Feb 25 - PEPCO Holdings Inc.'s (PHI) planned deposit with the Internal Revenue Service (IRS) will a remove major overhang to PHI's credit profile, though it will temporarily increase the company's leverage, according to Fitch Ratings. PHI plans to make a deposit with the IRS of between $220 million and $260 million related to its cross-border lease portfolio. This will raise PHI's leverage, which is already aggressive for the rating category. The planned deposit is well below PHI's cross-border related tax exposure of approximately $744 million. The difference results from the application of accumulated tax deductions unrelated to the lease portfolio and includes the carry back or forward of net operating losses, settled tax positions, and amounts on deposit with the IRS. Fitch expects PHI will seek to liquidate all or a portion of its lease portfolio and to use any proceeds to reduce debt. PHI estimates a partial or complete liquidation could be accomplished within one year. Fitch considers a reduction in leverage to be important to maintaining PHI's existing ratings and Stable Rating Outlook. After giving effect to the tax deposit, Fitch estimates the consolidated ratios of debt/EBITDA and FFO/debt will approximate 5.0x and 14%, respectively, in 2013. The planned deposit, which is expected by March 31, 2013, will stop the accrual of additional interest costs on the tax liability while PHI determines whether it will continue to litigate the IRS's tax position. PHI plans to fund the payment with short-term borrowings and available cash. Fitch believes existing credit facilities and funds from exercising a forward equity sale as previously planned provide sufficient liquidity. The forward equity sale, which must be exercised by March 5, 2013, is expected to provide approximately $312 million. PHI also expects to record a non-cash charge of between $355 million and $380 million (after-tax) reflecting a reduction in its equity investment in the lease portfolio and additional interest expense. The reduction in retained earnings is largely offset by exercising the equity forward contract. The cross-border lease portfolio is structured as a sale and leaseback transaction commonly referred to as a sale-in, lease-out (SILO) transaction. The IRS disallowed a substantial portion of the tax benefits related to the lease portfolio beginning with PHI's 2001 income tax return. After failing to negotiate a settlement, PHI initiated litigation in the U.S. federal Claims Court in January 2012 related to its 2001 and 2002 federal tax returns, which remains on-going. The decision to take the write-down and make the tax deposit follows a Jan. 9, 2013, decision by the U.S. Court of Appeals for the Federal Circuit in a similar case for Consolidated Edison Company of New York, Inc. that disallowed tax benefits of a lease-in, lease-out transaction. Consequently, PHI determined that its tax position related to the cross-border leases no longer meets the more likely than not standard of recognition for accounting purposes.