[Federal Register Volume 66, Number 8 (Thursday, January 11, 2001)]
[Rules and Regulations]
[Pages 2252-2256]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 01-487]



[[Page 2252]]

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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.

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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 Sec. 1.118-2, 
see Sec. 1.118-2(f).

FOR FURTHER INFORMATION CONTACT: Paul Handleman, (202) 622-3040 (not a 
toll-free 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

[[Page 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 8\1/2\ 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

[[Page 2254]]

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, Sec. 1.110-1(b)(4)(ii)(B); Sec. 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:


Sec. 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.

[[Page 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 8\1/2\ 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 8\1/2\ 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.

[[Page 2256]]

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 Sec. 602.101, paragraph (b) is amended by adding an 
entry to the table in numerical order to read as follows:


Sec. 602.101  OMB Control numbers.

* * * * *
    (b) * * *

------------------------------------------------------------------------
                                                            Current OMB
      CFR part or section identified and described          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