[Federal Register Volume 71, Number 44 (Tuesday, March 7, 2006)]
[Rules and Regulations]
[Pages 11306-11308]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 06-55510]


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DEPARTMENT OF THE TREASURY

Internal Revenue Service

26 CFR Part 1


Definition of Contribution in Aid of Construction Under Section 
118(c)

CFR Correction

    In Title 26 of the Code of Federal Regulations, part 1 (Sec. Sec.  
1.61 to 1.169), revised as of April 1, 2005, on page 495, reinstate 
Sec.  1.118-2 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.
    (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

[[Page 11307]]

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. 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

[[Page 11308]]

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.

[T.D. 8936, 66 FR 2254, Jan. 11, 2001]
[FR Doc. 06-55510 Filed 3-6-06; 8:45 am]
BILLING CODE 1505-01-D