2252 Federal Register / Vol. 66, No. 8 / Thursday, January 11, 2001 / Rules and Regulations

DEPARTMENT OF THE TREASURY

Internal Revenue Service

26 CFR Parts 1 and 602

[TD 8936]

RIN 1545–AW17

Definition of Contribution in Aid of

Construction Under Section 118(c)

AGENCY: Internal Revenue Service (IRS),

Treasury.

ACTION: Final regulations.

SUMMARY: This document contains final

regulations concerning an exclusion

from gross income for a contribution in

aid of construction under section 118(c)

that is treated as a contribution to

capital under section 118(a). The final

regulations affect a regulated public

utility that provides water or sewerage

services because a qualifying

contribution in aid of construction is

treated as a contribution to the capital

of the utility and excluded from gross

income. The final regulations provide

guidance on the definition of a

contribution in aid of construction, the

adjusted basis of any property acquired

with a contribution in aid of

construction, the information relating to

a contribution in aid of construction

required to be furnished by the utility,

and the time and manner for providing

that information to the IRS.

DATES: Effective Date: These regulations

are effective January 11, 2001.

Date of Applicability: For date of

applicability of § 1.118–2, see § 1.118–

2(f).

FOR FURTHER INFORMATION CONTACT: Paul

Handleman, (202) 622–3040 (not a tollfree number).

SUPPLEMENTARY INFORMATION:

Paperwork Reduction Act

The collections of information

contained in these final regulations have

been reviewed and approved by the

Office of Management and Budget in

accordance with the Paperwork

Reduction Act of 1995 (44 U.S.C. 3507)

under control number 1545–1639.

Responses to these collections of

information are mandatory.

An agency may not conduct or

sponsor, and a person is not required to

respond to, a collection of information

unless the collection of information

displays a valid control number.

The estimated annual burden per

respondent varies from .5 hour to 5

hours, depending on individual

circumstances, with an estimated

average of 1 hour.

Comments concerning the accuracy of

these burden estimates and suggestions

for reducing these burdens should be

sent to the Internal Revenue Service,

Attn: IRS Reports Clearance Officer,

W:CAR:MP:FP:S:O, Washington, DC

20224, and to the Office of Management

and Budget, Attn: Desk Officer for the

Department of the Treasury, Office of

Information and Regulatory Affairs,

Washington, DC 20503.

Books or records relating to this

collection of information must be

retained as long as their contents may

become material in the administration

of any internal revenue law. Generally,

tax returns and tax return information

are confidential, as required by 26

U.S.C. 6103.

Background

On December 20, 1999, the IRS

published proposed regulations (REG–

106012–98) in the Federal Register (64

FR 71082) inviting comments under

section 118(c). A public hearing was

held April 27, 2000. Numerous

comments have been received. After

consideration of all the comments, the

proposed regulations are adopted as

revised by this Treasury decision.

Summary of Comments

Under section 118(a), gross income

does not include any contribution to the

capital of the taxpayer. Section 118(c)(1)

provides that a contribution to the

capital of a taxpayer includes any

amount of money or other property

received from any person (whether or

not a shareholder) by a regulated public

utility that provides water or sewerage

disposal services if the amount is a

contribution in aid of construction,

satisfies the expenditure rule, and is not

included in rate base for ratemaking

purposes. Pursuant to the authority

granted to the Secretary under section

118(c)(3)(A), the proposed regulations

define a contribution in aid of

construction as any amount of money or

other property contributed to a

regulated public utility that provides

water or sewerage disposal services to

the extent that the purpose of the

contribution is to provide for the

expansion, improvement, or

replacement of the utility’s water or

sewerage disposal facilities.

Customer Connection Fees

The proposed regulations define

nontaxable contributions in aid of

construction to exclude customer

connection fees. Customer connection

fees are defined in the proposed

regulations to include amounts paid for

the cost of installing a connection or

service line (including the cost of meters

and piping) from the utility’s main lines

to the lines owned by the customer,

unless the connection or service line

serves, or is designed to serve, more

than one customer. Customer

connection fees also are defined in the

proposed regulations to include any

amounts paid as service charges for

starting or stopping services.

Several commentators contend that

connection and service lines should not

be treated as taxable customer

connection fees for a number of reasons.

For example, these commentators argue

that the omission from the current law

of the language included in former

section 118(b)(3)(A) that directed the

Secretary to define a contribution in aid

of construction to exclude amounts paid

to connect the customer’s line to a main

water or sewer line signals

congressional intent to include

connection and service lines in the

definition of a nontaxable contribution

in aid of construction. In addition, some

of these commentators believe that the

inclusion of connection and service

lines as taxable customer connection

fees is inconsistent with the judicial

interpretation of a contribution in aid of

construction, which arguably would

treat contributions for main lines and

connection and service lines as taxable

prerequisites for services under the

Supreme Court’s decision in United

States v. Chicago, Burlington & Quincy

R.R., 412 U.S. 401 (1973) (1973–2 C.B.

428). Some of these commentators also

contend that the exclusion of

connection and service lines from the

definition of a nontaxable contribution

in aid of construction is inconsistent

with regulatory accounting treatment,

which does not distinguish between

main lines and connection and service

lines for purposes of classifying

property or for purposes of ratemaking.

Finally, a few of these commentators

point out that the inclusion of

connection and service lines as taxable

customer connection fees will result in

customers being required to gross-up

their contributions of connection and

service lines for taxes, increasing the

cost of housing and development and

creating a competitive disadvantage for

investor-owned utilities.

The IRS and Treasury Department do

not agree with the commentators’

position with respect to connection and

service lines. As explained in the

preamble to the proposed regulations,

the inclusion of connection and service

lines in the definition of taxable

customer connection fees is consistent

with the legislative history explanation

that section 118(c) was intended to

restore the contribution in aid of

construction provision of former section

Federal Register / Vol. 66, No. 8 / Thursday, January 11, 2001 / Rules and Regulations 2253

118(b) that was repealed by The Tax

Reform Act of 1986 for regulated public

utilities that provide water or sewerage

disposal services. H.R. Conf. Rep. No.

737, 104th Cong., 2d Sess. 316 (1996)

(1996–3 C.B. 741, 1056). While the

language regarding the definition of a

contribution in aid of construction did

change from the language in former

section 118(b), Congress did not

explicitly include connection and

service lines in the definition of a

contribution in aid of construction but

instead directed the Secretary to define

a contribution in aid of construction,

presumably aware of the IRS’ and

Treasury Department’s position that

connection and service lines are taxable

customer connection fees based on Rev.

Rul. 75–557 (1975–2 C.B. 33), and the

proposed regulations under former

section 118(b) (43 FR 22997 (May 30,

1978)). Moreover, the IRS and Treasury

Department continue to believe that the

exclusion of connection and service

lines from a nontaxable contribution in

aid of construction is more consistent

with the judicial and regulatory

interpretation of a contribution in aid of

construction and with the Supreme

Court’s directive that exclusions be

narrowly construed. See, for example,

Edwards v. Cuba R.R., 268 U.S. 628

(1925) (IV–2 C.B. 122); Detroit Edison

Co. v. Commissioner, 319 U.S. 98 (1943)

(1943 C.B. 1019); Chicago, Burlington &

Quincy R.R., 412 U.S. at 401; Florida

Progress Corp. v. United States, No. 93–

246–CIV–T–25A (M.D. Fla. July 2,

1998), appeal docketed, No. 99–15389–

FF (11th Cir. Dec. 29, 1999);

Commissioner v. Schleier, 515 U.S. 323,

328 (1995); and Rev. Rul. 75–557. As

explained by the court in Teco Energy,

Inc. v. United States, No. 98–430–Civ–

J–TJC (M.D. Fla. Oct. 21, 1999), ‘‘former

[section] 118(b) codifies the principles

of Edwards that payments made by a

government or other group to a utility to

encourage the extension of facilities into

new areas benefiting a large number of

people are given tax free status, while

also affirming the reasoning of Detroit

Edison Revenue Ruling 75–557, that

payments made by an individual or

business entity to a utility as a

prerequisite to receiving water or

sewage services would be treated as

taxable income to the utility.’’ Further,

the IRS and Treasury Department

believe that the definition of a

contribution in aid of construction used

for regulatory accounting purposes

should not control for tax purposes. See,

for example, Thor Power Tool Co. v.

Commissioner, 439 U.S. 522, 541–45

(1979) (1979–1 C.B. 167). Accordingly,

the final regulations retain the exclusion

of connection and service lines from the

definition of a nontaxable contribution

in aid of construction.

Some commentators state that, before

the proposed regulations were

published, some utilities took the

position that payments for connection

and service lines were not taxable and

did not charge their contributors a

sufficient amount to cover their tax

liabilities. The IRS and Treasury

Department understand that there was

uncertainty before the proposed

regulations were published and that

some utilities may have reasonably

interpreted section 118(c)(3)(A) to mean

that connection and service lines should

not be treated as taxable. It is clear that

these final regulations apply to money

and other property received on or after

January 11, 2001 and do not apply to

transactions entered into prior to that

date. In addition, the IRS will take into

account all the facts and circumstances

in applying section 118(c) to such

transactions.

Commentators suggest that customer

connection fees relating to services

provided to public authorities, such as

schools, hospitals, public libraries, and

governmental entities, should be

included in the definition of nontaxable

contributions in aid of construction

because these services provide a broad

public benefit. In addition,

commentators recommend that

customer connection fees relating to fire

protection services should qualify as

nontaxable contributions in aid of

construction because a utility receives

no revenue for public fire protection

services and only a nominal standby fee

for private fire protection services. The

IRS and Treasury Department believe

that, regardless of whether the activities

of public authorities provide a public

benefit, connection and service lines

that serve these customers should be

treated in the same manner as

connection or service lines to any

paying customer—as a prerequisite for

services. Consequently, the final

regulations continue to treat amounts

paid for connection and service lines

with respect to public authorities as

customer connection fees. However, the

IRS and the Treasury Department agree

with commentators that amounts paid

with respect to fire protection services

should not be considered customer

connection fees.

Several commentators suggest that

connection and service lines that serve

more than one user, such as lines for

apartment houses, condominium

projects, shopping malls, and office

buildings, should be considered to serve

more than one customer and, thus, be

excluded from taxable customer

connection fees, regardless of whether

the utility treats the facility as one

customer or many. The final regulations

do not adopt this suggestion because

whether connection or service lines are

designed to serve more than one

customer does not depend on the

number of users but upon the number

of customers. Thus, for example, if a

water or sewerage disposal utility treats

an apartment or office building as one

utility customer, then the cost of

connecting the utility’s main lines to the

connection or service lines serving that

single customer is a taxable customer

connection fee.

Binding Agreement Rule

The proposed regulations provide that

if a water or sewerage disposal facility

is placed in service by the utility before

an amount is contributed to the utility,

the contribution is not a nontaxable

contribution in aid of construction

unless, at the time the facility is placed

in service by the utility, there is an

agreement, binding under local law

between the prospective contributor and

the utility, that the utility is to receive

the amount as reimbursement for the

cost of acquiring or constructing the

facility.

Commentators suggest that the

binding agreement rule should be

expanded to include enforceable public

utility commission orders and tariffs.

The final regulations adopt this

suggestion by treating an order or a

tariff, issued or approved by the

applicable public utility commission,

that requires a current or prospective

customer to reimburse the utility for the

cost of acquiring or constructing the

facility as a binding agreement. Because

public utility commission orders or

tariffs may be issued or approved before

or after the facility is placed in service,

the final regulations also extend the

time for entering into a binding

agreement or the issuance or approval of

an order or a tariff to no later than 81⁄2

months after the close of the taxable

year (the usual due date with extensions

for a taxpayer’s return) in which the

facility is placed in service.

One commentator suggests adding an

example demonstrating that payments

made pursuant to a binding agreement

qualify as a contribution in aid of

construction under section 118(c). The

final regulations adopt this suggestion.

Basis Rules

The proposed regulations provide that

the basis of a water or sewerage facility

acquired or constructed with a

contribution under a binding agreement

must be reduced by the amount of the

contribution at the time the facility is

2254 Federal Register / Vol. 66, No. 8 / Thursday, January 11, 2001 / Rules and Regulations

placed in service. Several commentators

suggest that if the receipt of all of the

expected contributions under the

agreement occurs more than one or two

years after a facility is placed in service,

the utility should be permitted to claim

the full cost of the facility as basis for

depreciation purposes, subject to

adjustment as the contributions are

received. The final regulations do not

adopt this comment because section

118(c)(4) disallows any depreciation

deductions for a water or sewerage

disposal facility that is fully paid with

a nontaxable contribution in aid of

construction under section under

section 118(c). This result is consistent

with similar rules that either exclude

expected contributions from basis or

deny a deduction to the extent the

taxpayer has a right to, or reasonable

prospect of, reimbursement. See, for

example, § 1.110–1(b)(4)(ii)(B); § 1.165–

1(d)(2)(i); and Rev. Rul. 79–263 (1979–

2 C.B. 82).

The proposed regulations provide

that, if a contribution in aid of

construction treated as a contribution to

the capital of the taxpayer is repaid to

the contributor, either in whole or in

part, then the repayment amount is a

capital expenditure in the taxable year

in which it is paid or incurred, resulting

in an increase in the property’s adjusted

basis in such year. A couple of

commentators suggest that the

repayment should be depreciated over

the remaining life of the property. The

final regulations adopt this suggestion.

Reporting Requirement

The proposed regulations provide that

a taxpayer treating a contribution in aid

of construction as a contribution to

capital must file a statement with its tax

returns to report the amount of the

contribution in aid of construction the

taxpayer: (1) Expended during the

taxable year for property described in

section 118(c)(2)(A) (qualified property);

(2) does not intend to expend for

qualified property; and (3) failed to

expend for qualified property. Several

commentators express concern that the

reporting requirement in the proposed

regulations exceeds the intent of the

statute because section 118(c)(2)(C) only

requires the maintenance of adequate

records. However, section 118(d)(1)

provides that if the taxpayer for any

taxable year treats an amount as a

contribution to the capital of the

taxpayer described in section 118(c),

then the statutory period for the

assessment of any deficiency

attributable to any part of the amount

does not expire before the expiration of

3 years from the date the Secretary is

notified by the taxpayer (in such

manner as the Secretary may prescribe)

of the amount of the expenditure

referred to in section 118(c)(2)(A), of the

taxpayer’s intention not to make the

expenditures referred to in section

118(c)(2)(A), or of a failure to make the

expenditure within the period described

in section 118(c)(2)(B). Thus, the

regulations do not impose an additional

reporting requirement but merely

provide the time and manner in which

taxpayers must notify the Secretary

under section 118(d)(1) of amounts

treated as contributions in aid of

construction.

Collection of Information under

Paperwork Reduction Act

Two comments were sent to OMB on

the collection of information contained

in the proposed regulations, with copies

of the comments sent to the IRS Reports

Clearance Officer. The commentators

estimate that complying with the

recordkeeping requirements of section

118(c)(2)(C) involves more hours and

that the number of respondents is

greater than estimated. The collection of

information burden under the proposed

regulations is based only upon the time

for notifying the IRS of the required

information under section 118(d)(1) and

is not required to include the time for

maintaining accurate books and records.

Thus, the individual time to comply

with the collection of information

burden was not increased to reflect

these commentators concerns. However,

the estimated number of annual

respondents has been increased to 300

and the estimated total annual reporting

burden has been increased to 300 hours.

Special Analyses

It has been determined that this

Treasury decision 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 regulations. It is hereby

certified that the collection of

information in these regulations will not

have a significant economic impact on

a substantial number of small entities.

This certification is based upon the fact

that any burden on taxpayers is

minimal. Accordingly, a Regulatory

Flexibility Analysis under the

Regulatory Flexibility Act (5 U.S.C.

chapter 6) is not required. Pursuant to

section 7805(f) of the Internal Revenue

Code, the notice of proposed rulemaking

preceding these regulations was

submitted to the Chief Counsel for

Advocacy of the Small Business

Administration for comment on its

impact on small business.

Drafting Information

The principal author of these

regulations is Paul F. Handleman, Office

of the Associate Chief Counsel

(Passthroughs and Special Industries),

IRS. However, other personnel from the

IRS and Treasury Department

participated in their development.

List of Subjects

26 CFR Part 1

Income taxes, Reporting and

recordkeeping requirements.

26 CFR Part 602

Reporting and recordkeeping

requirements.

Amendments to the Regulations

Accordingly, 26 CFR parts 1 and 602

are amended as follows:

PART 1—INCOME TAXES

Paragraph 1. The authority citation

for part 1 is amended by adding an entry

in numerical order to read in part as

follows:

Authority: 26 U.S.C. 7805 * * *

Section 1.118–2 also issued under 26

U.S.C. 118(c)(3)(A); * * *

Par. 2. Section 1.118–2 is added to

read as follows:

§ 1.118–2 Contribution in aid of

construction.

(a) Special rule for water and

sewerage disposal utilities—(1) In

general. For purposes of section 118, the

term contribution to the capital of the

taxpayer includes any amount of money

or other property received from any

person (whether or not a shareholder)

by a regulated public utility that

provides water or sewerage disposal

services if—

(i) The amount is a contribution in aid

of construction under paragraph (b) of

this section;

(ii) In the case of a contribution of

property other than water or sewerage

disposal facilities, the amount satisfies

the expenditure rule under paragraph

(c) of this section; and

(iii) The amount (or any property

acquired or constructed with the

amount) is not included in the

taxpayer’s rate base for ratemaking

purposes.

(2) Definitions—(i) Regulated public

utility has the meaning given such term

by section 7701(a)(33), except that such

term does not include any utility which

is not required to provide water or

sewerage disposal services to members

of the general public in its service area.

Federal Register / Vol. 66, No. 8 / Thursday, January 11, 2001 / Rules and Regulations 2255

(ii) Water or sewerage disposal facility

is defined as tangible property described

in section 1231(b) that is used

predominately (80% or more) in the

trade or business of furnishing water or

sewerage disposal services.

(b) Contribution in aid of

construction—(1) In general. For

purposes of section 118(c) and this

section, the term contribution in aid of

construction means any amount of

money or other property contributed to

a regulated public utility that provides

water or sewerage disposal services to

the extent that the purpose of the

contribution is to provide for the

expansion, improvement, or

replacement of the utility’s water or

sewerage disposal facilities.

(2) Advances. A contribution in aid of

construction may include an amount of

money or other property contributed to

a regulated public utility for a water or

sewerage disposal facility subject to a

contingent obligation to repay the

amount, in whole or in part, to the

contributor (commonly referred to as an

advance). For example, an amount

received by a utility from a developer to

construct a water facility pursuant to an

agreement under which the utility will

pay the developer a percentage of the

receipts from the facility over a fixed

period may constitute a contribution in

aid of construction. Whether an advance

is a contribution or a loan is determined

under general principles of federal tax

law based on all the facts and

circumstances. For the treatment of any

amount of a contribution in aid of

construction that is repaid by the utility

to the contributor, see paragraphs

(c)(2)(ii) and (d)(2) of this section.

(3) Customer connection fee—(i) In

general. Except as provided in

paragraph (b)(3)(ii) of this section, a

customer connection fee is not a

contribution in aid of construction

under this paragraph (b) and generally

is includible in income. The term

customer connection fee includes any

amount of money or other property

transferred to the utility representing

the cost of installing a connection or

service line (including the cost of meters

and piping) from the utility’s main

water or sewer lines to the line owned

by the customer or potential customer.

A customer connection fee also includes

any amount paid as a service charge for

starting or stopping service.

(ii) Exceptions—(A) Multiple

customers. Money or other property

contributed for a connection or service

line from the utility’s main line to the

customer’s or the potential customer’s

line is not a customer connection fee if

the connection or service line serves, or

is designed to serve, more than one

customer. For example, a contribution

for a split service line that is designed

to serve two customers is not a customer

connection fee. On the other hand, if a

water or sewerage disposal utility treats

an apartment or office building as one

utility customer, then the cost of

installing a connection or service line

from the utility’s main water or sewer

lines serving that single customer is a

customer connection fee.

(B) Fire protection services. Money or

other property contributed for public

and private fire protection services is

not a customer connection fee.

(4) Reimbursement for a facility

previously placed in service—(i) In

general. If a water or sewerage disposal

facility is placed in service by the utility

before an amount is contributed to the

utility, the contribution is not a

contribution in aid of construction

under this paragraph (b) with respect to

the cost of the facility unless, no later

than 81⁄2 months after the close of the

taxable year in which the facility was

placed in service, there is an agreement,

binding under local law, that the utility

is to receive the amount as

reimbursement for the cost of acquiring

or constructing the facility. An order or

tariff, binding under local law, that is

issued or approved by the applicable

public utility commission requiring

current or prospective utility customers

to reimburse the utility for the cost of

acquiring or constructing the facility, is

a binding agreement for purposes of the

preceding sentence. If an agreement

exists, the basis of the facility must be

reduced by the amount of the expected

contributions. Appropriate adjustments

must be made if actual contributions

differ from expected contributions.

(ii) Example. The application of

paragraph (b)(4)(i) of this section is

illustrated by the following example:

Example. M, a calendar year regulated

public utility that provides water services,

spent $1,000,000 for the construction of a

water facility that can serve 200 customers.

M placed the facility in service in 2000. In

June 2001, the public utility commission that

regulates M approves a tariff requiring new

customers to reimburse M for the cost of

constructing the facility by paying a service

availability charge of $5,000 per lot. Pursuant

to the tariff, M expects to receive

reimbursements for the cost of the facility of

$100,000 per year for the years 2001 through

2010. The reimbursements are contributions

in aid of construction under paragraph (b) of

this section because no later than 81⁄2 months

after the close of the taxable year in which

the facility was placed in service there was

a tariff, binding under local law, approved by

the public utility commission requiring new

customers to reimburse the utility for the cost

of constructing the facility. The basis of the

$1,000,000 facility is zero because the

expected contributions equal the cost of the

facility.

(5) Classification by ratemaking

authority. The fact that the applicable

ratemaking authority classifies any

money or other property received by a

utility as a contribution in aid of

construction is not conclusive as to its

treatment under this paragraph (b).

(c) Expenditure rule—(1) In general.

An amount satisfies the expenditure

rule of section 118(c)(2) if the amount is

expended for the acquisition or

construction of property described in

section 118(c)(2)(A), the amount is paid

or incurred before the end of the second

taxable year after the taxable year in

which the amount was received as

required by section 118(c)(2)(B), and

accurate records are kept of

contributions and expenditures as

provided in section 118(c)(2)(C).

(2) Excess amount—(i) Includible in

the utility’s income. An amount

received by a utility as a contribution in

aid of construction that is not expended

for the acquisition or construction of

water or sewerage disposal facilities as

required by paragraph (c)(1) of this

section (the excess amount) is not a

contribution to the capital of the

taxpayer under paragraph (a) of this

section. Except as provided in

paragraph (c)(2)(ii) of this section, such

excess amount is includible in the

utility’s income in the taxable year in

which the amount was received.

(ii) Repayment of excess amount. If

the excess amount described in

paragraph (c)(2)(i) of this section is

repaid, in whole or in part, either—

(A) Before the end of the time period

described in paragraph (c)(1) of this

section, the repayment amount is not

includible in the utility’s income; or

(B) After the end of the time period

described in paragraph (c)(1) of this

section, the repayment amount may be

deducted by the utility in the taxable

year in which it is paid or incurred to

the extent such amount was included in

income.

(3) Example. The application of this

paragraph (c) is illustrated by the

following example:

Example. M, a calendar year regulated

public utility that provides water services,

received a $1,000,000 contribution in aid of

construction in 2000 for the purpose of

constructing a water facility. To the extent

that the $1,000,000 exceeded the actual cost

of the facility, the contribution was subject to

being returned. In 2001, M built the facility

at a cost of $700,000 and returned $200,000

to the contributor. As of the end of 2002, M

had not returned the remaining $100,000.

Assuming accurate records are kept, the

requirement under section 118(c)(2) is

satisfied for $700,000 of the contribution.

2256 Federal Register / Vol. 66, No. 8 / Thursday, January 11, 2001 / Rules and Regulations

Because $200,000 of the contribution was

returned within the time period during

which qualifying expenditures could be

made, this amount is not includible in M’s

income. However, the remaining $100,000 is

includible in M’s income for its 2000 taxable

year (the taxable year in which the amount

was received) because the amount was

neither spent nor repaid during the

prescribed time period. To the extent M

repays the remaining $100,000 after year

2002, M would be entitled to a deduction in

the year such repayment is paid or incurred.

(d) Adjusted basis—(1) Exclusion

from basis. Except for a repayment

described in paragraph (d)(2) of this

section, to the extent that a water or

sewerage disposal facility is acquired or

constructed with an amount received as

a contribution to the capital of the

taxpayer under paragraph (a) of this

section, the basis of the facility is

reduced by the amount of the

contribution. To the extent the water or

sewerage disposal facility is acquired as

a contribution to the capital of the

taxpayer under paragraph (a) of this

section, the basis of the contributed

facility is zero.

(2) Repayment of contribution. If a

contribution to the capital of the

taxpayer under paragraph (a) of this

section is repaid to the contributor,

either in whole or in part, then the

repayment amount is a capital

expenditure in the taxable year in which

it is paid or incurred, resulting in an

increase in the property’s adjusted basis

in such year. Capital expenditures

allocated to depreciable property under

paragraph (d)(3) of this section may be

depreciated over the remaining recovery

period for that property.

(3) Allocation of contributions. An

amount treated as a capital expenditure

under this paragraph (d) is to be

allocated proportionately to the adjusted

basis of each property acquired or

constructed with the contribution based

on the relative cost of such property.

(4) Example. The application of this

paragraph (d) is illustrated by the

following example:

Example. A, a calendar year regulated

public utility that provides water services,

received a $1,000,000 contribution in aid of

construction in 2000 as an advance from B,

a developer, for the purpose of constructing

a water facility. To the extent that the

$1,000,000 exceeds the actual cost of the

facility, the contribution is subject to being

returned. Under the terms of the advance, A

agrees to pay to B a percentage of the receipts

from the facility over a fixed period, but

limited to the cost of the facility. In 2001, A

builds the facility at a cost of $700,000 and

returns $300,000 to B. In 2002, A pays

$20,000 to B out of the receipts from the

facility. Assuming accurate records are kept,

the $700,000 advance is a contribution to the

capital of A under paragraph (a) of this

section and is excludable from A’s income.

The basis of the $700,000 facility constructed

with this contribution to capital is zero. The

$300,000 excess amount is not a contribution

to the capital of A under paragraph (a) of this

section because it does not meet the

expenditure rule described in paragraph

(c)(1) of this section. However, this excess

amount is not includible in A’s income

pursuant to paragraph (c)(2)(ii) of this section

since the amount is repaid to B within the

required time period. The repayment of the

$300,000 excess amount to B in 2001 is not

treated as a capital expenditure by A. The

$20,000 payment to B in 2002 is treated as

a capital expenditure by A in 2002 resulting

in an increase in the adjusted basis of the

water facility from zero to $20,000.

(e) Statute of limitations—(1)

Extension of statute of limitations.

Under section 118(d)(1), the statutory

period for assessment of any deficiency

attributable to a contribution to capital

under paragraph (a) of this section does

not expire before the expiration of 3

years after the date the taxpayer notifies

the Secretary in the time and manner

prescribed in paragraph (e)(2) of this

section.

(2) Time and manner of notification.

Notification is made by attaching a

statement to the taxpayer’s federal

income tax return for the taxable year in

which any of the reportable items in

paragraphs (e)(2)(i) through (iii) of this

section occur. The statement must

contain the taxpayer’s name, address,

employer identification number, taxable

year, and the following information

with respect to contributions of property

other than water or sewerage disposal

facilities that are subject to the

expenditure rule described in paragraph

(c) of this section—

(i) The amount of contributions in aid

of construction expended during the

taxable year for property described in

section 118(c)(2)(A) (qualified property)

as required under paragraph (c)(1) of

this section, identified by taxable year

in which the contributions were

received;

(ii) The amount of contributions in

aid of construction that the taxpayer

does not intend to expend for qualified

property as required under paragraph

(c)(1) of this section, identified by

taxable year in which the contributions

were received; and

(iii) The amount of contributions in

aid of construction that the taxpayer

failed to expend for qualified property

as required under paragraph (c)(1) of

this section, identified by taxable year

in which the contributions were

received.

(f) Effective date. This section is

applicable for any money or other

property received by a regulated public

utility that provides water or sewerage

disposal services on or after January 11,

2001.

PART 602—OMB CONTROL NUMBERS

UNDER THE PAPERWORK

REDUCTION ACT

Par. 3. The authority citation for part

602 continues to read as follows:

Authority: 26 U.S.C. 7805.

Par. 4. In § 602.101, paragraph (b) is

amended by adding an entry to the table

in numerical order to read as follows:

§ 602.101 OMB Control numbers.

* * * * *

(b) * * *

CFR part or section identified

and described

Current OMB

control No.

*****

1.118–2 ................................. 1545–1639

*****

Robert E. Wenzel,

Deputy Commissioner of Internal Revenue.

Approved: December 20, 2000.

Jonathan Talisman,

Acting Assistant Secretary of the Treasury.

[FR Doc. 01–487 Filed 1–10–01; 8:45 am]

BILLING CODE 4830–01–P

DEPARTMENT OF THE TREASURY

Internal Revenue Service

26 CFR Parts 1 and 7

[TD 8937]

RIN 1545–AY53

Stock Transfer Rules: Transition Rules

AGENCY: Internal Revenue Service (IRS),

Treasury.

ACTION: Final regulations and removal of

temporary regulations.

SUMMARY: This document contains final

regulations addressing distributions

with respect to, or a disposition of,

certain stock that was subject to prior

temporary regulations under section

367(b). Section 367(b) addresses the

application of nonrecognition exchange

provisions in Subchapter C of the

Internal Revenue Code to transactions

that involve one or more foreign

corporations.

DATES: Effective Date. These regulations

are effective as of January 11, 2001.

Applicability Dates. These regulations

apply to distributions or dispositions

that occur on or after January 11, 2001.