                        T.C. Memo. 2000-323



                      UNITED STATES TAX COURT



     INGRAM INDUSTRIES, INC. & SUBSIDIARIES, Petitioners v.
          COMMISSIONER OF INTERNAL REVENUE, Respondent



     Docket No. 14175-98.                Filed October 18, 2000.



     N. Jerold Cohen, J.D. Fleming, Jr., Walter T. Henderson,

Jr., Matthew J. Gries, and Walter H. Wingfield, for petitioners.

     Bonnie L. Cameron and Vallie C. Brooks, for respondent.


             MEMORANDUM FINDINGS OF FACT AND OPINION

     GERBER, Judge:   Respondent determined income tax

deficiencies for petitioners’ 1992, 1993, and 1994 tax years in

the amounts of $1,315,659, $530,477, and $614,122, respectively.

Respondent also determined increased interest for each year under
                               - 2 -

section 6621(c).1   After agreements of the parties, the question

we consider is whether the cost of the work performed on

petitioners’ towboat engines constituted a currently deductible

expense or whether it is to be capitalized.

                         FINDINGS OF FACT2

A.   Background

      During the taxable years 1992, 1993, and 1994, petitioners

were members of an affiliated group of corporations of which

Ingram Industries, Inc. (Ingram) was the common parent.    Ingram

maintained its principal offices in Nashville, Tennessee, on the

date the petition was filed in this case.    During the years in

issue, petitioners were a closely held, diversified group of

corporations engaged principally in the wholesale marketing and

distribution of microcomputer software and hardware; books and

prerecorded video cassettes; inland barge transportation

services; energy-related manufacturing, production, and

marketing; and insurance.   The barge transportation service was

conducted by three wholly owned subsidiaries of Ingram--Ingram

Barge Co., Inc., Ingram Towing Co., Inc., and Great River Marine

Service, Inc.


      1
       All section references are to the Internal Revenue Code in
effect for the years under consideration, and all rule references
are to the Tax Court Rules of Practice and Procedure, unless
otherwise indicated.
      2
       The parties’ stipulation of facts and the exhibits are
incorporated by this reference.
                               - 3 -

     Petitioners’ barge transportation business involves towing a

variety of commodities and materials on the Ohio-Mississippi

inland waterway system.   The types of cargo transported by

petitioners for third parties varied considerably, and included

agricultural commodities, minerals (including coal and rocks),

and other types of cargo.   Petitioners owned and operated a fleet

of 55, 64, and 60 towboats at the end of 1992, 1993, and 1994,

respectively.   Petitioners also operated leased towboats,

numbering 11, 5, and 5 as of the end of 1992, 1993, and 1994,

respectively.   Thus, petitioners operated a total of 66, 69, and

65 towboats during 1992, 1993, and 1994, respectively.

Petitioners normally purchased used towboats and occasionally

purchased new towboats.

     The towboats ranged in size from 50 to 200 feet in length,

in age from 7 to 37 years, and were powered by engines with

capacities ranging in horsepower from 800 to 9,180.   Petitioners’

towboats were built by several different manufacturers, had

varying “gross official tonnage” ratings, and possessed different

makes and models of engines.

     The parties have specified two towboats--the R. Clayton

McWhorter and the Michael J. Grainger (formerly the Steel

Courier)--to serve as representative towboats for purposes of

this case.   The representative towboats measure from 140 to 168

feet long, 40 to 42 feet wide, and 40 feet high with gross

tonnage ranging from 536 tons to 710 tons.   Normally,
                               - 4 -

petitioners’ towboats will push between 15 and 40 cargo-laden

barges with an average of 1,500 tons of cargo.   For purposes of

comparison, a semitrailer truck holds about 26 tons of cargo, so

a barge carries the equivalent of 58 semitrailer loads of cargo.

During the taxable years in issue, a new towboat comparable to

the representative vessels cost approximately $6.25 million and a

used vessel cost approximately $2.2 to $2.3 million.

B.   Towboat Configuration, Maintenance, and Valuation

      The principal areas of a towboat are:   The wheelhouse, the

upper deckhouse, the main deck, the upper engine room, the deck

stores area, the steering room, and three areas of the hull--the

fuel and ballast tanks, the main engine room, and the shaft

alley.   A towboat is a very large, integrated item of machinery

comprised of a variety of components and systems, of which the

principal part is the propulsion system or engines and drive

train.

      There are three basic groups of operational systems on an

inland river towboat:   Those that perform the primary functions

of floating, maneuvering, and moving up and down the river (e.g.,

the engines, gears, clutches, steering systems, tailshafts and

propellers); those that support the primary systems (e.g., the

fuel system, the bilge system, the fire system, hydraulic

systems, ventilation systems, electrically powered auxiliary

systems, environmental systems, and others); and those that

support the crew and personnel operating the towboat (e.g., the
                               - 5 -

water, sewage, electrical, etc.).   These systems must be

compatible with each other for a towboat to perform its intended

function.

     A towboat’s propulsion system consists of the main engines,

reduction gears, tailshafts, and propellers.   The main engines

power reduction gears, which turn the tailshafts and the

propellers and propel the towboat forward or backward.      The

reduction gears (transmission system) are each attached to a

solid steel tailshaft (about 45 feet in length), which is

attached to a propeller.   Most towboats in petitioners’ fleet

have two propellers, measuring from 4 to 10 feet in diameter,

located at the rear of the towboat outside the hull.   Each

tailshaft system possesses a set of three steering type rudders

for navigating the towboat.

     Towboat mechanical systems require recurring inspection and

maintenance to attain their expected useful life.   The principal

systems that are inspected and maintained on a recurring and

routine basis include:   The reduction gears, the clutches, the

air filters, the main engines, the steering systems (including

the rudders), the shafting system (including the bearings and

propellers), the fuel centrifuge, the hull (both interior and

exterior), the pumps, the air compressors, the air conditioning,

the electrical systems, the search lights, the sewage systems,
                               - 6 -

the capstans, the barge connector winches, the communications

equipment, and the equipment in the galley.

     Appraisers of towboats rely upon asking or selling prices of

comparable vessels to arrive at estimated fair market value.

Appraisers do not necessarily inspect a towboat’s condition.

When a towboat’s condition is inspected, the appraiser generally

performs a visual inspection or a walk-through of the towboat

being appraised to determine its general, overall condition.     At

that time, a visual inspection of the exterior of its main

engines may be performed as the towboat is being inspected and

maintenance records for the towboat may be requested, but a

detailed inspection of the main engines is not performed.    A

potential towboat buyer is interested in the vessel’s towing

capacity, age, condition, and maintenance, all of which would

have an effect on the price.

     Towboats are generally classified as being in poor, fair,

good or excellent condition based on either a survey or a visual

inspection.   As long as a towboat’s engines are operating and are

said to have been well maintained, no further examination or

inspection of a towboat’s engines is performed as part of a

typical valuation.   Towboats are valued as a single asset and

separate values are not assigned to the various components.

Likewise, petitioners do not allocate the purchase or selling

price of a towboat among its various components.
                               - 7 -

C.   Towboat Engines and Petitioners’ Maintenance Procedures

      Most of the towboats in petitioners’ fleet are equipped with

two turbocharged, “V-type,” two-cycle, diesel-powered engines.

During the years in issue, between two-thirds and three-quarters

of the towboats in petitioners’ fleet possessed similar engines

to the representative boats’ engines.3   The horsepower produced

by two engines ranges from 5,000 to 5,600 horsepower, depending

on the rotations per minute at which the engines are set to

operate.   Assuming proper maintenance, towboat’s engines can

continue operating safely, efficiently and profitably as part of

a towboat’s main propulsion system for up to 40 years.

      The procedures in controversy involve petitioners’ cleaning

and inspecting of engines to determine which of their parts are

within acceptable operating tolerances and can be reused and

which (if any) of these parts need to be reconditioned back to

acceptable operating tolerances or replaced with appropriate

replacements.4




      3
       For purposes of this case, the parties have agreed that
the Electro-motive Division (EMD) No. 16-645-E5 engine,
manufactured by General Motors, will be the representative
engine.
      4
       As part of the controversy over whether the expenditures
involved are currently deductible or must be capitalized,
respondent refers to these procedures as an “engine overhaul” and
petitioners refer to these procedures as “center-section engine
maintenance”.
                               - 8 -

     The work performed by petitioners is included in the engine

manufacturer’s maintenance manuals.    These procedures are routine

and recurring and necessary to maintain a towboat in good

operating condition. Petitioners’ towboats were in good working

order and operating condition when they were brought in to have

the above procedures performed.

     Petitioners perform these procedures after a towboat has

operated for 25,000 to 35,000 hours.   A representative towboat is

used about 8,000 hours per year so that the procedures are

performed on a towboat every 3 to 4 years.   Petitioners select a

towboat for these procedures by utilizing a series of criteria.

First, they use a 25,000-hour guideline to screen towboats to

determine whether it is time to perform the procedures.   Next,

for towboats that have accrued 25,000 to 30,000 hours of use

since the last procedure, wear on a piston’s compression ring is

measured for each engine and the towboat’s oil consumption

patterns are studied.   Petitioners do not remove a towboat

engine’s power assemblies to measure the ring wear for each of

the pistons in the engine.   These measurements are taken by

removing the “air box handhole covers”, positioning the pistons

so that they are accessible from the air box handholes, and using

a “feeler gauge” to take these measurements.   If the ring wear

indicates that procedures involved are appropriate or if a

towboat appears to be consuming more oil than normal, the
                                - 9 -

procedures are performed on the towboat when the opportunity

arises based on seasonality and business needs.

     Normally a towboat is out of service for 10 to 12 calendar

days for the procedure so the work is performed during “off peak”

seasons--winter and early spring.   Normally, 8 to 10 individuals

(mostly off-duty crew members) perform the procedures.   The crew

members of a tugboat generally include a captain, pilot, chief

engineer, cook, mate and four deck-hands.   The chief engineer is

responsible for the propulsion system and other mechanical items

and reports to the captain and to a shore-based manager of

engineering.   One may become a chief engineer by on-the-job

experience or by formal training.   Employees with 1 year

experience may become apprentice engineers assigned to a chief

engineer for training.

     The procedures focus on the engine’s cylinder assemblies,

which are commonly referred to as the engine’s “power packs”.

Thus, a 16-cylinder engine would contain 16 power packs.    The

power packs are removed from a towboat’s engines and disassembled

as part of this procedure so that their parts can be cleaned and

inspected.   The process of accessing and removing a power pack is

detailed and labor intensive.   A power pack weighs between 363

and 408 pounds and consists of a cylinder head, four exhaust

valves, a cylinder liner, a piston and compression rings, a

piston pin, a bearing insert, a piston carrier, a thrust washer,
                              - 10 -

a piston snap ring, a connecting rod, and a basket or fork rod

assemblies.   With the exception of pistons, rings, and fuel

injectors, the items comprising a power pack are reused by

petitioners to the extent possible.    For example, cylinder heads,

piston pins, piston carriers, connecting rods, and cylinder

liners are reused where possible in connection with the

procedures.   Sometimes, parts other than pistons, rings, and fuel

injectors may need work performed in order to keep them within

acceptable operating tolerances.

     Pistons and rings, which consist of cast metal pieces

weighing approximately 40 pounds, are ordinarily replaced with

new pistons and rings, at a cost of materials of about $300 per

piston during the years in issue.   For economic and safety

reasons, petitioners do not reuse or attempt to recondition worn

pistons as part of these procedures.

     Cylinder liners are reused once by petitioners, but normally

are not reused a second time due to wear caused by the friction

between a piston and the interior surface of the cylinder liner.

After an initial use, cylinder liners are cleaned, visually

inspected for damage, and checked for acceptable dimensional

tolerances at various measurement points along the inside of the

liner.   If a cylinder liner is not damaged and is qualified for

further use, it is honed and cleaned for reuse.   The cost of

inspecting a used liner to determine whether it is within
                               - 11 -

acceptable operating tolerances (as well as honing and cleaning

it) was about $100 during the years in issue.    When a cylinder

liner needs to be replaced due to excessive wear, petitioners use

either new or used liners which are within acceptable operating

tolerances and which are similar in all material respects to the

liners removed from the towboat.    During the years in issue, the

cost of such a used liner was about $600, and the cost of a new

cylinder liner was about $1,200.

     In addition to the power packs, rocker arm assemblies, valve

bridges, fuel injectors, oil pumps, and water pumps are also

removed, disassembled, cleaned and inspected as part of the

procedures.   As with power packs, to the extent possible, parts

within these assemblies and pumps are reused unless damage is

detected.    The only parts of the rocker arm assemblies that are

always replaced with either new or used parts are the rocker arm

rollers and bushings (costing approximately $13 during the years

in issue).    In a similar manner to rocker arm assemblies, valve

bridges are disassembled, cleaned, and inspected and reused if no

irreparable damage is detected.    The valve bridge parts that are

routinely replaced are the valve bridge lash adjusters (costing

approximately $8 per valve bridge during the years in issue).

Fuel injectors are normally exchanged by petitioners with outside

contractors for reconditioned injectors at a cost of about $92

per injector.
                              - 12 -

     In connection with the maintenance, various bushings,

bearings, washers, retainers, gaskets and seals contained within

the oil and water pumps are also replaced.   Many of the parts

within these pumps--the gears, brackets, couplings, bolts, nuts,

keys, housings, dowels, sleeves, shafts, impellers, springs,

spacer plates, slingers, plugs and rings--are reused, assuming

they are within acceptable operating tolerances.   Other small

parts, such as gaskets, seals and filters, are replaced as an

incidental part of the disassembly and reassembly processes.     The

lower liner bore inserts--pieces of cast metal that rest between

the bottom of each cylinder liner and the crankcase so as to

provide a seal between the crankcase and the towboat engine’s air

box and to enable air to be retained in the air box while the

towboat’s engine is in operation--are replaced at a cost of $40

each.

     Certain moving and nonmoving parts are cleaned and visually

inspected for obvious operational problems as part of the

maintenance, but unless problems are identified during the

inspection process, no work is performed on such parts,

including:   The engine governors, the engine turbochargers, the

engine crankcase, oil pan, oil and fuel lines, the lower main

bearings, the piston cooling oil pipes, the cylinder test valves,

and the water inlet tubes.
                              - 13 -

     Several parts of a towboat’s engines, such as the exhaust

systems, mufflers and ductwork attached to the towboat’s engines,

the piping on the front and aft ends of the towboat’s engines,

and the towboat engines’ camshafts (including the camshaft gear

trains), crankshafts, and the drive gears (including the gear

boxes) attached to the engines are not included in the above-

described periodic procedures.    This equipment is not inspected

as part of the procedures unless a specific operational problem

has been previously identified.

     No part of a towboat’s main propulsion system other than its

main engines is affected as part of the above-described

procedures.   In addition, none of the equipment located in the

wheelhouse, the upper deckhouse, the main deck, the upper engine

room, the deck stores area, the steering room, the fuel and

ballast areas, and the shaft alley is affected by the procedures.

None of the equipment located in the main engine room other than

the main engines is affected by the procedures.   So for example,

the fire pump, the bilge and ballast pump, the deck wash pump,

the air compressors and tanks, etc., are not included in the

procedures.

     The engines under consideration weigh 37,700 pounds and

measure almost 16 feet long, 5 feet wide and 9½ feet high.     They

are designed and constructed so that a power pack can be

regularly removed from the engine so that the procedures involved
                              - 14 -

can be performed.   The engines are designed so that much of the

wear occurs in replaceable and/or disposable parts.

     Generally, a towboat’s engines are not removed from the

towboat in connection with the procedures involved, and it is not

necessary for a towboat to be in dry dock for the procedures to

be performed.   The operational tolerances used by petitioners in

the performance of the maintenance procedures in issue are within

the manufacturer’s minimum recommended operating tolerances,

which are not as stringent as the manufacturer’s required

dimensional tolerances for new parts.

     During the years in issue, the average cost incurred by

petitioners for the parts, labor, and supplies required to

perform the maintenance procedures in issue on both engines of a

representative towboat was $100,000.    The cost of two comparable

new engines was approximately $1.5 million, and two rebuilt used

engines cost approximately $600,000.    Approximately 30 percent to

35 percent of the $100,000 cost is for labor, and approximately

65 percent to 70 percent is for new or used parts.    The $100,000

cost does not vary based on the age of a towboat or its engines.

     Petitioners maintain records of the inspection results for

certain of the parts of a towboat’s engines that are cleaned and

inspected during the maintenance.   With respect to the two

representative towboats, the relative number of parts covered by
                                  - 15 -

these records that were reused (as compared to being replaced)

was as follows:

                  Total number
                  contained in      Number      Number     Relative
portion
Item              2 EMD engines     reused     replaced    of parts reused
Rocker arms             192            192         0        192/192 or

100%

Piston carriers         64              59         5        59/64 or 92.2%

Piston pins             64              54        10        54/64 or 84.4%

Cylinder heads          64              32        32        32/64 or 50%

Connecting rods         64              61         3        61/64 or 95.3%

Cylinder liners         64              59         5        59/64 or 92.2%

Pistons                 64                 0      64        0/64   or 0%

              Total    576             457       119        457/576 =

79.3%

A towboat’s horsepower is not increased, nor is its use or

ability changed, as a result of the procedures.           The procedures

are performed to keep the towboats in good, safe, reliable, and

profitable operating condition.

        The procedures performed by petitioners are consistent with

those performed by a majority of the inland-river towboat

operators in the United States.      The probable and anticipated

useful life of a towboat is not extended as a result of the

maintenance procedures in question.        A towboat engine would not

likely realize its anticipated useful life if the procedures in
                               - 16 -

question were not performed periodically.     If the procedures in

question are performed at appropriate intervals, a towboat engine

can continue operating safely, efficiently, and profitably for up

to 40 years.

      The performance of the procedures described above maintains

the relative value of a towboat, but it does not increase the

value.   The value of a towboat declines as it ages even if the

procedures are performed.    Any increase in the value of a towboat

immediately after the performance of the procedures in question

would generally be limited to the cost of performing the

procedures, or $100,000 for a representative towboat.

D.   Petitioners’ Procedures vs. Repowering

      Occasionally, a towboat owner may desire to replace existing

engines with new or rebuilt engines, to standardize the types of

engines in a fleet, to increase the towing capacity, or to

replace a dysfunctional engine.   This process (referred to in the

industry as “repowering”) involves drydocking the towboat.

      Removal or repowering of main engines is a complicated

process requiring disconnecting the engines from the water, fuel,

air, and exhaust systems.    In addition, the exhaust stacks on top

of the towboat’s main deck must be completely removed, as well as

those portions of the decking located underneath each stack and

over the main engine room.   The engines being removed are

disconnected from their mounts and are removed with the aid of a
                               - 17 -

crane.   The engine mounts are either modified or replaced, and

the replacement engines (in new or rebuilt condition) are

installed.   The towboat’s air, water, fuel, and exhaust systems

are then modified to the extent necessary to accommodate the new

or rebuilt engines, and the new or rebuilt engines are connected

to these systems of the towboat.   The decking and exhaust stacks

are reinstalled, and the new or rebuilt engines are operationally

tested, thus completing the repowering process.   The process of

repowering a towboat with new or rebuilt engines takes

approximately 3 to 5 months.

     The representative engines were no longer being manufactured

by General Motors during the years in issue.   The costs

associated with installing two new or rebuilt Electro-motive

Division (EMD) engines in a representative towboat (excluding the

costs of the engines themselves and any costs associated with

replacing a reduction gear system, a tailshaft, a propeller or

other equipment) would have been approximately $200,000 during

the years in issue.   If modifications or upgrades are required

for the reduction gear, tailshafts, propellers, or other

equipment in connection with a repowering, the installation costs

of a repowering could reach $500,000.   In addition, because a

repowering takes 3 to 5 months, that results in a loss of use of

the vessel for a period of time far in excess of the 10 to 12

days for the procedures performed by petitioners.
                                - 18 -

     An EMD engine is rebuilt (or “completely overhauled”)

through a series of steps designed to put the engine in like-new

operating condition to the maximum extent possible.    When an EMD

engine is rebuilt, the rebuilding process is performed by EMD or

an EMD-authorized service center.    EMD engines in a towboat

nearing the end of its useful life (and which has had the

procedures involved performed numerous times) or EMD engines

which have been removed from towboats due to a catastrophic

malfunction are likely candidates for the rebuilding process.

The goal of the rebuilding process is to bring each of an

engine’s component parts to EMD’s original dimensional

specifications for new parts.

     The rebuilding process for a towboat engine requires the

removal of the engine from the towboat of which it is a part and

the removal of all of the moving and nonmoving components from

the engine as well.   The engine’s crankcase and oil pan are

separated, and every part of the engine is carefully cleaned,

inspected using intense illumination, machined and treated with

special materials to restore the engine to a like-new operating

condition.   The engine crankcase and oil pan are extensively

machined and welded, and numerous dimensional tests and checks

are performed to ensure that the engine is returned to a like-new

condition through the rebuilding process.    In addition, a

reconditioned crankshaft and camshaft (with new camshaft bearings
                                - 19 -

and dowels) normally are installed in the engine during the

rebuilding process.   The power packs are completely rebuilt with

a large number of new parts during the rebuilding process.    The

oil pumps, water pumps, engine turbochargers, and governors are

normally removed and exchanged for rebuilt parts during the

rebuilding process.   The accessory drive gears, all of the piping

on the front and aft ends of the engine, the governor drive gear,

and the turbocharger drive gears are removed and normally

exchanged for rebuilt parts during the rebuilding process.

Normally, a rebuilder of EMD engines warrants its labor for 1

year.   Rebuilt parts normally carry a 6-month warranty, and new

EMD parts used in the rebuilding process carry a 1-year warranty.

During the years in issue, petitioners did not repower any of

their towboats.

E.   Petitioners’ Accounting Practices

      Petitioners use an accrual method of accounting for

reporting their income, expenses, and results of operations for

both financial and tax reporting purposes.   For Federal income

tax purposes, petitioners depreciate each of their towboats as a

single asset under the modified accelerated cost recovery system

using the prescribed recovery period of 10 years under the

composite 18-year class life.    For financial reporting purposes,

petitioners depreciate a new or used towboat as a single asset

over 35 years.    The useful life of a properly maintained towboat
                              - 20 -

is 40 years.   For financial reporting purposes, petitioners

accrue the estimated cost of the procedures in issue as the

towboats accrue hours of usage, and such estimated costs are

reflected as expenses for the periods to which they relate, which

are the periods prior to the performance of the maintenance.

     To illustrate petitioners’ financial accounting treatment of

the maintenance costs, if during a particular year a

representative towboat incurred 8,000 hours of use and the

maintenance procedures were expected to be performed after 25,000

hours of use and were expected to cost $100,000, petitioners

would reflect an expense of $32,000 (8,000/25,000 x $100,000) in

their consolidated income statement for that year.   An additional

$32,000 of expense would be reflected in petitioners’ income

statement for each of the 2 succeeding years (during which an

additional 14,000 hours of usage would have accrued), and $4,000

(1,000/25,000 x $100,000) would be reflected in petitioners’

income statement for the third succeeding year (during which

1,000 hours of usage would have accrued prior to the performance

of the maintenance).

     Petitioners use this financial accounting method in an

attempt to match the costs incurred for the maintenance

procedures in issue with the related revenues.   This accounting

method, which expenses the costs incurred for the maintenance

procedures prior to the performance of the maintenance, is in
                               - 21 -

accord with generally accepted accounting principles and was

verified by petitioners’ outside accountants as properly

representing petitioners’ income for financial reporting

purposes.

     Petitioners believed that their financial accounting method

was not permitted under the Internal Revenue Code for the tax

years under consideration.    Accordingly, for Federal income tax

purposes, petitioners deducted the costs associated with the

procedures involved in the taxable year in which they are

incurred.

     Respondent’s determination was to capitalize the costs and

depreciate them over the 10-year recovery period beginning with

the date the costs are incurred.

                               OPINION

     The issue we consider is whether petitioners’ expenditures

for the described procedures were expenses deductible under

section 162(a) or whether they should have been capitalized under

section 263(a).    Expenses incurred for regular maintenance to

keep property in an ordinarily efficient operating condition are

currently deductible.    Section 1.162-4, Income Tax Regs.,

provides:

            The cost of incidental repairs which neither
            materially add to the value of the property
            nor appreciably prolong its life, but keep it
            in an ordinarily efficient operating
                               - 22 -

          condition, may be deducted as an expense * *
          *

Similarly, section 1.263(a)-1(b), Income Tax Regs., provides that

          Amounts paid or incurred for incidental
          repairs and maintenance of property are not
          capital expenditures * * *

     Conversely, section 263 provides that no deduction may be

taken for amounts expended for permanent improvements or

betterments made to increase the value of property.    See also id.

The parties have taken refuge in particular nomenclature that

supports their position.    There is no legal question to be

answered here--instead we must decide which party’s labeling is

supported by the record.    Respondent uses the term “overhaul”5

and petitioners use the terms “routine maintenance”.

     The parties’ positions reduced to a concise statement of

facts, are as follows:   Petitioners contend that towboats,

including the engines, have an expected useful life of 40 years

and the procedures performed are routine maintenance to achieve

the expected useful life.    Respondent contends that a towboat

engine has a 25,000- to 35,000-hour useful life (here 3 to 4

years), and it must be completely overhauled after such use.




     5
       On brief, respondent does not argue that the procedures
performed by petitioners’ employees is, by definition, an
overhaul, which includes a complete rebuilding of the engine.
Instead, respondent argues that the procedures performed are
equivalent in scope to an overhaul.
                               - 23 -

     Preliminarily, we consider the parties’ disagreement

concerning whether a towboat engine should be considered

separately from the towboat.   Respondent’s argument is

constructed in a manner that focuses on the engines, which

ostensibly provides better comparisons for his arguments by

magnifying the cost of the procedures performed through a

reduction of the scale of the asset being considered.

Petitioners contend that, factually, there is no predicate for

treating the engine separately from the towboat.   Additionally,

petitioners argue that the result would not be changed by solely

focusing on the engines.   We agree with petitioners that the

record does not support a finding that, as a matter of industry

practice or otherwise, the engines are purchased or treated

separately from the tow boats.   To the contrary, the life of a

towboat is 40 years, and it is expected that the engines, if

properly maintained, will also last 40 years.   Towboats are

purchased with engines, albeit to the buyer’s specifications,

that are designed to be maintained without removing them from the

boat.   There was no showing that towboat owners regularly and

periodically over the life of the vessel replaced the engines.

Accordingly, we disregard any suggestion by respondent that the
                                - 24 -

engines, as a matter of fact or law, should be treated separately

from the towboats.6

         The tests for determining whether expenditures are

deductible maintenance expenses as opposed to capital

expenditures have remained fairly constant for more than 70

years.     In 1926, the Board of Tax Appeals explained:

             A repair is an expenditure for the purpose of
             keeping the property in an ordinarily
             efficient operating condition. It does not
             add to the value of the property, nor does it
             appreciably prolong its life. It merely
             keeps the property in an operating condition
             over its probable useful life for the uses
             for which it was acquired. Expenditures for
             that purpose are distinguishable from those
             for replacements, alterations, improvements
             or additions which prolong the life of the
             property, increase its value, or make it
             adaptable to a different use. The one is a
             maintenance charge, while the others are
             additions to capital investment which should
             not be applied against current earnings. * *
             *

Manierre v. Commissioner, 4 B.T.A. 103, 106 (1926).

     Those standards have persevered substantially unchanged.   In

Plainfield-Union Water Co. v. Commissioner, 39 T.C. 333, 337

(1962), the tests or standard was expressed as follows:

             An expenditure which returns property to the
             state it was in before the situation
             prompting the expenditure arose, and which

     6
       Respondent referenced a few opinions in which related
assets were treated separately in connection with the question of
expenses versus capital expenditures. In each instance, the
assets were separable and so treated by the owner/user.
Accordingly, the referenced cases are distinguishable.
                               - 25 -

          does not make the relevant property more
          valuable, more useful, or longer-lived, is
          usually deemed a deductible repair. A
          capital expenditure is generally considered
          to be a more permanent increment in the
          longevity, utility, or worth of the property.

     Accordingly, in determining whether an expenditure should be

capitalized, we consider whether it has:    (1) Adapted the

property for a new or different use, (2) appreciably prolonged

the life of the property, or (3) materially added to the value of

the property.    Initially, there is no question that the

procedures performed did not adapt the engine for a new or

different use.

     The question of whether the procedures appreciably prolonged

the life of the engine is more thought provoking.    Obviously, if

the procedures performed by petitioners were not performed, the

expected useful engine life would be approximately 4 or 5 years.

Based on the record, the procedures are performed after about

25,000 to 30,000 hours of operation.    In that regard,

petitioners’ towboats are operated about 8,000 hours per year.

With that much use, the maintenance procedures must be performed

every 3 or 4 years.    Considering that there are 8,760 hours in

most years (365 x 24), 8,000 hours of use translates into the

towboat and engines’ being operated about 91 percent of the time,

or almost 22 hours of each day of a 365-day year.
                              - 26 -

     From respondent’s perspective, the engines wear out every 3

or 4 years and must be completely overhauled.   From petitioners’

perspective, the towboat and its engines, if properly maintained,

have an expected useful life of 40 years.    Petitioners, however,

perform the procedures every 3 to 4 years.   So it could be argued

that each time the procedure is performed it extends an engine’s

life 3 to 4 years and permits the engine to achieve its 40-year

life expectancy.   It cannot be said, however, that the procedures

performed are the equivalent of rebuilding or overhauling an

engine, either in terms of time consumed, the extent of the

procedures, the amount of parts replaced, or cost of the work

performed.   Accordingly, it could also be argued that the

engine’s life is 40 years, and it must be maintained at 3- to 4-

year intervals.

     Petitioners make a distinction between a disabled engine

that must be replaced and/or overhauled and petitioners’

procedures which, for the most part, involve replacement or

repair only of items that show wear.   Petitioners’ approach is

more in the nature of preventative maintenance, and they

automatically replace only a limited number of items, such as

pistons.   The majority of the engine parts are inspected and

cleaned and only replaced or repaired if necessary.   Respondent

emphasizes that petitioners inspect more than 90 percent of the

parts, which, in respondent’s view, is tantamount to performing
                               - 27 -

an overhaul.   These procedures in the case of the representative

engines, however, resulted in the replacement of 119 of the 576

major parts of the engines.   In other words, approximately 79

percent of the parts are reused and approximately 21 percent

replaced.    For an engine overhaul, substantially more parts are

automatically replaced to totally recondition the engine.

     Respondent, however, seeks to have us focus on the fact that

the towboat engines are taken apart by 8 to 10 of petitioners’

employees and that it takes 10 to 12 days to inspect, handle,

clean, and/or replace the various engine parts.   To respondent,

there is no difference between these procedures and an overhaul.

Petitioners, by way of illustration, however, point out that they

expend $100,000 (for parts and labor) to maintain a towboat,

which if purchased new would have cost $6.25 million during the

years in issue.   That represents a 1.6-percent expenditure to

keep the most significant portion of the towboat operating

properly.7   If we were to assume that a new automobile cost

     7
       Petitioners chose to use the cost of a new towboat to make
the illustration more emphatic. However, if the cost of a used
towboat (approximately $2 million) is used, the cost-to-
maintenance ratio would be 5 percent ($100,000 divided by $2
million). If the cost of new engines is used ($1.5 million) the
ratio would increase to almost 7 percent ($100,000 divided by
$1.5 million). Finally, if the cost of a completely overhauled
or rebuilt engines is used ($600,000), the ratio would be almost
17 percent ($100,000 divided by $600,000). Ultimately, the
difference between the cost of the procedures to maintain
($100,000) and the cost of completely overhauled or rebuilt
engines($600,000) is more telling. Plus, there is also the extra
                                                   (continued...)
                              - 28 -

$30,000, then a 1.6-percent maintenance cost would equal $480.

Relatively and comparably, the $100,000 and $480 appear, at least

in size, to represent an incidental as opposed to a major repair,

improvement, or procedure.8

     Petitioners also emphasize that the maintenance procedures

take from 10 to 12 days and that the procedures are performed

during off-peak season, whereas complete overhauls are performed

by third parties and the engine is removed from the towboat

during a 3- to 5- month process.   Accordingly, there is a

substantial time differential between petitioners’ procedures and

a complete overhaul.   By comparison, up to 5 months of towboat

revenue could be lost during an overhaul.

     We think it is significant that petitioners perform the

procedures at a time when the engines are completely serviceable

and the purpose of performing the procedures is to keep the

towboat engines in good operating condition.   This is in contrast

to the cases relied on by respondent where the property was not

serviceable and had to be replaced or completely rebuilt or

overhauled.   For example, respondent relies on Ruane v.

     7
      (...continued)
cost of removal, installation, and refitting a new or rebuilt
engine.
     8
       In that regard, towboats are operated about 8,000 hours
per year, whereas an automobile, for example, would generally be
operated for substantially fewer hours annually. Accordingly,
the cost of normal maintenance for a towboat should be
comparatively larger in a shorter period of time.
                                - 29 -

Commissioner, T.C. Memo. 1958-175, where the question was whether

the cost of work performed on the taxpayer’s coke ovens was

deductible or whether it had to be capitalized.    In that case,

oven linings became unserviceable, and the taxpayer had to

replace them periodically.   In holding that the cost of replacing

the oven linings had to be capitalized, it was found that the

ovens had a normal life expectancy of 3 to 4 years because after

that time, they “fell into such a state of deterioration” that

they had to be shut down and “substantially rebuilt”.    Id.    The

Court then held that the substantial rebuilding of the ovens

prolonged their useful lives.    The other cases relied on by

respondent are similar to Ruane v. Commissioner, supra.

Generally, in the cases relied on by respondent, the taxpayer

allowed the asset to completely deteriorate and then rebuilt it

resulting in a clearly defined new useful life.

     Here petitioners’ towboats (including the engines) do not

completely deteriorate and do not have to be substantially

rebuilt.   Petitioners’ towboats are in operating condition and

are operating when they are brought in to have the maintenance

performed, and all of the significant components and systems that

comprise the towboats (including their engines) are in good

working order immediately prior to the performance of the

maintenance.   Petitioners do not allow their equipment to become

unserviceable before performing the described procedures.
                              - 30 -

Petitioners purchase a towboat, including the engines, with the

expectation that its useful life is 40 years.   To achieve the

expected useful life, petitioners regularly maintain the engines.

They replace a relatively limited number of parts on a regular

basis and inspect the vast majority of remaining parts, replacing

only those that are worn beyond a certain tolerance.

     Petitioners also point out that two new engines would cost

$1.5 million plus installation of approximately $200,000.     If

petitioners had replaced the two engines with overhauled or

rebuilt engines, the cost would have been about $800,000.     By

comparison, the $100,000 maintenance is incidental when compared

to the cost of an overhauled or rebuilt engine.   If respondent’s

perspective in this case were correct, the cost of a rebuilt

engine would be more similar in cost to the maintenance performed

by petitioners’ employees.

     Accordingly, the procedures performed here are routine

maintenance that does not extend the expected 40-year life of the

boat or engine.   The procedures constituted preventative

maintenance that permitted the engine to operate as intended by

the manufacturer and the owner.   Although it could be said that

such procedures extended the life of the engine (in the sense

that failure to perform them would have resulted in engine

default) the life of the engine was not appreciably prolonged by

these procedures.   Considered in a vacuum, a $100,000 cost for
                               - 31 -

maintaining two pieces of machinery appears to be a large sum.

But in the context of a towboat and/or its engines, the amount is

more representative of an incidental expense.    Finally, in this

case the engines are obviously being maintained in good operating

condition and are not being improved in such a manner as to

extend the life expectancy.9

     We now consider whether petitioners’ maintenance procedures

materially added to the value of the towboat.    Petitioners admit

that there must be some value connected with the performance of

the procedures in question.    Petitioners contend that the

maintenance keeps the engines (towboat) in efficient operating

condition, but it does not adapt the engines to a new or

different use, does not extend their useful life (which is

equivalent to the life of the towboat of which they are a part),

and does not materially increase their value.

     Respondent contends that the value is materially increased

and that the procedures performed are not merely incidental.

Other than labeling the value as material and noting that

petitioners expend $100,000 per towboat to perform the

procedures, respondent does not attach any particular value

increase to the performance of the procedures.    As more fully

     9
       It would be without reason to accept the premise that an
owner of a $6.5-million piece of equipment would intentionally
fail to maintain the mechanical portion and incur a cost six
times greater than the cost of maintenance to purchase rebuilt
equipment every 3 or 4 years.
                               - 32 -

discussed above, we do not find that the $100,000 expended was

material relative to the overall value of the towboat or the

engine, even if it were appropriate to consider the engine

separately.

     More importantly, it is not clear that a buyer would pay

$100,000 more for a towboat that had just been maintained, as

opposed to one that needed maintenance.    Certainly, a towboat

buyer would be more interested in a well-maintained towboat and,

in particular, one that recently had maintenance.    But, on this

record, there is no accurate or reliable way to measure the

increment in value that could be attributed to how recently

maintenance had been performed.    Even if $100,000 was the

increment in value, we have found that amount not to be material

in the factual context of this case.

     Finally, the parties address the role, if any, that INDOPCO,

Inc. v. Commissioner, 503 U.S. 79 (1992) (INDOPCO) should play in

our consideration of this issue.    Respondent references INDOPCO

along with section 1.162-4, Income Tax Regs., for the following

position:

            In order to be entitled to a deduction for
            the engine overhaul, petitioners must clearly
            show that it is an incidental repair that
            does not appreciably prolong the property’s
            useful life, but keeps it in an ordinarily
            efficient operating condition. * * *
                             - 33 -

Accordingly, respondent’s use of INDOPCO does not vary from the

standards set forth earlier in this opinion.    There is no unique

aspect or requirement in the Supreme Court’s INDOPCO opinion that

pertains specifically to the issue we consider.    Likewise,

petitioners confirm that the INDOPCO holding did nothing to

change the standards established by the pre-INDOPCO body of law

that deals with repair and maintenance expenses.    Accordingly, it

is not necessary to analyze further the INDOPCO holding in the

context of this case.

     Accordingly, we hold that petitioners are entitled to deduct

the cost of maintaining their towboat engines under section

162.10

     To reflect the foregoing and to give effect to the

agreements of the parties,

                                   Decision will be entered

                              under Rule 155.




     10
       Respondent, on brief, stated that increased interest
under sec. 6621(c) was in dispute, but neither party presented
any argument or findings addressing that item. In that regard,
our holding that petitioners are entitled to deduct the costs in
question would obviate the need to consider sec. 6621(c) with
respect to that adjustment. See also Pen Coal Corp. v.
Commissioner, 107 T.C. 249 (1996).
