrepair. The outbuilding previously
was used for storage but can no longer be used for
that purpose because the building is not structurally
sound. X decides to restore the outbuilding and incurs
costs to shore up the walls and replace the siding.
Under paragraph (g)(1)(iv) of this section, X must
capitalize the amounts paid to restore the outbuilding
because they return the outbuilding to its ordinarily
efficient operating condition after it had deteriorated
to a state of disrepair and was no longer functional for
its intended use.
Example 6.Rebuild of property to like-new con-
dition before end of economic useful life.XisaClass
I railroad that owns a fleet of freight cars. Freight
cars have a recovery period of 7 years under section
168(c) and an economic useful life of 30 years. Ev-
ery 8 to 10 years, X rebuilds its freight cars. Ten
years after the freight car is placed in service by X,
X performs a rebuild, which includes a complete dis-
assembly, inspection, and reconditioning and/or re-
placement of components of the suspension and draft
systems, trailer hitches, and other special equipment.
X modifies the car to upgrade various components to
the latest engineering standards. The freight car es-
sentially is stripped to the frame, with all of its sub-
stantial components either reconditioned or replaced.
The frame itself is the longest-lasting part of the car
and is reconditioned. The walls of the freight car
are replaced or are sandblasted and repainted. New
wheels are installed on the car. All the remaining
components of the car are restored before they are
reassembled. At the end of the rebuild, the freight
car has been restored to a rebuilt condition under the
manufacturer’s specifications. Assume the freight car
is the unit of property. X is not required to capitalize
under paragraph (g)(1)(v) of this section the amounts
paid to rebuild the freight car because, although the
amounts paid restore the freight car to a like-new con-
dition, the amounts were not paid after the end of the
economic useful life of the freight car.
Example 7.Rebuild of property to like-new con-
dition after end of economic useful life. Assume the
samefactsasinExample 6, except that X rebuilds
the freight car 40 years after it is placed in service by
X. Under paragraph (g)(1)(v) of this section, X must
capitalize the amounts paid to rebuild the freight car
because the amounts paid restore the freight car to a
like-new condition after the end of the economic use-
ful life of the freight car.
Example 8.Replacement of major component.X
is a common carrier that owns a fleet of petroleum
hauling trucks. X replacesthe existing engine, cab,
and petroleum tank with a new engine, cab, and tank.
The new engine and cab cost $25,000; the new tank
costs $10,000. The cost of a new tractor is $50,000
and the cost of a new trailer is $30,000. Assume the
tractor of the truck (which includes the cab and the
engine) is a separate unit of property from the rest of
the truck, and that the trailer (which contains the pe-
troleum tank) is a separate unit of property from the
rest of the truck. Also assume that X replaced the
components after the end of the recovery periods un-
der section 168(c) for the tractor and the trailer. The
amounts paid for the new engine and cab comprise
50% of the cost of a new tractor and must be capital-
ized under paragraph (g)(1)(vi) of this section. The
amounts paid for the new petroleum tank do not com-
prise 50% or more of the cost of a new trailer; how-
ever, the tank comprises more than 50% of the phys-
ical structure of the trailer. Therefore, the amounts
paid for the new tank also must be capitalized under
paragraph (g)(1)(vi) of this section.
Example 9.Repair performed during a restora-
tion. Assume the same facts as inExample 8,ex-
cept that, at the same time the engine and cab of the
tractor are replaced, X paints the cab of the tractor
with its company logo and fixes a broken taillight
on the tractor. The repair of the broken taillight and
the painting of the cab generally are deductible ex-
penses under §1.162–4. However, under paragraph
(d)(4)(i) of this section, a taxpayer must capitalize all
the direct costs of an improvement and all the indi-
rect costs that directly benefit or are incurred by rea-
son of an improvement in accordance with the rules
under section 263A. Repairs and maintenance that
do not directly benefit or are not incurred by reason
of an improvement are not required to be capitalized
under section 263(a), regardless of whether they are
made at the same time as an improvement. Therefore,
all amounts paid that directly benefit or are incurred
by reason of the tractor restoration must be capital-
ized, including amounts paid for activities that usu-
ally would be deductible maintenance expenses, such
as the painting of the cab. Amounts paid to repair the
broken taillight, however, are not incurred by reason
of the restoration of the tractor, nor do the amounts
paid directly benefit the tractor restoration, despite
that the repair was performed at the same time as the
restoration. Thus, X must capitalize to the restoration
of the tractor the amounts paid to paint the cab, but X
is not required to capitalize to the restoration of the
tractor the amounts paid to repair the broken taillight.
Example 10.Notareplacementofsubstantial
structural part. X owns a large retail store. X discov-
ers a leak in the roof of the store and hires a contractor
to inspect and fix the roof. The contractor discovers
that a major portion of the sheathing and rafters has
rotted, and recommends the replacement of the entire
roof. X pays the contractor to replace the roof. As-
sume the store and its structural components are the
unit of property and that the roof does not comprise
50% or more of the physical structure of the store.
Also assume the cost of the roof does not comprise
50% or more of the cost to acquire a new store. Con-
sequently, the new roof is not a major component or
substantial structural part of the store. Therefore, X is
not required to capitalize under paragraph (g)(1)(vi)
of this section the amounts paid to replace the roof.
Example 11.Related amounts to replace major
component. (i) X owns a retail gasoline station, con-
sisting of a paved area used for automobile access
to the pumps and parking areas, a building used to
market gasoline, and a canopy covering the gasoline
pumps. The premises also consist of underground
storage tanks (USTs) that are connected by piping to
the pumps and are part of the machinery used in the
immediate retail sale of gas. To comply with regula-
tions issued by the Environmental Protection Agency,
X is required to remove and replace leaking USTs.
In 2008, X hires a contractor to perform the removal
and replacement, which consists of removing the old
tanks and installing new tanks with leak detection
systems. The removal of the old tanks includes re-
moving the paving material covering the tanks, exca-
vating a hole large enough to gain access to the old
tanks, disconnecting any strapping and pipe connec-
tions to the old tanks, and lifting the old tanks out of
the hole. Installation of the new tanks includes place-
ment of a liner in the excavated hole, placement of
the new tanks, installation of a leak detection system,
installation of an overfill system, connection of the
tanks to the pipes leading to the pumps, backfilling
of the hole, and replacement of the paving. Assume
the new tanks comprise 50% or more of the physical
structure of the gasoline distribution system. X also
is required to pay a permit fee to the county to under-
take the installation of the new tanks.
(ii) X pays the permit fee to the county on October
15, 2008. The contractor performs all of the required
work and, on November 1, 2008, bills X for the costs
of removing the old USTs. On November 15, 2008,
the contractor bills X for the remainder of the work.
Assume the gasoline distribution system is the unit
of property. The USTs are major components of the
gasoline distribution system. Therefore, under para-
graphs (d)(5) and (g)(1)(vi) of this section, X must
capitalize as an improvement to the distribution sys-
tem the aggregate of related amounts paid to replace
the USTs, which related amounts include the amount
paid to the county, the amount paid to remove the old
USTs, and the amount paid to install the new USTs
(regardless that the amounts were separately invoiced
and paid to two different parties).
Example 12.Minor part replacement; coordina-
tion with section 263A. X is in the business of smelt-
ing aluminum. X’s aluminum smelting facility in-
cludes a plant where molten aluminum is poured into
molds and allowed to solidify. Because of the poten-
tial of fire from a molten metal explosion, the plant’s
roof must be made of fire-resistant material. The roof
must also be without leaks because rain water hit-
ting the molten aluminum could cause an explosion.
During 2008, X removed and replaced a major por-
tion of the plant’s roof decking and roofing material.
Assume the plant building and its structural compo-
nents are the unit of property and that the portion of
the roof that is replaced is not a major component or
substantial structural part of the building. X is not re-
quired to capitalize under paragraph (g)(1)(vi) of this
section the amounts paid to remove and replace the
roof decking and materials. However, under section
263A, all direct and indirect costs, including other-
wise deductible costs, that directly benefit or are in-
curred by reason of X’s manufacturing activities must
be capitalized to the property produced by X. There-
fore, because the amounts paid for the roof decking
and materials are incurred by reason of X’s manufac-
turing operations, the amounts paid must be capital-
ized under section 263A to the property produced by
X.
(h)Capitalization of amounts to adapt
property to a new or different use—(1)
In general. Taxpayers must capitalize
amounts paid to adapt a unit of property
May 5, 20088992008–18 I.R.B.

to a new or different use. In general, an
amount is paid to adapt a unit of property
to a new or different use if the adaptation
is not consistent with the taxpayer’s in-
tended ordinary use of the unit of property
at the time originally placed in service by
the taxpayer.
(2)Examples.The following examples
illustrate solely the rules of this paragraph
(h). Even if capitalization is not required
in an example under this paragraph (h),
the amounts paid in the example may be
subject to capitalization under a different
provision of this section.
Example 1.New or different use.Xisaman-
ufacturer and owns a manufacturing facility that it
has used for manufacturing since 1970, when it was
placed in service by X. Assume the manufacturing fa-
cility is a unit of property. In 2008, X incurred costs
to convert its manufacturing facility into a showroom
for its business. To convert the facility, X replaces
various structural components to provide a better lay-
out for the showroom and its offices. X also rewires
and repaints the building as part of the conversion.
None of the materials used, such as the wiring, are
better than existing materials in the building. Under
this paragraph (h), the amounts paid by X to convert
the manufacturing facility into a showroom are paid
to adapt the building to a new or different use because
the conversion is not consistent with X’s intended or-
dinary use of the property at the time it was placed in
service. Therefore, X is required to capitalize these
amounts under paragraph (h)(1) of this section.
Example 2.Not a new or different use.Xowns
a building, which is a unit of property, consisting of
twenty retail spaces. The space was designed to be
reconfigured; that is, adjoining spaces could be com-
bined into one space. In 2008, one of the tenants ex-
panded its occupancy to include two adjoining retail
spaces. To facilitate the new lease, X incurred costs
to remove the walls between the three retail spaces.
Under this paragraph (h), the amounts paid by X to
convert three retail spaces into one larger space for an
existing tenant do not adapt X’s building to a new or
different use because the combination of retail spaces
is consistent with X’s intended, ordinary use of the
building. Therefore, the costs are not required by this
paragraph (h) to be capitalized.
Example 3.Not a new or different use.Xowns
a building, which is a unit of property, consisting
of twenty retail spaces. X decides to sell the build-
ing. In anticipation of selling the building, X repaints
the interior walls and refinishes the hardwood floors.
Preparing the building for sale does not constitute
a new or different use for the building. Therefore,
amounts paid in preparing the building for sale are
not required by this paragraph (h) to be capitalized.
Example 4.New or different use. Since 1930, X
has owned a parcel of land on which it previously
operated a manufacturing facility. Assume that the
land is the unit of property. During the course of
X’s operation of the manufacturing facility, the land
became contaminated with wastes from its manufac-
turing processes. In 1995, X discontinued manufac-
turing operations at the site. In 2008, X decides to
sell the property to a developer that intends to use the
property for residential housing. In anticipation of
selling the land, X pays amounts to clean up the land
to a standard that is required for the land to be used for
residential purposes. In addition, X pays amounts to
regrade the land so that it can be used for residential
purposes. Amounts paid by X to clean up wastes that
were discharged in the course of X’s manufacturing
operations do not adapt the land to a new or different
use, regardless of the extent to which the land was
cleaned. However, amounts to regrade the land so
that it can be used for residential purposes adapts the
land to a new or different use that is inconsistent with
X’s intended ordinary use of the property at the time
it was placed in service. Accordingly, the amounts
paid by X to regrade the land must be capitalized un-
der paragraph (h)(1) of this section.
(i)Optional regulatory accounting
method—(1)In general. This paragraph
(i) provides an optional simplified method
(the regulatory accounting method) for
regulated taxpayers to determine whether
amounts paid to repair, maintain, or im-
prove tangible property are to be treated
as deductible expenses or capital expen-
ditures. A taxpayer that elects to use the
regulatory accounting method described
in paragraph (i)(3) of this section must use
that method for property subject to regu-
latory accounting instead of determining
whether amounts paid to repair, maintain,
or improve property are capital expen-
ditures or deductible expenses under the
general principles of sections 162(a), 212,
and 263(a). Thus, the capitalization rules
in §1.263(a)–3(d) (and the routine mainte-
nance safe harbor described in paragraph
(e) of this section) do not apply to amounts
paid to repair, maintain, or improve prop-
erty subject to regulatory accounting by
taxpayers that elect to use the regulatory
accounting method under this paragraph
(i). However, section 263A continues to
apply to costs required to be capitalized to
property produced by the taxpayer or to
property acquired for resale.
(2)Eligibility for regulatory account-
ing method. A taxpayer that is engaged
in a trade or business in a regulated in-
dustry may use the regulatory accounting
method under this paragraph (i). For pur-
poses of this paragraph (i), a taxpayer in a
regulated industry is a taxpayer that is sub-
ject to the regulatory accounting rules of
the Federal Energy Regulatory Commis-
sion (FERC), the Federal Communications
Commission (FCC), or the Surface Trans-
portation Board (STB).
(3)Description of regulatory account-
ing method. Under the regulatory account-
ing method, a taxpayer must follow its
method of accounting for regulatory ac-
counting purposes in determining whether
an amount paid improves property under
this section. Therefore, a taxpayer must
capitalize for Federal income tax purposes
an amount paid that is capitalized as an im-
provement for regulatory accounting pur-
poses. A taxpayer must not capitalize for
Federal income tax purposes under this
section an amount paid that is not capital-
ized as an improvement for regulatory ac-
counting purposes. A taxpayer that uses
the regulatory accounting method must use
that method for all of its tangible prop-
erty that is subject to regulatory account-
ing rules. The method does not apply to
tangible property that is not subject to reg-
ulatory accounting rules.
(4) [Reserved]
(5)Examples. The rules of this para-
graph (i) are illustrated by the following
examples.
Example 1.Taxpayer subject to regulatory ac-
counting rules of FERC. X is an electric utility com-
pany that operates a power plant to generate electric-
ity. X is subject to the regulatory accounting rules of
FERC and X chooses to use the regulatory accounting
method under this paragraph (i). X does not capital-
ize on its books and records for regulatory account-
ing purposes the cost of repairs made to its turbines.
Under the regulatory accounting method, X must not
capitalize for Federal income tax purposes amounts
paid for repairs made to its turbines.
Example 2.Taxpayer not subject to regulatory ac-
counting rules of FERC. X is an electric utility com-
pany that operates a power plant to generate electric-
ity. X previously was subject to the regulatory ac-
counting rules of FERC but, for various reasons, X
is no longer required to use FERC’s regulatory ac-
counting rules. X cannot use the regulatory account-
ingmethodprovidedinthisparagraph(i).
Example 3.Taxpayer subject to regulatory ac-
counting rules of FCC. X is a telecommunications
company that is subject to the regulatory accounting
rules of the FCC. X chooses to use the regulatory ac-
counting method under this paragraph (i). The assets
of X include a telephone central office switching cen-
ter, which contains numerous switches and various
switching equipment. X capitalizes on its books and
records for regulatory accounting purposes the cost of
replacing each switch. Under the regulatory account-
ing method, X is required to capitalize for Federal
income tax purposes amounts paid to replace each
switch.
Example 4.Taxpayer subject to regulatory ac-
counting rules of STB. X is a Class I railroad that is
subject to the regulatory accounting rules of the STB.
X chooses to use the regulatory accounting method
under this paragraph (i). X capitalizes on its books
and records for regulatory accounting purposes the
cost of locomotive rebuilds. Under the regulatory ac-
counting method, X is required to capitalize for Fed-
eral income tax purposes amounts paid to rebuild its
locomotives.
2008–18 I.R.B.900May 5, 2008

(j)Repair allowance. A taxpayer may
use a repair allowance method of ac-
countingthatisidentifiedinpublished
guidance in theFederal Registeror
in the Internal Revenue Bulletin (see
§601.601(d)(2)(ii)(b) of this chapter).
(k)Treatment of capital expenditures.
Amounts required to be capitalized un-
der this section are capital expenditures
and must be taken into account through
a charge to capital account or basis, or in
the case of property that is inventory in
the hands of a taxpayer, through inclusion
in inventory costs. See section 263A for
the treatment of amounts referred to in
this section as well as other amounts paid
in connection with the production of real
property and personal property, includ-
ing films, sound recordings, video tapes,
books, or similar properties.
(l)Recovery of capitalized amounts.
Amounts that are capitalized under this
section are recovered through deprecia-
tion, cost of goods sold, or by an adjust-
ment to basis at the time the property is
placed in service, sold, used, or otherwise
disposed of by the taxpayer. Cost recovery
is determined by the applicable Code and
regulation provisions relating to the use,
sale, or disposition of property.
(m) [Reserved]
(n)Effective/applicability date.The
rules in this section apply to taxable years
beginning on or after the date of publi-
cation of the Treasury decision adopting
these rules as final regulations in theFed-
eral Register.
Par. 9. Section 1.263A–1 is amended
by adding paragraph (b)(14) as follows:
§1.263A–1 Uniform capitalization of
costs.
*****
(b) * * *
(14)Property subject to de minimis
rule. Section 263A does not apply to the
costs of property produced by a taxpayer
to which the taxpayer properly applies the
de minimisrule under §1.263(a)–2(d)(4).
However, the cost of property to which a
taxpayer properly applies thede minimis
rule under §1.263(a)–2(d)(4) may be re-
quired to be capitalized to other property
as a cost incurred by reason of the produc-
tion of the other property that is subject to
section 263A.
*****
Linda E. Stiff,
Deputy Commissioner for
Services and Enforcement.
(Filed by the Office of the Federal Register on March 7, 2008,
8:45 a.m., and published in the issue of the Federal Register
for March 10, 2008, 73 F.R. 12837)
Notice of Proposed
Rulemaking by
Cross-Reference to
Temporary Regulations
Disclosure of Return
InformationinConnection
With Written Contracts Among
the IRS, Whistleblowers, and
Legal Representatives of
Whistleblowers
REG–114942–07
AGENCY: Internal Revenue Service
(IRS), Treasury.
ACTION: Notice of proposed rulemaking
by cross-reference to temporary regula-
tions.
SUMMARY: In this issue of the Bulletin,
the IRS is issuing temporary regulations
(T.D. 9389) relating to the disclosure of
return information, pursuant to section
6103(n), to whistleblowers and their legal
representatives. The temporary regula-
tions describe the circumstances by which
an officer or employee of the Treasury De-
partment may disclose return information
to a whistleblower and, if applicable, the
legal representative of the whistleblower,
to the extent necessary in connection with
a written contract among the IRS, the
whistleblower and, if applicable, the le-
gal representative of the whistleblower,
for services relating to the detection of
violations of the internal revenue laws or
related statutes. The temporary regula-
tions will affect officers and employees
of the Treasury Department who disclose
return information to whistleblowers, or
their legal representatives, in connection
with written contracts among the IRS,
whistleblowers and, if applicable, their
legal representatives, for services relat-
ing to the detection of violations of the
internal revenue laws or related statutes.
The temporary regulations will also affect
any whistleblower, or legal representative
of a whistleblower, who receives return
information in connection with a written
contract among the IRS, the whistleblower
and, if applicable, the legal representative
of the whistleblower, for services relating
to the detection of violations of the inter-
nal revenue laws or related statutes.
DATES: Written or electronic comments
and requests for a public hearing must be
received by June 23, 2008.
ADDRESSES: Send submissions to
CC:PA:LPD:PR(REG–114942–07),
room 5203, Internal Revenue Service,
PO Box 7604, Ben Franklin Station,
Washington, DC 20044. Submissions may
be hand-delivered Monday through Friday
between the hours of 8 a.m. and 4 p.m.
to CC:PA:LPD:PR (REG–114942–07),
Courier’s Desk, Internal Revenue
Service, 1111 Constitution Avenue, NW,
Washington, DC, or sent electronically,
viatheFederaleRulemaking
Portal atwww.regulations.gov(IRS
REG–114942–07).
FOR FURTHER INFORMATION
CONTACT: Helene R. Newsome,
202–622–7950 (not a toll-free number).
SUPPLEMENTARY INFORMATION:
Background and Explanation of
Provisions
Temporary regulations in this issue
of the Bulletin amend the Procedure and
Administration Regulations (26 CFR part
301) under section 6103(n) relating to the
disclosure of return information in con-
nection with written contracts among the
IRS, whistleblowers and, if applicable,
their legal representatives.
The Tax Relief and Health Care Act
of 2006, Public Law 109–432 (120 Stat.
2958), (the Act) was enacted on December
20, 2006. Section 406 of the Act amends
section 7623, concerning the payment of
awards to whistleblowers, and establishes
a Whistleblower Office within the IRS
that has responsibility for the adminis-
tration of a whistleblower program. The
Whistleblower Office, in connection with
administering a whistleblower program,
will analyze information provided by a
whistleblower, and either investigate the
matter itself or assign it to the appropriate
May 5, 20089012008–18 I.R.B.

IRS office for investigation. In analyzing
information provided by a whistleblower,
or investigating a matter, the Whistle-
blower Office may determine that it re-
quires the assistance of the whistleblower,
or the legal representative of the whistle-
blower. The legislative history of section
406 of the Act states that “[t]o the extent
the disclosure of returns or return infor-
mation is required [for the whistleblower
or his or her legal representative] to ren-
der such assistance, the disclosure must
be pursuant to an IRS tax administration
contract.” Joint Committee of Taxation,
Technical Explanation of H.R. 6408, The
“Tax Relief and Health Care Act of 2006,”
as Introduced in the House on December
7, 2006, at 89 (JCX–50–06), December 7,
2006. The legislative history further states
that “[i]t is expected that such disclosures
will be infrequent and will be made only
when the assigned task cannot be properly
or timely completed without the return
information to be disclosed.”Id.
Under section 6103(a), returns and re-
turn information are confidential unless
the Internal Revenue Code (Code) au-
thorizes disclosure. Section 6103(n) is
the authority by which returns and return
information may be disclosed pursuant
to a tax administration contract. Section
6103(n) authorizes, pursuant to regula-
tions prescribed by the Secretary, returns
and return information to be disclosed
to any person, including any person de-
scribed in section 7513(a), for purposes of
tax administration, to the extent necessary
in connection with: (1) the processing,
storage, transmission, and reproduction
of returns and return information; (2) the
programming, maintenance, repair, test-
ing, and procurement of equipment; and
(3) the providing of other services. These
proposed regulations describe the cir-
cumstances, pursuant to section 6103(n),
by which officers and employees of the
Treasury Department may disclose re-
turn information to whistleblowers and, if
applicable, their legal representatives, in
connection with written contracts for ser-
vices relating to the detection of violations
of the internal revenue laws or related
statutes.
The text of the temporary regulations
also serves as the text of these proposed
regulations. The preamble to the tempo-
rary regulations explains these proposed
regulations.
Special Analyses
It has been determined that this notice
of proposed rulemaking is not a signifi-
cant regulatory action as defined in Exec-
utive Order 12866. Therefore, a regula-
tory assessment is not required. It also has
been determined that section 553(b) of the
Administrative Procedure Act (5 U.S.C.
chapter 5) does not apply to these reg-
ulations, and because the regulations do
not impose a collection of information on
small entities, the Regulatory Flexibility
Act (5 U.S.C. chapter 6) does not apply.
Pursuant to section 7805(f) of the Code,
these regulations have been submitted to
the Chief Counsel of the Small Business
Administration for comment on its impact
on small businesses.
Comments and Request for a Public
Hearing
Before these proposed regulations are
adopted as final regulations, consideration
will be given to any electronic and writ-
ten comments (a signed original and eight
(8) copies) that are submitted timely to the
IRS. The IRS and Treasury Department re-
quest comments on the clarity of the pro-
posed rule and how it may be made eas-
ier to understand. All comments will be
available for public inspection and copy-
ing. A public hearing may be scheduled if
requested in writing by a person that timely
submits written comments. If a public
hearing is scheduled, notice of the date,
time, and place of the hearing will be pub-
lished in theFederal Register.
Drafting Information
The principal author of these regula-
tions is Helene R. Newsome, Office of
the Associate Chief Counsel (Procedure &
Administration).
*****
Proposed Amendments to the
Regulations
Accordingly, 26 CFR part 301 is pro-
posed to be amended as follows:
PART 301—PROCEDURE AND
ADMINISTRATION
Paragraph 1. The authority citation for
part 301 is amended by adding an entry in
numerical order to read as follows:
Authority: 26 U.S.C. 7805 * * *
Section 301.6103(n)–2 also issued un-
der 26 U.S.C. 6103(n); * * *
Par. 2. Section 301.6103(n)–2 is added
to read as follows:
§301.6103(n)–2 Disclosure of return
information in connection with
written contracts among the IRS,
whistleblowers, and legal representatives
of whistleblowers.
[The text of this proposed section is the
same as the text of §301.6103(n)–2T pub-
lished elsewhere in this issue of the Bul-
letin].
LindaE.Stiff,
Deputy Commissioner for
Services and Enforcement.
(Filed by the Office of the Federal Register on March 24,
2008, 8:45 a.m., and published in the issue of the Federal
Register for March 25, 2008, 73 F.R. 15687)
2008–18 I.R.B.902May 5, 2008

Definition of Terms
Revenue rulings and revenue procedures
(hereinafter referred to as “rulings”) that
have an effect on previous rulings use the
following defined terms to describe the ef-
fect:
Amplifieddescribes a situation where
no change is being made in a prior pub-
lished position, but the prior position is be-
ingextendedtoapplytoavariationofthe
fact situation set forth therein. Thus, if
an earlier ruling held that a principle ap-
plied to A, and the new ruling holds that the
same principle also applies to B, the earlier
ruling is amplified. (Compare withmodi-
fied,below).
Clarifiedis used in those instances
where the language in a prior ruling is be-
ing made clear because the language has
caused, or may cause, some confusion.
It is not used where a position in a prior
ruling is being changed.
Distinguisheddescribes a situation
where a ruling mentions a previously pub-
lished ruling and points out an essential
difference between them.
Modifiedis used where the substance
of a previously published position is being
changed. Thus, if a prior ruling held that a
principle applied to A but not to B, and the
new ruling holds that it applies to both A
and B, the prior ruling is modified because
it corrects a published position. (Compare
withamplifiedandclarified, above).
Obsoleteddescribes a previously pub-
lished ruling that is not considered deter-
minative with respect to future transac-
tions. This term is most commonly used in
a ruling that lists previously published rul-
ings that are obsoleted because of changes
in laws or regulations. A ruling may also
be obsoleted because the substance has
been included in regulations subsequently
adopted.
Revokeddescribes situations where the
position in the previously published ruling
is not correct and the correct position is
beingstatedinanewruling.
Supersededdescribes a situation where
the new ruling does nothing more than re-
state the substance and situation of a previ-
ously published ruling (or rulings). Thus,
the term is used to republish under the
1986 Code and regulations the same po-
sition published under the 1939 Code and
regulations. The term is also used when
it is desired to republish in a single rul-
ing a series of situations, names, etc., that
were previously published over a period of
time in separate rulings. If the new rul-
ing does more than restate the substance
of a prior ruling, a combination of terms
is used. For example,modifiedandsu-
persededdescribes a situation where the
substance of a previously published ruling
is being changed in part and is continued
without change in part and it is desired to
restate the valid portion of the previously
published ruling in a new ruling that is self
contained. In this case, the previously pub-
lished ruling is first modified and then, as
modified, is superseded.
Supplementedis used in situations in
which a list, such as a list of the names of
countries, is published in a ruling and that
list is expanded by adding further names in
subsequent rulings. After the original rul-
ing has been supplemented several times, a
new ruling may be published that includes
the list in the original ruling and the ad-
ditions, and supersedes all prior rulings in
the series.
Suspendedis used in rare situations to
show that the previous published rulings
will not be applied pending some future
action such as the issuance of new or
amended regulations, the outcome of cases
in litigation, or the outcome of a Service
study.
Abbreviations
The fol
lowing abbreviations in current use
and for
merly used will appear in material
publis
hedintheBulletin.
A—Individual.
Acq.—A
cquiescence.
B—Individual.
BE—Beneficiary.
BK—Bank
.
B.T.A.—Board of Tax Appeals.
C—Individual.
C.B.—Cu
mulative Bulletin.
CFR—Code of Federal Regulations.
CI—City.
COOP—Coo
perative.
Ct.D.—Court Decision.
CY—County.
D—Decede
nt.
DC—Dummy Corporation.
DE—Donee.
Del. Order
—Delegation Order.
DISC—Domestic International Sales Corporation.
DR—Donor.
E—Estate.
EE—Employee.
E.O.—Executive Order.
ER—Emp
loyer.
ERISA—Employee Retirement Income Security Act.
EX—Executor.
F—Fiduc
iary.
FC—Foreign Country.
FICA—Federal Insurance Contributions Act.
FISC—Fo
reign International Sales Company.
FPH—Foreign Personal Holding Company.
F.R.—Federal Register.
FUTA—Fed
eral Unemployment Tax Act.
FX—Foreign corporation.
G.C.M.—Chief Counsel’s Memorandum.
GE—Grante
e.
GP—General Partner.
GR—Grantor.
IC—Insura
nce Company.
I.R.B.—Internal Revenue Bulletin.
LE—Lessee.
LP—Limited
Partner.
LR—Lessor.
M—Minor.
Nonacq.—No
nacquiescence.
O—Organization.
P—Parent Corporation.
PHC—Persona
l Holding Company.
PO—Possession of the U.S.
PR—Partner.
PRS—Pa
rtnership.
PTE—Prohibited Transaction Exemption.
Pub. L.—Public Law.
REIT—Re
al Estate Investment Trust.
Rev. Proc.—Revenue Procedure.
Rev. Rul.—Revenue Ruling.
S—Subsi
diary.
S.P.R.—Statement of Procedural Rules.
Stat.—Statutes at Large.
T—Target
Corporation.
T.C.—Tax Court.
T.D.—Treasury Decision.
TFE—Trans
feree.
TFR—Transferor.
T.I.R.—Technical Information Release.
TP—Taxpay
er.
TR—Trust.
TT—Trustee.
U.S.C.—Uni
ted States Code.
X—Corporation.
Y—Corporation.
Z—Corporat
ion.
May 5, 2008i2008–18 I.R.B.

Numerical Finding List
1
Bulletins 2008–1 through 2008–18
Announcements:
2008-1, 2008-1 I.R.B.246
2008-2, 2008-3 I.R.B.307
2008-3, 2008-2 I.R.B.269
2008-4, 2008-2 I.R.B.269
2008-5, 2008-4 I.R.B.333
2008-6, 2008-5 I.R.B.378
2008-7, 2008-5 I.R.B.379
2008-8, 2008-6 I.R.B.403
2008-9, 2008-7 I.R.B.444
2008-10, 2008-7 I.R.B.445
2008-11, 2008-7 I.R.B.445
2008-12, 2008-7 I.R.B.446
2008-13, 2008-8 I.R.B.480
2008-14, 2008-8 I.R.B.481
2008-15, 2008-9 I.R.B.511
2008-16, 2008-9 I.R.B.511
2008-17, 2008-9 I.R.B.512
2008-18, 2008-12 I.R.B.667
2008-19, 2008-11 I.R.B.624
2008-20, 2008-11 I.R.B.625
2008-21, 2008-13 I.R.B.691
2008-22, 2008-13 I.R.B.692
2008-23, 2008-14 I.R.B.731
2008-24, 2008-13 I.R.B.692
2008-25, 2008-14 I.R.B.732
2008-26, 2008-13 I.R.B.693
2008-27, 2008-15 I.R.B.751
2008-28, 2008-14 I.R.B.733
2008-29, 2008-15 I.R.B.786
2008-30, 2008-16 I.R.B.825
2008-31, 2008-15 I.R.B.787
2008-32, 2008-16 I.R.B.826
2008-33, 2008-16 I.R.B.826
2008-34, 2008-17 I.R.B.849
2008-35, 2008-17 I.R.B.849
2008-36, 2008-16 I.R.B.827
2008-37, 2008-17 I.R.B.850
2008-38, 2008-17 I.R.B.851
2008-39, 2008-18 I.R.B.867
Court Decisions:
2085, 2008-17 I.R.B.828
Notices:
2008-1, 2008-2 I.R.B.251
2008-2, 2008-2 I.R.B.252
2008-3, 2008-2 I.R.B.253
2008-4, 2008-2 I.R.B.253
2008-5, 2008-2 I.R.B.256
2008-6, 2008-3 I.R.B.275
2008-7, 2008-3 I.R.B.276
Notices— Continued:
2008-8, 2008-3 I.R.B.276
2008-9, 2008-3 I.R.B.277
2008-10, 2008-3 I.R.B.277
2008-11, 2008-3 I.R.B.279
2008-12, 2008-3 I.R.B.280
2008-13, 2008-3 I.R.B.282
2008-14, 2008-4 I.R.B.310
2008-15, 2008-4 I.R.B.313
2008-16, 2008-4 I.R.B.315
2008-17, 2008-4 I.R.B.316
2008-18, 2008-5 I.R.B.363
2008-19, 2008-5 I.R.B.366
2008-20, 2008-6 I.R.B.406
2008-21, 2008-7 I.R.B.431
2008-22, 2008-8 I.R.B.465
2008-23, 2008-7 I.R.B.433
2008-24, 2008-8 I.R.B.466
2008-25, 2008-9 I.R.B.484
2008-26, 2008-9 I.R.B.487
2008-27, 2008-10 I.R.B.543
2008-28, 2008-10 I.R.B.546
2008-29, 2008-12 I.R.B.637
2008-30, 2008-12 I.R.B.638
2008-31, 2008-11 I.R.B.592
2008-32, 2008-11 I.R.B.593
2008-33, 2008-12 I.R.B.642
2008-34, 2008-12 I.R.B.645
2008-35, 2008-12 I.R.B.647
2008-36, 2008-12 I.R.B.650
2008-37, 2008-12 I.R.B.654
2008-38, 2008-13 I.R.B.683
2008-39, 2008-13 I.R.B.684
2008-40, 2008-14 I.R.B.725
2008-41, 2008-15 I.R.B.742
2008-42, 2008-15 I.R.B.747
2008-43, 2008-15 I.R.B.748
2008-44, 2008-16 I.R.B.799
2008-45, 2008-17 I.R.B.835
2008-46, 2008-18 I.R.B.868
2008-47, 2008-18 I.R.B.869
Proposed Regulations:
REG-168745-03, 2008-18 I.R.B.871
REG-147290-05, 2008-10 I.R.B.576
REG-153589-06, 2008-14 I.R.B.730
REG-104713-07, 2008-6 I.R.B.409
REG-104946-07, 2008-11 I.R.B.596
REG-110136-07, 2008-17 I.R.B.838
REG-111583-07, 2008-4 I.R.B.319
REG-114126-07, 2008-6 I.R.B.410
REG-114942-07, 2008-18 I.R.B.901
REG-119518-07, 2008-17 I.R.B.844
REG-124590-07, 2008-16 I.R.B.801
REG-127391-07, 2008-13 I.R.B.689
REG-136701-07, 2008-11 I.R.B.616
Proposed Regulations— Continued:
REG-137573-07, 2008-15 I.R.B.750
REG-139236-07, 2008-9 I.R.B.491
REG-141399-07, 2008-8 I.R.B.470
REG-143468-07, 2008-17 I.R.B.848
REG-147832-07, 2008-8 I.R.B.472
REG-149475-07, 2008-9 I.R.B.510
REG-151135-07, 2008-16 I.R.B.815
Revenue Procedures:
2008-1, 2008-1 I.R.B.1
2008-2, 2008-1 I.R.B.90
2008-3, 2008-1 I.R.B.110
2008-4, 2008-1 I.R.B.121
2008-5, 2008-1 I.R.B.164
2008-6, 2008-1 I.R.B.192
2008-7, 2008-1 I.R.B.229
2008-8, 2008-1 I.R.B.233
2008-9, 2008-2 I.R.B.258
2008-10, 2008-3 I.R.B.290
2008-11, 2008-3 I.R.B.301
2008-12, 2008-5 I.R.B.368
2008-13, 2008-6 I.R.B.407
2008-14, 2008-7 I.R.B.435
2008-15, 2008-9 I.R.B.489
2008-16, 2008-10 I.R.B.547
2008-17, 2008-10 I.R.B.549
2008-18, 2008-10 I.R.B.573
2008-19, 2008-11 I.R.B.594
2008-21, 2008-12 I.R.B.657
2008-22, 2008-12 I.R.B.658
2008-23, 2008-12 I.R.B.664
2008-24, 2008-13 I.R.B.684
2008-25, 2008-13 I.R.B.686
Revenue Rulings:
2008-1, 2008-2 I.R.B.248
2008-2, 2008-2 I.R.B.247
2008-3, 2008-2 I.R.B.249
2008-4, 2008-3 I.R.B.272
2008-5, 2008-3 I.R.B.271
2008-6, 2008-3 I.R.B.271
2008-7, 2008-7 I.R.B.419
2008-8, 2008-5 I.R.B.340
2008-9, 2008-5 I.R.B.342
2008-10, 2008-13 I.R.B.676
2008-11, 2008-10 I.R.B.541
2008-12, 2008-10 I.R.B.520
2008-13, 2008-10 I.R.B.518
2008-14, 2008-11 I.R.B.578
2008-15, 2008-12 I.R.B.633
2008-16, 2008-11 I.R.B.585
2008-17, 2008-12 I.R.B.626
2008-18, 2008-13 I.R.B.674
2008-19, 2008-13 I.R.B.669
2008-20, 2008-14 I.R.B.716
1
A cumulative list of all revenue rulings, revenue procedures, Treasury decisions, etc., published in Internal Revenue Bulletins 2007–27 through 2007–52 is in Internal Revenue Bulletin
2007–52, dated December 26, 2007.
2008–18 I.R.B.iiMay 5, 2008

Revenue Rulings— Continued:
2008-21, 2008-15 I.R.B.734
2008-22, 2008-16 I.R.B.796
2008-23, 2008-18 I.R.B.852
2008-24, 2008-18 I.R.B.861
Tax Conventions:
2008-8, 2008-6 I.R.B.403
2008-39, 2008-18 I.R.B.867
Treasury Decisions:
9368, 2008-6 I.R.B.382
9369, 2008-6 I.R.B.394
9370, 2008-7 I.R.B.428
9371, 2008-8 I.R.B.447
9372, 2008-8 I.R.B.462
9373, 2008-8 I.R.B.463
9374, 2008-10 I.R.B.521
9375, 2008-5 I.R.B.344
9376, 2008-11 I.R.B.587
9377, 2008-11 I.R.B.578
9378, 2008-14 I.R.B.720
9379, 2008-14 I.R.B.715
9380, 2008-14 I.R.B.718
9381, 2008-14 I.R.B.694
9382, 2008-9 I.R.B.482
9383, 2008-15 I.R.B.738
9384, 2008-16 I.R.B.792
9385, 2008-15 I.R.B.735
9386, 2008-16 I.R.B.788
9387, 2008-16 I.R.B.789
9388, 2008-17 I.R.B.832
9389, 2008-18 I.R.B.863
9390, 2008-18 I.R.B.855
May 5, 2008iii2008–18 I.R.B.

Finding List of Current Actions on
Previously Published Items
1
Bulletins 2008–1 through 2008–18
Announcements:
2006-88
Clarified and superseded by
Notice 2008-35, 2008-12 I.R.B.647
Notice 2008-36, 2008-12 I.R.B.650
2008-6
Superseded by
Ann. 2008-19, 2008-11 I.R.B.624
Notices:
2001-16
Modified by
Notice 2008-20, 2008-6 I.R.B.406
2001-60
Modified and superseded by
Notice 2008-31, 2008-11 I.R.B.592
2002-44
Superseded by
Notice 2008-39, 2008-13 I.R.B.684
2003-51
Superseded by
Rev. Proc. 2008-24, 2008-13 I.R.B.684
2006-27
Clarified and superseded by
Notice 2008-35, 2008-12 I.R.B.647
2006-28
Clarified and superseded by
Notice 2008-36, 2008-12 I.R.B.650
2006-52
Clarified and amplified by
Notice 2008-40, 2008-14 I.R.B.725
2006-77
Clarified and amplified by
Notice 2008-25, 2008-9 I.R.B.484
2006-107
Modified by
Notice 2008-7, 2008-3 I.R.B.276
2007-30
Modified and superseded by
Notice 2008-14, 2008-4 I.R.B.310
2007-54
Clarified by
Notice 2008-11, 2008-3 I.R.B.279
2008-13
Supplemented by
Notice 2008-46, 2008-18 I.R.B.868
Notices— Continued:
2008-27
Clarified, amended, supplemented, and
superseded by
Notice 2008-41, 2008-15 I.R.B.742
Proposed Regulations:
REG-209020-86
Corrected by
Ann. 2008-11, 2008-7 I.R.B.445
REG-107592-00
Partial withdrawal by
Ann. 2008-25, 2008-14 I.R.B.732
REG-149856-03
Hearing scheduled by
Ann. 2008-26, 2008-13 I.R.B.693
REG-113891-07
Hearing scheduled by
Ann. 2008-4, 2008-2 I.R.B.269
REG-114126-07
Corrected by
Ann. 2008-36, 2008-16 I.R.B.827
REG-127770-07
Hearing scheduled by
Ann. 2008-24, 2008-13 I.R.B.692
REG-133300-07
Hearing scheduled by
Ann. 2008-34, 2008-17 I.R.B.849
REG-141399-07
Hearing cancelled by
Ann. 2008-31, 2008-15 I.R.B.787
Revenue Procedures:
97-36
Modified by
Rev. Proc. 2008-23, 2008-12 I.R.B.664
2001-23
Modified by
Rev. Proc. 2008-23, 2008-12 I.R.B.664
2002-9
Modified by
Rev. Proc. 2008-18, 2008-10 I.R.B.573
Modified and amplified by
Rev. Proc. 2008-25, 2008-13 I.R.B.686
2007-1
Superseded by
Rev. Proc. 2008-1, 2008-1 I.R.B.1
2007-2
Superseded by
Rev. Proc. 2008-2, 2008-1 I.R.B.90
Revenue Procedures— Continued:
2007-3
Superseded by
Rev. Proc. 2008-3, 2008-1 I.R.B.110
2007-4
Superseded by
Rev. Proc. 2008-4, 2008-1 I.R.B.121
2007-5
Superseded by
Rev. Proc. 2008-5, 2008-1 I.R.B.164
2007-6
Superseded by
Rev. Proc. 2008-6, 2008-1 I.R.B.192
2007-7
Superseded by
Rev. Proc. 2008-7, 2008-1 I.R.B.229
2007-8
Superseded by
Rev. Proc. 2008-8, 2008-1 I.R.B.233
2007-26
Obsoleted in part by
Rev. Proc. 2008-17, 2008-10 I.R.B.549
2007-31
Obsoleted in part by
Rev. Proc. 2008-19, 2008-11 I.R.B.594
2007-39
Superseded by
Rev. Proc. 2008-3, 2008-1 I.R.B.110
2007-52
Superseded by
Rev. Proc. 2008-9, 2008-2 I.R.B.258
2008-13
Corrected by
Ann. 2008-15, 2008-9 I.R.B.511
Revenue Rulings:
58-612
Clarified and amplified by
Rev. Rul. 2008-15, 2008-12 I.R.B.633
64-250
Amplified by
Rev. Rul. 2008-18, 2008-13 I.R.B.674
89-42
Modified and superseded by
Rev. Rul. 2008-17, 2008-12 I.R.B.626
92-19
Supplemented in part by
Rev. Rul. 2008-19, 2008-13 I.R.B.669
97-31
Modified and superseded by
Rev. Rul. 2008-17, 2008-12 I.R.B.626
1
A cumulative list of current actions on previously published items in Internal Revenue Bulletins 2007–27 through 2007–52 is in Internal Revenue Bulletin 2007–52, dated December 26,
2007.
2008–18 I.R.B.ivMay 5, 2008

Revenue Rulings— Continued:
2001-48
Modified and superseded by
Rev. Rul. 2008-17, 2008-12 I.R.B.626
2007-4
Supplemented and superseded by
Rev. Rul. 2008-3, 2008-2 I.R.B.249
Treasury Decisions:
8697
Corrected by
Ann. 2008-38, 2008-17 I.R.B.851
9273
Corrected by
Ann. 2008-33, 2008-16 I.R.B.826
9362
Corrected by
Ann. 2008-9, 2008-7 I.R.B.444
Ann. 2008-12, 2008-7 I.R.B.446
9363
Corrected by
Ann. 2008-10, 2008-7 I.R.B.445
9368
Corrected by
Ann. 2008-29, 2008-15 I.R.B.786
Ann. 2008-30, 2008-16 I.R.B.825
9375
Corrected by
Ann. 2008-16, 2008-9 I.R.B.511
9386
Corrected by
Ann. 2008-35, 2008-17 I.R.B.849
May 5, 2008v2008–18 I.R.B.

2008–18 I.R.B.May 5, 2008

May 5, 20082008–18 I.R.B.

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