US SUPREME COURT DECISIONS

Section 167(a) of the Internal Revenue Code of 1954 allows a depreciation deduction from gross income for "property used in the [taxpayer's] trade or business" or "held for the production of income," whereas § 263(a)(1) of the Code disallows a deduction for "[a]ny amount paid out for new buildings or for permanent improvements or betterments made to increase the value of any property or estate," expenditures which, the regulations state, include the "cost of acquisition, construction, or erection of buildings." Section 161 makes the deductions specified in that part of the Code, including § 167(a), subject to the exceptions provided in the part including § 263. Respondent public utility claimed a deduction from gross income under § 167(a) for all the depreciation for the year on its transportation equipment (car, trucks, etc.), including that portion attributable to its use in constructing capital facilities, although, on its books, as required by the regulatory agencies, it charged such equipment, to the extent it was used in construction, to the capital assets so constructed. The Commissioner of Internal Revenue disallowed the deduction for the construction-related depreciation, ruling that that depreciation was a nondeductible capital expenditure under § 263(a). chanrobles.com-red

Page 418 U. S. 2

The Commissioner was upheld by the Tax Court, but the Court of Appeals reversed, holding that a deduction expressly enumerated in the Code, such as that for depreciation, may properly be taken even if it relates to a capital item, and that § 263(a)(1) was inapplicable because depreciation is not an "amount paid out" as required by that section.

Held: The equipment depreciation allocable to the taxpayer's construction of capital facilities must be capitalized under § 263(a)(1). Pp. 418 U. S. 10-19.

(a) Accepted accounting practice and established tax principles require the capitalization of the cost of acquiring a capital asset, including the cost incurred in a taxpayer's construction of capital facilities. The purpose of depreciation accounting is the allocation of the expense of using an asset over the tax periods benefited by that asset. Pp. 418 U. S. 10-13.

(b) Construction-related depreciation is not unlike expenditure for other construction-related items, such as construction workers' wages, which must be treated as part of the cost of acquiring a capital asset. The significant fact is that the exhaustion of the construction equipment does not represent the final disposition of the taxpayer's investment in that equipment; rather such investment is assimilated into the cost of the capital asset constructed, and this capitalization prevents the distortion of income that would otherwise occur if depreciation properly allocable to asset acquisition were deducted from gross income currently realized. Pp. 418 U. S. 13-14.

(c) Capitalization of construction-related equipment depreciation by the taxpayer which does its own construction work maintains tax parity with the taxpayer which has such work done independently. P. 418 U. S. 14.

(d) Where a taxpayer's generally accepted method of accounting is made compulsory by the regulatory agency and that method clearly reflects income, as here, it is almost presumptively controlling of federal income tax consequences. Pp. 418 U. S. 14-15.

(e) Considering § 263(a)(1)'s literal language in denying a deduction for "[a]ny amount paid out" for construction or permanent improvement of facilities, and its purpose to reflect the basic principle that a capital expenditure may not be deducted from current income, as well as the regulations indicating that, for purposes of § 263(a)(1) "amount paid out" equates with "cost incurred," there is no question that the cost of the transportation equipment was "paid out" in the same manner as the cost of other chanrobles.com-red

Page 418 U. S. 3

construction-related items, such as supplies, materials, and wages, which the taxpayer capitalized. Pp. 418 U. S. 16-17.

(f) The priority-ordering directive of § 161 requires that § 263(a)'s capitalization provision take precedence, on the facts, over § 167(a). Pp. 418 U. S. 17-19.

477 F.2d 688, reversed.

BLACKMUN, J., delivered the opinion of the Court, in which BURGER, C.J.,and BRENNAN, STEWART, WHITE, MARSHALL, POWELL, and REHNQUIST, JJ., joined. DOUGLAS, J., filed a dissenting opinion, post, p. 418 U. S. 19.