8. Airbrake system reconditioning

9. Exterior sandblasting

10. Painting and inspection

The Darby process for rebuilding open-top hopper cars generally involved items 2, 4, 7, 8, 9, and 10 above; and the following:

11. Superstructure dismantling

12. Superstructure rebuilding

13. Safety appliances

The Darby process for rebuilding bulkhead flatcars generally involved items 2, 4, 7, 8, 9, 10, 11, and 12 above.

The Darby process for rebuilding covered hopper cars generally involved items 2, 4, 7, 8, 9, 10, 12, and 13 above; and the following:

14. Roof dismantling

15. Interior rebuilding

The Darby process for rebuilding 1981 U.S. Tax Ct. LEXIS 104">*180 gondola cars generally involved items 2, 4, 7, 8, 9, 10, 11, 12, and 13 above; and the following:

16. Flooring

The Darby process for rebuilding woodchip hopper cars generally involved items 2, 4, 7, 8, 9, 10, 11, and 12 above. New car numbers were assigned upon completion of the Darby rebulding process.

During the years in controversy, the Darby freight car rebuilding process for the cars at issue was supervised by qualified Darby inspectors. During these years, Darby employed an average of three inspectors whose duty was to see that the plans, specifications, and blueprints as agreed to for each series of cars were carried out and that the work was done in a workmanlike manner. The Darby inspectors worked at both the 76 T.C. 1067">*1109 main plant and the shipyard and, on behalf of Darby, inspected each car that was being rebuilt. In addition to the plans, specifications, and blueprints, the Darby inspectors used the AAR Interchange Rules as part of their inspection criteria since these rules are the accepted and governing rules for rebuilding cars for all member railroads. Railway and L & A also had an employee at Darby whose duty was to inspect the rebuilt cars on behalf of Railway and L & A. The 1981 U.S. Tax Ct. LEXIS 104">*181 Railway and L & A inspectors stationed at Darby during the taxable years in issue inspected cars being rebuilt at both the main plant and the shipyard, and it was their duty to see that the plans, specifications, and blueprints as agreed to by Darby and Railway or L & A were fully carried out, that Railway's and L & A's best interests were protected, and that the work was performed by Darby employees in a workmanlike manner. Any required interpretations of the plans, specifications, and blueprints arising during the construction process were generally resolved by reference to the applicable AAR rules.

For purposes of considering the questions presented by this issue, the 3,984 cars are separated below into four groupings under the following headings: "3,137 Freight Cars," "522 Freight Cars," "66 Freight Cars," and "259 Freight Cars." These 3,984 cars constitute tangible personal property subject to depreciation under section 167, or other tangible property subject to depreciation used as an integral part of furnishing transportation services. The useful life of each of the freight cars was 8 years or more.

Petitioner claimed accelerated depreciation (sec. 167(b)) on its pertinent Federal 1981 U.S. Tax Ct. LEXIS 104">*182 income tax returns for all of the cars at issue except those discussed below under the heading "259 Freight Cars." Respondent has disallowed these claims. (See note 28 infra.) Petitioner claimed the investment credit (sec. 38) on its pertinent Federal income tax returns for all of the cars at issue except those discussed below under the heading "522 Freight Cars." ^{301981 U.S. Tax Ct. LEXIS 104">*183} Respondent has disallowed these claims as well.

76 T.C. 1067">*1110 3,137 Freight Cars

In the taxable year 1963, petitioner ³¹ transferred 67 freight cars to: Tamarack, Inc. (60), Comet Distributing Corp. (6), and Darby (1). (Ultimately all 67 cars were received by Darby.) In the listed years, petitioner transferred freight cars to Darby as follows:

These 3,137 freight cars were of various types and all had been acquired by petitioner in prior years. The transfers described above were evidenced in most part by bills of sale from petitioner.

When the 3,137 freight cars were received by Darby, they underwent the appropriate Darby rebuilding process. ³² During 1963, petitioner received from Darby and placed into service 67 rebuilt freight cars. During 1964, petitioner received from Darby and placed into service 500 rebuilt freight cars. On or about January 15, 1964, Darby and petitioner entered into a conditional sales agreement relating to the financing of 497 of the 500 rebuilt freight cars which Darby assigned to 1981 U.S. Tax Ct. LEXIS 104">*184 Chemical Bank New York Trust Co., agent (hereinafter Chemical Bank). In 1965, petitioner received from Darby and placed into service, 703 rebuilt freight cars. On or about April 1, 1965, Darby and petitioner entered into a conditional sales agreement relating to financing of the cost of 685 of the 703 rebuilt freight cars which 76 T.C. 1067">*1111 Darby assigned to Chemical Bank. In 1966, petitioner received from Darby 730 rebuilt freight cars. On or about March 15, 1966, Darby and petitioner entered into a conditional sales agreement relating to the financing of the cost of the 730 rebuilt freight cars which Darby assigned to Chemical Bank. The 730 rebuilt freight cars were placed in service by petitioner during 1966. In 1967, petitioner received from Darby 675 rebuilt freight cars. On or about February 15, 1967, Darby and petitioner entered into a conditional sales agreement relating to the financing of the cost of 691 rebuilt freight cars, which group included the 675 rebuilt freight cars received from Darby and placed into service by petitioner in 1967. The conditional sales agreement was assigned by Darby to Chemical Bank on or about February 15, 1967. During the taxable years ended December 1981 U.S. Tax Ct. LEXIS 104">*185 31, 1968, and December 31, 1969, petitioner received from Darby 462 rebuilt freight cars. On or about May 2, 1968, Darby and petitioner entered into a conditional sales agreement relating to the financing of the cost of the 462 rebuilt freight cars which Darby assigned to Chemical Bank. Petitioner placed in service in 1968, 360 of the 462 rebuilt freight cars, and 102, thereof, were placed in service by petitioner in 1969.

The total costs paid or incurred by petitioner during the taxable years in issue with respect to the 3,137 freight cars were as follows:

During 1963 through 1981 U.S. Tax Ct. LEXIS 104">*186 1969, petitioner requested and received rebuilt recognition status from the AAR on 3,117 of the 3,137 freight cars transferred to Darby. No such request was made of the AAR with respect to 20 of the 3,137 rebuilt freight cars. In the case of 2,645 of the 3,137 cars, the value of the reused parts 76 T.C. 1067">*1112 in each car, as reported to the AAR, exceeded 20 percent, and was as much as 66 percent, of the total value of all parts contained in the car. In the case of 472 of the 3,137 cars, the value of the reused parts in each car, as reported to the AAR, did not exceed 20 percent of the value of all parts contained in the car. ³⁴

522 Freight Cars

In 1962, petitioner sold to Darby Railway Cars, Inc. (DRC), 522 freight cars. DRC transferred the 522 freight cars to Darby where they underwent the rebuilding process described above. DRC, as lessor, and petitioner, as lessee, entered into a lease agreement on or about June 14, 1962, leasing the 522 rebuilt freight cars. ³⁵ In 1963, petitioner purchased the 522 rebuilt freight cars from DRC. On or about August 1, 1963, DRC and petitioner 1981 U.S. Tax Ct. LEXIS 104">*187 entered into a conditional sales agreement relating to the financing of the cost of the 522 rebuilt freight cars which agreement was assigned by DRC to Continental Illinois Bank, agent, on or about August 1, 1963. The 522 rebuilt freight cars were placed in service by petitioner in 1963. The total cost of the 522 freight cars was $ 3,161,144.

66 Freight Cars

In 1962, petitioner sold to Tamarack, Inc., 66 freight cars, 49 were Clejan rack cars on the sale of which abnormal retirement losses were realized during the taxable periods ended October 31, 1962, and December 31, 1962, in the respective amounts of $ 59,591.86 and $ 26,460.45. Tamarack transferred the 66 freight cars to Darby where they underwent the rebuilding process described above.

In the period April 17, 1962, to March 13, 1963, Tamarack, as lessor, entered into certain lease agreements with petitioner leasing 49 rack cars and 17 boxcars -- 66 rebuilt freight cars in all. ³⁶ In 1963, Tamarack sold to Chemical Bank as agent for certain investors (under a conditional sales agreement dated 76 T.C. 1067">*1113 October 1, 1956, as amended, between Pullman-Standard 1981 U.S. Tax Ct. LEXIS 104">*188 Car Manufacturing Co. and petitioner) 47 of the 49 rebuilt rack cars. In addition to this acquisition, petitioner purchased directly from Tamarack 2 of the 49 rebuilt rack cars. As a result of these transactions, petitioner acquired, in 1963, ownership of the 49 rebuilt cars, subject to the lien of the conditional sales agreement with respect to 47 rack cars, at a cost of $ 686,527. Petitioner purchased from Tamarack the remaining 17 rebuilt freight cars at a total cost of $ 186,390. The 66 rebuilt cars were placed in service by petitioner in 1963.

259 Freight Cars

In 1963, petitioner sold to Choctaw, Inc., 184 freight cars. Choctaw transferred the freight cars to Darby where they underwent the rebuilding process described above. In 1964, 1965, 1967, and 1969, petitioner transferred to Darby 13, 35, 9, and 18 freight cars, respectively, where they, too, underwent the same rebuilding process.

On or about July 15, 1963, Choctaw, as lessor, entered into an equipment lease with petitioner leasing 30 chip hopper cars, 75 open-top hopper cars, and 33 covered hopper cars, a total of 138 rebuilt freight 1981 U.S. Tax Ct. LEXIS 104">*189 cars. Choctaw elected to pass through to petitioner the investment credit relating to the 138 rebuilt freight cars costing $ 1,034,250. The 138 rebuilt freight cars were placed in service by petitioner on September 10, 1963. On or about December 19, 1963, Choctaw, as lessor, entered into an equipment lease with petitioner leasing 35 gondola cars and 11 covered hopper cars, a total of 46 rebuilt freight cars. Choctaw elected to pass through to petitioner the investment tax credit relating to the 46 rebuilt cars costing $ 520,675. The 46 rebuilt freight cars were placed in service by petitioner on December 27, 1963.

In 1964, Carland, Inc., purchased from Darby 13 rebuilt freight cars. On or about December 1, 1964, Carland, as lessor, entered into a lease with petitioner leasing four rebuilt boxcars. Carland elected to pass through to petitioner the investment tax credit relating to the four rebuilt boxcars costing $ 69,000. The four rebuilt boxcars were placed in service by petitioner on November 16, 1964. On or about June 16, 1964, Carland, as lessor, entered into a lease with petitioner leasing nine rebuilt boxcars. Carland elected to pass through the investment tax credit 76 T.C. 1067">*1114 1981 U.S. Tax Ct. LEXIS 104">*190 relating to the nine rebuilt boxcars costing $ 99,135. The nine rebuilt boxcars were placed in service by petitioner on June 16, 1964.

During 1965, Carland purchased from Darby 35 rebuilt freight cars. On or about December 24, 1965, Carland, as lessor, entered into a lease with petitioner leasing 25 chip hopper cars and 10 boxcars, a total of 35 rebuilt freight cars. Carland elected to pass through to petitioner the investment tax credit relating to the 35 rebuilt freight cars costing $ 484,559. The 35 rebuilt freight cars were placed in service by petitioner on December 24, 1965.

In 1967, Carland purchased from Darby nine rebuilt boxcars. On or about March 1, 1967, Carland, as lessor, entered into a lease with petitioner leasing nine rebuilt boxcars. Carland elected to pass through to petitioner the investment tax credit relating to the nine rebuilt boxcars costing $ 168,318.54. The nine rebuilt boxcars were placed in service by petitioner on March 1, 1967.

In 1969, Carland purchased from Darby 18 rebuilt freight cars. On or about April 1, 1969, Carland, as lessor, entered into a lease with petitioner leasing 12 rebuilt outfit cars. Carland elected to pass through to petitioner 1981 U.S. Tax Ct. LEXIS 104">*191 the investment tax credit relating to the 12 rebuilt outfit cars costing $ 275,646. The 12 rebuilt outfit cars were placed in service by petitioner on April 1, 1969. On or about October 22, 1969, Carland, as lessor, entered into a lease with petitioner leasing four boxcars and two gondola cars. Carland elected to pass through to petitioner the investment tax credit on the six rebuilt freight cars costing $ 46,638.68. The six rebuilt freight cars were placed in service by petitioner on April 1, 1969.

ULTIMATE FINDINGS OF FACT

3,137 Freight cars. -- During 1963-69, 2,665 of petitioner's freight cars, which petitioner had acquired prior to the years at issue, were "reconstructed" (rebuilt) according to petitioner's plans and specifications.

522 Freight cars. -- During 1962, petitioner leased from Darby Railway Cars, Inc., 522 "reconstructed" (rebuilt) freight cars, and during 1963, petitioner acquired those cars by purchase.

66 Freight cars. -- During 1962 and 1963, petitioner leased from Tamarack, Inc., 66 "reconstructed" (rebuilt) freight cars, and, during 1963, petitioner acquired those cars by purchase.

76 T.C. 1067">*1115 259 Freight cars. -- During 1963, petitioner leased from Choctaw, Inc., 184 1981 U.S. Tax Ct. LEXIS 104">*192 "reconstructed" (rebuilt) freight cars, and, during 1964-69, petitioner leased from Carland, Inc., 75 "reconstructed" (rebuilt) freight cars.

OPINION

The issue here is whether the total costs of certain rolling stock (freight cars) qualify for the section 38 investment credit in light of the definition of "new section 38 property" provided in section 48(b) and qualify for section 167 accelerated depreciation in light of the requirements set forth in section 167(c).

Section 48(b) and 167(c) contain similar wording. Section 48(b) provides:

SEC. 48(b). New Section 38 Property. -- For purposes of this subpart, the term "new section 38 property" means section 38 property --

(1) the construction, reconstruction, or erection of which is completed by the taxpayer after December 31, 1961, or

(2) acquired after December 31, 1961, if the original use of such property commences with the taxpayer and commences after such date.

And 1981 U.S. Tax Ct. LEXIS 104">*193 section 167(c) provides:

SEC. 167(c). Limitations on Use of Certain Methods and Rates. -- Paragraphs (2), (3), and (4) of subsection (b) shall apply only in the case of property (other than intangible property) described in subsection (a) with a useful life of 3 years or more --

(1) the construction, reconstruction, or erection of which is completed after December 31, 1953, and then only to that portion of the basis which is properly attributable to such construction, reconstruction, or erection after December 31, 1953, or

(2) acquired after December 31, 1953, if the original use of such property commences with the taxpayer and commences after such date.

A total of 3,984 freight cars are involved in this issue. In order to address conveniently the questions presented, our discussion below divides these 3,984 cars into several groups.

76 T.C. 1067">*1116 3,137 Freight Cars

During the years 1963 through 1969, Railway ³⁷ transferred 3,137 freight cars to Darby Products of Steel Plate Corp. (Darby). Darby rebuilt the rolling stock in accordance with mutually agreed upon specifications and transferred all 3,137 cars back to Railway. On its Federal income tax returns for 1963 to 1969, inclusive, petitioner 1981 U.S. Tax Ct. LEXIS 104">*194 treated the transactions as sales to Darby. On repurchase of the cars, Railway claimed investment credit and accelerated depreciation on the entire purchase price.

Respondent disallowed the credit and accelerated depreciation with respect to that part of the purchase price equal to Railway's adjusted basis in the cars at the time of the transfer to Darby, but allowed the credit and accelerated depreciation with respect to the remainder of the purchase price.

Respondent argues that these cars were not "acquired" by Railway within the meaning of sections 48(b)(2) and 167(c)(2). Rather, he claims the cars were reconstructed and, as such, are within the contemplation of sections 48(b)(1) and 167(c)(1). As a result, respondent contends there is no basis for treating the entire repurchase price as subject to the investment credit and accelerated depreciation; under sections 48(b)(1) and 167(c)(1), Railway's adjusted basis 1981 U.S. Tax Ct. LEXIS 104">*195 in the reconstructed freight cars (before the sale to Darby) would be excluded from those benefits. ³⁸

It is respondent's position that the 3,137 freight cars were not "acquired" by Railway during the years at issue but were merely rebuilt during that period. We believe respondent is correct.

It is clear from 1981 U.S. Tax Ct. LEXIS 104">*196 the evidence of record that, during the years in question, Railway embarked on a major rebuilding program to 76 T.C. 1067">*1117 modernize its inventory of rolling stock and that Railway contracted with Darby to accomplish this objective. During the years at issue, Railway transferred the 3,137 freight cars to Darby through purported bills of sale. After rebuilding the cars to Railway's prearranged specifications, Darby returned them to Railway, also in purported sales transactions. When viewed from the perspective of economic reality, these alleged sales to Darby and repurchases lack economic substance. See Commissioner v. Brown, 380 U.S. 563">380 U.S. 563 (1965); Helvering v. Lazarus & Co., 308 U.S. 252">308 U.S. 252 (1939); Kraut v. Commissioner, 62 T.C. 420">62 T.C. 420 (1974), affd. 527 F.2d 1014">527 F.2d 1014 (2d Cir. 1975), cert. denied 425 U.S. 973">425 U.S. 973 (1976). Railway was simply engaged in a major refurbishing of its freight car fleet. It was not engaged in a plan to divest itself of rolling stock and to acquire replacement rolling stock. On the contrary, Railway wanted to modernize its freight cars and to employ Darby in the process. Petitioner has failed to establish a business purpose for casting the transactions involving Railway and Darby 1981 U.S. Tax Ct. LEXIS 104">*197 in the form of a sale except to attempt to secure a step-up in tax basis.

Under these circumstances, we must hold that when Darby transferred the freight cars back to Railway during the years at issue, those cars were not being "acquired" by Railway for purposes of sections 48(b)(2) and 167(c)(2). The cars had been reconstructed by Railway and the limitations of sections 48(b)(1) and 167(c)(1) are applicable. Petitioner cannot be permitted the benefits of the investment credit and accelerated depreciation based solely on the form in which the modernization project was cast.

Petitioner makes the alternative argument that, even if sections 48(b)(2) and 167(c)(2) are inapplicable, petitioner is nonetheless entitled to investment credit and accelerated depreciation on Railway's total expenditure (i.e., the total amount paid to Darby to "purchase" the cars) under the provisions of sections 48(b)(1) and 167(c)(1). Petitioner premises this alternative argument on its view that the "construction * * * or erection" of the cars was completed after the dates specified in those sections and that the entire purchase price was paid for the construction or erection of the cars. Respondent, seeking 1981 U.S. Tax Ct. LEXIS 104">*198 to limit the benefits of those sections to only a part of the costs at issue, takes the position that the cars had been reconstructed and that only the cost of reconstruction (exclusive of petitioner's adjusted basis in 76 T.C. 1067">*1118 the freight cars) qualified for purposes of section 48(b)(1) and 167(c)(1). ³⁹

We agree with respondent that 1981 U.S. Tax Ct. LEXIS 104">*199 the freight cars were reconstructed rather than constructed (or erected). We believe Congress intended that the term "reconstruction" be given its commonly accepted meaning. Cf. H. Rept. 1447, supra, 1962-3 C.B. at 516. ⁴⁰ In the context of the statute, "construction" and "erection" are synonymous with each other, but not with "reconstruction." A "reconstructed" freight car is the same as a "rebuilt" or "reconditioned" freight car. Cf. sec. 1.167(c)-1(b)(1), Income Tax Regs.

The Association of American Railroads (AAR) defines a "new" car as "an additional unit having a completely new car body and underframe" which could also have certain specified "secondhand material provided it meets with requirements for new cars per Rule 3." A rebuilt car is defined as "an existing unit that has been recognized as rebuilt under the provisions of" certain sections of the AAR Interchange Rules. ⁴¹ All but a few freight cars involved here have received rebuilt recognition under the AAR Interchange Rules. Consequently, by industry standards 1981 U.S. Tax Ct. LEXIS 104">*200 and practice, these rebuilt freight cars are not new. In fact, in one of the forms required by the AAR in an application of rebuilt recognition status there is the following question: "6. Was the dismantled car written out of your capital account and the reconstructed car accounted for as an added unit?" ⁴² (Emphasis supplied.) The answer to this question supplied by petitioner was: "Cars were written out of the Capital Account and the reconstructed car accounted for as an added unit."

76 T.C. 1067">*1119 After a careful consideration of the evidence bearing on this question, it is our conclusion that the freight cars at issue were "reconstructed" by Railway. In our view, the process of disassembling the various components of a freight car, the examination and discarding of unusable or unrepairable parts and their replacement with new or restored parts (including such parts which serve as an improvement or which meet changed standards), and the reassembling of those parts into a freight car (of the same or different type), i.e, the 1981 U.S. Tax Ct. LEXIS 104">*201 work which Darby performed, are all part of the "reconstruction" activity contemplated by sections 48(b)(1) and 167(c)(1). ⁴³

In light of this conclusion and respondent's position with respect to these 3,137 cars, we need not discuss at this point the requirement that the reconstruction work be completed "by the taxpayer." See sec. 48(b)(1); secs. 1.48-2(a)(1), 1.167(c)-1(a)(1), Income Tax Regs.

Accordingly, we conclude that these 3,137 cars are entitled to the investment credit and to accelerated 1981 U.S. Tax Ct. LEXIS 104">*202 depreciation to the extent allowed by respondent.

522 Freight Cars

In 1962, Railway sold 522 cars to Darby Railway Cars, Inc. (DRC), which in turn transferred them to Darby for rebuilding. In 1962, Railway leased the 522 cars from DRC and, in 1963, Railway acquired the cars by purchase from DRC. As with the other freight cars at issue herein, petitioner claims the total purchase price is within the purview of sections 48(b)⁴⁴ and 167(c).

Respondent does not dispute that Railway sold these cars to 76 T.C. 1067">*1120 DRC and "acquired" them from DRC in 1963 within the meaning of sections 48(b)(2) and 167(c)(2). ⁴⁵ However, respondent takes the position that Railway was not the original user of these cars as required by those two sections and hence Railway does not qualify for the investment credit or accelerated depreciation with respect to any part of the repurchase price. Respondent argues that the "original use" of these cars commenced with DRC as lessor and not with Railway. Additionally, he argues that, since DRC did not elect 1981 U.S. Tax Ct. LEXIS 104">*203 to pass through the investment credit pursuant to section 48(d), Railway is not entitled to the investment credit under that provision. (We consider the section 48(d) passthrough in the discussion below entitled "259 Freight Cars.") Also, respondent argues that Railway fails to qualify as the original user after the critical dates of the 522 cars because they were "rebuilt" property within the meaning of section 1.48-2(b)(7), Income Tax Regs. See also sec. 1.167(c)-1(a)(2), Income Tax Regs.

Both sections 48(b)(2) and 167(c)(2) contain a requirement that the "original use" of the subject property must "[commence] with the taxpayer" after the relevant effective dates. "Original use" is discussed in both the House and Senate committee reports on H.R. 8300. 1981 U.S. Tax Ct. LEXIS 104">*204 The term relates to "property * * * new in use, that is, never before having been subject to depreciation whether or not depreciation deductions relating to such property were allowable." H. Rept. 1337, 83d Cong., 2d Sess. A49; S. Rept. 1622, 83d Cong., 2d Sess. 203. The principles applicable under section 167(c)(2) are to be applied under section 48(b)(2) in determining whether the property is "acquired" by the taxpayer and whether the "original use" of the property commences with the taxpayer. H. Rept. 1447, 87th Cong., 2d Sess., 1962-3 C.B. 402, 519; S. Rept. 1881, 87th Cong., 2d Sess., 1962-3 C.B. 703, 862.

The regulations provide that "The term 'original use' means the first use to which the property is put, whether or not such use corresponds to the use of such property by the taxpayer." Secs. 1.167(c)-1(a)(2), 1.48-2(b)(7), Income Tax Regs. Given this definition, we are unable to conclude that Railway was the 76 T.C. 1067">*1121 original user of the 522 freight cars. It is clear that DRC was the original user.

For purposes of section 48(b)(2), the fact that Railway initially leased the cars from DRC is significant. In Haddock v. Commissioner, 70 T.C. 511">70 T.C. 511 (1978), the taxpayer leased certain 1981 U.S. Tax Ct. LEXIS 104">*205 equipment which he subsequently purchased from his lessors. Although no election under section 48(d) was made by any of the lessors to treat the taxpayer as having acquired the equipment when it was leased, the taxpayer claimed investment credits for the years in which he purchased the equipment. We denied the taxpayer's claim because, in the absence of an election, the "original use" of the leased property commenced with the lessor which had used the equipment in its leasing operation. See 70 T.C. 511">70 T.C. 514. ⁴⁶

We see no meaningful distinction between the facts of the Haddock case and the facts of the case at bar. ^{471981 U.S. Tax Ct. LEXIS 104">*206} We must therefore agree with respondent that Railway, as lessee, does not satisfy the "original use" requirement. While Haddock has specific reference to section 48(b)(2), the case has obvious application to section 167(c)(2), given the similar language of the two provisions.

Support for respondent's contentions is also found in section 1.48-2(b)(7), Income Tax Regs., which provides that "a reconditioned or rebuilt machine acquired by the taxpayer will not be treated as being put to original use by the taxpayer." Similarly, section 1.167(c)-1(a)(2), Income Tax Regs., provides that "a reconditioned or rebuilt machine acquired after December 31, 1953, will not be treated as being put to original use by the taxpayer even though it is put to a different use." For the reasons similar to those set forth in the portion of this opinion entitled "3,137 Freight Cars," we agree with respondent that the 76 T.C. 1067">*1122 522 freight cars currently under 1981 U.S. Tax Ct. LEXIS 104">*207 discussion were "rebuilt," as that term is used in sections 1.48-2(b)(7) and 1.167(c)-1(a)(2), Income Tax Regs.

We do not believe these 522 "reconstructed" (rebuilt) cars fall within the purview of sections 48(b)(1) and 167(c)(1). In view of the intervening corporate entities and the manner in which the transactions were structured, the facts relating to these 522 cars differ sufficiently from those relating to the group of 3,137 cars to warrant a different result. In our view, the 522 cars cannot be viewed as having been "constructed, reconstructed, or erected by the taxpayer," as that term is used in sections 1.167(c)-1(a)(2) and 1.48-2(a) and (b), Income Tax Regs.^{481981 U.S. Tax Ct. LEXIS 104">*208}

We recognize that the requirement that the reconstruction work be completed "by the taxpayer" does not necessitate a showing that the work was actually performed by the taxpayer. Rather, it need only be shown that the taxpayer exercised the requisite degree of control and supervision over the details of reconstruction relating to the manner and means of performing the work. Public Service Co. of New Mexico v. United States, 431 F.2d 980">431 F.2d 980 (10th Cir. 1970). See Lykes Bros. Steamship Co. v. United States, 206 Ct. Cl. 354">206 Ct. Cl. 354, 513 F.2d 1342">513 F.2d 1342 (1975); Pacific Far East Line, Inc. v. United States, 206 Ct. Cl. 378">206 Ct. Cl. 378, 513 F.2d 1355">513 F.2d 1355 (1975). See also sections 1.167(c)-1(a)(1) and 1.48-2(b)(1), Income Tax Regs., which provide that "Property is considered as * * * reconstructed * * * by the taxpayer if the work is done for him in accordance with his specifications." But these interpretations apply where the taxpayer contracts with someone else to do the work for the taxpayer. We do not believe they are applicable to the circumstances presently before us. The 522 freight cars under discussion were sold to a second party which contracted to have the reconstruction 1981 U.S. Tax Ct. LEXIS 104">*209 work done by a third party and then leased the reconstructed cars to Railway. Under such circumstances, we do not believe the reconstruction work can be considered as having been completed "by the taxpayer" within 76 T.C. 1067">*1123 the meaning of section 48(b)(1) and the cited regulations. If these cars are to qualify for the investment credit and accelerated depreciation, they must do so under sections 48(b)(2) and 167(c)(2).

Accordingly, petitioner is not entitled to the investment credit and accelerated depreciation for these 522 freight cars.

66 Freight Cars

In 1962, Railway sold 66 freight cars to Tamarack which in turn transferred them to Darby for rebuilding. In 1962 and 1963, Railway leased the 66 cars from Tamarack, and, in 1963, Railway acquired the cars by purchase from Tamarack. Here, also, petitioner claims the total purchase price is within the purview of sections 48(b) and 167(c). Respondent's position with respect to these 66 cars is identical to that described above in our discussion of the 522 cars. The facts relating to the 522 cars and these 66 cars are quite similar. For the reasons given above in our discussion entitled "522 Freight Cars," we conclude that petitioner is not 1981 U.S. Tax Ct. LEXIS 104">*210 entitled to the investment credit and accelerated depreciation for these cars.

259 Freight Cars

In 1963, Railway sold 184 cars to Choctaw, which in turn transferred them to Darby for rebuilding. In 1964, 1965, 1967, and 1969, Railway sold a total of 75 cars to Carland, which in turn transferred them to Darby for rebuilding. Railway leased the 184 rebuilt cars from Choctaw in 1963 and leased the 75 rebuilt cars from Carland during 1964-69. As to these 259 cars, petitioner's claim herein is limited to the section 48 investment credit. Both Choctaw and Carland elected to pass the credit through to Railway pursuant to section 48(d). Respondent's position is that the pass through election for these cars was not proper on the facts of this case.

Section 48(d) provides in part:

(1) General rule. -- A person * * * who is a lessor of property may (at such time, in such manner, and subject to such conditions as are provided by regulations prescribed by the Secretary) elect with respect to any new section 38 property * * * to treat the lessee as having acquired such property * * *

The pertinent regulations mirror the statutory requirement that the property subject to the election must be "new section 381981 U.S. Tax Ct. LEXIS 104">*211 76 T.C. 1067">*1124 property." Sec. 1.48-4(a)(1)(ii) and (iii), Income Tax Regs. The last-cited regulatory provision states that the following conditions must be satisfied in order for there to be a valid passthrough election:

(iii) The property would constitute "new section 38 property" to the lessee if such lessee had actually purchased the property. Thus, the election is not available if the lessee is not the original user of the property. See paragraph (b) of this section for the application of the rules relating to "original use" in the case of leased property. * * *

Section 1.48-4(b), Income Tax Regs., provides in part:

The determination of whether the lessee qualifies as the original user of leased property shall be made, under paragraph (b)(7) of sec. 1.48-2, as if the lessee actually purchased the property. Thus, the lessee would not be considered the original user of the property if it has been previously used by the lessor or another person, or if it is reconstructed, rebuilt, or reconditioned property. However, the lessee would be considered the original user if he is the first person to use the property for its intended function. Thus, the fact that the lessor may have, for example, 1981 U.S. Tax Ct. LEXIS 104">*212 tested, stored, or attempted to lease the property to other persons will not preclude the lessee from being considered the original user.

Respondent argues that the "original use" of the leased 259 cars did not commence with Railway after the relevant date because they were rebuilt by Darby prior to being leased to Railway. ^{491981 U.S. Tax Ct. LEXIS 104">*213} Thus, the "original use" test was not met, according to respondent, and the cars were not "new section 38 property." As a result, respondent concludes that the elections made by Choctaw and Carland to pass through the investment credit were not valid.

For reasons similar to those given above in our discussion entitled "3,137 Freight Cars," we agree with respondent that the 259 cars at issue were "reconstructed, rebuilt, or reconditioned property," as that term is used in section 1.48-4(b), Income Tax Regs. See also sec. 1.48-2(b)(7), Income Tax Regs. See and compare the discussion above entitled "522 Freight Cars." Since 76 T.C. 1067">*1125 the 259 freight cars were "reconstructed" or "rebuilt" Railway cannot qualify as the original user under the above-cited regulatory provisions. ^{501981 U.S. Tax Ct. LEXIS 104">*214} Accordingly, the 259 cars were not "new section 38 property" (see sec. 1.48-4(a)(1)(iii), Income Tax Regs.), and no investment credit with respect to those cars could properly be passed through to Railway under section 48(d). ⁵¹

FINDINGS OF FACT

Throughout the years at issue, petitioner, as the rail in its tracks became worn, replaced such worn rail with either new or better used track. The replaced track, depending on the extent of the wear, was either sold as scrap or was relaid somewhere else as additional or better track or was placed in inventory to be used for such purpose at a later date. 1981 U.S. Tax Ct. LEXIS 104">*215 Under the retirement-replacement-betterment (RRB) method of accounting used by petitioner, the value assigned to the rail that is picked up but is to be used again elsewhere in the system (relay rail) enters into the computation of the charge made to the operating expense account and thus has an impact on taxable income. The higher the value assigned to the relay rail the lower the deduction will be, and an increase in taxable income results.

Railway and L & A were required to maintain and did maintain their accounts relating to rail under the Interstate Commerce Commission (ICC) Uniform System of Accounts for Railroad Companies during all the taxable years in issue. During the taxable years 1962 to 1969, Railway and L & A used the RRB method of accounting for Federal income tax and ICC purposes 76 T.C. 1067">*1126 for determining the amounts of allowable deductions with respect to property in track accounts. ⁵²

"Relay rail" is rail which has been removed (released) from the tracks but which has additional service life 1981 U.S. Tax Ct. LEXIS 104">*216 remaining; it must be reasonably straight and free of major defects and may contain only minor defects.

"Scrap rail" is rail which has been removed (released) from the tracks with no additional service life remaining, and consists of broken rail, defective rail, short rail, or other rail not suitable for relay.

When a planned relay, i.e., one involving a tangent stretch of track a mile or more in length or the length of a curve, occurred on Railway or L & A during the taxable years in issue, the accounting department was advised by the road foreman of the pattern weight and linear feet of the rail released. From this information, the accounting department determined mathematically the number of tons of rail involved in the relay and made appropriate accounting entries.

The dollar amounts assigned by Railway and L & A to rail released from the track structure and placed in inventory during the taxable years in issue depended upon whether the released rail was to be scrapped or relaid. During all the taxable years here in issue, Railway and L & A used approximately $ 20-per-net-ton pattern weight for scrap rail and approximately $ 30-per-net-ton pattern weight for relay rail. Prior to 1981 U.S. Tax Ct. LEXIS 104">*217 1957, the amounts in use were approximately $ 12.50- and $ 20-per-net-ton pattern weight for scrap rail and relay rail, respectively.

During the taxable years here in issue, Railway and L & A released and relaid (picked up and reused) and charged to track accounts as additions and betterments the following tons of relay rail:

76 T.C. 1067">*1127 During these taxable years, Railway and L & A, pursuant to the accounting practices described above, used the following values for Federal income tax, ICC, and financial accounting purposes for relay rail released and relaid and charged to track accounts as additions and betterments:

Respondent assigned the following amounts as representing the fair market values (per ton) of Railway's and L & A's rail as new:

Respondent assigned the following value to relay rail released and relaid and charged to track accounts as additions and betterments: 76 T.C. 1067">*1128

In determining the net adjustments to taxable income for the taxable years in issue arising out of the increases in value assigned to relay rail, respondent amortized said increases over a 20-year period on a straight line basis and reduced the gross adjustments to 1981 U.S. Tax Ct. LEXIS 104">*219 taxable income relating to relay rail by the amount of such amortization, beginning with the taxable year immediately following the taxable year with respect to which each such adjustment was made.

The values assigned to relay rail by respondent and the determined amortization of such adjustments as set forth above resulted in the following adjustments to the taxable income of Railway for each of the taxable years in issue.

The values assigned to relay rail by respondent and the determined amortization of such adjustments as set forth above resulted in the following adjustments to the taxable income of Railway for each of the taxable years in issue. 76 T.C. 1067">*1129

1981 U.S. Tax Ct. LEXIS 104">*220 Construction of the Railway line commenced in Jackson County, Mo., in 1866. The line was completed to Port Arthur, Tex., by 1897. Ownership of Railway was substantially the same throughout this period, resulting in a track structure with substantially homogeneous engineering characteristics.

Construction of the L & A line commenced at Stamps, Ark., in 1896. L & A subsequently acquired a number of other lines, including the Louisiana Railway & Navigation Co., and the Louisiana Railway & Navigation Co. of Texas. The accumulation of the various lines resulted in a track structure with diversified engineering characteristics.

The net change between December 31, 1962, and December 31, 1968, in all classes ⁵³ of track operated by Railway was 14.86 miles determined as follows:

The 1981 U.S. Tax Ct. LEXIS 104">*221 net change between December 31, 1962, and December 31, 1968, in all classes of track operated by L & A was 2.93 miles determined as follows: 76 T.C. 1067">*1130

Railway and L & A filed a combined Railroad Annual Report Form A with the ICC for the calendar year 1969. The total net mileage change during 1969 in all classes of track for Railway and L & A combined was 4.14 miles.

Between December 31, 1961, and December 31, 1969, the net mileage change in Railway's total track structure was less than 20 miles.

Between December 31, 1961, and December 31, 1969, the net mileage change in L & A's total track structure was less than 10 miles.

The engineering characteristics of rail depend upon the type of manufacturing process, the chemical composition, and the weight. Steel rail is presently manufactured by one of two processes, the basic oxygen process and the open hearth process. The basic oxygen process is a more efficient method of steel production than the open hearth process. Prior to World War I, the Bessemer process was in general use. This process produced rails of quality 1981 U.S. Tax Ct. LEXIS 104">*222 inferior to those produced by the basic oxygen and open hearth processes. Rails are high carbon steel. Rails with a pattern weight of over 110 to 112 pounds normally have the following chemical composition:

Wear resistance and brittleness increase with increased carbon content. The pattern weight of rail installed in the track structures of common carrier railroads in the United States since 1900 has ranged from 52 to 155 pounds.

With respect to each of the taxable years in issue, Railway was required to maintain accounting records reflecting by miles the gauge of track and pattern weight of rail in place in its mainline track and to report such information to the ICC on 76 T.C. 1067">*1131 Schedule 517 of the Annual Report Form A. The pattern weights ^{541981 U.S. Tax Ct. LEXIS 104">*223} of rail by miles in place in Railway's main line track at December 31, 1962, and December 31, 1968, were as follows:

During the taxable years in issue, the predominant pattern weight of rail in place in Railway's Northern Division, extending from Kansas City, Mo., to De Queen, Ark., was 127 pounds. During the taxable years in issue, the predominant pattern weights of rail in place in Railway's Southern Division, extending from De Queen, Ark., to Port Arthur, Tex., were 112 and 115 pounds. During the taxable years in issue, the predominant pattern weight of rail in place in Railway's Port Arthur Terminal Division main line track was 115 pounds. The predominant pattern weights of rail in the Port Arthur Terminal Division branch line tracks were 90, 85, and 80 pounds. During the taxable years in issue, the predominant pattern weight of rail in place in Railway's (Kansas City) Terminal Division main line track was 85 pounds. The pattern weight of rail in the (Kansas City) Terminal Division main line track was 85 pounds. The pattern weights of rail in the (Kansas City) Terminal 1981 U.S. Tax Ct. LEXIS 104">*224 Division branch line tracks were 127, 115, 112, 100, 80, 75, 70, and 65 pounds.

The elevation of Railway's track structure at Kansas City, Mo., is 800 feet above mean sea level. From Kansas City, the 76 T.C. 1067">*1132 track structure generally rises in a series of undulating grade changes to Rich Mountain near Mena, Ark., where it reaches its highest elevation of approximately 1,622 feet above mean sea level. From Rich Mountain, the track structure descends 1,100 feet in 70 miles to 500 feet above mean sea level at De Queen, Ark. From De Queen to the Gulf Coast, the track structure descends in a series of mildly undulating grade changes, reaching mean sea level at Port Arthur, Tex.

With respect to each of the taxable years in issue, L & A was required to maintain accounting records reflecting by miles the gauge of track and pattern weight of rail in place in its main line track and to report such information to the ICC on schedule 517 of its Annual Report Form A. The pattern weights of rail by miles in place in L & A's main line track at December 31, 1962, and December 31, 1968, were as follows:

During 1981 U.S. Tax Ct. LEXIS 104">*225 the taxable years in issue, the predominant pattern weight of rail in place in L & A's "Texas Line," extending from Farmersville, Tex., to Texas Junction, La., was 90 pounds.

During the taxable years in issue, the predominant pattern weight of rail in place in L & A's "Hope" line, extending from Hope, Ark., to Minden, La., and the "Hill Line," from Minden to Alexandria, La., was 90 pounds.

During the taxable years in issue, the predominant pattern weights of rail in place in L & A's Shreveport Line, extending from Shreveport to New Orleans, La., were 90 and 115 pounds.

As of December 31, 1961, the combined main line mileage of Railway and L & A was approximately 1,558 miles. Of this total, approximately 1,245 miles, or about 80 percent, lay in tangent 76 T.C. 1067">*1133 (straight) track, and approximately 313 miles, or about 20 percent, lay in curved track.

The curve in a particular segment of a railroad track is measured by the degree of the central angle which is determined by the intersection at the center of the curve of two lines. These lines extend from either end of a 100-foot chord (straight line) both ends of which touch the curve. The 313 miles of curves on the main line of Railway and L & A 1981 U.S. Tax Ct. LEXIS 104">*226 at December 31, 1961, ranged from 0 o 1' to 10 o.

The standard length of a segment of rail in use by common carrier railroads in the United States is 39 feet. The three principal parts making up the rail section are the head, the web, and the base, the head being the top part of the rail on which the trains roll, the base being the bottom of the rail, which is attached with plates to the ties, and the web being the thinner, middle part of the rail between the head and the base. With respect to 85-, 90-, 112-, and 127-pound rail, the base of the rail constitutes approximately 40 percent of the total area and weight. The area and weight of the web vary from 21 percent to 25.1 percent; the area and weight of the head vary from 42 percent to 35.1 percent, depending upon the pattern weight of the rail.

Rails in place in the track structure are connected by angle bars which are placed on either side of the rail web at the point of the juncture of two contiguous rails. The angle bars are fastened together by bolts running through the webs of the rails. The contact area between the angle bar and the head and the base of the rail are referred to as "fishing surfaces."

Tie plates are metal plates 1981 U.S. Tax Ct. LEXIS 104">*227 which are placed between the base of the rails and the crossties to distribute the load and to prevent the rails from cutting into the ties. The tie plates are affixed to the crossties by large metal spikes, and a portion of the head of the spikes rests on the base of the rail holding it firmly in place.

The surcharge or loading of trains, including locomotives and freight cars, passing over the track structure causes physical wear and tear upon the track structure, including the rails, angle bars, tie plates, and crossties.

The principal wear with respect to the rail portion of the track structure occurs on the head of the rail, specifically on the inner or gauge side of the rail where the flange of the metal wheel contacts the rail. Wear also occurs on the fishing surfaces 76 T.C. 1067">*1134 between rail ends and angle bars and between the base of the rails and the tie plates. Rail wear is evidenced by the wearing down of the rail at the points of contact, as described above, resulting in an accompanying loss of weight. The continuing contact between the flange of the metal wheels of locomotives and freight cars and the gauge side of the head of the rail wears down the contour of the rail. Rail on 1981 U.S. Tax Ct. LEXIS 104">*228 curved track wears more rapidly than rail on a tangent track.

The outer rail in a curve is placed at a higher elevation than the inner rail in order to counteract the effect of the centrifugal force generated by the passing of a train around the curve. The effect of such centrifugal force is to throw the wheels of the train cars against the outside of the curve, placing more pressure on the outside rail and wearing it away faster than the inner rail. The head of the inside rail on the curve is flattened.

Rail wear occurs on those portions of track with ascending gradient ⁵⁵ because of the slippage in obtaining traction going uphill and on those portions of track with descending gradient in obtaining braking action going downhill. The application of sand to the rail to obtain additional traction where needed on grades and in braking also causes additional wear on the rail.

Unstable grading and underlying soil conditions cause the track structure to sub-surface and get out of line, which results in low joints. Low joints cause end batter and other rail wear.

Wear on rail produces a loss 1981 U.S. Tax Ct. LEXIS 104">*229 of weight in the head, web, and base of the rail, the majority of the loss occurring in the head area. Wear on the head of a rail is measured in terms of the percentage of weight loss from the original pattern weight of the head portion. The weight loss is directly proportional to the loss of area of the railhead. The amount of railhead wear can be measured by an instrument known as a caliper and by visual inspection.

When the head of the rail is 20 percent or more worn away, the flange of the rail wheel begins to strike the angle bars on the gauge side of the rails. The striking of the angle bars by locomotive and/or freight car wheels sometimes causes broken flanges, broken angle bars, loose joints, and derailments.

As the area of the railhead decreases, the frequency with 76 T.C. 1067">*1135 which the rail wheels strike the angle bars increases, with a resulting increase in operational hazards. An individual experienced in railroad track maintenance can determine with a reasonable degree of accuracy the percentage of head wear in a particular segment of track by visual inspection of the rail and angle bars. In determining whether a particular segment of rail was suitable for continued use in Railway's 1981 U.S. Tax Ct. LEXIS 104">*230 and L & A's track structure, the criterion applied by Railway and L & A during the taxable years in issue was primarily the degree of wear on the railhead.

Under the relay rail policies followed by Railway and L & A during the taxable years in issue, rails were generally, but not always, classified as scrap if 25 percent or more of the railhead was worn away; if more than 20 percent but less than 25 percent of the railhead was worn away, such rails were classified as relay rail.

The initial determination of whether a particular segment of rail to be released in connection with a planned relay by Railway and L & A was relay rail or scrap rail was generally made by visual inspection and caliper measurements by engineering employees during their regular inspections while the rails were in place in the track structure.

After the segments of rail were taken up, a determination was then made with respect to each individual rail as to whether such rail was relay rail or scrap rail. Rail released from the track structure and classified as relay rail was generally loaded onto flatcars and transported to the relay site. Rail released from the track and classified as scrap was generally sold alongside 1981 U.S. Tax Ct. LEXIS 104">*231 the track to scrap dealers.

With respect to each planned relay during the taxable years in issue, the accounting and engineering records maintained by Railway and L & A reflected the number of linear feet of relay rail relaid in the track structure by pattern weight and location, and the amounts to be expensed or to be capitalized as additions and betterments, based upon an assigned amount of $ 30 per ton.

The value of a relay rail is dependent upon the amount of service life remaining in the individual rail at the time it is released from the track structure. A rail which has sustained a loss of 25 percent of the cross-sectional head area will have sustained an average overall loss of 10 percent of its pattern 76 T.C. 1067">*1136 weight. Scrap rail is sold on the basis of scale (actual) weight and not pattern weight.

The process of releasing rail from one location in the track system and relaying it in another location in the system is frequently referred to as the "cascading" of rail. Generally, the rail is removed from a high-density traffic area, such as the main line, to a lower-traffic density area, such as a branch line or yard.

The general relay rail policy of Railway and L & A at all times relevant 1981 U.S. Tax Ct. LEXIS 104">*232 hereto was to derive a very high portion of the total service life of new rail at the location of its original installation, and to cascade the rail only once. The term "relay rail" did not in general refer to a single rail but normally involved a planned relay of a mile or more of tangent track, or all of the rail necessary to relay a particular curve. When a planned relay was contemplated, normally the section foreman would submit a report to the roadmaster. Together they would inspect the rail involved and submit a report to the division engineer. The roadmasters had responsibility for a district usually consisting of about 100 miles of track and they inspected their districts at least twice weekly; the section foremen were responsible for about 20 miles of track, which increased over the period here involved to 50 or 60 miles, and which they came in contact with daily. If the amount of worn rail was large, the division engineer would make a report to the chief engineer and a decision was made with respect to the planned relay.

Under the aforesaid general relay rail policy of Railway and L & A, rail was taken up for relay from its original location when it had sustained approximately 1981 U.S. Tax Ct. LEXIS 104">*233 20-percent cross-sectional head wear. Rail which has sustained 20-percent cross-sectional head wear has exhausted 80 percent of its service potential since rail with 25-percent cross-sectional head wear is scrap.

Arthur D. Little, Inc., prepared a report for the U.S. Department of Justice and the Internal Revenue Service dated September 1973, entitled "The Value of Relay Rail." The Little Report states that the proper formula to determine the value of relay rail should take into account the following factors:

(a) The amount to be assigned to the worth-as-rail factor should be 35.7 percent of the difference between the value of new rail and scrap rail;

(b) The value of scrap rail should be 90 percent of the value employed by the 76 T.C. 1067">*1137 Internal Revenue Service to account for the weight of rail that may be lost through use.

Petitioner's witness, Thomas S. Carter, president of Railway and L & A, a professional engineer having approximately 35 years of experience in the rail industry, and familiar with Railway's and L & A's relay rail policies, made a study of the engineering principles involved in the valuation of relay rail under such policy and prepared a report for this case entitled "Development 1981 U.S. Tax Ct. LEXIS 104">*234 of a Formula to Determine Value of Relay Rail on KCS Lines."

Carter's report sets forth the following algebraic formula for the valuation of relay rail released from Railway's and L & A's track structures and relaid as additions and betterments during the taxable years in issue:

VR = .9VS + .2 (VN - .9 VS)

where:

VR = Value of relay rail ($ /net ton)

VN = Value of new rail ($ /net ton)

VS = Value of scrap rail ($ /net ton)

Relays which may be required prior to the occurrence of 20-percent head wear, as a result of various metallurgical defects in the rail, such as transverse defects, engine burns, compound fissures, bolt hole defects, and others, are not taken into account in Carter's formula. ^{561981 U.S. Tax Ct. LEXIS 104">*235}

ULTIMATE FINDINGS OF FACT

The amounts to assign to relay rail are properly determined by reference to fair market value. The proper formula to be applied is:

V = .25 (N - .9S) + .9S

where:

V = fair market value of relay rail

N = price of rail new

S = price of rail for scrap based on pattern weight

OPINION

Throughout the years at issue, Railway and L & A used the retirement-replacement-betterment (RRB) method of accounting, both for book and tax purposes, and in accordance with that method, determined the amounts of allowable deductions with respect to property in their track accounts, including rail. During these taxable years, Railway and L & A picked up and relaid 10,085 tons and 6,085 tons of rail, respectively, which they charged to track accounts as additions and betterments. (Such rail is referred to herein as relay rail.) For RRB purposes, Railway and L & A assigned to relay rail an amount of approximately $ 30 per ton. ^{571981 U.S. Tax Ct. LEXIS 104">*236} Respondent seeks herein to assign greater amounts to the relay rail, ⁵⁸ resulting in increased taxable income for Railway and L & A during the years at bar. ⁵⁹

Succinctly stated, the relay rail issue is whether, under the RRB method, the proper amount (i.e., salvage value) to be assigned to rail released from the track system and relaid as additions and betterments during the years at issue is to be determined by reference to the cost of the released rail, as petitioner contends, or by reference to its fair market value, as respondent contends.

Respondent's position in this regard ⁶⁰ has been the subject of considerable litigation, and the courts have been consistent in upholding respondent's use of fair market value to determine the salvage value of relay rail. The most recent opinion of this Court on this subject is Southern Pacific Transportation Co. v. Commissioner, 75 T.C. 497">75 T.C. 497, 75 T.C. 497">732-739 (1980), 1981 U.S. Tax Ct. LEXIS 104">*237 in which we followed our prior opinions in Seaboard Coast Line Railroad Co. v. Commissioner, 72 T.C. 855">72 T.C. 855 (1979), affd. per curiam 645 F.2d 72">645 F.2d 7276 T.C. 1067">*1139 (5th Cir. 1981), and in Louisville & Nashville Railroad Co. v. Commissioner, 66 T.C. 962">66 T.C. 962 (1976), affd. as to this issue 641 F.2d 435">641 F.2d 435 (6th Cir. 1981). We have considered petitioner's extensive arguments, and we see no reason to depart from the position which we adopted in those cases.

Other courts have also reached the conclusion that the salvage value of relay rail for RRB purposes is its fair market value at the time it is picked up. See United States v. St. Louis -- San Francisco Railway Co., 537 F.2d 312">537 F.2d 312 (8th Cir. 1976), affg. an unreported opinion ( E.D. Mo. 1975, 35 AFTR 2d 75-1317, 75-1 USTC par. 9395); Missouri Pacific Railroad Co. v. United States, 204 Ct. Cl. 837">204 Ct. Cl. 837, 497 F.2d 1386">497 F.2d 1386 (1974); Chicago, Burlington & Quincy Railroad Co. v. United States, 197 Ct. Cl. 264">197 Ct. Cl. 264, 455 F.2d 993">455 F.2d 993 (1972), revd. on another issue 412 U.S. 401">412 U.S. 401 (1973).

In sum, we are in agreement with the fair-market-value approach advanced herein by respondent. ⁶¹ The rationale for our conclusion is set 1981 U.S. Tax Ct. LEXIS 104">*238 forth at length in the cited opinions. We believe this matter is now well settled and warrants no additional discussion.

We next turn to the question of how to calculate the fair market value of the relay rail at issue herein. Respondent argues that the proper method for valuation of the rail is that set forth in Rev. Proc. 68-46, 1968-2 C.B. 961. That revenue procedure permits railroads to determine the salvage value of relay rail "at an amount equal to the average of the market price for such 1981 U.S. Tax Ct. LEXIS 104">*239 track materials new, and the market price for such track materials as scrap, as of the taxable year of recovery." This method of valuation may be expressed in terms of a formula as follows:

V = .50 (N - S ) + S

where:

V = value of relay rail

N = price of rail new

S = price of scrap rail

76 T.C. 1067">*1140 Petitioner points to the arbitrary nature of respondent's approach and argues that his formula should be modified to comport with the evidence which it has presented herein. Petitioner relies on Chesapeake & Ohio Railway Co. v. Commissioner, 64 T.C. 352">64 T.C. 352, 64 T.C. 352">384-393 (1975), hereinafter referred to as the "C & O" case. In that case, we held that the taxpayer's evidence warranted the use of the following formula to value the relay rail there at issue (64 T.C. 352">64 T.C. 392):

V = .30 (N - .9S) + .9S

where

V = fair market value of relay rail

N = price of rail new

S = price of rail for scrap based on pattern weight

In arriving at this variation of the Commissioner's formula, we concluded that there should be a modification of scrap value by a factor of .9 to account for the difference in the pattern weight used by the Commissioner and the actual weight by which the scrap rail was in fact sold. We also concluded in C & O that 1981 U.S. Tax Ct. LEXIS 104">*240 the Commissioner's formula should be adjusted downward to reflect 30 percent rather than 50 percent of the price difference between new and scrap rail. In making this latter modification, we took into account all matters of record, including (1) evidence showing the useful life of rail, based upon gross tonnage of freight, and (2) the prices at which relay rail was in fact being sold. See 64 T.C. 352">64 T.C. 391-392.

As in the C & O case, the evidence in the present case warrants a modification of scrap value by a factor of .9 to account for the difference between the pattern weight of rail and the actual weight at which it was sold. We believe the record establishes that, due to wear, the original pattern weight of petitioner's scrap rail was reduced by 10 percent. ⁶²

We further conclude, as we did in C & O, that a downward adjustment is warranted in the .50 factor used in respondent's formula.

In making such an adjustment, we have considered, 1981 U.S. Tax Ct. LEXIS 104">*241 among 76 T.C. 1067">*1141 other things, petitioner's evidence relating to the useful life of rail, based on the percentage of head wear. The record establishes that it was petitioner's general policy to consider rail to be scrap quality if 25 percent or more of the head had worn away, and to consider it to be relay quality if 20 percent of the head had worn away. While petitioner's method of calculating useful life by reference to head wear differs from the approach adopted by the taxpayer in the C & O case, the two methods are not necessarily incompatible. The evidence in this case, including the authoritative testimony of petitioner's witnesses, supports the view that head wear is the most accurate way of measuring the useful life of rail. ⁶³

We are not dissuaded from this conclusion by the contrary evidence presented by respondent. ^{641981 U.S. Tax Ct. LEXIS 104">*244} Although respondent places great stress on millions of ton miles as a measure of wear, his expert witness 1981 U.S. Tax Ct. LEXIS 104">*242 ranked that the lowest of the factors to be considered in determining rail wear. ⁶⁵ We conclude that wear on the head of the rail is the most relevant factor in determining whether rail is to be treated as relay or scrap. Petitioner's policy was to cascade rail only once, because petitioner's lines have a very small percentage of branch lines which are usually designated as relay rail territory. We do not have a situation where 76 T.C. 1067">*1142 elimination of double track produces relay rail with considerable remaining useful life and having high value. ⁶⁶ We find persuasive the testimony of petitioner's president and former chief engineer, Thomas S. Carter, that the petitioner's policy with respect to cascading was carried out and that, in relay programs undertaken, those charged with the task of distinguishing relay rail from scrap were capable of performing that duty. Section foremen worked daily with the rail in their district. Their primary function was to inspect rail. The roadmasters were required to inspect track, among other things, at least twice weekly. The district engineer was involved in the determination of whether rail was to be replaced. There is substantial evidence that it 1981 U.S. Tax Ct. LEXIS 104">*243 was petitioner's general practice to pick up and reuse rail with a head loss of 20 percent and to dispose of as scrap rail with a head loss of 25 percent. This evidence is convincing that the .50 factor used in respondent's formula is excessive as applied to petitioner. ⁶⁷

The following statement appearing in the C & O case has application here as well (64 T.C. 352">64 T.C. 391):

As is the situation in virtually every valuation case, an elaborate discussion of the evidence and the relative weight of the various judgmental factors taken into account in reaching the final result is a fruitless exercise giving rise to a misleading inference that value is susceptible of determination with mathematical 1981 U.S. Tax Ct. LEXIS 104">*245 precision. In fact, it represents at most a practical judgment based upon all the materials that are properly before the Court.

Accordingly, upon consideration of the entire record, it is our best judgment, and we have found as a fact, that the fair market value of petitioner's relay rail is an amount arrived at by using the following formula:

V = .25 (N - .9S) + .9S

where:

V = fair market value of relay rail

N = price of new rail

S = price of scrap rail based on pattern weight

Our finding is based on the evidence presented in this record in respect of this petitioner ^{681981 U.S. Tax Ct. LEXIS 104">*246} and is so limited.

FINDINGS OF FACT

During the years in controversy, petitioner paid or accrued certain amounts ⁶⁹ relating to the grading ^{701981 U.S. Tax Ct. LEXIS 104">*247} of roadways. Generally, these expenses were incurred in connection with (1) the addition of new tracks and/or the lengthening of tracks in a railroad yard, (2) the extension of passing tracks paralleling main track, (3) the connection of industry-owned track to railroad-owned track, (4) the filling-in of areas previously traversed by a bridge, and (5) the extension of spur tracks.

The amounts paid or accrued by Railway, L & A, and Fort Smith-Van Buren for grading additions were capitalized and accounted for in their books and records in Property Account 3, Grading (hereinafter referred to as account 3), as prescribed by the Interstate Commerce Commission (ICC) in its Uniform System of Accounts for Railroad Companies. The amounts paid or accrued by Tolmak for grading additions were capitalized for purposes of depreciating said amounts.

The ICC and the Internal Revenue Service have historically treated account 3 as consisting of "depreciable" and "nondepreciable" portions. Costs paid or accrued by petitioner for masonry, 76 T.C. 1067">*1144 riprap, timber, pipe, and miscellaneous embankment protection items have been ratably depreciated. 1981 U.S. Tax Ct. LEXIS 104">*248 The remainder of petitioner's investment in account 3 has been considered "nondepreciable" for ICC and Federal income tax purposes.

With respect to each of its taxable years 1962 through 1969, inclusive, Railway's basis in the "depreciable" and "nondepreciable" portions of its account 3 were as follows:

With respect to each of its taxable years 1962 through 1969, inclusive, L & A's bases in the "depreciable" and "nondepreciable" portions of its account 3 were as follows:

On its Federal income tax returns for the taxable period ended October 31, 1962, and the taxable years ended December 31, 1963, to December 31, 1969, inclusive, petitioner claimed investment credit with respect to amounts totaling $ 1,475,130.20 which were paid or accrued by Railway, L & A, 1981 U.S. Tax Ct. LEXIS 104">*249 Fort Smith-Van Buren, and Tolmak to unrelated third parties during such taxable years for grading additions. In his statutory notices of deficiency, respondent disallowed the investment credit on the basis that grading is "not depreciable property."

76 T.C. 1067">*1145 On November 3, 1975, petitioner amended its petitions in all docket numbers to claim additional deductions for depreciation of the "nondepreciable" ⁷¹ portions of Railway's and L & A's accounts 3, Grading. Petitioner pleaded average remaining useful lives for Railway and L & A grading placed in service prior to January 1, 1962, and average whole lives for grading placed in service during the taxable years in issue. Petitioner claimed overpayments in various amounts arising out of the additional depreciation deductions for Railway and L & A. ^{721981 U.S. Tax Ct. LEXIS 104">*250}

Various factors affect petitioner's grading, including moisture, settlement, subsidence, liquefaction, and the effect of loads and rail traffic. Some grading is more adversely affected by these conditions than is other grading of petitioner, and varying degrees of maintenance are required.

The condition of the line and the operation of trains are affected by the physical condition of the grading. When grading fails, the track settles unevenly, causing the rails to become uneven and out of alignment. Soil heaves on each side of the ties and water pumps up between the rails. Low joints develop in the rails, and derailments related to the failing grading occur. Drainage problems develop. Cars lean because the grading has failed and the track is out of alignment. The speed limit in the failing areas is reduced. Abnormal maintenance is required, and maintenance costs increase.

Petitioner's grading has been retired from service for a variety of causes. These causes can be generalized into two ultimate classifications: (1) Line abandonments, 1981 U.S. Tax Ct. LEXIS 104">*251 and (2) line changes. Lines are abandoned or changed because of physical inadequacy, shifting industry and population centers, eminent domain, changing technology, management policies, and economic factors.

As of 1962, it was probable that these causes of grading retirements experienced by petitioner in the past would recur in 76 T.C. 1067">*1146 future years. Certain of these causes recurred during the period from 1963 to 1976.

The impact of unit coal trains (trains carrying coal exclusively) on Railway and L & A, beginning in the fall of 1976, will require more line changes than have occurred in any period in the past. Excessive curves and grades will need to be eliminated in order to operate unit coal trains safely and competitively. Several line changes are already underway or in the planning stages to accommodate the unit coal trains. Centralized traffic control has been installed on part of the line and has continued to be installed over other segments of the line.

In addition to unit coal trains, changing freight patterns will probably increase the tonnage carried by Railway and L & A. Increases in the quantities of paper, automobiles, plastics, and grain carried over Railway and L & A are 1981 U.S. Tax Ct. LEXIS 104">*252 expected in the future. The energy crisis is expected to produce a flow of tonnage back from trucks to rails as well as stimulate the construction of at least one new refinery along the L & A line.

Grading has had no salvage value to petitioner upon retirement. In certain instances, railroads have been required to degrade retired grading; in such cases the grading has been a liability and the salvage value, if any, has been negative. In those instances in which grading is retired from petitioner's account 3 because of a sale, the sales price has been established on the basis of the recoverable metallics, i.e., rail, angle bars, and tie plates, and not the grading.

Past grading retirements demonstrate that the useful life of petitioner's grading is not perpetual. Grading retirements occurred each year on Railway from 1915 to 1974 (with the exception of 1957) having a cost of $ 982,162. Between 1918 and 1974, L & A retired grading having a cost of $ 2,574,718.

In connection with the present case, studies were conducted for petitioner in which statistical analyses were made of petitioner's grading retirements, and projections were made regarding the anticipated service (useful) life 1981 U.S. Tax Ct. LEXIS 104">*253 of such grading. These estimates of the useful life of Railway's and L & A's grading were made for petitioner by two of the most knowledgeable and experienced individuals in the field of life analysis and life estimation -- John J. Reilly and Robley Winfrey, both consulting engineers.

76 T.C. 1067">*1147 Both Reilly and Winfrey employed the actuarial method of life analysis in their studies of Railway's and L & A's grading. ^{731981 U.S. Tax Ct. LEXIS 104">*254} Of the two general methods of life analysis -- the actuarial method and the turnover method -- the most accepted and reliable is the actuarial method. The wide acceptance of the actuarial method is due to the refined data upon which this method is based. While the turnover methods of analyzing historical retirements employ only gross additions and gross retirements, the actuarial method identifies the actual ages of property retired and property surviving. This use of "aged data" allows for a more detailed and, hence, more reliable analysis of past retirement experience.

Reilly and Winfrey each presented a study of the useful lives of Railway's and L & A's grading based upon data gathered by employees of petitioner pursuant to the guidelines established by Reilly and Winfrey. Reilly's report contains tables of data under study, charts showing the application of the selected Iowa-type curve to the stub survivor curves, and an explanation of the methodology employed and the results of his study. Winfrey's report consists of charts showing his handdrawn stub survivor curves based upon the data presented in Reilly's report and his findings with respect to the average service lives of Railway's and L & A's grading.

Step one of the actuarial method employed herein for petitioner involved data gathering and refinement, which was accomplished by employees of petitioner at the direction of Reilly and Winfrey. Pursuant to their directions, petitioner's employees prepared schedules of additions to account 3, retirements from the account, and the ages of retirements at the date retired. These schedules included data from the original year of construction to and including December 1981 U.S. Tax Ct. LEXIS 104">*255 31, 1974. It was necessary to determine the year of construction for grading placed in service prior to the ICC valuation dates ⁷⁴ because prior 76 T.C. 1067">*1148 to 1914, most railroads, including Railway and L & A, did not maintain records of the costs of individual items in their road property accounts. The method of relating prevaluation grading to the original year of construction, as well as the procedures used by petitioner in gathering and refining the additions and retirements data, was found by both Reilly and Winfrey to be proper for the purpose of making life analysis studies. ^{751981 U.S. Tax Ct. LEXIS 104">*256}

The second step involved the development of a life table and survivor curve. In general terms, this step entailed the arrangement of the data derived in step one into five tables which made possible their analysis. Each table summarizes the data for a different retirement band, i.e., a span of years over which retirements are analyzed. Different retirement bands were used to enable Reilly and Winfrey to determine whether an increasing or decreasing trend of average life was evident for account 3.

Based upon the life tables, ^{761981 U.S. Tax Ct. LEXIS 104">*257} Reilly and Winfrey independently plotted on graph paper the percentage surviving at the beginning of each age interval. These stub survivor curves, although drawn to different scales by Reilly and Winfrey, are identical in shape because they were plotted from the same life tables.

After Reilly and Winfrey plotted the stub survivor curves on graph paper, each independently overlaid the Iowa-type curves on the plotted stub curves for the purpose of carrying out step three of their method -- smoothing and extending the stub survivor curve. For each of the 10 retirement bands under study, a curve was selected which, in the expert judgments of Reilly and Winfrey, best fitted the stub survivor curves. Based upon 76 T.C. 1067">*1149 their analyses, Reilly and Winfrey each identified a trend toward a decreasing average life for Railway's grading. As the retirement bands were contracted, overall average life shortened. Reilly's and Winfrey's independent band analyses establish 1981 U.S. Tax Ct. LEXIS 104">*258 that Railway's grading retirements have occurred with greater frequency during the more recent retirement bands.

With respect to L & A, Reilly's and Winfrey's band analyses demonstrate a similar, although less pronounced, shortening of life as the retirement bands are contracted. As the bands were contracted, both Reilly and Winfrey identified a similar trend toward a shorter life for L & A until the 1963-74 band, in which the average life was greater than that of previous bands, although there are slight differences between Reilly and Winfrey in the specific lives chosen for each band.

Step four involved the application of judgment. Judgment is necessary to interpret the extent to which historical service lives may be altered by future developments. The application of judgment must be performed by an analyst familiar with the type of property under study, past and expected future causes of retirements, and management policies and plans for the future. Based upon this knowledge, the analyst can adjust the historically determined average service life in accordance with his judgment concerning the extent to which the rate of future retirements will increase or decrease over the past 1981 U.S. Tax Ct. LEXIS 104">*259 retirement rate. The application of judgment to determine future average service life is called "life estimation."

In considering the impact of probable future developments which would affect the lives of Railway's and L & A's grading, Reilly and Winfrey made visual inspections of the grading. They also consulted with Railway and L & A employees regarding factors affecting grading retirements -- past, present, and future. Thomas S. Carter, president of Railway and L & A, indicated the causes of line changes and line abandonments and pointed to their recurring nature. He emphasized that present projections of the future impact of unit coal trains and new types of freight and freight cars will require numerous changes in the location and structure of the present lines. Unit coal trains will require more line changes than Railway and L & A have experienced in any period in the past. New technology, Federal legislation encouraging the consolidation of duplicate lines, and 76 T.C. 1067">*1150 changes in the economy will also lead to line changes and line abandonments in the future.

In taking into account the impact of probable future developments, Reilly and Winfrey did not substantially modify the historically 1981 U.S. Tax Ct. LEXIS 104">*260 determined lives of Railway's and L & A's grading. By the application of judgment to the historical band lives in his actuarial study, Reilly estimated 100 years as the expected life of Railway's grading, and 75 years as the expected life of L & A's grading. These findings are clearly within the range of the historically determined lives and are consistent with the trend toward a decreasing life as the bands are shortened. Winfrey's estimated useful lives of 95 years for Railway's grading and 80 years for L & A's grading similarly fall within the range and reflect the trend of his historically determined lives.

Based upon his knowledge of the property under study and his consultations with officials of petitioner relating to causes of retirements and future plans and policies, Winfrey applied his judgment to the historically determined lives and estimated the following average service lives of Railway's and L & A's grading reflected in the "nondepreciable" portions of their accounts 3 as of December 31, 1962:

Reilly, based upon his knowledge of the property under study and his consultations with officials of petitioner relating 1981 U.S. Tax Ct. LEXIS 104">*261 to causes of retirements and future plans and policies, applied his judgment to the historically determined lives and estimated the following average service lives of Railway's and L & A's grading reflected in the "nondepreciable" portions of their accounts 3 as of December 31, 1962:

Employing actuarial procedures to compute average remaining life for assets in service at December 31, 1962, Reilly determined the following average remaining lives for Railway's and L & A's grading reflected in the "nondepreciable" portions of their accounts 3 at December 31, 1962: 76 T.C. 1067">*1151

Respondent's expert witness, Ronald J. Bartyczak, used the same retirement data used by petitioner's expert witnesses, Winfrey and Reilly. The method-of-life analysis employed by Winfrey and Reilly used survivor ratios. The method-of-life analysis employed by Bartyczak used retirement rations, i.e., the complement of the survivor ratios in Reilly's report. Bartyczak's analysis and extension of the retirement data to project a probable average service life for petitioner's grading employed a 1981 U.S. Tax Ct. LEXIS 104">*262 curve fitting by least squares of polynomial equations to the retirement ratios. Bartyczak's projection of a probable average service life of petitioner's grading from an analysis of the historical data assumes that future retirements will be affected by the same forces affecting past retirements.

ULTIMATE FINDINGS OF FACT

Railway and L & A are entitled to depreciate the "nondepreciable" portions of the accounts 3, Grading, over the following useful lives:

Railway's and L & A's grading is other tangible property used as an integral part of furnishing transportation services and is property with respect to which depreciation is allowable, having a useful life of 8 years or more. Grading constructed or acquired by Railway and L & A in the respective amounts of $ 1,114,146.09 and $ 312,477.37 during the taxable years in issue qualifies as "new section 38 property" for purposes of the investment credit.

OPINION

This issue involves petitioner's claim that it is entitled to depreciation deductions under section 167⁷⁷ and investment credits under section 38^{781981 U.S. Tax Ct. LEXIS 104">*264} for certain 1981 U.S. Tax Ct. LEXIS 104">*263 of its grading. The applicability of these sections is dependent upon our determination of whether petitioner's grading has a reasonably determinable useful life over which its cost can be allocated. If so, petitioner is entitled to deductions under section 167 and to credits under section 38. ⁷⁹Southern Pacific Transportation Co. v. Commissioner, 75 T.C. 497">75 T.C. 497, 75 T.C. 497">788-807 (1980); Spartanburg Terminal Co. v. Commissioner, 66 T.C. 916">66 T.C. 916, 66 T.C. 916">925-932, 66 T.C. 916">935-938 (1976); Chesapeake & Ohio Railway Co. v. Commissioner, 64 T.C. 352">64 T.C. 352, 64 T.C. 352">376-384 (1975). As we pointed out recently in the Southern Pacific case, the taxpayer's estimates need not be made with precision. 75 T.C. 790. "A reasonable approximation of the amount that fairly may be included in the accounts of any year is all that is required." Burnet v. Niagara Falls Brewing Co., 282 U.S. 648">282 U.S. 648, 282 U.S. 648">655 (1931).

In the Southern Pacific and Chesapeake & Ohio cases, the taxpayers used statistical 1981 U.S. Tax Ct. LEXIS 104">*265 studies and projections to show that 76 T.C. 1067">*1153 their grading would, in the course of time, lose utility and be retired from service. The evidence in both cases showed that grading had a reasonably determinable useful life, permitting a reasonable approximation of the allowable annual deduction under section 167. While neither of the cases states a rule of general application regarding the depreciability of grading, they clearly stand as precedent for the proposition that statistical methods can properly be used to establish the useful life of grading for tax purposes. See also Pennsylvania Power & Light Co. v. United States, 188 Ct. Cl. 76">188 Ct. Cl. 76, 411 F.2d 1300">411 F.2d 1300 (1969), and Virginia Electric & Power Co. v. United States, 188 Ct. Cl. 120">188 Ct. Cl. 120, 411 F.2d 1314">411 F.2d 1314 (1969). ⁸⁰ We believe the facts of the instant case are similar to the facts (relating to the useful life of grading) in the Southern Pacific and Chesapeake & Ohio cases, and we conclude that a similar result should obtain in this case. We will not repeat herein the various matters recently dealt with at length in the Southern Pacific opinion except to note that the principles outlined and the authorities cited in our discussion of the grading issue 1981 U.S. Tax Ct. LEXIS 104">*266 therein have guided us in the resolution of the present controversy.

The facts in this case clearly show that Railway's and L & A's grading is subject to the forces of obsolescence identified in section 1.167(a)-9, Income Tax Regs. Between 1915 and 1974, Railway retired grading having a cost of $ 982,162; between 1918 and 1974, L & A retired grading having a cost of $ 2,574,718. The causes of the retirements analyzed by petitioner fall within two general classifications: (1) Line abandonments and (2) line changes. Railway's and L & A's lines have been abandoned or changed because of physical inadequacy, ⁸¹ shifting industrial and 76 T.C. 1067">*1154 population centers, eminent domain, ^{821981 U.S. Tax Ct. LEXIS 104">*268} changing technology, management policies, and economic factors. Based on all of the evidence of record, as outlined in our findings of fact, we hold that petitioner has established useful lives 1981 U.S. Tax Ct. LEXIS 104">*267 for its grading (added after December 31, 1962) of 100 years (Railway) and 75 years (L & A), with average remaining lives for grading in existence on December 31, 1962, of 63 years (Railway) and 48 years (L & A).

The projections by petitioner's expert witnesses do not significantly shorten the historically determined lives of the grading. Petitioner's witnesses have not claimed, and petitioner does not now claim, that petitioner's projections of future developments are entirely accurate or precisely measurable. Rather, petitioner has estimated, based upon a demonstrated historical trend toward a shortened life and upon an informed evaluation of foreseeable future developments, the expected lives of Railway's and L & A's grading. ^{831981 U.S. Tax Ct. LEXIS 104">*269 1981 U.S. Tax Ct. LEXIS 104">*270} This is all that the law requires.

To the extent respondent argues that petitioner's projections 76 T.C. 1067">*1155 are in some manner tainted by speculative elements entering into the analysis, we believe he is in error. The factors considered by petitioner are within the contemplation of section 1.167(a)-9, Income Tax Regs., which specifically mentions "progress of the arts and sciences, * * * inadequacy brought about by developments in the industry, products, methods, markets, sources of supply, and other like changes, and legislative and regulatory action." See also section 1.167(a)-1(b), Income Tax Regs., stating that, in estimating useful life a taxpayer should "[take] into account present conditions and probable future developments." The pertinent regulations reflect the need to look into the future, however unsusceptible of precise 1981 U.S. Tax Ct. LEXIS 104">*271 prediction the future may be. Based on all of the evidence of record, it is our conclusion that it could reasonably be anticipated that grading retirements by Railway and L & A would continue and, in fact, would increase.

In summary, we conclude that, through the use of the actuarial method of life analysis involving the application of Iowa curves, petitioner has shown that the useful life of its grading is reasonably determinable, taking into account the character of past retirements and petitioner's reasonable expectations regarding future retirements. Petitioner has shown that the grading of Railway and L & A is depreciable property and that its grading additions during the taxable periods in issue comply in all respects with the requirements for "new section 38 property." As a result, petitioner is entitled to the section 38 investment credit with respect to such additions. ⁸⁴ Moreover, petitioner has established the depreciable bases of Railway and L & A in the "nondepreciable" portion of their ICC grading accounts and has established that the salvage value of the grading at issue is zero. ⁸⁵ Petitioner is therefore entitled to depreciation deductions in accordance with the 1981 U.S. Tax Ct. LEXIS 104">*272 provisions of section 167.

One additional point must be mentioned. Respondent contends 76 T.C. 1067">*1156 that petitioner's claim for ratable depreciation of the grading in issue constitutes a change in petitioner's method of accounting for which the necessary consent has been neither requested nor given. ^{861981 U.S. Tax Ct. LEXIS 104">*274} See sec. 446(e). A similar accounting method argument was made by respondent in the Southern Pacific case in connection with the grading useful life issue involved therein. For the reasons expressed in the Southern Pacific opinion, we hold that the adoption of ratable depreciation in the present case is not a change in method of accounting. Based on a change in underlying facts, petitioner is assigning 1981 U.S. Tax Ct. LEXIS 104">*273 a useful life to an asset whose life was previously indeterminate. See sec. 1.446-1(e)(2)(ii)(b), Income Tax Regs. Under these circumstances, petitioner is not required to obtain consent pursuant to section 446(e). 197 F.2d 745">Southern Pacific Transportation Co. v. Commissioner, supra at 802-807.

Decisions will be entered under Rule 155.