Rev. Proc. 65-13

                               SUMMARY

THE GUIDELINE FORM OF THE RESERVE RATIO TEST

SECTION 1. INTRODUCTION.

.01 The purpose of the reserve ratio test is to measure objectively the consistency between the class life used by a taxpayer for tax depreciation purposes with respect to a guideline class and the taxpayer's retirement and replacement practices for the depreciable assets in that class.

.02 The `reserve ratio' is the ratio of the depreciation reserves for the assets in any guideline class to the basis of those assets./1/

.03 The reserve ratio test is met if the taxpayer's actual reserve ratio is not higher than the appropriate reserve ratio upper limit.

SEC. 2. TABULAR FORM OF THE RESERVE RATIO TEST.

.01 The reserve ratio test as set forth in Revenue Procedure 62-21, C.B. 1962-2, 418, is herein called the tabular form of the reserve ratio test (or simply `tabular form'). Under the tabular form, the taxpayer's actual reserve ratio for any guideline class is compared to the reserve ratio upper limit for that class determined from the Reserve Ratio Table/2/ to be appropriate for (a) the depreciation method used by the taxpayer to calculate his depreciation deductions for the assets in the guideline class, (b) the test life for the class, and (c) the taxpayer's rate of growth for the class.

.02 A taxpayer's rate of growth may be determined from the Rate of Growth Conversion Table./3/ The rate of growth is based on a comparison of the total basis of the assets in a guideline class at the close of the taxable year for which the rate of growth is being determined (growth rate year) with the total basis of the assets in the class at the close of the taxable year ending one class life period earlier (base year). Under the Rate of Growth Conversion Table, taxpayers may find that they have the same rate of growth although their patterns of acquiring assets are quite different.

.03 The tabular form of the reserve ratio test may not be appropriate either for a new taxpayer or for an existing taxpayer who starts a new guideline class or for any taxpayer who has a guideline class that contains relatively few assets, most of which are retired at or about the same time.

SEC. 3. GUIDELINE FORM OF THE RESERVE RATIO TEST.

.01 A new method (herein called the `guideline form of the reserve ratio test', or simply `guideline form') of computing the reserve ratio upper limit is authorized as an optional alternative to the tabular form of the reserve ratio test. The guideline form may be used for all taxable years to which Revenue Procedure 62-21 is applicable. The guideline form will provide an appropriate reserve ratio upper limit in situations such as those mentioned in sections 2.02 and 2.03 above. It will provide each taxpayer with an individually tailored reserve ratio upper limit against which he can measure his actual reserve ratio to determine whether his retirement and replacement practices are consistent with the class lives he is using for tax depreciation purposes. A taxpayer may use the guideline form to determine the reserve ratio upper limit for a guideline class in one year and the tabular form for the same class in another year. Moreover, in the same taxable year a taxpayer may use the guideline form for one guideline class and use the tabular form for another guideline class.

.02 Under the guideline form, the taxpayer's actual reserve ratio for a guideline class is compared with a reserve ratio upper limit computed by dividing the total `cost of assets' acquired during the `extended life' for the guideline class into the total `computed reserve' for that class for the same period. See examples 1 and 2 in section 5 of this Part.

.03 For purposes of paragraph .02 of this section, the following definitions shall apply:

(a) The `cost of assets' for any year means the total cost or other basis to the taxpayer (at the time of acquisition) of all assets in the guideline class acquired during the year, regardless of present status. Thus, it includes assets even if they have been retired or depreciated in part or in full. For example, if $30,000 of assets were acquired in 1959 and by 1965 $5,000 of those assets have been sold or retired, the cost of assets for 1959 is nevertheless $30,000 for purpose of the guideline form.

For purposes of determining cost of assets-

(1) there shall not be included the portion of the basis of any asset subject to amortization under section 168 or 169 of the Internal Revenue Code of 1954 or recovered by the additional first-year depreciation allowance;

(2) there shall be included the reductions and increases in the basis of any asset required by the investment credit provisions of the Internal Revenue Code for the year such reductions and increases are required to be made;

(3) there shall be included charges to the capital account or to the depreciation reserve in respect of overhauls, etc. in the year such expenditures are properly charged; and

(4) if a taxpayer has in prior years included the cost or other basis of depreciable assets in accounts which are inconsistent with the guideline classes, any reasonable method of allocating such cost or other basis among the taxpayer's guideline classes will be acceptable, provided that the actual reserve for depreciation is consistently allocated.

(b) The `extended life,' for any guideline class, means the test life for that class plus 20 percent of such test life./4/ For example, if a taxpayer used the guideline form in 1965 for a guideline class with a 10-year test life, the extended life would be 12 years (10 years plus 20 percent of 10 years), and he would take into account the cost of assets back through 1954. Thus, the guideline form furnishes a 20 percent tolerance similar to that contained in the Reserve Ratio Table.

If the `extended life' includes a fractional part of a year, the fraction applies to the year preceding the earliest full year of the extended life and only the proportional part of the cost of assets for such year is to be taken into account for purposes of the guideline form. For example, in the case of a 14.4 year extended life, the fraction (40%) would apply to the 14th year preceding the year under examination. Thus, only 40 percent of the cost of assets (under each method of depreciation used) acquired during such 14th year is to be taken into account.

(c) The `computed reserve,' for any year is the product of the cost of assets for such year multiplied by the appropriate annual factor determined from Table A, Annual Factors, Appendix I, page 776, this Bulletin. Table A shows appropriate annual factors for commonly used test lives and depreciation methods (straight line, double declining balance, etc.)./5/

SEC. 4. DIFFERENT DEPRECIATION METHODS APPLIED TO A GUIDELINE CLASS.

.01 If a taxpayer uses or has used more than one method of depreciation with respect to different assets in the same guideline class, to obtain the computed reserve he must multiply the portion of the cost of assets for each year depreciated under each method of depreciation by the annual factor appropriate for that year and for that method of depreciation. Example 2 of section 5.03 of this Part illustrates one way of computing the reserve ratio upper limit under the guideline form where more than one method of depreciation is used for a guideline class.

.02 If a taxpayer has changed his method of depreciating an asset or assets, the combination of depreciation methods actually used for that asset is treated as a separate method of depreciation for purposes of applying the rule in section 4.01 above. (See example 2 of section 5.03 of this Part.)

Table A provides annual factors for use in cases where a taxpayer changes from the double declining balance method of computing depreciation with respect to an asset or assets to the straight line method, regardless of when the change is made. In the case of any other change of method of depreciating an asset or assets, such as from the sum of the years-digits method to the straight line method, the taxpayer may use any reasonable method in calculating his annual factors.

For example, assume that taxpayer A , who reports on a calendar year basis and uses the half-year convention, acquired $1,000 of assets in 1962; that the guideline life of the assets was 10 years; and that A for 1962 adopted a 10-year class life and the sum of the years-digits method of depreciation for such assets. Assume further that for 1965, A received the consent of the Commissioner to change his method of depreciating such assets to the straight line method. In determining the reserve ratio upper limit under the guideline form for the guideline class of such assets for 1965 (the year under examination), A may compute the annual factor for such assets as follows:

 (a) Annual factor from Table A for 10-year test life, sum

SEC. 5. EXAMPLES OF USE OF GUIDELINE FORM.

.01 The examples that follow illustrate the use of the guideline form of the reserve ratio test. The general format used in the examples to compute the reserve ratio upper limit may be used by taxpayers. However, taxpayers may also develop their own formats, provided that they are consistent with the rules set forth in this Procedure.

.02 Example 1 .-Taxpayer B

Taxable year under examination: 1965

Test life: 10 years

Extended life: 12 years

Depreciation Method: Straight line

                                                            Computed

.03 Example 2 .-Taxpayer C

Taxable year under examination: 1965

Test life: 6 years

Extended life: 7.2 years

Depreciation methods:

(1) Double declining balance-with a later switch to straight line: on assets that were acquired new in 1958 through 1961.

(2) Double declining balance: on assets that were acquired new in 1962 through 1965.

(3) Straight line: on assets that were acquired used in 1963.

      (1) Double Declining Balance -- Straight Line

      (2) Double Declining Balance

PART II. -- TRANSITIONAL RULES

SECTION 1. INTRODUCTION.

.01 Under Revenue Procedure 62-21, taxpayers who use appropriate class lives to calculate depreciation deductions are treated as meeting the reserve ratio test for the first three taxable years to which the provisions of that Procedure apply. However, the use of such lives for the fourth taxable year (1965 for most calendar year taxpayers) and subsequent years may be questioned by the Internal Revenue Service if a taxpayer fails to meet the reserve ratio test and if the taxpayer is not demonstrating a trend towards a retirement and replacement practice consistent with the class life used to calculate depreciation deductions. (See section 2 of this Part.) In such a case, under Revenue Procedure 62-21 if the taxpayer was unable to justify the class life under all the facts and circumstances, the class life would have been lengthened as provided in the Adjustment Table for Class Lives./6/

.02 In order to facilitate the transition to the guidelines and rules of Revenue Procedure 62-21, two additional rules are authorized: (1) the transitional allowance rule (see section 3 of this Part), and (2) the minimal adjustment rule (see section 4 of this Part). The use of these two new rules will be permitted beginning with the fourth taxable year (1965 for most calendar year taxpayers) to which Revenue Procedure 62-21 applies.

SEC. 2. TAXPAYERS MAY CONTINUE TO RELY ON THE PRESENT TRENDING RULE.

.01 Under Revenue Procedure 62-21, a trend towards a retirement and replacement practice consistent with the class life used is demonstrated if, in the taxable year under examination, the amount by which the taxpayer's actual reserve ratio exceeds the reserve ratio upper limit is lower than the excess for any one of the three immediately preceding years. This rule is herein called the `trending rule.'

.02 A taxpayer may continue to rely on the trending rule during the `trending period.' The `trending period' for any guideline class began with the first taxable year of the taxpayer for which a return was (without regard to extensions of time) due to be filed on or after July 12, 1962, the effective date of Revenue Procedure 62-21 (1962 for most calendar year taxpayers) and shall continue for a period equal to the guideline life of that class.

.03 For purposes of determining whether a taxpayer meets the trending rule for a guideline class for any taxable year within the trending period, the reserve ratio upper limit for such class for such year and for the three preceding taxable years must be calculated consistently by use of either the guideline form or the tabular form of the reserve ratio test.

.04 The example below illustrates the application of the trending rule.

Taxpayer D, who reprots on the calendar year basis, determines that the margins by which his actual reserve ratios for a guideline class exceed the reserve ratio upper limits are as follows:

                                          (In percentage points)

For 1966, the trending rule would be failed if the taxpayer looked to the guideline form, but is met since he may look to the tabular form. Using the tabular form for each of the years 1963 through 1966, the margin of failure in 1966 (9 percentage points) is lower than it was in one of the three preceding years (1965-10 percentage points).

For 1967, the trending rule is not met if the guideline form is used for that year and the three preceding years; nor is it met if the tabular form is used for each of those years. Accordingly, the trending rule is not met for 1967, notwithstanding that the margin of failure in 1967, using the guideline form is lower than the margin of failure for 1966 using the tabular form.

.05 Once the trending rule is failed (under both the guideline form and the tabular form in the same taxable year), it cannot be relied upon in any later year, even though, in the year of failure of the trending rule, the reserve ratio test is met with the assistance of the transitional allowance rule and no lengthening adjustment is made.

SEC. 3. TRANSITIONAL ALLOWANCE RULE.

.01 Under the transitional allowance rule, the reserve ratio test will be considered to be met during the `transitional period' if the taxpayer's actual reserve ratio for the taxable year under examination does not exceed the reserve ratio upper limit (either as determined from the Reserve Ratio Table if the tabular form is used, or as determined by computation if the guideline form is used) by more than the applicable transitional allowance for such year. The sum of the reserve ratio upper limit and the applicable transitional allowance is herein called the `transitional upper limit.'

Example: Taxpayer E files his returns on the calendar year basis. For 1965, the reserve ratio upper limit for one of his guideline classes is 60 percent. E's actual reserve ratio is 75 percent. The transitional allowance for 1965 is 15 percentage points. Thus, the transitional upper limit is 75 percent (60 percent plus 15 percent). For 1965, the reserve ratio test is considered to be met for this particular guideline class since E's actual reserve ratio does not exceed the transitional upper limit.

.02 The transitional allowance is applicable for each taxable year during the transitional period even if, in a prior year, the reserve ratio test was not met and a lengthening adjustment was made.

.03 For purposes of this Procedure, the `transitional period' for any guideline class shall begin with the fourth taxable year to which Revenue Procedure 62-21 applies/7/ (1965 for most calendar year taxpayers). The transitional period for any guideline class shall continue for a period equal to the guideline life of that class.

.04 The transitional allowance for the first year of the transitional period is 15 percentage points. The transitional allowance declines annually over the transitional period as follows:

(a) One-third of the allowance (5 percentage points) tapers off ratably over the first one-half of the transitional period.

(b) The remaining two-thirds of the transitional allowance (10 percentage points) tapers off ratably over the remaining one-half of the transitional period.

Table B, Transitional Allowances, page 809, this Bulletin, shows the transitional allowances for most guideline lives.

SEC. 4. MINIMAL ADJUSTMENT RULE-LIMITATIONS ON ADJUSTMENTS BY THE INTERNAL REVENUE SERVICE.

.01 Under Revenue Procedure 62-21, if the class life used by a taxpayer for the fourth or subsequent years to which that Procedure applies cannot be justified (by reference to the reserve ratio test, the trending rule or the facts and circumstances), the class life for such year would have been lengthened in accordance with Part II, section 6 of Revenue Procedure 62-21, generally by about 25 percent, as provided in the Adjustment Table for Class Lives. Under the minimal adjustment rule provided in this Procedure, class lives will not be lengthened by more than 10 percent in any taxable year.

.02 Under the minimal adjustment rule, if, for any taxable year during the transitional period, the class life used by the taxpayer for a guideline class cannot be justified, such class life may be lengthened as follows:

(a) If the actual reserve ratio exceeds the transitional upper limit (i.e., the reserve ratio upper limit (under the guideline form or the tabular form) plus the applicable transitional allowance) by 10 or more percentage points, such class life may be lengthened to the class life used for such guideline class for the immediately preceding taxable year increased by 10 percent of the shorter of (1) the guideline life for such guideline class or (2) the class life used for such guideline class for the taxpayer's first taxable year during the transitional period for which the taxpayer chose to be examined under Revenue Procedure 62-21./8/

(b) If the actual reserve ratio exceeds the transitional upper limit by less than 10 percentage points, such class life may be lengthened to the class life used for such guideline class for the immediately preceding taxable year increased by 5 percent of the shorter of (1) the guideline life for such guideline class or (2) the class life used for such guideline class for the taxpayer's first taxable year during the transitional period for which the taxpayer chose to be examined under Revenue Procedure 62-21./9/

However, a class life shall not be lengthened beyond the shortest life which can be justified for the guideline class under all the facts and circumstances.

.03 Under the minimal adjustment rule, no additional lengthening of class life will be made for the taxable year immediately subsequent to-

(a) a taxable year for which a lengthening adjustment has been made under section 4.02 of this Part, or

(b) a taxable year for which the taxpayer has voluntarily lengthened the class life to the life provided under section 4.02(b) of this Part (or to a longer life);

provided the taxpayer uses such lengthened class life or a longer class life in such immediately subsequent taxable year.

.04 The example below illustrates the general operation of the minimal adjustment rule.

Example: Taxpayer F reports on the calendar year basis with respect to a guideline class with a 10-year guideline life; he uses a 10-year class life, and makes the following calculations.

             A           B             C            D          E

 1966.........  49           14            63         72           9

 1968.........  51           12            63         73          10

For 1970, since the actual reserve ratio exceeds the transitional upper limit by less than 10 points, the class life for 1970 may be lengthened to 12 years (the class life for 1969 (11.5 years) plus 5 percent of the guideline life). Since an adjustment was made for 1970, none will be made for 1971, if 12 years or a longer life is used.

SEC. 5. SPECIAL RULE WHERE ADJUSTMENTS DURING THE TRANSITIONAL PERIOD EQUAL OR EXCEED 25 PERCENT.

.01 If, during the transitional period, the cumulative lengthening adjustments of the class life for a particular guideline class of a taxpayer equal or exceed 25 percent of the shorter of the guideline life for such guideline class or the class life used for such guideline class for the taxpayer's first taxable year during the transitional period for which the taxpayer chose to be examined under Revenue Procedure 62-21, the taxpayer may elect to terminate the applicability of the minimal adjustment rule with respect to such guideline class for any subsequent taxable year. If he so elects, he will not be subject to any further lengthening adjustment by the Revenue Service for such class until the fourth taxable year after the year for which such class life was last lengthened under section 4.02 of this Part and any subsequent lengthening adjustment will be based on all the facts and circumstances.

Example: Assume, under the facts presented in the example of section 4.04 of this Part, that F's actual reserve ratio for 1972 exceeded the transitional upper limit by 10 or more points, and that his class life was lengthened to 13 years (the class life for 1971 (12 years) plus 10 percent of the guideline life (10 years). After the adjustment for 1972, F's cumulative lengthening adjustments (3 years) would have equaled 30 percent of the guideline life and he could elect to terminate the minimal adjustment rule. If he so elected, no lengthening adjustment would be made for 1973, 1974, or 1975. In 1976, F's class life could be lengthened under all the facts and circumstances if his actual reserve ratio exceeded the reserve ratio upper limit for that year.

.02 If, for any taxable year during the balance of the transitional period, such taxpayer's actual reserve ratio equals or is less than the transitional upper limit, he may for that taxable year shorten his class life as provided in section 7 of this Part.

.03 The election described in section 5.01 of this Part must be made by the taxpayer on or before the date (including any extensions thereof) for filing the return for the first taxable year for which the election is effective. The election shall be made by filing a written statement with the District Director of Internal Revenue with whom the return for such taxable year is filed. The election shall be made effective for the taxable year for which it is filed and for all subsequent taxable years and shall be irrevocable once made.

SEC. 6. LENGTHENING ADJUSTMENTS AFTER THE TRANSITIONAL PERIOD.

.01 After the transitional period has terminated,/10/ if the class life used by a taxpayer for a guideline class for any year cannot be justified, it shall be lengthened in accordance with the rules of this section.

.02 If the actual reserve ratio exceeds the reserve ratio upper limit (under the guideline form or the tabular form) by 10 or more percentage points, the class life may be lengthened to the class life used for such guideline class for the immediately preceding taxable year increased by 10 percent of the guideline life for such guideline class.

.03 If the actual reserve ratio exceeds the reserve ratio upper limit (under the guideline form or the tabular form) by less than 10 percentage points, the class life may be lengthened to the class life used for such guideline class for the immediately preceding taxable year increased by 5 percent of the guideline life for such guideline class.

.04 In no event shall a class life be lengthened beyond the shortest life which can be justified for the guideline class under all the facts and circumstances.

.05 If the cumulative lengthening adjustments (for all years since the beginning of the transitional period) of the class life of such guideline class equal or exceed 25 percent of the guideline life for such guideline class, sections 6.02 and 6.03 of this Part shall not apply and the class life shall be lengthened on the basis of all the facts and circumstances.

.06 If the class life has been lengthened for a prior taxable year, no additional lengthening of the class life will be made:

(a) For the taxable year immediately subsequent to-

(1) a taxable year for which a lengthening adjustment has been made under section 4.02, section 6.02 or section 6.03 of this Part, or

(2) a taxable year for which the taxpayer has voluntarily lengthened the class life to the life provided under section 6.03 of this Part (or to a longer life); or

(b) Until the fourth taxable year subsequent to a taxable year for which a lengthening adjustment has been made-

(1) under section 6.05 of this Part, or

(2) after an election has been made under section 5.01 of this part; provided the taxpayer uses the class life, as last lengthened, for the taxable year under examination.

SEC. 7. RULES FOR SHORTENING THE CLASS LIFE.

.01 Where the class life used by a taxpayer for a guideline class for a taxable year during or after the transitional period is shorter than (a) the class life used by the taxpayer for the immediately preceding taxable year, or (b) the class life previously justified (see section 3.05 of Part II of Revenue Procedure 62-21), the rules of this section shall apply.

.02 If the shortened class life is equal to or longer than the guideline life for the class,/11/ the depreciation deduction for such class will not be disturbed if the actual reserve ratio for such class equals or is below the reserve ratio upper limit (or the transitional upper limit) under the guideline form or the tabular form.

.03 If the shortened class life is shorter than the guideline life for the guideline class, the depreciation deduction for such class will not be disturbed if factors (1), (2), and (3) of section 3.03(a) of Part II of Revenue Procedure 62-21 are present. For purposes of this section, if the taxpayer uses the guideline form, `the lower limit of the appropriate reserve ratio range' shall equal a reserve ratio upper limit computed under the guideline form using an extended life equal to 90 percent of the test life.

.04 If neither section 7.02 nor 7.03 of this Part applies and if the shortened class life cannot be justified on the basis of all the facts and circumstances, the class life shall be lengthened as provided in section 4, 5, or 6 of this Part, whichever is appropriate, except that, in determining the life to which the class life may be lengthened under sections 4.02, 6.02, or 6.03 of this Part, the `class life previously justified' shall be substituted for the `immediately preceding taxable year'.

SEC. 8. TEST LIFE.

For purposes of this Procedure, the test life for any guideline class shall be determined under section 2.02(b) of Part III of Revenue Procedure 62-21, except that, if the class life has been lengthened for a prior taxable year, the taxpayer may choose any one of the following as the test life:

(a) The life to which the class life was last lengthened;

(b) The life used for the taxable year immediately preceding the last taxable year for which a lengthening adjustment was made; or

(c) The average of the class lives used for the three taxable years preceding the taxable year under examination.

PART III. -- LIMITATIONS ON SOME DEPRECIATION CALCULATION TECHNIQUES

SECTION 1. INTRODUCTION.

.01 The Revenue Service has observed that certain depreciation calculation techniques, used in conjunction with the rules of Revenue Procedure 62-21, have resulted in exaggerated depreciation deductions. Therefore, limitations are imposed upon the use of Revenue Procedure 62-21 and this Procedure in the case of taxpayers using open-end, multiple asset accounts with either the straight line or the sum of the years-digits method.

.02 An `open-end, multiple asset account' is an account to which additions and from which retirements are made as they occur. The use of an open-end multiple asset account generally has been regarded as an acceptable accounting practice or technique. However, it is recognized that this practice does involve difficult problems. Most of the difficulty arises because the depreciation reserve must be kept under constant surveillance and the useful life of new additions to the account and timing of retirements must be studied continuously in order to keep annual depreciation deductions consistent with actual retirement and replacement practice.

.03 If either the straight line or the sum of the years-digits method is used to calculate depreciation, the amount of the depreciation deduction is a function of the total original cost of assets that are still in use and recorded in the asset account. Thus, if the cost of new assets is added to the account (as in the case of an open-end multiple asset account), and the assets already in the account are, on the average, kept in use beyond the class life, the calculation causes an exaggerated depreciation deduction unless the rate is adjusted regularly.

.04 Prior to Revenue Procedure 62-21, depreciation deductions of taxpayers who used open-end multiple asset accounts in combination with the straight line or sum of the years-digits method were adjusted by taxpayers or on audit by Revenue Agents to prevent exaggerated deductions. Under Revenue Procedure 62-21, however, a taxpayer may justify his depreciation deduction and preclude adjustment by meeting the reserve ratio test. The reserve ratio test is designed to permit a taxpayer to demonstrate objectively that the annual depreciation deduction is consistent with actual retirement and replacement practice. However, the reserve ratio test is treated as being met automatically for most taxpayers during the first three taxable years to which Revenue Procedure 62-21 applies. Furthermore, the reserve ratio test incorporates the transitional allowance, the minimal adjustment rules, and a 20-percent tolerance.

.05 The type of exaggeration of depreciation deductions described in section 1.03 of this Part cannot occur if year's acquisition or item accounts are used or if a declining balance method of depreciation is used. A `year's acquisition account' is an account in which is recorded only the cost or other basis of depreciable assets acquired in a particular year. An `item account' is an account in which is recorded the cost or other basis of only one item (asset). Where year's acquisition or item accounts are used and assets are not retired at the end of the life used to calculate depreciation, the cost of such equipment does not continue to enter into the depreciable base used to calculate current depreciation on assets acquired in other years. Under the declining balance method of depreciation, depreciation is computed on a base which is diminished each year by the amount of depreciation already deducted. Thus, the use of year's acquisition or item accounts or the declining balance method prevents this type of exaggeration of the current depreciation deduction.

SEC. 2. GENERAL RULE.

.01 If, in a taxable year, the cost or other basis of any asset in a guideline class acquired during or after the `first limitation year' has for tax purposes been recorded by a taxpayer in an open-end multiple asset account and the taxpayer's depreciation deduction for such account is calculated under either the straight line or the sum of the years-digits method, then the taxpayer's depreciation deduction for such guideline class for such taxable year shall be examined without regard to Revenue Procedure 62-21 or this Procedure.

.02 For purposes of this Procedure, the `first limitation year' is the taxpayer's first taxable year during the transitional period/12/ that ends after March 31, 1965, in the case of a corporation or ends after February 28, 1965, in the case of a taxpayer other than a corporation. Thus, in the case of most taxpayers, the first limitation year is the fourth taxable year to which Revenue Procedure 62-21 applies (1965 for most calendar year taxpayers).

.03 The limitation of section 2.01 of this Part shall have no application to any guideline class-

(a) if the cost or other basis of all assets (other than assets specified in subparagraph (b)) in such class acquired during or after the first limitation year has been recorded in year's acquisition accounts or item accounts (even if the straight line or sum of the years-digits method of depreciation is used for such assets); or

(b) if the depreciation deduction for the cost or other basis of all assets (other than assets specified in subparagraph (a)) in such class acquired during or after the first limitation year and recorded in open-end multiple asset accounts is calculated under a declining balance method;/13/ or

(c) merely because the cost or other basis of assets in such class acquired prior to the first limitation year is recorded in open-end multiple asset accounts and the depreciation deduction for such assets is calculated under the straight line or sum of the years-digits method for the taxable year under examination./14/ For example, a taxpayer may continue to use the straight line or sum of the years-digits method (or both) with respect to assets in a guideline class acquired prior to the first limitation year and a declining balance method with respect to later acquired assets in the same class.

.04 If in a taxable year a taxpayer computes his depreciation deduction for the cost or other basis of certain assets in a guideline class under one method (e.g., straight line) and his depreciation deduction for the cost or other basis of other assets under a second method (e.g., double declining balance), the taxpayer may not assign different useful lives to the assets depreciated under the first method than to those depreciated under the second method, unless the taxpayer is able to demonstrate, on the basis of all the facts and circumstances, that the lives assigned are reasonable.

SEC. 3. SPECIAL RULE FOR CERTAIN ACCOUNTS DEPRECIATED UNDER THE STRAIGHT LINE METHOD.

.01 Except as provided in section 3.02 of this Part, if the cost or other basis of any asset in a guideline class acquired during the taxable year immediately preceding the first limitation year/15/ has been recorded by the taxpayer in an open-end multiple asset account and the taxpayer's depreciation deduction for such account is calculated under the straight line method, then the taxpayer's depreciation deduction for such class for such taxable year/15/ shall be examined without regard to Revenue Procedure 62-21 or this Procedure.

Example: Taxpayer G , who reports on a calendar year basis, has recorded the cost of equipment purchased prior to 1954 in one multiple asset account for which depreciation is calculated under the straight line method. The cost of all assets purchased from 1954 through 1963 is recorded in one account for which depreciation is calculated under the declining balance method.

G purchased $1,000,000 of equipment in 1964. If he adds this cost to the previously established straight line account, his depreciation deduction for 1964 will be examined without regard to Revenue Procedure 62-21 or this Procedure (unless one of the exceptions in section 3.02 of this Part applies).

.02 The limitation of section 3.01 of this Part shall have no application to any guideline class-

(a) if the cost or other basis of all assets in such class acquired during the second taxable year preceding the first limitation year/16/ has been recorded in open-end multiple asset accounts and the depreciation deduction for such class for such taxable year was calculated under the straight line method.

Example: If, in the example in section 3.01 of this Part, taxpayer G had added the cost of all his 1963 acquisitions to the established straight line account, his depreciation deduction for 1964 could be examined under Revenue Procedure 62-21 and this Procedure.

(b) if the taxpayer (not covered by section 3.02(a) of this Part) planned to adopt the straight line method to depreciate assets in a guideline class acquired in the taxable year immediately preceding the first limitation year and to record the cost or other basis of those assets in open-end, multiple asset accounts, and he demonstrates to the Revenue Service that, prior to February 19, 1965, he had placed substantial reliance on the prior rules in his planning.

Example: If, in the example in section 3.01 of this Part, taxpayer G had, prior to February 19, 1965, made a public announcement of earnings based on a plan to add the cost of his 1964 acquisitions to the established straight line account and that statement would be significantly changed if the use of the plan were not permitted, G's depreciation deduction for 1964 could be examined under Revenue Procedure 62-21 and this Procedure.

(c) if the taxpayer's return for the taxable year immediately preceding the first limitation year was due before February 28, 1965 (without regard to extensions of time).

SEC. 4. SPECIAL RULE FOR RETROACTIVE ADDITIONS TO CERTAIN ACCOUNTS.

If-

(a) after February 19, 1965, the amount of the depreciation deduction claimed on a taxpayer's income tax return for a taxable year for which the return was due before February 19, 1965 (without regard to extensions of time) is changed (by means of a claim for refund or otherwise), and

(b) such change is based (in whole or in part) on transferring the cost or other basis of any asset in a guideline class from one account (regardless of type) to a multiple asset account (other than a year's acquisition account) which is depreciated under either the straight line or sum of the years-digits method,

then the depreciation deduction for such guideline class for such taxable year shall be examined without regard to Revenue Procedure 62-21 or this Procedure, and, if the taxable year for which such change is made is the second taxable year preceding the first limitation year, section 3.02(a) of this Part shall not apply to such guideline class.

SEC. 5. EFFECT ON OTHER DOCUMENTS.

Revenue Procedure 62-21, C.B. 1962-2, 418, supplemented.

                              APPENDIX I

/**/ Transitional allowances are stated in percentage points.

¹ Except as otherwise provided herein, the terms used in this Procedure shall have the same meaning as they have in Rev. Proc. 62-21.

² See Rev. Proc. 62-21, C.B. 1962-2, 418, starting at p. 446.

³ Table 1, Rev. Proc. 62-21, C.B. 1962-2, pp. 444 and 445.

⁴ See Part III, section 2.02(b) of Rev. Proc. 62-21 and section 8 of Part II of this Procedure for the determination of the test life.

⁵ Table A assumes the use of the half-year convention. If the taxpayer does not use the half-year convention, he may nevertheless use Table A unless it results in a substantial distortion of the reserve ratio test.

⁶ See table 3, Rev. Proc. 62-21, C.B. 1962-2, p. 459.

⁷ That is, the third taxable year after the first taxable year of the taxpayer for which a return was due to be filed on or after July 12, 1962 (without regard to extensions of time). A taxpayer which was not in existence on July 12, 1962, shall be treated as having come into existence on such date for purposes of determining the beginning of the transitional period.

⁸ If the year under examination is the first taxable year for which the taxpayer chose to be examined under Rev. Proc. 62-21, alternative (2) in the text is not applicable.

⁹ See footnote 8, above.

¹⁰ See section 3.03 of this Part.

¹¹ Or, for a taxable year during the transitional period, if the shortened class life is equal to or longer than the class life used for such guideline class for the taxpayer's first taxable year during the transitional period for which the taxpayer chose to be examined under Revenue Procedure 62-21 (see footnote 8, p. 768).

¹² See section 3.03 of Part II of this Procedure.

¹³ However, if the taxpayer changes (before or after the beginning of the first limitation year) the method of depreciating assets from a declining balance method to the straight line or sum of the years-digits method, subparagraph (b) does not apply.

¹⁴ See section 3 of this Part for an exception to this rule.

¹⁵ For most taxpayers, the taxable year immediately preceding the first limitation year is the third taxable year to which Rev. Proc. 62-21 applies; i.e., 1964 for most calendar year taxpayers.

¹⁶ For most taxpayers, the second taxable year preceding the first limitation year is the second taxable year to which Revenue Procedure 62-21 applies; i.e., 1963 for most calendar year taxpayers.