                         T.C. Memo. 2004-109



                       UNITED STATES TAX COURT



         BASIN ELECTRIC POWER COOPERATIVE, Petitioner v.
           COMMISSIONER OF INTERNAL REVENUE, Respondent



     Docket No. 14792-02.              Filed May 3, 2004.



     Sue Ann Nelson and Robert J. Stuart, for petitioner.

     Reid M. Huey, for respondent.



             MEMORANDUM FINDINGS OF FACT AND OPINION


     CHIECHI, Judge:    Respondent determined the following defi-

ciencies in petitioner’s Federal income tax (tax):
                               - 2 -

                    Taxable Year        Deficiency
                        1992             $123,999
                        1993              300,475
                        1995              306,346
                        1996           1,228,868

     The issues remaining for decision are:

     (1) Should the Court sustain respondent’s determination that

the expenditures at issue must be capitalized under section

263(a)?1   We hold that the Court should.

     (2) Should the Court sustain respondent’s determination that

the period over which the expenditures at issue must be amortized

and deducted is the term of certain identical modified sale and

leaseback agreements beginning with taxable year 1995 and ending

with taxable year 2020?   We hold that the Court should.

                          FINDINGS OF FACT

     Most of the facts have been stipulated and are so found.

     Petitioner had its principal office in Bismarck, North

Dakota, at the time it filed the petition in this case.

     During the years at issue, petitioner’s principal business

was the generation and transmission of electrical power to its

member rural electrical systems located in an eight-State region

of the upper Midwest.   During the late-1970s through the mid-

1980s, petitioner constructed new electrical power generating and



     1
      All section references are to the Internal Revenue Code in
effect for the years at issue. All Rule references are to the
Tax Court Rules of Practice and Procedure.
                               - 3 -

transmission facilities, including the facilities at Antelope

Valley Station (AVS facilities).

     The AVS facilities consisted of a two-unit electric generat-

ing station.   The first unit was placed in service in two phases

on January 1, 1982, and May 24, 1983.    The second unit (AVS unit

II) was placed in service on October 29, 1985.   The total cost of

constructing the AVS facilities was approximately $1.9 billion.

     The AVS facilities included pollution control facilities,

certain portions of which related solely to the AVS unit II (AVS

unit II pollution control facilities).   The construction of the

AVS unit II pollution control facilities was largely financed

through certain tax-exempt bonds issued by Mercer County, North

Dakota (Mercer County).   In order to effect that financing,

Mercer County executed a document, effective as of November 1,

1984, entitled “TRUST INDENTURE” (1984 bond indenture agreement).

Pursuant to the 1984 bond indenture agreement, Mercer County

issued the Pollution Control Revenue Bonds, 1984 Series (1984

tax-exempt bonds), in the aggregate amount of $112,750,000.    The

1984 tax-exempt bonds had an interest rate of 10.5 percent, were

payable semiannually on June 30 and December 30, and matured on

June 30, 2013.   Mercer County had the right to redeem the 1984

tax-exempt bonds prior to maturity but not before December 30,

1994.   If Mercer County were to redeem the 1984 tax-exempt bonds

between December 30, 1994, and December 29, 1995, the redemption
                               - 4 -

price was to include a 2 percent, or $2,255,000, premium over the

stated aggregate principal amount of such bonds.

     On December 5, 1984, Mercer County and petitioner entered

into an agreement entitled “LEASE AND SUBLEASE”, which was

effective as of November 1, 1984 (1984 lease and sublease).

Pursuant to the 1984 lease and sublease, petitioner agreed to

lease the AVS unit II pollution control facilities to Mercer

County, and Mercer County agreed to pay $112,750,000 to peti-

tioner as rent at the beginning of the term of that lease.

Pursuant to the 1984 lease and sublease, Mercer County agreed to

sublease the AVS unit II pollution control facilities to peti-

tioner, and petitioner agreed to pay to Mercer County as rent “an

amount [of money] sufficient to pay, when due, the principal of

and premium, if any, and interest on the [1984 tax-exempt] Bonds

in funds available at such times to make all payments when due on

the Bonds.”   (We shall refer to the amounts that petitioner was

obligated to pay to Mercer County under the 1984 lease and

sublease as the 1984 sublease rent.)   Petitioner agreed to, and

did, issue a promissory note (Basin Electric 1984 note) to

evidence its obligation to Mercer County to pay the 1984 sublease

rent.

     At the time petitioner and Mercer County entered into the

1984 lease and sublease, petitioner intended to transfer by sale

or otherwise its interest in the AVS unit II to one or more
                               - 5 -

transferees and to lease the AVS unit II back from such trans-

feree(s).   In this connection, the 1984 lease and sublease

allowed petitioner to sell, convey, assign, or otherwise transfer

to one or more transferees a percentage undivided interest in the

AVS unit II provided that, inter alia, any such transferee assume

a portion of petitioner’s obligation to pay the 1984 sublease

rent (i.e., to make payments when due of interest and principal

on the 1984 tax-exempt bonds) which was proportionate to the

percentage undivided interest in the AVS unit II that such

transferee acquired from petitioner.   Pursuant to the 1984 lease

and sublease, if petitioner were to transfer in the aggregate 100

percent of its interest in the AVS unit II, petitioner was to be

released from its obligations under the 1984 lease and sublease

and the Basin Electric 1984 note.

     Each of six unrelated entities (owner participants) wanted

to, and did, acquire from and lease back to petitioner a percent-

age undivided interest in the AVS unit II.   Those entities

acquired in the aggregate 100 percent of petitioner’s interest in

that unit, and petitioner was released from its obligations under

the 1984 lease and sublease.   In order to effect each acquisition

and leaseback, on December 3, 1985, each of the six unrelated

entities, inter alia, established a grantor trust (grantor

trust), which was materially identical to each of the other five
                               - 6 -

grantor trusts.2   The initial trustee (trustee) of each of the

six grantor trusts was The Connecticut Bank and Trust Company,

National Association (Connecticut Bank).   Thereafter, State

Street Bank & Trust Company succeeded Connecticut Bank as the

trustee of each of such grantor trusts.

     The trustee of each grantor trust entered into various

interrelated and interdependent agreements with petitioner, each

of which was dated as of November 1, 1985.   (We shall refer to

all the various interrelated and interdependent agreements that

petitioner and the trustee of each grantor trust entered into as

the 1985 sale and leaseback or the 1985 sale and leaseback

agreement.3)   Pursuant to all six of the 1985 sale and leaseback

     2
      The initial six owner participants and the respective
percentage undivided ownership interests in the AVS unit II that
they acquired from petitioner were:

          Owner Participant       Percentage Undivided Interest
First Chicago Leasing Corporation             4.3334
       Dart & Kraft Financial                36.8333
              Corporation
Beatrice Financial Services, Inc.            10.8333
     J.C. Penney Company, Inc.               30.6667
            Saks & Company                    9.0000
  Chrysler Financial Corporation              8.3333

     3
      Although the trustee of each of the grantor trusts was a
party to each 1985 sale and leaseback agreement, each owner
participant was the real party in interest to such agreement.
Unless otherwise indicated, we shall for convenience when dis-
cussing the 1985 sale and leaseback agreement(s) refer to the
owner participant(s) and not to the trustee.
                                                   (continued...)
                              - 7 -

agreements, petitioner sold to and leased back from the trustee

of the six grantor trusts in the aggregate petitioner’s entire

interest in AVS unit II, including the AVS unit II pollution

control facilities.

     The 1984 lease and sublease, the 1984 bond indenture agree-

ment, the 1984 tax-exempt bonds, and the 1985 sale and leaseback

agreements were agreements reflecting an integrated plan of

interrelated and interdependent transactions or steps.   Each of

those transactions or steps was necessary in order to effectuate

petitioner’s objective of transferring by sale or otherwise the

AVS unit II to one or more transferees and leasing that unit back

from such transferee(s).

     Under the 1985 sale and leaseback, part of the total consid-

eration that the owner participant provided to petitioner to

acquire a percentage undivided interest in the AVS unit II

consisted of the owner participant’s assumption of that portion

of petitioner’s obligation to pay the 1984 sublease rent (i.e.,

to make payments when due of interest and principal on the 1984

tax-exempt bonds) which was proportionate to the percentage

     3
      (...continued)

     Each 1985 sale and leaseback agreement that petitioner and
the owner participant entered into was materially identical to
each of the other five 1985 sale and leaseback agreements.
Unless otherwise indicated, we shall for convenience refer only
to the 1985 sale and leaseback or the 1985 sale and leaseback
agreement and the owner participant. However, any such refer-
ences pertain to all six sale and leaseback agreements and all
six owner participants.
                                 - 8 -

undivided interest in the AVS unit II that such owner participant

acquired from petitioner.    The owner participants assumed in the

aggregate 100 percent of petitioner’s obligation to Mercer County

to pay the 1984 sublease rent.    Each owner participant agreed to,

and did, issue a promissory note (series B secured note) to

evidence its obligation to pay that portion of the 1984 sublease

rent that it assumed when it acquired from petitioner its per-

centage undivided interest in the AVS unit II.    As a result,

pursuant to the 1984 lease and sublease, petitioner was dis-

charged from its obligation under the Basin Electric 1984 note,

and the owner participants became the obligors under the 1984

tax-exempt bonds.

       Under the 1985 sale and leaseback, the owner participant

leased to petitioner its percentage undivided interest in the AVS

unit II for a term that began on December 3, 1985, and that was

to end on December 30, 2015.    Petitioner had the right to extend

that lease term for each of two five-year terms.    The 1985 sale

and leaseback required petitioner to pay a variable amount of

money as rent (basic rent) semiannually on June 30 and December

30.4    With respect to that variable amount of basic rent, the

1985 sale and leaseback provided:


       4
      The amount of basic rent agreed to was a fixed amount set
forth in a schedule to the 1985 sale and leaseback plus or minus
an amount calculated by reference to certain specified interest
rates set forth in another schedule to the 1985 sale and
leaseback.
                               - 9 -

     Notwithstanding any other provision of [the 1985 sale
     and leaseback] * * * the amount of Basic Rent payable
     [by petitioner] on each Basic Rent Payment Date shall
     be at least equal to the aggregate amount of principal
     and interest payable on all Notes then Outstanding
     * * *.

(We shall refer to the minimum amount of basic rent payable by

petitioner under the above-quoted provision of the 1985 sale and

leaseback as the “minimum annual basic rent”.)   The “Notes”

referred to in the above-quoted provision of the 1985 sale and

leaseback included the series B secured note, which evidenced the

owner participant’s obligation to pay that portion of peti-

tioner’s obligation to pay the 1984 sublease rent (i.e., to make

payments when due of interest and principal on the 1984 tax-

exempt bonds) which was proportionate to the percentage undivided

interest that such owner participant acquired from petitioner.

     Under the 1985 sale and leaseback, the minimum annual basic

rent was to be adjusted if, inter alia, Mercer County refinanced

the 1984 tax-exempt bonds.   The 1985 sale and leaseback did not

contain a provision under which petitioner had the right to

request a refinancing of the 1984 tax-exempt bonds.    However,

each owner participant had the right under the 1984 bond inden-

ture to require Mercer County to redeem those bonds.

     It was petitioner’s practice to examine and consider ways to

reduce its operating expenses, including its lease expenses.      In

late 1991, petitioner focused on its rent obligations under the

1985 sale and leaseback, which were based in substantial part on
                              - 10 -

the interest rates extant in 1984 when Mercer County issued the

1984 tax-exempt bonds, and not on interest rates for tax-exempt

bonds issued in 1991.   Specifically, on or about December 12,

1991, petitioner initiated a study (refinancing study) regarding

the benefits that it would derive in the event of a modification

of the 1985 sale and leaseback which would require calculation of

the minimum annual basic rent payable by petitioner on the basis

of the annual debt service of newly issued tax-exempt bonds

bearing the interest rate for such bonds extant at that time.

     By January 1992, when petitioner’s board of directors met to

consider the results of the refinancing study, interest rates on

newly issued tax-exempt bonds had declined dramatically to

approximately 6.5 percent from the 10.5 percent rate extant in

1984 when Mercer County issued the 1984 tax-exempt bonds.

Petitioner determined from the refinancing study that if the 1985

sale and leaseback were modified to require petitioner to pay

minimum annual basic rent calculated by reference to tax-exempt

bonds issued in early 1992, its minimum annual basic rent obliga-

tion would be decreased by approximately $4.2 million.   Conse-

quently, petitioner concluded that it would attempt to effect a

modification of the 1985 sale and leaseback in order to achieve

such a substantial reduction in its minimum annual basic rent

obligation.

     There were three significant hurdles that petitioner faced
                               - 11 -

in achieving its objective of modifying the 1985 sale and

leaseback in order to reduce substantially its minimum annual

basic rent obligation.   First, pursuant to the terms of the 1984

tax-exempt bonds, such bonds were not redeemable before December

30, 1994.    Second, the 1985 sale and leaseback did not allow

petitioner to require Mercer County to redeem the 1984 tax-exempt

bonds.   Third, although each owner participant had the right

under the 1984 bond indenture to require Mercer County to redeem

those bonds, petitioner did not have the right under the 1985

sale and leaseback to request that the owner participant exercise

its right.

     Petitioner, in consultation with its lease advisor Morgan

Stanley, developed a strategy to overcome the foregoing hurdles.

That strategy included petitioner’s offering certain inducements

to each owner participant and Mercer County in order to persuade

them to agree to the modification of the 1985 sale and leaseback

and the concomitant refinancing of the 1984 tax-exempt bonds.

Thus, petitioner offered (1) to exercise its option under the

1985 sale and leaseback to elect to extend for five years the

term of the lease and (2) to pay the costs associated with

modifying the 1985 sale and leaseback and effecting the concomi-

tant refinancing of the 1984 tax-exempt bonds.

     Petitioner’s strategy to overcome the hurdles that it faced

in achieving its objective of modifying the 1985 sale and
                             - 12 -

leaseback was successful, and petitioner, the owner participants,

and Mercer County agreed to take the steps necessary to modify

and enhance5 the 1985 sale and leaseback, which included the

concomitant refinancing of the 1984 tax-exempt bonds, in order to

achieve a substantial rent reduction for petitioner.   Specifi-

cally, they agreed to certain modifications (1992 amendments) to

the 1985 sale and leaseback and to the concomitant transactions

necessary to achieve that objective.

     On or about December 28, 1992, petitioner and each owner

participant6 modified, effective as of October 1, 1992, the

various agreements that comprised the 1985 sale and leaseback.

(We shall refer to the 1985 sale and leaseback as modified by the

1992 amendments as the modified 1985 sale and leaseback or the




     5
      Our use of the word “enhance” with respect to the 1985 sale
and leaseback agreements means that the modifications to such
agreements (discussed below) resulted in petitioner’s having a
minimum annual basic rent obligation under such agreements as
modified that was significantly more favorable to petitioner than
its minimum annual basic rent obligation under the 1985 sale and
leaseback agreements.
     6
      On Dec. 28, 1992, First Chicago Leasing Corporation, GELCO
Corporation, Arbella Leasing Corporation, J.C. Penney Company,
Inc., Batus Retail Services, Inc., and Chrysler Financial Corpo-
ration were the entities that owned respectively the grantor
trusts which held the respective percentage undivided interests
in the AVS unit II on behalf of such entities. We shall for
convenience continue to use the terms “owner participant” or
“owner participants” when referring to one or more of those
entities.
                             - 13 -

modified 1985 sale and leaseback agreement.7)   Under the modified

1985 sale and leaseback, petitioner agreed to, and did:

(1) Exercise its right under the 1985 sale and leaseback to elect

a five-year extension of the term of the lease8 and (2) pay the

reasonable costs incurred by the owner participant and Mercer

County in refinancing the 1984 tax-exempt bonds.   With respect to

petitioner’s agreement to pay such reasonable costs, the modified

1985 sale and leaseback provided in pertinent part:

     Any Bond Premium and accrued interest in respect of a
     redemption permitted by * * * [the modified 1985 sale
     and leaseback] shall be paid * * * by the Lessee [peti-
     tioner] * * *. The Lessee shall pay, or shall reim-
     burse the Owner Participant, the Owner Trustee, the
     County, the Bank, the Funding Corp and the Indenture
     Trustee * * * for all out-of-pocket costs and expenses
     paid to unrelated third parties at arm’s length (in-
     cluding counsel fees, investment banking fees, fees of
     financial advisors, underwriting fees, * * *) incurred
     by any of such parties in connection with any refunding
     or attempted refunding permitted by or requested pursu-
     ant to * * * [the modified 1985 sale and leaseback].
     * * * the Lessee shall [also] pay to the Owner Partici-
     pant, as additional Supplemental Rent, a tax gross-up
     payment * * *.

In addition, pursuant to all six modified 1985 sale and leaseback



     7
      The 1992 amendments to each 1985 sale and leaseback were
materially identical. Unless otherwise indicated, we shall for
convenience refer to the 1992 amendments and the modified 1985
sale and leaseback. However, any such references pertain to the
1992 amendments to all six 1985 sale and leaseback agreements and
all six modified 1985 sale and leaseback agreements.
     8
      Petitioner and the owner participant agreed in the modified
1985 sale and leaseback that petitioner was to pay to the owner
participant semiannual rent of at least $390,006 during the five-
year extension of the term of the 1985 sale and leaseback.
                             - 14 -

agreements, petitioner agreed to, and did, share with all the

owner participants 20 percent in the aggregate of the annual

interest savings attributable to the refinancing of the 1984 tax-

exempt bonds after petitioner recouped, through a reduction in

its minimum annual basic rent obligation, its payment of the

costs associated with modifying the 1985 sale and leaseback and

effecting the concomitant refinancing of the 1984 tax-exempt

bonds.9

     The 1992 amendments to the 1985 sale and leaseback agree-

ments and the concomitant refinancing of the 1984 tax-exempt

bonds, which was achieved through the redemption of those bonds

and the issuance of new tax-exempt bonds, were interrelated and

interdependent transactions or steps in an integrated plan to


     9
      Pursuant to all the modified 1985 sale and leaseback agree-
ments, petitioner’s minimum annual basic rent was reduced by an
amount equal to (1) 100 percent of the annual interest savings
attributable to refinancing the 1984 tax-exempt bonds until
petitioner recouped its payment of the costs (plus 8.34 percent
interest) associated with modifying the 1985 sale and leaseback
agreements and effecting the concomitant refinancing of the 1984
tax-exempt bonds and (2) 80 percent of such amount thereafter.
In effect, petitioner recouped in 1995 and 1996, through a
reduction in its minimum annual basic rent obligation equal to
100 percent of the annual interest savings attributable to
refinancing the 1984 tax-exempt bonds, its payment of any reason-
able costs incurred by the owner participants and Mercer County
in effecting such refinancing. Thereafter, pursuant to all the
modified 1985 sale and leaseback agreements, petitioner agreed
to, and did, pay to all the owner participants as part of its
minimum annual basic rent, inter alia, 20 percent in the aggre-
gate of such annual interest savings. In addition, the minimum
annual basic rent was decreased by a portion of the so-called
“tax gross-up” payments (discussed below) plus 8.34 percent
interest.
                              - 15 -

achieve petitioner’s objective of modifying the 1985 sale and

leaseback agreements in order to reduce substantially peti-

tioner’s minimum annual basic rent obligation to the owner

participants.   That integrated plan required execution of not

only the 1992 amendments but also other interrelated and interde-

pendent agreements as discussed below.

     The 1992 amendments detailed the refinancing of the 1984

tax-exempt bonds, which was to be accomplished through the

issuance of new tax-exempt bonds (1995 tax-exempt bonds) by

Mercer County in January 1995, in pertinent part as follows:

     Anticipated Refunding of Initial Series B Secured Note
     with Proceeds of Refunding Series B Secured Note.

     Lessee [Basin Electric] Election to Initiate Refunding
     of Initial Series B Secured Note. In accordance with
     Subsection 4(c)(i) of the Participation Agreement [of
     the modified 1985 sale and leaseback], the Lessee has
     elected to request a refunding of the Initial Series B
     Secured Note [evidencing the owner participant’s obli-
     gation to make payments of interest and principal on
     the 1984 tax-exempt bonds] with the proceeds of an
     Additional Note issued pursuant to Section 3.5 of the
     [Trust] Indenture. Such Refunding Series B Note will
     be purchased by the County [Mercer County] with the
     proceeds of the sale of its Mercer County, North Da-
     kota, Pollution Control Refunding Revenue Bonds, Series
     1995 (the Refunding Bonds) [i.e., the 1995 tax-exempt
     bonds]. The Refunding Bonds will be sold pursuant to a
     Forward Purchase Contract (the Refunding Bond Purchase
     Agreement) between the County and Morgan Stanley & Co.
     Incorporated (the date of execution of such Refunding
     Bond Purchase Agreement hereinafter called the Refund-
     ing Bond Sale Date) providing for the future delivery
     of Refunding Bonds on a date (the Refunding Bond Deliv-
     ery Date) shortly after the first optional call date
     [December 30, 1994] for the [1984 tax-exempt] Bonds.
     * * * On the Refunding Bond Delivery Date, (i) the
                             - 16 -

     County will issue the Refunding Bonds and purchase the
     Refunding Series B Secured Note from the Owner Trustee
     with the proceeds of the Refunding Bonds, (ii) the
     Owner Trustee will prepay the Initial Series B Secured
     Note with the proceeds of the sale of the Refunding
     Series B Secured Note and Supplemental Rent paid by the
     Lessee, (iii) the County will use the funds received
     from the Owner Trustee in respect of the prepayment of
     the Initial Series B Secured Notes to redeem the Bonds
     * * *.

     The modified 1985 sale and leaseback detailed the calcula-

tion of petitioner’s annual basic rent obligation in pertinent

part as follows:

     (3) the amount of Basic Rent payable on each Basic
     Rent Payment Date following such refinancing [of the
     1984 tax-exempt bonds] shall be reduced by the amount
     of Bond Premium, Owner Participant’s Refunding Transac-
     tion Expenses and Lessee’s [petitioner’s] Refunding
     Transaction Expenses paid by the Lessee in connection
     with such refinancing and not previously taken into
     account in any adjustment to Basic Rent plus interest
     at the Weighted Average Cost of Capital [8.34 percent],
     compounded semi-annually, on any such amounts paid by
     the Lessee from the date of payment by the Lessee to
     the date of recovery through a reduction in Basic Rent
     pursuant to this Clause 3;

     (4) after the Lessee has recovered the amounts de-
     scribed in paragraph (3) above, the amount of Basic
     Rent payable on any Basic Rent Payment Date following
     such refinancing shall be reduced by an amount equal to
     80% of the difference between the interest that would
     have been payable on such Basic Rent Payment Date with
     respect to the prepaid Series B Secured Note and the
     interest payable on such Basic Rent Payment Date with
     respect to the Series B Refunding Note;

     As described in the foregoing excerpt from the modified 1985

sale and leaseback, the 1992 amendments did not effect a reduc-

tion in petitioner’s minimum annual basic rent obligation until

the redemption of the 1984 tax-exempt bonds and the issuance of
                                 - 17 -

the new tax-exempt bonds (i.e., the 1995 tax-exempt bonds), which

occurred on January 1, 1995.10

        Pursuant to the modified 1985 sale and leaseback, in 1992

petitioner paid $423,736 to Morgan Stanley for lease advisory

fees associated with modifying the 1985 sale and leaseback and

$397,339.79 to Mudge, Rose, Guthrie, Alexander & Ferdon (Mudge,

Rose) for legal services associated with modifying the 1985 sale

and leaseback and as bond counsel for Mercer County in the

concomitant refinancing of the 1984 tax-exempt bonds.

        The modified 1985 sale and leaseback granted petitioner the

right to request the owner participants to take reasonable

actions to refinance the 1984 tax-exempt bonds.     That modified

sale and leaseback required the owner participants to cooperate

in order to ensure that such refinancing was implemented.11


     10
      The modified 1985 sale and leaseback changed the defini-
tion of “Notes” in the 1985 sale and leaseback to include the
series B refunding note. The series B refunding note evidenced
the owner participant’s obligation to make payments on the 1995
tax-exempt bonds and served a function in the modified 1985 sale
and leaseback similar to the function served by the series B
secured note in the 1985 sale and leaseback. The series B
refunding note was substituted in the modified 1985 sale and
leaseback for the series B secured note in determining the
minimum annual basic rent due from petitioner under the modified
1985 sale and leaseback after the 1984 tax-exempt bonds were
refinanced on Jan. 1, 1995.
     11
          The modified 1985 sale and leaseback provided in pertinent
part:

     The Lessee [petitioner] shall have the right, at its
     option and upon prior written notice to the Owner
                                                   (continued...)
                                - 18 -

     The 1992 amendments expressly stated that petitioner exer-

cised its right to request that the owner participants take

reasonable actions to refinance the 1984 tax-exempt bonds.    Each

owner participant exercised its right under the 1984 bond inden-

ture agreement to require Mercer County to redeem the 1984 tax-

exempt bonds.

     Pursuant to the plan detailed in the 1992 amendments, Mercer

County executed a document entitled “TRUST INDENTURE” (1995 bond

indenture agreement), effective as of October 1, 1992, which

provided that in order to refinance the 1984 tax-exempt bonds

Mercer County was to issue new tax-exempt bonds (i.e., the 1995

tax-exempt bonds) pursuant to the terms of that indenture agree-

ment.     Pursuant to that plan, on January 20, 1993, Mercer County

entered into a forward purchase contract (forward purchase

contract) with Morgan Stanley, pursuant to which Morgan Stanley


     11
      (...continued)
     Participant, to request the Owner Trustee to, and upon
     any such request and instruction from the Owner Partic-
     ipant, the Owner Trustee shall, [sic] take such actions
     as are reasonably requested by the Lessee for a refund-
     ing [of the 1984 tax-exempt bonds]* * *.* * * The
     Lessee will provide the written notice contemplated by
     the first sentence of this Subsection 4(c)(i), along
     with a description of any documents, agreements and
     supplements or amendments to Transaction Documents
     contemplated by the preceding sentence, not less than
     90 days prior to any proposed date for a refunding.
     The Owner Participant agrees that during such 90 day
     period it will cooperate in connection with the negoti-
     ation in good faith of such documents, agreements and
     supplements as are necessary to implement such refund-
     ing. * * *
                              - 19 -

agreed to offer the 1995 tax-exempt bonds for sale to the public.

     Pursuant to the modified 1985 sale and leaseback agreements,

in 1993 petitioner paid $984,551.50 to Morgan Stanley for under-

writing fees and $113,510.22 to Mudge, Rose for legal services

associated with the forward purchase contract and $891,572 in the

aggregate to the owner participants for so-called tax gross-up

payments required by those agreements.

     On January 1, 1995, the refinancing of the 1984 tax-exempt

bonds was effected by the simultaneous redemption of the 1984

tax-exempt bonds and issuance of the 1995 tax-exempt bonds.    The

1995 tax-exempt bonds had an interest rate of 7.2 percent, were

payable semiannually on June 30 and December 30, and matured on

June 30, 2013.   Because of the 7.2-percent interest rate on the

1995 tax-exempt bonds, the annual interest payment on those bonds

was $3,720,750 less than the annual interest payment that would

have been due on the 1984 tax-exempt bonds.

     During each of the years 1995 and 1996, petitioner’s aggre-

gate minimum annual basic rent obligation under the modified 1985

sale and leaseback agreements was reduced by 100 percent of the

interest savings attributable to the refinancing of the 1984 tax-

exempt bonds, i.e., by $3,720,750.     After 1996 and until June 30,

2013, when the 1995 tax-exempt bonds were to mature, petitioner’s

aggregate minimum annual basic rent obligation under the modified

1985 sale and leaseback agreements was reduced by, inter alia, 80
                              - 20 -

percent of the interest savings attributable to such refinancing,

i.e., by $2,976,600.12

     Pursuant to the modified 1985 sale and leaseback agreements,

in 1995 petitioner paid $54,672.28 to Mudge, Rose for services

rendered as bond counsel and other legal services associated with

the refinancing of the 1984 tax-exempt bonds, $40,218.22 to

Sherman & Sterling for legal services associated with the refi-

nancing of such bonds, $3,499 to Bingham, Dana & Gould for legal

services associated with representing the trustee during the

refinancing of such bonds, $2,255,000 to First National Bank of

Chicago for the redemption premium due on the redemption of such

bonds, $14,595.88 to Morgan Stanley for services associated with

the issuance of the 1995 tax-exempt bonds, and $17,896.08 to

Arthur Andersen for a comfort letter associated with the issuance

of such bonds.

     Petitioner paid the expenditures described above in order to

modify and enhance the 1985 sale and leaseback agreements so that

petitioner’s aggregate minimum annual basic rent obligation under

those modified agreements would be substantially less than its

minimum annual basic rent obligation under the 1985 sale and

leaseback agreements.

     In Forms 1120, U.S. Corporation Income Tax Return, for the

taxable years indicated, petitioner deducted the following


     12
          See supra note 9.
                             - 21 -

amounts with respect to its payment in 1992, 1993, and 1995 of

the expenditures described above (expenditures at issue) relating

to the 1992 amendments to the 1985 sale and leaseback agreements

and the concomitant refinancing of the 1984 tax-exempt bonds:

         Taxable Year                         Amount
             1992                           $821,075.79
             1993                         1,989,633.72
                                         1
             1995                          2,228,381.46

     1
       The amount deducted for 1995 is the amount of petitioner’s
expenditures during that year relating to the 1992 amendments to
the 1985 sale and leaseback agreements and the concomitant
refinancing of the 1984 tax-exempt bonds reduced by $157,500,
which represented petitioner’s accrual of certain costs for 1994,
a taxable year not at issue. The record does not explain the
nature of such costs or why such a reduction of petitioner’s 1995
expenditures was made, but the parties agree that the expendi-
tures at issue for 1995 total $2,228,381.46.

     Respondent issued a notice of deficiency (notice) to peti-

tioner for its taxable years 1992, 1993, 1995, and 1996.    In that

notice, respondent determined that the expenditures at issue must

be capitalized and amortized and deducted over the term of the

modified 1985 sale and leaseback beginning with taxable year 1995

and ending with taxable year 2020.    Consequently, respondent

further determined in the notice that petitioner is entitled to a

deduction of $199,869 for each of its taxable years 1995 and

1996.

                             OPINION

     Petitioner bears the burden of proving that the determina-

tions in the notice that remain at issue are erroneous.    See Rule
                              - 22 -

142(a); INDOPCO, Inc. v. Commissioner, 503 U.S. 79, 84 (1992);

Welch v. Helvering, 290 U.S. 111, 115 (1933).     Deductions are

strictly a matter of legislative grace, and petitioner bears the

burden of proving that it is entitled to any deductions claimed.

INDOPCO, Inc. v. Commissioner, supra.

     Section 162(a) generally allows a deduction for ordinary and

necessary expenses paid or incurred during the taxable year in

carrying on any trade or business.     In general, an expense is

ordinary if it is considered normal, usual, or customary in the

context of the particular business out of which it arose.     Deputy

v. du Pont, 308 U.S. 488, 495 (1940).     Ordinarily, an expense is

necessary if it is appropriate and helpful to the operation of

the taxpayer's trade or business.    Commissioner v. Tellier, 383

U.S. 687, 689 (1966); Carbine v. Commissioner, 83 T.C. 356, 363

(1984), affd. 777 F.2d 662 (11th Cir. 1985).

     Section 263(a) provides that “No deduction shall be allowed

for--(1) Any amount paid out for new buildings or for permanent

improvements or betterments made to increase the value of any

property or estate.”   Section 263(a) denies a deduction under

section 162(a) when the amount paid or incurred:     (1) Creates or

enhances a separate and distinct asset, see Commissioner v.

Lincoln Sav. & Loan Association, 403 U.S. 345, 354 (1971); Wells

Fargo & Co. and Subs. v. Commissioner, 224 F.3d 874, 882 (8th

Cir. 2000), affg. in part and revg. in part 112 T.C. 89 (1999);
                              - 23 -

(2) produces a significant benefit beyond the current taxable

year (significant future benefits), see INDOPCO, Inc. v. Commis-

sioner, supra at 87-89; Wells Fargo & Co. and Subs. v. Commis-

sioner, supra at 887; or (3) is in connection with the acquisi-

tion of a capital asset, Commissioner v. Idaho Power Co., 418

U.S. 1, 13 (1974).

     It is petitioner’s position that the expenditures at issue

should be deducted under section 162(a) and not capitalized under

section 263(a).   In support of that position, petitioner argues

that it paid the expenditures at issue in order to reduce its

future operating costs, viz., the future minimum annual basic

rent that the 1985 sale and leaseback required petitioner to pay

to the owner participants for the use of the AVS unit II, and

that, under Metrocorp, Inc. v. Commissioner, 116 T.C. 211 (2001),

and T.J. Enters., Inc. v. Commissioner, 101 T.C. 581 (1993), such

expenditures are deductible under section 162(a).

     It is respondent’s position that the expenditures at issue

should be capitalized under section 263(a) and not deducted under

section 162(a).   In support of that position, respondent argues

that petitioner paid the expenditures at issue in order to modify

and enhance a capital asset, viz., the 1985 sale and leaseback,

and that, under U.S. Bancorp & Consol. Subs. v. Commissioner, 111

T.C. 231 (1998), such expenditures must be capitalized.

     The “decisive distinctions” between current expenses and
                                - 24 -

capital expenditures “‘are those of degree and not of kind’”,

INDOPCO, Inc. v. Commissioner, supra at 86 (quoting Welch v.

Helvering, supra at 114), with each individual case “‘[turning]

on its special facts.’”     Id. (quoting Deputy v. du Pont, supra at

496).     In the instant case, the material facts on which we must

determine whether the expenditures at issue should be capitalized

are not in dispute.     Under the 1985 sale and leaseback,13 the

amount of basic rent due from petitioner was dependent upon,

inter alia, the amount of interest payable on the 1984 tax-exempt

bonds.14    The annual interest rate on the 1984 tax-exempt bonds

was 10.5 percent, and the annual amount of interest payable on

such bonds was $11,838,750.     Thus, the 1985 sale and leaseback

agreements required petitioner to pay in the aggregate at least

$11,838,750 per year in basic rent to the owner participants.

     On or about December 12, 1991, petitioner initiated a

refinancing study regarding the benefits that it would derive in

the event of a modification of the 1985 sale and leaseback which



     13
      We have found that the 1984 lease and sublease, the 1984
bond indenture agreement, the 1984 tax-exempt bonds, and the 1985
sale and leaseback were agreements reflecting an integrated plan
of interrelated and interdependent transactions or steps. Each
of those transactions or steps was necessary in order to effectu-
ate petitioner’s objective of transferring by sale or otherwise
the AVS unit II to one or more transferees and leasing that unit
back from such transferee(s).
     14
      The minimum annual basic rent payable by petitioner was
equal to the principal and interest payable on the 1984 tax-
exempt bonds.
                              - 25 -

would require calculation of the minimum annual basic rent

payable by petitioner on the basis of the annual debt service of

newly issued tax-exempt bonds bearing the interest rate for such

bonds extant at that time.   By January 1992, interest rates on

newly issued tax-exempt bonds had declined dramatically to

approximately 6.5 percent from the 10.5 percent rate extant in

1984 when Mercer County issued the 1984 tax-exempt bonds.

Petitioner determined from the refinancing study that if the 1985

sale and leaseback were modified to require petitioner to pay

minimum annual basic rent calculated by reference to tax-exempt

bonds issued in early 1992, its minimum annual basic rent obliga-

tion would be decreased by approximately $4.2 million.   Conse-

quently, petitioner concluded that it would attempt to effect a

modification of the 1985 sale and leaseback in order to achieve

such a substantial reduction in its minimum annual basic rent

obligation.

     There were three significant hurdles that petitioner faced

in achieving its objective of modifying the 1985 sale and

leaseback in order to reduce substantially its minimum annual

basic rent obligation.   First, pursuant to the terms of the 1984

tax-exempt bonds, such bonds were not redeemable before December

30, 1994.   Second, the 1985 sale and leaseback did not allow

petitioner to require Mercer County to redeem the 1984 tax-exempt

bonds.   Third, although each owner participant had the right
                              - 26 -

under the 1984 bond indenture to require Mercer County to redeem

those bonds, petitioner did not have the right under the 1985

sale and leaseback to request that the owner participant exercise

its right.

     Petitioner developed a strategy to overcome the foregoing

hurdles.   That strategy included petitioner’s offering certain

inducements to each owner participant and Mercer County in order

to persuade them to agree to the modification of the 1985 sale

and leaseback and the concomitant refinancing of the 1984 tax-

exempt bonds.   Thus, petitioner offered (1) to exercise its

option under the 1985 sale and leaseback to elect to extend for

five years the term of the lease and (2) to pay the costs associ-

ated with modifying the 1985 sale and leaseback and effecting the

concomitant refinancing of the 1984 tax-exempt bonds.

     Petitioner’s strategy to overcome the hurdles that it faced

in achieving its objective of modifying the 1985 sale and

leaseback was successful, and petitioner, the owner participants,

and Mercer County agreed to take the steps necessary to modify

and enhance the 1985 sale and leaseback, which included the

concomitant refinancing of the 1984 tax-exempt bonds, in order to

achieve a substantial rent reduction for petitioner.    Specifi-

cally, they agreed to the 1992 amendments to the 1985 sale and

leaseback agreements and to the concomitant transactions neces-

sary to achieve that objective.
                                - 27 -

     On or about December 28, 1992, petitioner and each owner

participant modified, effective as of October 1, 1992, the

various agreements that comprised the 1985 sale and leaseback.

Under the modified 1985 sale and leaseback, petitioner agreed to,

and did:     (1) Exercise its option under the 1985 sale and

leaseback to elect a five-year extension of the term of the

lease15 and (2) pay the expenditures at issue.    With respect to

petitioner’s agreement to pay the expenditures at issue, the

modified 1985 sale and leaseback provided in pertinent part:

     Any Bond Premium and accrued interest in respect of a
     redemption permitted by * * * [the modified 1985 sale
     and leaseback] shall be paid * * * by the Lessee [peti-
     tioner] * * *. The Lessee shall pay, or shall reim-
     burse the Owner Participant, the Owner Trustee, the
     County, the Bank, the Funding Corp and the Indenture
     Trustee * * * for all out-of-pocket costs and expenses
     paid to unrelated third parties at arm’s length (in-
     cluding counsel fees, investment banking fees, fees of
     financial advisors, underwriting fees, * * *) incurred
     by any of such parties in connection with any refunding
     or attempted refunding permitted by or requested pursu-
     ant to * * * [the modified 1985 sale and leaseback].
     * * * the Lessee shall [also] pay to the Owner Partici-
     pant, as additional Supplemental Rent, a tax gross-up
     payment * * *.

In addition, pursuant to all six modified sale and leaseback

agreements, petitioner agreed to, and did, share with all the

owner participants 20 percent in the aggregate of the annual

interest savings attributable to the refinancing of the 1984 tax-

exempt bonds after petitioner recouped the expenditures at issue



     15
          See supra note 8.
                                  - 28 -

through a reduction in its minimum annual basic rent obliga-

tion.16

     We have found that the 1992 amendments to the 1985 sale and

leaseback agreements and the concomitant refinancing of the 1984

tax-exempt bonds, which was achieved through the redemption of

those bonds and the issuance of the 1995 tax-exempt bonds, were

interrelated and interdependent transactions or steps in an

integrated plan to achieve petitioner’s objective of modifying

the 1985 sale and leaseback agreements in order to reduce sub-

stantially petitioner’s minimum annual basic rent obligation to

the owner participants.       That integrated plan required execution

of not only the 1992 amendments but also other interrelated and

interdependent agreements, including the 1995 bond indenture

agreement and the forward purchase contract.

     The 1992 amendments detailed the refinancing of the 1984

tax-exempt bonds, which was to be accomplished through the

issuance of the 1995 tax-exempt bonds by Mercer County in January

1995, in pertinent part as follows:

     Anticipated Refunding of Initial Series B Secured Note
     with Proceeds of Refunding Series B Secured Note.

     Lessee [Basin Electric] Election to Initiate Refunding
     of Initial Series B Secured Note. In accordance with
     Subsection 4(c)(i) of the Participation Agreement [of
     the modified 1985 sale and leaseback], the Lessee has
     elected to request a refunding of the Initial Series B
     Secured Note [evidencing the owner participant’s obli-

     16
          See supra note 9.
                             - 29 -

     gation to make payments of interest and principal on
     the 1984 tax-exempt bonds] with the proceeds of an
     Additional Note issued pursuant to Section 3.5 of the
     [Trust] Indenture. Such Refunding Series B Note will
     be purchased by the County [Mercer County] with the
     proceeds of the sale of its Mercer County, North Da-
     kota, Pollution Control Refunding Revenue Bonds, Series
     1995 (the Refunding Bonds) [i.e., the 1995 tax-exempt
     bonds]. The Refunding Bonds will be sold pursuant to a
     Forward Purchase Contract (the Refunding Bond Purchase
     Agreement) between the County and Morgan Stanley & Co.
     Incorporated (the date of execution of such Refunding
     Bond Purchase Agreement hereinafter called the Refund-
     ing Bond Sale Date) providing for the future delivery
     of Refunding Bonds on a date (the Refunding Bond Deliv-
     ery Date) shortly after the first optional call date
     [December 30, 1994] for the [1984 tax-exempt] Bonds.
     * * * On the Refunding Bond Delivery Date, (i) the
     County will issue the Refunding Bonds and purchase the
     Refunding Series B Secured Note from the Owner Trustee
     with the proceeds of the Refunding Bonds, (ii) the
     Owner Trustee will prepay the Initial Series B Secured
     Note with the proceeds of the sale of the Refunding
     Series B Secured Note and Supplemental Rent paid by the
     Lessee, (iii) the County will use the funds received
     from the Owner Trustee in respect of the prepayment of
     the Initial Series B Secured Notes to redeem the Bonds
     * * *.

     The modified 1985 sale and leaseback detailed the calcula-

tion of petitioner’s annual basic rent obligation in pertinent

part as follows:

     (3) the amount of Basic Rent payable on each Basic
     Rent Payment Date following such refinancing [of the
     1984 tax-exempt bonds] shall be reduced by the amount
     of Bond Premium, Owner Participant’s Refunding Transac-
     tion Expenses and Lessee’s [petitioner’s] Refunding
     Transaction Expenses paid by the Lessee in connection
     with such refinancing and not previously taken into
     account in any adjustment to Basic Rent plus interest
     at the Weighted Average Cost of Capital [8.34 percent],
     compounded semi-annually, on any such amounts paid by
     the Lessee from the date of payment by the Lessee to
     the date of recovery through a reduction in Basic Rent
     pursuant to this Clause 3;
                                 - 30 -


     (4) after the Lessee has recovered the amounts de-
     scribed in paragraph (3) above, the amount of Basic
     Rent payable on any Basic Rent Payment Date following
     such refinancing shall be reduced by an amount equal to
     80% of the difference between the interest that would
     have been payable on such Basic Rent Payment Date with
     respect to the prepaid Series B Secured Note and the
     interest payable on such Basic Rent Payment Date with
     respect to the Series B Refunding Note;

     As described in the foregoing excerpt from the modified 1985

sale and leaseback, the 1992 amendments did not effect a reduc-

tion in petitioner’s minimum annual basic rent obligation until

the redemption of the 1984 tax-exempt bonds and the issuance of

the new tax-exempt bonds (i.e., the 1995 tax-exempt bonds), which

occurred on January 1, 1995.17

     The modified 1985 sale and leaseback granted petitioner the

right to request the owner participants to take reasonable

actions to refinance the 1984 tax-exempt bonds.   That modified

sale and leaseback required the owner participants to cooperate

in order to ensure that such refinancing was implemented.18

     The 1992 amendments expressly stated that petitioner exer-

cised its right to request that the owner participants take

reasonable actions to refinance the 1984 tax-exempt bonds.19


     17
      The modified 1985 sale and leaseback changed the defini-
tion of “Notes” in the 1985 sale and leaseback to include the
series B refunding note. See supra note 10.
     18
          See supra note 11.
     19
      In petitioner’s answering brief, petitioner argues that at
least certain of the expenditures at issue that it paid after
                                                   (continued...)
                              - 31 -

Each owner participant exercised its right under the 1984 bond

indenture agreement to require Mercer County to redeem the 1984

tax-exempt bonds.

     Pursuant to the plan detailed in the 1992 amendments, Mercer

County executed the 1995 bond indenture agreement, effective as

of October 1, 1992, which provided that in order to refinance the

1984 tax-exempt bonds Mercer County was to issue new tax-exempt

bonds (i.e., the 1995 tax-exempt bonds) pursuant to the terms of

that indenture agreement.   Pursuant to that plan, on January 20,

1993, Mercer County entered into a forward purchase contract with

Morgan Stanley, pursuant to which Morgan Stanley agreed to offer

the 1995 tax-exempt bonds for sale to the public.



     19
      (...continued)
1992 should not be capitalized because according to petitioner:

     Basin Electric [petitioner] was under no obligation to
     refinance the 1984 [tax-exempt] Bonds. The expendi-
     tures that Basin Electric would have avoided had it
     decided not to proceed with the refinancing totaled at
     least $3,583,005, including the $2,255,000 call premium
     paid in 1995 * * * relative to the redemption of the
     1984 Bonds. [Citations and fn. ref. omitted.]

     On the record before us, we reject petitioner’s argument.
The modified 1985 sale and leaseback granted petitioner the right
to request a refinancing of the 1984 tax-exempt bonds. The 1992
amendments expressly stated that petitioner exercised that right.
Once petitioner exercised that right, the owner participants were
obligated to cooperate in order to ensure that such refinancing
was implemented, and petitioner became obligated under the
modified 1985 sale and leaseback to pay the costs associated with
modifying the 1985 sale and leaseback and effecting the concomi-
tant refinancing of the 1984 tax-exempt bonds. We must determine
the tax treatment of the expenditures at issue based on the facts
as they occurred.
                                - 32 -

     On January 1, 1995, the refinancing of the 1984 tax-exempt

bonds was effected by the simultaneous redemption of the 1984

tax-exempt bonds and issuance of the 1995 tax-exempt bonds.      The

1995 tax-exempt bonds had an interest rate of 7.2 percent, were

payable semiannually on June 30 and December 30, and matured on

June 30, 2013.     Because of the 7.2-percent interest rate on the

1995 tax-exempt bonds, the annual interest payment on those bonds

was $3,720,750 less than the annual interest payment that would

have been due on the 1984 tax-exempt bonds.

     During each of the years 1995 and 1996, petitioner’s aggre-

gate minimum annual basic rent obligation under the modified 1985

sale and leaseback agreements was reduced by 100 percent of the

interest savings attributable to the refinancing of the 1984 tax-

exempt bonds, i.e., by $3,720,750.       After 1996 and until June 30,

2013, when the 1995 tax-exempt bonds were to mature, petitioner’s

aggregate minimum annual basic rent obligation under the modified

1985 sale and leaseback agreements was reduced by, inter alia, 80

percent of the interest savings attributable to such refinancing,

i.e., by $2,976,600.20

     We have found that petitioner paid the expenditures at issue

in order to modify and enhance the 1985 sale and leaseback

agreements so that petitioner’s aggregate minimum annual basic

rent obligation under those modified agreements would be substan-



     20
          See supra note 9.
                                 - 33 -

tially less than its minimum annual basic rent obligation under

the 1985 sale and leaseback agreements.

     We conclude that the material facts outlined above bring the

expenditures at issue within the purview of U.S. Bancorp &

Consol. Subs. v. Commissioner, 111 T.C. 231 (1998).     On the

record before us, we reject petitioner’s argument that Metrocorp,

Inc. v. Commissioner, 116 T.C. 211 (2001), and T.J. Enters., Inc.

v. Commissioner, 101 T.C. 581 (1993), require that such expendi-

tures be deducted under section 162(a).21     The material facts in

Metrocorp, Inc. v. Commissioner, supra, and T.J. Enters., Inc. v.

Commissioner, supra, are distinguishable from the material facts

in the instant case, and petitioner’s reliance on those cases is

misplaced.22


     21
      Petitioner argues in the alternative that, even if the
expenditures at issue paid in 1992 are required to be capital-
ized, the expenditures at issue paid in 1993 and 1995 were not
directly related to the modification of the 1985 sale and
leaseback and should not be capitalized. On the record before
us, we reject that argument. We have found that there was an
integrated plan to modify and enhance the 1985 sale and leaseback
agreements in order to reduce substantially petitioner’s minimum
annual basic rent obligation to the owner participants. Peti-
tioner’s obligation to pay the expenditures at issue was imposed
by and had its origins in the 1992 amendments. See Wells Fargo &
Co. and Subs. v. Commissioner, 224 F.3d 874, 884, 886-887 (8th
Cir. 2000), affg. in part and revg. in part 112 T.C. 89 (1999).
Petitioner undertook such an obligation in order to induce the
owner participants and Mercer County to agree to the integrated
plan to modify and enhance the 1985 sale and leaseback agreements
so as to reduce substantially petitioner’s minimum annual basic
rent obligation to the owner participants.
     22
          Unlike respondent who argues here that petitioner paid the
                                                       (continued...)
                               - 34 -

     In U.S. Bancorp & Consol. Subs. v. Commissioner, supra at

233-234, the taxpayer had a lease for a mainframe computer and

paid a fee (rollover fee) in order to cancel that lease and enter

into a new lease for a second, more powerful mainframe computer.

The Court held that the taxpayer was required to capitalize the

rollover fee.   Id. at 239.   In reaching that holding, the Court

observed:

          The cases brought to our attention * * * occupy
     opposite ends of a spectrum. At one end is the case
     where a lessee pays a lessor to terminate a lease and
     no subsequent lease is entered into between the par-
     ties. In such a case the termination fee is clearly
     deductible in the year incurred, as there is no second
     lease raising the possibility that the lessee will
     realize significant future benefits beyond the current
     taxable year as a result of the termination payment.
     At the opposite end is the case of a lessee that can-
     cels a lease and then immediately enters into another
     lease with the same lessor, covering the same property.
     In substance, the first lease is not canceled but
     continues in modified form, and any unrecovered costs


     22
      (...continued)
expenditures at issue in order to modify and enhance the 1985
sale and leaseback agreements, the Commissioner of Internal
Revenue (Commissioner) did not argue in Metrocorp, Inc. v.
Commissioner, 116 T.C. 211 (2001), and T.J. Enters., Inc. v.
Commissioner, 101 T.C. 581 (1993), that the costs at issue there
modified, enhanced, or created a capital asset. The Commissioner
argued in those two cases only that the costs at issue there
created significant future benefits for the taxpayers there
involved. On the record presented in Metrocorp, Inc. v. Commis-
sioner, supra at 222, and T.J. Enters., Inc. v. Commissioner,
supra at 592-593, the Court found that there were no significant
future benefits requiring capitalization of the costs at issue in
those cases. In the instant case, we have found that petitioner
paid the expenditures at issue in order to modify and enhance the
1985 sale and leaseback agreements, thereby necessarily providing
significant future benefits to petitioner. See Wells Fargo & Co.
and Subs. v. Commissioner, supra at 884.
                               - 35 -

     of the first lease, or costs incurred to cancel the
     first lease, are not currently deductible but rather
     are costs of continuing the first lease in modified
     form. [Id.]

     In U.S. Bancorp & Consol. Subs., the Court analogized the

cancellation of a lease and the execution of a new lease for the

same property as in substance a modification of the original

lease, which requires that the costs incurred in order to effect

such modification be capitalized.    Under U.S. Bancorp & Consol.

Subs. v. Commissioner, supra at 240 (citing Pig & Whistle Co. v.

Commissioner, 9 B.T.A. 668 (1927); Phil Gluckstern’s, Inc. v.

Commissioner, T.C. Memo. 1956-9), costs paid or incurred to

modify a lease, like the expenditures at issue here, must be

capitalized and may not be deducted when paid or incurred.

     Petitioner argues that U.S. Bancorp & Consol. Subs. is

distinguishable from the instant case because in U.S. Bancorp &

Consol. Subs. the new lease covered property (i.e., a new more

powerful mainframe computer) different from the property that the

old lease covered, while in the instant case the modified 1985

sale and leaseback covered the same property that the 1985 sale

and leaseback covered.    We reject that argument.   In U.S. Bancorp

& Consol. Subs., the Court found unpersuasive the taxpayer’s

argument that it was significant that the new lease involved

there covered property different from the property that the

original lease covered.    That argument, according to the Court,

ignored the integrated nature of those two leases.     U.S. Bancorp
                              - 36 -

& Consol. Subs. v. Commissioner, supra at 240-241.   If the

rollover fee in U.S. Bancorp & Consol. Subs. paid or incurred to

cancel the original lease covering certain property and to enter

into a new lease covering different property must be capitalized,

a fortiori fees or costs paid or incurred to modify an existing

lease covering the same property, like the expenditures at issue

here, must be capitalized.   See id.; Pig & Whistle Co. v. Commis-

sioner, supra; Phil Gluckstern’s, Inc. v. Commissioner, supra.

     On the record before us, we hold that petitioner must

capitalize the expenditures at issue.23


     23
      In a footnote in petitioner’s opening brief, petitioner
advances for the first time the following alternative argument:

     the lessor’s expenses paid by Basin Electric [peti-
     tioner] and recouped through the special allocation of
     the interest savings could be viewed as a “loan” from
     Basin Electric to lessors and a repayment of such loans
     through reduced rent in 1995 and 1996. * * * Under such
     a characterization, Basin Electric would be entitled to
     deduct the unreduced rent for 1995 and 1996 (effec-
     tively allowing Basin Electric to amortize the costs
     over that period).

     It is well settled that the Court will not consider issues
raised for the first time on brief when to do so would prevent
the opposing party from presenting evidence that that party might
have proffered if the issue had been timely raised. DiLeo v.
Commissioner, 96 T.C. 858, 891 (1991), affd. 959 F.2d 16 (2d Cir.
1992); Shelby U.S. Distribs., Inc. v. Commissioner, 71 T.C. 874,
885 (1979). The determination of whether a debtor-creditor
relationship exists is a highly fact-specific inquiry. See,
e.g., Ga.-Pac. Corp. v. Commissioner, 63 T.C. 790, 796 (1975).
We conclude that it would be prejudicial to respondent to con-
sider petitioner's alternative argument that certain of the
expenditures at issue constituted a loan from petitioner to the
owner participants. That is because respondent had no opportu-
                                                   (continued...)
                             - 37 -

     We turn now to the dispute between the parties regarding the

period over which the expenditures at issue, which we have held

must be capitalized, should be amortized and deducted.   Peti-

tioner argues that, under section 1.167(a)-3, Income Tax Regs.,

it should amortize and deduct the expenditures at issue over the

two-year period 1995 and 1996.   In support of that argument,

petitioner points out that 1995 and 1996 are the years during

which petitioner recouped the expenditures at issue.24   Respon-

dent counters that petitioner should amortize and deduct the

expenditures at issue over the term of the modified 1985 sale and

leaseback beginning with taxable year 199525 and ending with

taxable year 2020.

     We turn first to petitioner’s argument that the appropriate


     23
      (...continued)
nity to present evidence at trial relating to whether a bona fide
debtor-creditor relationship existed. Consequently, we shall not
address petitioner’s alternative argument regarding an alleged
loan from petitioner to the owner participants.
     24
      Under the modified 1985 sale and leaseback agreements,
petitioner recouped, through reductions in 1995 and 1996 in its
minimum annual basic rent, the entire amount of the expenditures
at issue. See supra note 9.
     25
      Petitioner paid the expenditures at issue in 1992, 1993,
and 1995. The modified 1985 sale and leaseback agreements became
effective on Oct. 1, 1992. Pursuant to the terms of the modified
1985 sale and leaseback agreements, petitioner did not realize a
substantial reduction in its minimum annual basic rent obligation
until after the redemption of the 1984 tax-exempt bonds and the
issuance of the 1995 tax-exempt bonds on Jan. 1, 1995. Respon-
dent does not argue that, and therefore we shall not consider
whether, the appropriate period over which to amortize and deduct
such expenditures should begin with taxable year 1992.
                              - 38 -

period over which to amortize and deduct the expenditures at

issue is 1995 and 1996.   Section 1.167(a)-3, Income Tax Regs., on

which petitioner relies in support of that argument, states that

an intangible asset may be the subject of a depreciation allow-

ance if that intangible asset has an ascertainable, limited

useful life.   Petitioner has not offered any evidence establish-

ing that the useful life of the modified 1985 sale and leaseback

is only the two-year period 1995 and 1996.   That petitioner in

effect recouped the expenditures at issue over 1995 and 1996

pursuant to the terms of the modified 1985 sale and leaseback

agreements does not establish that the useful life of each of

those agreements is that two-year period.    On the record before

us, we reject petitioner’s argument that section 1.167(a)-3,

Income Tax Regs., requires that the expenditures at issue be

amortized and deducted over the two-year period 1995 and 1996.

      We turn now to respondent’s argument that the appropriate

period over which to amortize and deduct the expenditures at

issue is the term of the modified 1985 sale and leaseback agree-

ments beginning with 1995 and ending with 2020.   The Supreme

Court of the United States has concluded that “a capital expendi-

ture usually is amortized and depreciated over the life of the

relevant asset”.   INDOPCO, Inc. v. Commissioner, 503 U.S. at 83-

84.   Petitioner cites no authority that would take the instant
                              - 39 -

case outside the purview of that general rule.26   Moreover, U.S.

Bancorp & Consol. Subs. v. Commissioner, 111 T.C. at 242, and Pig

& Whistle Co. v. Commissioner, 9 B.T.A. at 670, held that costs

paid or incurred to cancel a lease and enter into a new lease

must be amortized and deducted over the term of the new lease.

On the record before us, we find that petitioner is required to

amortize and deduct the expenditures at issue over the term of

the modified 1985 sale and leaseback agreements ending with

taxable year 2020.27

     Based on our examination of the entire record before us, we

find that petitioner has failed to carry its burden of establish-

ing that the Court should not sustain respondent’s determinations

that the expenditures at issue should be capitalized and amor-

tized and deducted over the term of the modified 1985 sale and

leaseback agreements beginning with taxable year 1995 and ending




     26
      In a footnote in petitioner’s opening brief, petitioner
advances for the first time an alternative argument that, because
petitioner’s minimum annual basic rent obligation was reduced
only throughout each of the years during which the 1995 tax-
exempt bonds were outstanding, the expenditures at issue should
be amortized and deducted over the term of such bonds, which were
to mature on June 30, 2013. Petitioner cites no authority in
support of that alternative argument. On the record before us,
we reject it.
     27
      Respondent does not argue that, and we have not considered
whether, the amortization and deduction of the expenditures at
issue should begin with taxable year 1992. See supra note 25.
                               - 40 -

with taxable year 2020.28

     We have considered all of the contentions and arguments of

petitioner and respondent that are not discussed herein, and we

find them to be without merit, irrelevant, and/or moot.

     To reflect the foregoing and the concessions of the parties,


                                    Decision will be entered

                               under Rule 155.




     28
          See supra note 27.
