United States v. ConocoPhillips, 2012 WL 3646809 (WD Okla) provides a good illustration on how closing agreements with the IRS are like any other contracts, only moreso, because the IRS is likely to be a particularly unbending contract partner if interpretive issues arise.
Facts. Owners of the Trans-Alaska Pipeline agreed with the IRS in a closing agreement that they could deduct $900 million—ratably, over 25 years—for remediation costs that would be paid at the end of the lifetime of the pipeline. The agreement allowed the deductions to the current owners and successors in interest who assumed the liability.
ConocoPhillips bought part of the pipeline assets and assumed part of the liability three years before the end of the 25-year amortization period. Its seller, BP, did not include the assumption of liability in its amount realized, but included its prior deductions for 22 years as a recapture. ConocoPhillips then tried to set that same amount up as basis and amortize it over 15 years, evidently under section 197.
The IRS disagreed, and the trial court agreed with the IRS. It held that the closing agreement did not provide for creating basis under the term of the agreement and that even as to the last three years, ConocoPhillips was not a successor in the interest of the original pipeline owners. As a result, presumably ConocoPhillips must wait until it actually pays the costs to deduct them under section 461(h).
Drafting Problem. The problem with the closing agreement drafting was that it contemplated a sale of the property and the court likely was wrong in ruling that the buyer of the property could not be a successor in interest. Apparently, it contemplated a recapture of deductions on a sale, or at least BP thought so (but maybe it did not matter to BP because the alternative would have been to have more amount realized). But it did not contemplate how the buyer would get the deduction that the seller recaptured.
ConocoPhillips made a valiant effort to create a solution to the gap in the drafting, but the trial court would not agree. Perhaps more surprising, the IRS would not agree. After all, ConocoPhillips was only trying to deduct over what would be 38 years part of the amount that the closing agreement allowed to be deducted over 25 years.