Certain rotable spare parts are depreciable

By Jim Wilhelm, CPA
Stout, Causey & Horning, P.A.

On March 24, 2003, the Internal Revenue Service issued Revenue Ruling 2003-37, providing that taxpayers can treat rotable spare parts as depreciable assets under certain circumstances.

The ruling follows two court decisions holding that a pool of rotable spare parts was not held for sale and that the taxpayer was not required to treat the individual parts as inventory (Hewlett Packard Inc. v. United States, 71 F.3d 398, (Fed. Cir. 1995); rev'g Apollo Computer Inc. and Subsidiaries v. United States, 32 Fed. Cl. 334 (1994); and Honeywell Inc. and Subsidiaries v. Commissioner, T.C. Memo. 1992-453, aff'd 27 F.3d 571 (8th Cir. 1994)).

In Hewlett Packard, and similarly in Honeywell, the taxpayer provided maintenance and repair services under its product warranties and maintenance agreements. The company maintained a pool of rotable spare parts that it would use to replace customers' parts until they were repaired.

The company treated the pool of rotable spare parts as a capitalized fixed asset, which it depreciated and on which it took investment tax credits. A key point: A planning issue for today is that these rotable parts may qualify for "bonus" depreciation of 30 percent in the year the parts are purchased.

In the case of Hewlett Packard, the IRS disallowed the depreciation deductions and investment tax credits on the grounds that the taxpayer was required to characterize its pool of rotable spare parts as property held primarily for sale in the ordinary course of business that should be included in inventory.

By issuing Revenue Ruling 2003-37, the IRS has reversed that stance and determined that it will follow the court rulings. This means taxpayers can now take depreciation deductions instead of locking up the costs of rotable parts on their balance sheets, thus improving after-tax cash flow.

The IRS said it intends to issue a revenue procedure in time for taxpayers to make the change for taxable years ending on or after Dec. 31, 2002. The procedure will allow qualifying taxpayers to apply to obtain automatic consent to change to a method of accounting consistent with the Hewlett Packard and Honeywell rulings. It would appear that it would be necessary to file Form 3115 to elect this new treatment for rotable parts.

Also in the ruling, the IRS requested comments on the maximum amount of rotable spare parts sales that should be permitted from a rotable spare parts pool that is treated as a depreciable asset. The ruling was to have appeared in Internal Revenue Bulletin 2003-15, dated April 14, 2003.

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