[Federal Register Volume 62, Number 163 (Friday, August 22, 1997)]
[Rules and Regulations]
[Pages 44542-44551]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 97-21772]
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DEPARTMENT OF THE TREASURY
Internal Revenue Service
26 CFR Part 1
[TD 8729]
RIN 1545-AV37
Rules for Property Produced in a Farming Business
AGENCY: Internal Revenue Service (IRS), Treasury.
ACTION: Final and temporary regulations.
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SUMMARY: This document contains final and temporary regulations
relating to the application of section 263A of the Internal Revenue
Code to property produced in a farming business. These regulations
affect certain taxpayers engaged in the trade or business of farming.
These regulations are necessary to provide guidance with respect to
section 263A(d).
The text of the temporary regulations also serves as the text of
the proposed regulations set forth in the notice of proposed rulemaking
on this subject in the Proposed Rules section of this issue of the
Federal Register.
DATES: These regulations are effective August 22, 1997. For dates of
applicability, see Sec. 1.263A-4T(f) of these regulations.
FOR FURTHER INFORMATION CONTACT: Jan Skelton, (202) 622-4970 (not a
toll-free call).
SUPPLEMENTARY INFORMATION:
Background
Prior to the enactment of section 263A, the rules that governed the
deduction or capitalization of costs incurred with respect to property
produced in the trade or business of farming were set forth in several
different statutory and regulatory provisions. Costs regarded as
preparatory expenditures were required to be capitalized under section
263. Preparatory expenditures are expenditures incurred prior to
raising agricultural or horticultural commodities or that otherwise
enable a farmer to begin the farming process. See, e.g., Rev. Rul. 83-
28, 1983-1 C.B. 47. Preparatory expenditures include the costs of
clearing land, leveling and grading land, drilling and equipping wells,
acquiring irrigation systems, acquiring seeds or seedlings, budding
trees, and acquiring animals.
Costs regarded as developmental expenditures (sometimes referred to
as cultural practices expenditures) were generally permitted to be
deducted, or, at a taxpayer's election, could be capitalized. See,
e.g.,Wilbur v. Commissioner, 43 T.C. 322 (1964), acq., 1965-2 C.B. 7.
Developmental expenditures are those expenditures incurred by a
taxpayer so that the growing process may continue in the desired
manner. Developmental expenditures are expenditures that, if incurred
while the plant or animal was in a productive state, would be
deductible. See, Maple v. Commissioner, 27 T.C.M. 944 (1968), aff'd,
440 F.2d 1055 (9th Cir. 1971). Developmental expenditures include the
costs of irrigating, fertilizing, spraying, cultivating, pruning,
feeding, providing veterinary services, rent on land, and depreciation
allowances on irrigation systems or structures.
Former sections 278 and 447 provided special rules requiring the
capitalization of certain developmental expenditures. Former section
278(a) provided special rules for citrus and almond groves. Under
former section 278(a), all otherwise deductible costs of developing
citrus or almond groves incurred before the end of the fourth taxable
year after permanent planting were required to be capitalized. Rev.
Rul. 83-128, 1983-2 C.B. 57, clarified that the costs incurred prior to
permanent planting were also required to be capitalized.
Former sections 278(b) and 447(b) provided special rules for
farming syndicates, corporations, and partnerships with a corporate
partner. Section 447 requires certain corporations and partnerships
with a corporate partner to use an accrual method of accounting
(accrual method). Former section 447(b) required these taxpayers to
capitalize preproductive period expenses. Preproductive period expenses
were defined as any expenses attributable to crops, animals, trees, or
other property having a crop or yield and that are incurred during the
preproductive period of such property. Soil and water conservation
expenditures, as defined in section 175, and land-clearing expenditures
as defined in former section 182, are preproductive period expenses if
they are incurred in a preproductive period of an agricultural or
horticultural activity and if the taxpayer elects to deduct these
expenses rather than capitalize them. House Comm. on Ways and Means,
Tax Reform Act of 1975, H.R. Rep. No. 94-658, 94th Cong., 1st Sess. 93
(1975).
In the case of a farming syndicate engaged in planting,
cultivating, maintaining, or developing an orchard, vineyard, or grove,
former section 278(b) required the capitalization of all otherwise
deductible expenditures incurred with respect to the orchard, vineyard,
or grove, if incurred prior to the first taxable year in which there
was a crop or yield in commercial quantities.
Former section 278(c) provided a relief provision. Under this
provision, sections 278 (a) or (b) would not require the capitalization
of developmental expenditures attributable to an orchard, vineyard, or
grove that was replanted after having been lost or damaged by reason of
freezing temperatures, disease, drought, pests, or casualty.
Section 263A, enacted in the Tax Reform Act of 1986, Public Law 99-
514, 100 Stat. 2085, 1986-3 C.B. Vol. 1 (the 1986 Act), provides
uniform capitalization rules that govern the treatment of costs
incurred in the production of property or the acquisition of property
for resale. Section 263A was enacted, in part, to
[[Page 44543]]
prevent the inappropriate mismatching of income and expense that
results from the current deduction of the costs of producing property.
Section 263A generally incorporates and expands upon the rules set
forth in several code and regulatory sections, including section 263,
and former sections 278 and 447.
Section 263A(b) generally provides that the uniform capitalization
rules apply to the taxpayer's production of real or tangible personal
property. Section 1.263A-2(a)(1)(i) clarifies that for purposes of
section 263A, produce includes the following: construct, build,
install, manufacture, develop, improve, create, raise, or grow.
Sections 263A (d) and (e) provide special rules for property produced
in a farming business.
Section 263A, as enacted in 1986, generally required taxpayers to
capitalize the costs of producing plants and animals. Taxpayers not
required by section 447 or 448(a)(3) to use an accrual method were
excepted from capitalizing the preproductive period costs of plants and
animals (except animals held for slaughter) that had a preproductive
period of 2 years or less. Section 263A was amended as part of the
Omnibus Budget Reconciliation Act of 1987, Pub. L. 100-203, 101 Stat.
1330, 1987-3 C.B. Vol. 1 (the 1987 Act), the Technical and
Miscellaneous Revenue Act of 1988, Pub. L. 100-647, 102 Stat. 3342,
1988-3 C.B. Vol. 1 (the 1988 Act), and the Omnibus Budget
Reconciliation Act of 1989, Pub. L. 101-239, 103 Stat. 2106 (the 1989
Act). Under the 1988 Act, the scope of the exception for these
taxpayers is expanded to include all animals irrespective of the length
of the preproductive period.
In addition, taxpayers not required by section 447 or 448(a)(3) to
use an accrual method may elect not to capitalize the costs of plants
(other than certain costs of producing citrus and almond trees) with a
preproductive period in excess of 2 years. If a taxpayer makes this
election, the taxpayer must treat such plants as section 1245 property
and upon disposition of these plants any amount allowable as a
deduction that would, but for the election, have been capitalized must
be recaptured and treated as a deduction allowed for depreciation with
respect to such property. See section 263A(e)(1). Also, if the taxpayer
makes the election, the taxpayer and related persons must apply the
alternative depreciation system provided in section 168(g)(2) to all
property used by the taxpayer or related person predominantly in a
farming business and placed in service in any taxable year in which the
election out of section 263A is in effect. See section 263A(e)(2).
On March 30, 1987, the IRS published in the Federal Register a
notice of proposed rulemaking (52 FR 10118) by cross reference to
temporary regulations published the same day (T.D. 8131, 52 FR 10052).
Amendments to the notice of proposed rulemaking and temporary
regulations were published in the Federal Register on August 7, 1987,
by a notice of proposed rulemaking (52 FR 29391) that cross referenced
to temporary regulations published the same day (T.D. 8148, 52 FR
29375). Notice 88-24, 1988-1 C.B. 491, provided that forthcoming
regulations would modify the temporary regulations and the regulations
under Sec. 1.471-6. Notice 88-86, 1988-2 C.B. 401, provided that
forthcoming regulations would clarify the definition of a related
person for purposes of the election out of section 263A. In addition,
Notice 88-86 provided that forthcoming regulations would provide that
certain taxpayers could elect to use the simplified production method
for property used in the trade or business of farming. On August 5,
1994, the temporary regulations relating to property produced in a
farming business were reissued and published in the Federal Register
(T.D. 8559, 59 FR 39958). Because substantial changes are being made
from the 1994 temporary regulations, the IRS and Treasury Department
have decided to issue, in part, new proposed and temporary, rather than
final, regulations.
Explanation of Provisions
Property Produced in the Trade or Business of Farming
The temporary regulations clarify that the special rules of section
263A(d) apply only to property produced in a farming business. The
temporary regulations provide that for purposes of section 263A, the
term farming means the cultivation of land or the raising or harvesting
of any agricultural or horticultural commodity. Examples include the
trade or business of operating a nursery or sod farm; the raising or
harvesting of trees bearing fruit, nuts, or other crops; the raising of
ornamental trees (other than evergreen trees that are more than six
years old at the time they are severed from their roots); and the
raising, shearing, feeding, caring for, training, and management of
animals. The regulations clarify that for this purpose harvesting does
not include contract harvesting of an agricultural or horticultural
commodity grown or raised by another taxpayer. Accordingly, while a
taxpayer that grows a plant may apply the special rules of section
263A(d) to the costs of growing and harvesting the plant, the special
rules of section 263A(d) do not apply to a taxpayer that merely
contract harvests agricultural or horticultural commodities grown or
raised by another taxpayer. Similarly, the temporary regulations
clarify that the special rules of section 263A(d) do not apply to a
taxpayer that merely buys and resells plants or animals grown or raised
by another. In evaluating whether a taxpayer is engaged in the
production, or merely the resale, of plants or animals, it is
anticipated that consideration will be given to factors including: The
length of time between the taxpayer's acquisition of a plant or animal
and the time the plant or animal is made available for sale to the
taxpayer's customers, and, in the case of plants, whether plants
acquired by the taxpayer are planted in the ground or kept in temporary
containers.
The temporary regulations provide that a farming business does not
include the processing of commodities or products beyond those
activities that are incident to the growing, raising, or harvesting of
such products.
Preparatory and Developmental Costs
The IRS and Treasury Department believe that, in general, section
263A does not change the rules regarding capitalization of costs during
the preparatory period. Thus, the temporary regulations clarify that,
as under prior law, taxpayers generally must capitalize preparatory
expenditures, including the cost of seeds, seedlings, and animals;
clearing, leveling and grading land; drilling and equipping wells;
irrigation systems; and budding trees. However, because section 263A
requires the capitalization of certain indirect costs as well as direct
costs, the amount of preparatory expenditures capitalized may be
greater under section 263A than under prior law.
Section 263A expands the circumstances under which costs that were
once termed developmental expenditures must be capitalized. The
temporary regulations clarify that costs that were, in years prior to
the enactment of section 263A, regarded as developmental are included
in the category of preproductive period costs. Section 263A generally
requires the capitalization of preproductive period costs including the
costs of irrigating, fertilizing, spraying, cultivating, pruning,
feeding, providing veterinary services, rent on land, and depreciation
allowances on irrigation systems or structures. Preproductive period
costs also include real estate taxes, interest,
[[Page 44544]]
and soil and water conservation expenditures incurred during the
preproductive period of a plant.
Taxpayers that are required by section 447 or 448(a)(3) to use an
accrual method must capitalize all preproductive period costs of plants
(without regard to the length of the preproductive period) and animals.
Taxpayers that are not required by section 447 or 448(a)(3) to use an
accrual method qualify for an exception to this general rule. Under
this exception, taxpayers are not required to capitalize preproductive
period costs incurred with respect to animals, or with respect to
plants that have a preproductive period of 2 years or less. Thus, under
this exception, taxpayers are required to capitalize only those
preproductive period costs incurred with respect to plants that have a
preproductive period in excess of 2 years. The temporary regulations
clarify that, for purposes of determining whether a plant has a
preproductive period in excess of 2 years, in the case of a plant grown
in commercial quantities in the United States, the nationwide weighted
average preproductive period of such plant is used.
The IRS and Treasury Department are considering the publication of
guidance with respect to the length of the preproductive period of
certain plants that will have more than one crop or yield. At the
present time, the IRS and Treasury Department anticipate that such
guidance would provide that plants producing the following crops or
yields have a nationwide weighted average preproductive period in
excess of 2 years: almonds, apples, apricots, avocados, blueberries,
blackberries, cherries, chestnuts, coffee beans, currants, dates, figs,
grapefruit, grapes, guavas, kiwifruit, kumquats, lemons, limes,
macadamia nuts, mangoes, nectarines, olives, oranges, peaches, pears,
pecans, persimmons, pistachio nuts, plums, pomegranates, prunes,
raspberries, tangelos, tangerines, tangors, and walnuts. The IRS and
Treasury Department invite comments on this issue.
Capitalization Period
Preproductive period costs (e.g., irrigating, fertilizing, real
estate taxes, etc.) are capitalized during the preproductive period of
a plant or animal. A taxpayer that grows a plant that will have more
than one crop or yield is engaged in the production of two types of
property, the plant and the crop or yield of the plant (e.g., the
orange tree and the orange). The temporary regulations clarify the
capitalization period for plants that will have more than one crop or
yield, for crops or yields of plants that will have more than one crop
or yield, and for other plants.
The temporary regulations clarify that the preproductive period of
a plant generally begins when a taxpayer first incurs costs with
respect to the plant, e.g., when the plant is acquired or the seed is
planted. In the case of the crop or yield of a plant that has become
productive in marketable quantities, the preproductive period of the
crop or yield begins when the crop or yield first appears, whether in
the form of a sprout, bloom, blossom, bud, etc.
In the case of a plant that will have more than one crop or yield,
the preproductive period of the plant ends when the plant becomes
productive in marketable quantities (i.e., when the plant is placed in
service for purposes of depreciation). In the case of the crop or yield
of a plant that has become productive in marketable quantities, the
preproductive period of the crop or yield ends when the crop or yield
is disposed of. Finally, in the case of other plants, the preproductive
period ends when the plant is disposed of.
The temporary regulations provide that the preproductive period of
an animal begins at the time of acquisition, breeding, or embryo
implantation. The temporary regulations clarify that, in the case of an
animal that will be used in the trade or business of farming, the
preproductive period generally ends when the animal is placed in
service for purposes of depreciation. However, in the case of an animal
that will have more than one yield, the preproductive period ends when
the animal produces (e.g., gives birth to) its first yield. In the case
of any other animal, the preproductive period ends when the animal is
sold or otherwise disposed of. The temporary regulations additionally
clarify that, in the case of an animal that will have more than one
yield, the costs incurred after the beginning of the preproductive
period of the first yield but before the end of the preproductive
period of the animal must be allocated between the animal and the yield
on a reasonable and consistent basis. Any depreciation allowance on the
animal may be allocated entirely to the yield.
Method of Capitalizing Costs
The temporary regulations provide that the costs required to be
capitalized with respect to farming property may, if the taxpayer
chooses, be determined using any reasonable inventory valuation method,
such as the farm-price method of accounting (farm-price method) or the
unit-livestock-price method of accounting (unit-livestock-price
method). The use of these inventory valuation methods avoids the
necessity of accounting for the costs of raising plants or animals by
tracing costs to each separate plant or animal. In addition, under the
temporary regulations, these inventory methods may be used by a
taxpayer regardless of whether the farming property being produced is
otherwise treated as inventory by the taxpayer, and regardless of
whether the taxpayer is otherwise using the cash method or an accrual
method.
The temporary regulations clarify that notwithstanding a taxpayer's
use of the farm-price method with respect to farming property to which
the provisions of section 263A apply, the taxpayer is not required,
solely by such use, to use the same method of accounting with respect
to farming property to which the provisions of section 263A do not
apply.
Under the unit-livestock-price method, the taxpayer adopts a
standard unit price for each animal within a particular class. This
standard unit price is used by the taxpayer in lieu of specifically
identifying and tracing the costs of raising each animal in the
taxpayer's farming business. Taxpayers using the unit-livestock-price
method must adopt a reasonable method of classifying animals with
respect to their age and kind so that the unit prices assigned by the
taxpayer to animals in each class are reasonable. Thus, taxpayers using
the unit-livestock-price method typically classify livestock based on
their age (for example, a separate class will typically be established
for calves, yearlings, and 2-year olds).
The temporary regulations under section 263A modify the rule set
forth in Sec. 1.471-6 providing that no increase in unit cost is
required under the unit-livestock-price method with respect to the
taxable year in which certain animals are purchased, if the purchases
occur in the last 6 months of the taxable year. The temporary
regulations provide that any taxpayer required to use an accrual method
under section 448(a)(3) must include in inventory the annual standard
unit price for all animals purchased during the taxable year,
regardless of when in the taxable year the purchases are made. The
temporary regulations further amend this rule and provide that all
taxpayers using the unit-livestock-price method must modify the annual
standard price to reasonably reflect the particular period in the
taxable year in which purchases of livestock are made, if such
modification is necessary in order to
[[Page 44545]]
avoid significant distortions in income that would otherwise occur
through operation of the unit-livestock-price method. The temporary
regulations do not specify the particular modification that must be
made to the annual standard price for any particular taxpayer, but
rather allow any reasonable modification made by the taxpayer to the
annual standard price to avoid significant distortions in income. For
example, assume a taxpayer purchases and raises cattle for slaughter.
Assume further that the taxpayer is required to use an accrual method
under section 447 so that section 263A applies to the taxpayer's costs
of raising the cattle. The temporary regulations provide that the
taxpayer may not expense the costs of raising cattle that are purchased
in the latter half of the taxpayer's taxable year. Instead, the
taxpayer must modify the annual standard price so as to reasonably
capitalize the costs of raising the cattle, based on the date of their
purchase.
In Notice 88-86, the IRS noted that commentators had inquired as to
the availability of the simplified production method of accounting
(simplified production method) for farmers using the unit-livestock-
price method for the costs of raising livestock. The temporary
regulations clarify that farmers using the unit-livestock-price method
are permitted to elect the simplified production method, as well as the
simplified service cost method of accounting, under section 263A. In
such a situation, section 471 costs are the costs taken into account by
the taxpayer under the unit-livestock-price method using the taxpayer's
standard unit price determined under these temporary and final
regulations. The term additional section 263A costs includes all
additional costs required to be capitalized under section 263A
including costs that are required to be capitalized under section 263A
that are not reflected in the standard unit prices (e.g., general and
administrative costs and depreciation, including depreciation on a
calf's mother).
In light of the additional costs required to be capitalized under
section 263A, taxpayers should not adopt unit prices utilized under
pre-section 263A unit-livestock-price rules without carefully analyzing
whether these unit prices reflect all of the costs required to be
capitalized under section 263A.
Election Not To Capitalize Costs
Certain taxpayers, other than those required to use an accrual
method by section 447 or 448(a)(3), may elect not to capitalize the
preproductive period costs of certain plants even though such plants
have a preproductive period in excess of 2 years and would otherwise be
subject to the capitalization requirements of section 263A. Taxpayers
making this election may continue to deduct (subject to other
limitations of the Code) the preproductive period costs that were
deductible under the rules in effect before the enactment of section
263A. The temporary regulations clarify that although a taxpayer
producing a citrus or almond grove may make this election, the election
does not apply to the preproductive period costs of a citrus or almond
grove that are incurred before the close of the fourth taxable year
beginning with the taxable year in which the trees were planted.
If a taxpayer makes this election with respect to any plant, the
taxpayer must treat the plant as section 1245 property. In addition,
the taxpayer, and any person related to the taxpayer, must use the
alternative depreciation system of section 168(g)(2) for any property
used predominantly in a farming business that is placed in service in a
taxable year for which the election is in effect.
Casualty Loss Exception
Section 263A(d) provides an exception from capitalization for
preproductive period costs incurred with respect to plants that are
replacing certain plants that were lost by reason of certain
casualties. The temporary regulations clarify that this exception for
preproductive period costs does not apply to preparatory expenditures
or the costs of capital assets. In addition, the temporary regulations
clarify that the casualty loss exception applies whether the plants are
replanted on the same parcel of land as the plants destroyed by
casualty or a parcel of land of the same acreage in the United States.
The temporary regulations additionally clarify that the exception
applies to all plants replanted on such acreage, even if the plants are
replanted in greater density than the plants destroyed by the casualty.
Final Regulations
In final regulations, cross references to Sec. 1.263A-4T are
provided in Secs. 1.61-4, 1.162-12, 1.263A-1, and 1.471-6.
Under Sec. 1.471-6(f), taxpayers using the unit livestock method
may not subsequently change the classification or unit costs they
initially adopted without obtaining the approval of the Commissioner.
As provided in Notice 88-24, the final regulations modify the rule in
Sec. 1.471-6(f) and require that taxpayers adjust the unit prices
upward from time to time, to reflect increases in costs taxpayers
experience in raising livestock. Any other changes in the
classification or unit prices used in the unit-livestock-price method
will continue to be allowed only with the consent of the Commissioner.
Effective Date and Transitional Rule
The temporary regulations provide that, in the case of property
that is not inventory in the hands of the taxpayer, the regulations are
generally effective for costs incurred on or after August 22, 1997, in
taxable years ending after such date. In the case of inventory
property, the temporary regulations are generally effective for taxable
years beginning after August 22, 1997. However, taxpayers in compliance
with Sec. 1.263A-4T in effect prior to August 22, 1997 (See 26 CFR part
1 edition revised as of April 1, 1997.), as modified by other
administrative guidance, that continue to comply with Sec. 1.263A-4T in
effect prior to August 22, 1997 (See 26 CFR part 1 edition revised as
of April 1, 1997.), as modified by other administrative guidance, will
not be required to apply these new temporary rules until the notice of
proposed rulemaking that cross-references these temporary regulations
is finalized. The amendment to Sec. 1.471-6(f) is effective for taxable
years beginning after August 22, 1997.
Effect on Other Documents
The following publications will be obsolete when the notice of
proposed rulemaking that cross-references these temporary regulations
is finalized: Notice 87-76, 1987-2 C.B. 384; Notice 88-24, 1988-1 C.B.
491; and section V of Notice 88-86, 1988-2 C.B. 401.
Special Analyses
It has been determined that this Treasury decision is not a
significant regulatory action as defined in EO 12866. Therefore, a
regulatory assessment is not required. It has also been determined that
section 553(b) of the Administrative Procedure Act (5 U.S.C. chapter 5)
does not apply to these regulations, and because the regulations do not
impose a collection of information on small entities, the Regulatory
Flexibility Act (5 U.S.C. chapter 6) does not apply. Pursuant to
section 7805(f) of the Internal Revenue Code, the temporary regulations
will be submitted, and the notice of proposed rulemaking that preceded
the final regulations were submitted, to the Chief Counsel for Advocacy
of the Small Business Administration for comment on their impact on
small business.
Drafting Information: The principal author of these temporary
regulations is Jan Skelton of the Office of Assistant
[[Page 44546]]
Chief Counsel (Income Tax and Accounting). However, other personnel
from the IRS and Treasury Department participated in their development.
List of Subjects in 26 CFR Part 1
Income taxes, Reporting and recordkeeping requirements.
Adoption of Amendments to the Regulations
Accordingly, 26 CFR Part 1 is amended as follows:
PART 1--INCOME TAXES
Paragraph 1. The authority citation for part 1 continues to read in
part as follows:
Authority: 26 U.S.C. 7805 * * *.
Sec. 1.61-4 [Amended]
Par. 2. Section 1.61-4 is amended by:
1. Adding a new sentence ``See section 263A for rules regarding
costs that are required to be capitalized.'' at the end of the
concluding text of paragraph (a).
2. Adding a new sentence ``See section 263A for rules regarding
costs that are required to be capitalized.'' after the fourth sentence
of the concluding text of paragraph (b).
Sec. 1.162-12 [Amended]
Par. 3. Section 1.162-12(a) is amended by:
1. Removing the eighth sentence, and adding the sentence ``For
rules regarding the capitalization of expenses of producing property in
the trade or business of farming, see section 263A and Sec. 1.263A-
4T.'' in its place.
2. Adding a new sentence ``For rules regarding the capitalization
of expenses of producing property in the trade or business of farming,
see section 263A and the regulations thereunder.'' after the third
sentence.
Par. 4. Section 1.263A-0T is added to read as follows:
Sec. 1.263A-0T Outline of regulations under section 263A (temporary).
This section lists the paragraphs in Sec. 1.263A-4T.
Sec. 1.263A-4T Rules for property produced in a farming business
(temporary).
(a) Introduction.
(1) In general.
(2) Exception.
(i) In general.
(ii) Tax shelter.
(iii) Presumption.
(iv) Costs required to be capitalized or inventoried under
another provision.
(v) Examples.
(3) Farming business.
(i) In general.
(A) Plant.
(B) Animal.
(ii) Incidental activities.
(A) In general.
(B) Activities that are not incidental.
(1) In general.
(2) Examples.
(b) Application of section 263A to property produced in a
farming business.
(1) In general.
(i) Plants.
(ii) Animals.
(2) Preproductive period.
(i) Plant.
(A) In general.
(B) Applicability of section 263A.
(C) Actual preproductive period.
(1) Beginning of the preproductive period.
(2) End of the preproductive period.
(i) In general.
(ii) Marketable quantities.
(D) Examples.
(ii) Animal.
(A) Beginning of the preproductive period.
(B) End of the preproductive period.
(C) Allocation of costs between animal and first yield.
(c) Inventory methods.
(1) In general.
(2) Available for property used in a trade or business.
(3) Exclusion of property to which section 263A does not apply.
(d) Election not to have section 263A apply.
(1) Introduction.
(2) Availability of the election.
(3) Time and manner of making the election.
(4) Special rules.
(i) Section 1245 treatment.
(ii) Required use of alternative depreciation system.
(iii) Related person.
(A) In general.
(B) Members of family.
(5) Examples.
(e) Exception for certain costs resulting from casualty losses.
(1) In general.
(2) Ownership.
(3) Examples.
(4) Special rule for citrus and almond groves.
(i) In general.
(ii) Example.
(f) Effective date and transition rule.
Sec. 1.263A-1 [Amended]
Par. 5. Section 1.263A-1 is amended by:
1. Removing the last sentence of paragraph (b)(3) and adding the
sentence ``See Sec. 1.263A-4T for specific rules relating to taxpayers
engaged in the trade or business of farming.'' in its place.
2. Removing the last sentence of paragraph (b)(4) and adding the
sentence ``See Sec. 1.263A-4T, however, for rules relating to taxpayers
producing certain trees to which section 263A applies.'' in its place.
Par. 6. Section 1.263A-4T is revised to read as follows:
Sec. 1.263A-4T Rules for property produced in a farming business
(temporary).
(a) Introduction--(1) In general. The regulations under this
section provide guidance with respect to the application of section
263A to property produced in a farming business as defined in paragraph
(a)(3) of this section. Except as otherwise provided by the rules of
this section, the general rules of Secs. 1.263A-1 through 1.263A-3 and
1.263A-7 through 1.263A-15 apply to property produced in a farming
business. A taxpayer that engages in the raising or growing of any
agricultural or horticultural commodity, including both plants and
animals, is engaged in the production of property. Section 263A
generally requires the capitalization of the direct costs and an
allocable portion of the indirect costs that benefit or are incurred by
reason of the production of this property. Taxpayers that do not
qualify for the exception described in paragraph (a)(2) of this section
must capitalize these costs of producing all plants and animals unless
the election described in paragraph (d) of this section is made.
(2) Exception--(i) In general. A taxpayer is not required to
capitalize the preproductive period costs of producing plants with a
preproductive period of 2 years or less or the costs of producing
animals, if the taxpayer is not--
(A) A corporation or partnership required to use an accrual method
of accounting (accrual method) under section 447 in computing its
taxable income from farming; or
(B) A tax shelter required to use an accrual method under section
448(a)(3).
(ii) Tax shelter. A farming business is considered a tax shelter,
and thus a taxpayer required to use an accrual method under section
448(a)(3), if the farming business is--
(A) A farming syndicate as defined in section 464(c); or
(B) A tax shelter, within the meaning of section
6662(d)(2)(C)(iii).
(iii) Presumption. Marketed arrangements in which persons carry on
farming activities using the services of a common managerial or
administrative service will be presumed to have the principal purpose
of tax avoidance, within the meaning of section 6662(d)(2)(C)(iii), if
such persons prepay a substantial portion of their farming expenses
with borrowed funds.
(iv) Costs required to be capitalized or inventoried under another
provision. The exception from capitalization provided in this paragraph
(a)(2) does not apply to any cost that is required to be capitalized or
inventoried under another Code or regulatory provision, such as section
263 or section 471.
[[Page 44547]]
(v) Examples. The following examples illustrate the provisions of
this paragraph (a)(2):
Example 1. Farmer A grows trees that have a preproductive period
in excess of 2 years, and that produce an annual crop. Farmer A is
not required by section 447 or 448(a)(3) to use an accrual method.
Accordingly, Farmer A qualifies for the exception described in this
paragraph (a)(2). Since the trees have a preproductive period in
excess of 2 years, Farmer A must capitalize the direct costs and an
allocable portion of the indirect costs that benefit or are incurred
by reason of the production of the trees. Since the annual crop has
a preproductive period of 2 years or less, Farmer A is not required
to capitalize the costs of the crops.
Example 2. Assume the same facts as Example 1, except that
Farmer A is required by section 447 or 448(a)(3) to use an accrual
method. Farmer A does not qualify for the exception described in
this paragraph (a)(2). Farmer A is required to capitalize the direct
costs and an allocable portion of the indirect costs that benefit or
are incurred by reason of the production of the trees and crops,
including all preproductive period costs.
(3) Farming business--(i) In general. A farming business means a
trade or business involving the cultivation of land or the raising or
harvesting of any agricultural or horticultural commodity. Examples
include the trade or business of operating a nursery or sod farm; the
raising or harvesting of trees bearing fruit, nuts, or other crops; the
raising of ornamental trees (other than evergreen trees that are more
than 6 years old at the time they are severed from their roots); and
the raising, shearing, feeding, caring for, training, and management of
animals. For purposes of this section, the term harvesting does not
include contract harvesting of an agricultural or horticultural
commodity grown or raised by another. Similarly, the trade or business
of merely buying and reselling plants or animals grown or raised by
another is not a farming business.
(A) Plant. A plant produced in a farming business includes, but is
not limited to, a fruit, nut, or other crop bearing tree, an ornamental
tree, a vine, a bush, sod, and the crop or yield of a plant that will
have more than one crop or yield. Sea plants are produced in a farming
business if they are tended and cultivated as opposed to merely
harvested.
(B) Animal. An animal produced in a farming business includes, but
is not limited to, any stock, poultry or other bird, and fish or other
sea life raised by the taxpayer. Thus, for example, the term animal may
include a cow, chicken, emu, or salmon raised by the taxpayer. Fish and
other sea life are produced in a farming business if they are raised on
a fish farm.
A fish farm is an area where fish or other sea life are grown or
raised as opposed to merely caught or harvested.
(ii) Incidental activities--(A) In general. Farming business
includes processing activities that are normally incident to the
growing, raising, or harvesting of agricultural products. For example,
a taxpayer in the trade or business of growing fruits and vegetables
may harvest, wash, inspect, and package the fruits and vegetables for
sale. Such activities are normally incident to the raising of these
crops by farmers. The taxpayer will be considered to be in the trade or
business of farming with respect to the growing of fruits and
vegetables and the processing activities incident to their harvest.
(B) Activities that are not incidental--(1) In general. Farming
business does not include the processing of commodities or products
beyond those activities that are normally incident to the growing,
raising, or harvesting of such products.
(2) Examples. The following examples illustrate the provisions of
this paragraph (a)(3)(ii):
Example 1. Individual A is in the business of growing and
harvesting wheat and other grains. Individual A also processes grain
that Individual A has harvested in order to produce breads, cereals,
and other similar food products, which Individual A then sells to
customers in the course of its business. Although Individual A is in
the farming business with respect to the growing and harvesting of
grain, Individual A is not in the farming business with respect to
the processing of such grain to produce the food products.
Example 2. Individual B is in the business of raising poultry
and other livestock. Individual B also operates a meat processing
operation in which the poultry and other livestock are slaughtered,
processed, and packaged or canned. The packaged or canned meat is
sold to Individual B's customers. Although Individual B is in the
farming business with respect to the raising of poultry and other
livestock, Individual B is not in the farming business with respect
to the slaughtering, processing, packaging, and canning of such
animals to produce the food products.
(b) Application of section 263A to property produced in a farming
business--(1) In general. Unless otherwise provided in this section,
section 263A requires the capitalization of the direct costs and an
allocable portion of the indirect costs that benefit or are incurred by
reason of the production of any property in a farming business
(including animals and plants without regard to the length of their
preproductive period).
(i) Plants. Costs typically required to be capitalized under
section 263A include the acquisition costs of the seed, seedling, or
plant, and the costs of planting, cultivating, maintaining, or
developing such plant during the preproductive period. These costs
include, but are not limited to, management, irrigation, pruning,
fertilizing (including costs that the taxpayer has elected to deduct
under section 180), soil and water conservation (including costs that
the taxpayer has elected to deduct under section 175), frost
protection, spraying, upkeep, electricity, tax depreciation and repairs
on buildings and equipment used in raising the plants, farm overhead,
taxes (except state and federal income taxes), and interest required to
be capitalized under section 263A(f).
(ii) Animals. Costs typically required to be capitalized under
section 263A include the acquisition cost of the animal, and the costs
of raising or caring for such animal during the preproductive period.
Preproductive period costs include, but are not limited to, the costs
of management, feed (such as grain, silage, concentrates, supplements,
haylage, hay, pasture and other forages), maintaining pasture or pen
areas (including costs that the taxpayer has elected to deduct under
sections 175 or 180), breeding, artificial insemination, veterinary
services and medicine, livestock hauling, bedding, fuel, electricity,
hired labor, tax depreciation and repairs on buildings and equipment
used in raising the animals (for example, barns, trucks, and trailers),
farm overhead, taxes (except state and federal income taxes), and
interest required to be capitalized under section 263A(f).
(2) Preproductive period--(i) Plant--(A) In general. The
preproductive period of property produced in a farming business means--
(1) In the case of a plant that will have more than one crop or
yield, the period before the first marketable crop or yield from such
plant;
(2) In the case of the crop or yield of a plant that will have more
than one crop or yield, the period before such crop or yield is
disposed of; or
(3) In the case of any other plant, the period before such plant is
disposed of.
(B) Applicability of section 263A. For purposes of determining
whether a plant has a preproductive period in excess of 2 years, the
preproductive period of plants grown in commercial quantities in the
United States is based on the nationwide weighted average preproductive
period for such plant. For all other plants, the taxpayer is required,
at or before the time the seed or plant is acquired or planted, to
reasonably estimate the preproductive period of the
[[Page 44548]]
plant. If the taxpayer estimates a preproductive period in excess of 2
years, the taxpayer must capitalize preproductive period costs. If the
estimate is reasonable, based on the facts in existence at the time it
is made, the determination of whether section 263A applies is not
modified at a later time even if the actual length of the preproductive
period differs from the estimate. The actual length of the
preproductive period will, however, be considered in evaluating the
reasonableness of the taxpayer's future estimates. Thus, the nationwide
weighted average preproductive period or the estimated preproductive
period are only used for purposes of determining whether the
preproductive period of a plant is greater than 2 years.
(C) Actual preproductive period. The plant's actual preproductive
period is used for purposes of determining the period during which a
taxpayer must capitalize preproductive period costs with respect to a
particular plant.
(1) Beginning of the preproductive period. The actual preproductive
period of a plant begins when the taxpayer first incurs costs that
directly benefit or are incurred by reason of the plant. Generally,
this occurs when the taxpayer plants the seed or plant. In the case of
a taxpayer that acquires plants that have already been planted, or
plants that are tended, by the taxpayer or another, prior to permanent
planting, the actual preproductive period of the plant begins upon
acquisition of the plant by the taxpayer. In the case of the crop or
yield of a plant that will have more than one crop or yield and that
has become productive in marketable quantities, the actual
preproductive period begins when the crop or yield first appears, for
example, in the form of a sprout, bloom, blossom, or bud.
(2) End of the preproductive period--(i) In general. In the case of
a plant that will have more than one crop or yield, the actual
preproductive period ends when the plant first becomes productive in
marketable quantities. In the case of any other plant (including the
crop or yield of a plant that will have more than one crop or yield),
the actual preproductive period ends when the plant, crop, or yield is
sold or otherwise disposed of.
(ii) Marketable quantities. A plant that will have more than one
crop or yield becomes productive in marketable quantities when it is
(or would be considered) placed in service for purposes of section 168
(without regard to the applicable convention).
(D) Examples. The following examples illustrate the provisions of
this paragraph (b)(2)(i):
Example 1. (i) Farmer A, a taxpayer that qualifies for the
exception in paragraph (a)(2) of this section, grows plants that
will have more than one crop or yield. The plants are grown in
commercial quantities in the United States. Farmer A acquires the
plants by purchasing them from an unrelated party, Corporation B,
and plants them immediately. The nationwide weighted average
preproductive period of the plant is 4 years. The particular plants
grown by Farmer A do not begin to produce in marketable quantities
until 4 years and 6 months after they are planted by Farmer A.
(ii) Since the plants are deemed to have a preproductive period
in excess of 2 years, Farmer A is required to capitalize the
preproductive period costs of the plants. See paragraphs (a)(2) and
(b)(2)(i)(B) of this section. In accordance with paragraph
(b)(2)(i)(C)(1) of this section, Farmer A must begin to capitalize
such costs when the plants are planted. In accordance with paragraph
(b)(2)(i)(C)(2) of this section, Farmer A must continue to
capitalize costs to the plants until the plants begin to produce in
marketable quantities. Thus, Farmer A must capitalize the
preproductive period costs of the plants for a period of 4 years and
6 months, notwithstanding the fact that the plants, in general, have
a nationwide weighted average preproductive period of 4 years.
Example 2. (i) Farmer B, a taxpayer that qualifies for the
exception in paragraph (a)(2) of this section, grows plants that
will have more than one crop or yield. The plants are grown in
commercial quantities in the United States. The nationwide weighted
average preproductive period of the plant is 2 years and 5 months.
Farmer B acquires the plants by purchasing them from an unrelated
party, Corporation B. Farmer B enters into a contract with
Corporation B under which Corporation B will retain and tend the
plants for 7 months following the sale. At the end of 7 months,
Farmer B takes possession of the plants and plants them in the
permanent orchard. The plants become productive in marketable
quantities 1 year and 11 months after they are planted by Farmer B.
(ii) Since the plants are deemed to have a preproductive period
in excess of 2 years, Farmer B is required to capitalize the
preproductive period costs of the plants. See paragraphs (a)(2) and
(b)(2)(i)(B) of this section. In accordance with paragraph
(b)(2)(i)(C)(1) of this section, Farmer B must begin to capitalize
such costs when the purchase occurs. In accordance with paragraph
(b)(2)(i)(C)(2) of this section, Farmer B must continue to
capitalize costs to the plants until the plants begin to produce in
marketable quantities. Thus, Farmer B must capitalize the
preproductive period costs of the plants for a period of 2 years and
6 months (the 7 months the plants are tended by Corporation B and
the 1 year and 11 months after the plants are planted by Farmer B),
notwithstanding the fact that the plants, in general, have a
nationwide weighted average preproductive period of 2 years and 5
months.
Example 3. (i) Assume the same facts as in Example 2, except
that Farmer B acquires the plants by purchasing them from
Corporation B when the plants are 7 months old and that the plants
are planted by Farmer B upon acquisition.
(ii) Since the plants are deemed to have a preproductive period
in excess of 2 years, Farmer B is required to capitalize the
preproductive period costs of the plants. See paragraphs (a)(2) and
(b)(2)(i)(B) of this section. In accordance with paragraph
(b)(2)(i)(C)(1) of this section, Farmer B must begin to capitalize
such costs when the plants are planted. In accordance with paragraph
(b)(2)(i)(C)(2) of this section, Farmer B must continue to
capitalize costs to the plants until the plants begin to produce in
marketable quantities. Thus, Farmer B must capitalize the
preproductive period costs of the plants for a period of 1 year and
11 months.
Example 4. (i) Farmer C, a taxpayer that qualifies for the
exception in paragraph (a)(2) of this section, grows plants that
will have more than one crop or yield. The plants are grown in
commercial quantities in the United States. Farmer C acquires the
plants from an unrelated party and plants them immediately. The
nationwide weighted average preproductive period of the plant is 2
years and 3 months. The particular plants grown by Farmer C begin to
produce in marketable quantities 1 year and 10 months after they are
planted by Farmer C.
(ii) Since the plants are deemed to have a nationwide weighted
average preproductive period in excess of 2 years, Farmer C is
required to capitalize the preproductive period costs of the plants,
notwithstanding the fact that the particular plants grown by Farmer
C become productive in less than 2 years. See paragraph (b)(2)(i)(B)
of this section. In accordance with paragraph (b)(2)(i)(C)(1) of
this section, Farmer C must begin to capitalize such costs when it
plants the plants. In accordance with paragraph (b)(2)(i)(C)(2) of
this section, Farmer C properly ceases capitalization of
preproductive period costs when the plants become productive in
marketable quantities (i.e., after 1 year and 10 months).
Example 5. (i) Farmer D, a taxpayer that qualifies for the
exception in paragraph (a)(2) of this section, grows plants that
will have more than one crop or yield. The plants are not grown in
commercial quantities in the United States. At the time the plants
are planted Farmer D reasonably estimates that the plants will have
a preproductive period of 4 years. The actual plants grown by Farmer
D do not begin to produce in marketable quantities until 4 years and
6 months after they are planted by Farmer D.
(ii) Since the plants have an estimated preproductive period in
excess of 2 years, Farmer D is required to capitalize the
preproductive period costs of the plants. See paragraph (b)(2)(i)(B)
of this section. In accordance with paragraph (b)(2)(i)(C)(1) of
this section, Farmer D must begin to capitalize such costs when it
plants the plants. In accordance with paragraph (b)(2)(i)(C)(2) of
this section, Farmer D must continue to capitalize costs until the
plants begin to produce in marketable quantities. Thus, Farmer D
must capitalize the preproductive period costs of the plants for a
period of 4 years and 6 months,
[[Page 44549]]
notwithstanding the fact that Farmer D estimated that the plants
would become productive after 4 years.
Example 6. (i) Farmer E, a taxpayer that qualifies for the
exception in paragraph (a)(2) of this section grows plants that are
not grown in commercial quantities in the United States. The plants
do not have more than 1 crop or yield. At the time the plants are
planted Farmer E reasonably estimates that the plants will have a
preproductive period of 1 year and 10 months. The actual plants
grown by Farmer E are not ready for harvesting and disposal until 2
years and 2 months after the seeds are planted by Farmer E.
(ii) Because Farmer E's estimate of the preproductive period
(which was 2 years or less) was reasonable at the time made based on
the facts, Farmer E will not be required to capitalize the
preproductive period costs of the plants notwithstanding the fact
that the actual preproductive period of the plants exceeded 2 years.
See paragraph (b)(2)(i)(B) of this section. However, Farmer E must
take the actual preproductive period of the plants into
consideration when making future estimates of the preproductive
period of such plants.
Example 7. Farmer F, a calendar year taxpayer that does not
qualify for the exception in paragraph (a)(2) of this section, grows
trees that will have more than one crop. Farmer F acquires and
plants the trees in April, 1998. On October 1, 2003, the trees are
placed in service within the meaning of section 168. Under paragraph
(b)(2)(i)(C)(2)(ii) of this section, the trees become productive in
marketable quantities on October 1, 2003. The preproductive period
costs incurred by Farmer F on or before October 1, 2003, are
capitalized to the trees. Preproductive period costs incurred after
October 1, 2003, are capitalized to a crop when incurred during the
preproductive period of the crop and expensed when incurred between
the disposal of one crop and the appearance of the next crop. See
paragraphs (b)(2)(i)(A), (b)(2)(i)(C)(1) and (b)(2)(i)(C)(2) of this
section.
(ii) Animal. An animal's actual preproductive period is used to
determine the period that the taxpayer must capitalize preproductive
period expenses with respect to a particular animal.
(A) Beginning of the preproductive period. The preproductive period
of an animal begins at the time of acquisition, breeding, or embryo
implantation.
(B) End of the preproductive period. In the case of an animal that
will be used in the trade or business of farming (e.g., a dairy cow),
the preproductive period generally ends when the animal is (or would be
considered) placed in service for purposes of section 168 (without
regard to the applicable convention). However, in the case of an animal
that will have more than one yield (e.g., a breeding cow), the
preproductive period ends when the animal produces (e.g., gives birth
to) its first yield. In the case of any other animal, the preproductive
period ends when the animal is sold or otherwise disposed of.
(C) Allocation of costs between animal and first yield. In the case
of an animal that will have more than one yield, the costs incurred
after the beginning of the preproductive period of the first yield but
before the end of the preproductive period of the animal must be
allocated between the animal and the yield on a reasonable basis. Any
depreciation allowance on the animal may be allocated entirely to the
yield. The allocation method used by a taxpayer is a method of
accounting that must be used consistently and is subject to the rules
of section 446 and the regulations thereunder.
(c) Inventory methods--(1) In general. Except as otherwise
provided, the costs required to be allocated to any plant or animal
under this section may be determined using reasonable inventory
valuation methods such as the farm-price method or the unit-livestock-
price method. See Sec. 1.471-6. Under the unit-livestock-price method,
unit prices must include all costs required to be capitalized under
section 263A. A taxpayer using the unit-livestock-price method may
elect to use the cost allocation methods in Sec. 1.263A-1(f) or 1.263A-
2(b) to allocate its direct and indirect costs to the property produced
in the business of farming. In such a situation, section 471 costs are
the costs taken into account by the taxpayer under the unit-livestock-
price method using the taxpayer's standard unit price as modified by
this paragraph (c)(1). The term additional section 263A costs includes
all additional costs required to be capitalized under section 263A. Tax
shelters, as defined in paragraph (a)(2)(ii) of this section, that use
the unit-livestock-price method for inventories must include in
inventory the annual standard unit price for all animals that are
acquired during the taxable year, regardless of whether the purchases
are made during the last 6 months of the taxable year. Taxpayers
required by section 447 or 448(a)(3) to use an accrual method that use
the unit-livestock-price method must modify the annual standard price
in order to reasonably reflect the particular period in the taxable
year in which purchases of livestock are made, if such modification is
necessary in order to avoid significant distortions in income that
would otherwise occur through operation of the unit livestock method.
(2) Available for property used in a trade or business. The farm
price method or the unit livestock method may be used by any taxpayer
to allocate costs to any plant or animal under this section, regardless
of whether the plant or animal is held or treated as inventory property
by the taxpayer. Thus, for example, a taxpayer may use the unit
livestock method to account for the costs of raising livestock that
will be used in the trade or business of farming (e.g., a breeding
animal or a dairy cow) even though the property in question is not
inventory property.
(3) Exclusion of property to which section 263A does not apply.
Notwithstanding a taxpayer's use of the farm price method with respect
to farm property to which the provisions of section 263A apply, that
taxpayer is not required, solely by such use, to use the farm price
method with respect to farm property to which the provisions of section
263A do not apply. Thus, for example, assume Farmer A raises fruit
trees that have a preproductive period in excess of 2 years and to
which the provisions of section 263A, therefore, apply. Assume also
that Farmer A raises cattle and is not required to use an accrual
method by section 447 or 448(a)(3). Because Farmer A qualifies for the
exception in paragraph (a)(2) of this section, Farmer A is not required
to capitalize the costs of raising the cattle. Although Farmer A may
use the farm price method with respect to the fruit trees, Farmer A is
not required to use the farm price method with respect to the cattle.
Instead, Farmer A's accounting for the cattle is determined under other
provisions of the Code and regulations.
(d) Election not to have section 263A apply--(1) Introduction.
This paragraph (d) permits certain taxpayers to make an election not to
have the rules of this section apply to any plant produced in a farming
business conducted by the electing taxpayer. The election is a method
of accounting under section 446, and once an election is made, it is
revocable only with the consent of the Commissioner.
(2) Availability of the election. The election described in this
paragraph (d) is available to any taxpayer that produces plants in a
farming business, except that no election may be made by a corporation,
partnership, or tax shelter required to use the accrual method under
section 447 or 448(a)(3). Moreover, the election does not apply to the
costs of planting, cultivation, maintenance, or development of a citrus
or almond grove (or any part thereof) incurred prior to the close of
the fourth taxable year beginning with the taxable year in which the
trees were planted in the permanent grove (including costs incurred
prior to the permanent planting). If a citrus or almond grove is
[[Page 44550]]
planted in more than one taxable year, the portion of the grove planted
in any one taxable year is treated as a separate grove for purposes of
determining the year of planting.
(3) Time and manner of making the election. A taxpayer makes the
election under this paragraph (d) by not capitalizing the preproductive
period costs of producing property in a farming business and by
applying the special rules in paragraph (d)(4) of this section, on its
timely filed original return (including extensions) for the first
taxable year in which the taxpayer is otherwise required to capitalize
preproductive period costs under section 263A. Thus, in order to be
treated as having made the election under this paragraph (d), it is
necessary to report both income and expenses in accordance with the
rules of this paragraph (d) (e.g., it is necessary to use the
alternative depreciation system as provided in paragraph (d)(4)(ii) of
this section). Thus, for example, a farmer who deducts preproductive
period costs that are otherwise required to be capitalized under
section 263A but fails to use the alternative depreciation system under
section 168(g)(2) for applicable property placed in service has not
made an election under this paragraph (d) and is not in compliance with
the provisions of section 263A. In the case of a partnership or S
corporation, the election must be made by the partner, shareholder, or
member.
(4) Special rules. If the election under this paragraph (d) is
made, the taxpayer is subject to the special rules in this paragraph
(d)(4).
(i) Section 1245 treatment. The plant produced by the taxpayer is
treated as section 1245 property and any gain resulting from any
disposition of the plant is recaptured (i.e., treated as ordinary
income) to the extent of the total amount of the deductions that, but
for the election, would have been required to be capitalized with
respect to the plant. In calculating the amount of gain that is
recaptured under this paragraph (d)(4)(i), a taxpayer may use the farm
price method or another simplified method permitted under these
regulations in determining the deductions that otherwise would have
been capitalized with respect to the plant.
(ii) Required use of alternative depreciation system. If the
taxpayer or a related person makes an election under this paragraph
(d), the alternative depreciation system (as defined in section
168(g)(2)) must be applied to all property used predominantly in any
farming business of the taxpayer or related person and placed in
service in any taxable year during which the election is in effect. The
requirement to use the alternative depreciation system by reason of an
election under this paragraph (d) will not prevent a taxpayer from
making an election under section 179 to deduct certain depreciable
business assets.
(iii) Related person--(A) In general. For purposes of this
paragraph (d)(4), related person means--
(1) The taxpayer and members of the taxpayer's family;
(2) Any corporation (including an S corporation) if 50 percent or
more of the stock (in value) is owned directly or indirectly (through
the application of section 318) by the taxpayer or members of the
taxpayer's family;
(3) A corporation and any other corporation that is a member of the
same controlled group (within the meaning of section 1563(a)(1)); and
(4) Any partnership if 50 percent or more (in value) of the
interests in such partnership is owned directly or indirectly by the
taxpayer or members of the taxpayer's family.
(B) Members of family. For purposes of this paragraph (d)(4)(iii),
members of the taxpayer's family, and members of family (for purposes
of applying section 318(a)(1)), means the spouse of the taxpayer (other
than a spouse who is legally separated from the individual under a
decree of divorce or separate maintenance) and any of the taxpayer's
children (including legally adopted children) who have not reached the
age of 18 as of the last day of the taxable year in question.
(5) Examples. The following examples illustrate the provisions of
this paragraph (d):
Example 1. (i) Farmer A, an individual, is engaged in the trade
or business of farming. Farmer A grows apple trees that have a
preproductive period greater than 2 years. In addition, Farmer A
grows and harvests wheat and other grains. Farmer A elects under
this paragraph (d) not to have the rules of section 263A apply to
the preproductive period costs of growing the apple trees.
(ii) In accordance with paragraph (d)(4) of this section, Farmer
A is required to use the alternative depreciation system described
in section 168(g)(2) with respect to all property used predominantly
in any farming business in which Farmer A engages (including the
growing and harvesting of wheat) if such property is placed in
service during a year for which the election is in effect. Thus, for
example, all assets and equipment (including trees and any equipment
used to grow and harvest wheat) placed in service during a year for
which the election is in effect must be depreciated as provided in
section 168(g)(2).
Example 2. Assume the same facts as in Example 1, except that
Farmer A and members of Farmer A's family (as defined in paragraph
(d)(4)(iii)(B) of this section) also own 51 percent (in value) of
the interests in Partnership P, which is engaged in the trade or
business of growing and harvesting corn. Partnership P is a related
person to Farmer A under the provisions of paragraph (d)(4)(iii) of
this section. Thus, the requirements to use the alternative
depreciation system under section 168(g)(2) also apply to any
property used predominantly in a trade or business of farming which
Partnership P places in service during a year for which an election
made by Farmer A is in effect.
(e) Exception for certain costs resulting from casualty losses--(1)
In general. Section 263A does not require the capitalization of costs
that are attributable to the replanting, cultivating, maintaining, and
developing of any plants bearing an edible crop for human consumption
(including, but not limited to, plants that constitute a grove,
orchard, or vineyard) that were lost or damaged while owned by the
taxpayer by reason of freezing temperatures, disease, drought, pests,
or other casualty (replanting costs). Such replanting costs may be
incurred with respect to property other than the property on which the
damage or loss occurred to the extent the acreage of the property with
respect to which the replanting costs are incurred is not in excess of
the acreage of the property on which the damage or loss occurred. This
paragraph (e) applies only to the replanting of plants of the same type
as those lost or damaged. This paragraph (e) applies to plants
replanted on the property on which the damage or loss occurred or
property of the same or lesser acreage in the United States
irrespective of differences in density between the lost or damaged and
replanted plants. Plants bearing crops for human consumption are those
crops normally eaten or drunk by humans. Thus, for example, costs
incurred with respect to replanting plants bearing jojoba beans do not
qualify for the exception provided in this paragraph (e) because that
crop is not normally eaten or drunk by humans.
(2) Ownership. Replanting costs described in paragraph (e)(1) of
this section generally must be incurred by the taxpayer that owned the
property at the time the plants were lost or damaged. Paragraph (e)(1)
of this section will apply, however, to costs incurred by a person
other than the taxpayer that owned the plants at the time of damage or
loss if--
(i) The taxpayer that owned the plants at the time the damage or
loss occurred owns an equity interest of more than 50 percent in such
plants at all times during the taxable year in which the
[[Page 44551]]
replanting costs are paid or incurred; and
(ii) Such other person owns any portion of the remaining equity
interest and materially participates in the replanting, cultivating,
maintaining, or developing of such plants during the taxable year in
which the replanting costs are paid or incurred. A person will be
treated as materially participating for purposes of this provision if
such person would otherwise meet the requirements with respect to
material participation within the meaning of section 2032A(e)(6).
(3) Examples. The following examples illustrate the provisions of
this paragraph (e):
Example 1. (i) Farmer T grows cherry trees that have a
preproductive period in excess of 2 years and produce an annual
crop. These cherries are normally eaten by humans. Farmer T grows
the trees on a 100 acre parcel of land (parcel 1) and the groves of
trees cover the entire acreage of parcel 1. Farmer T also owns a 150
acre parcel of land (parcel 2) that Farmer T holds for future use.
Both parcels are in the United States. In 1998, the trees and the
irrigation and drainage systems that service the trees are destroyed
in a casualty (within the meaning of paragraph (e)(1) of this
section). Farmer T installs new irrigation and drainage systems on
parcel 1, purchases young trees (seedlings), and plants the
seedlings on parcel 1.
(ii) The costs of the irrigation and drainage systems and the
seedlings must be capitalized under section 263A. In accordance with
paragraph (e)(1) of this section, the costs of planting,
cultivating, developing, and maintaining the seedlings during their
preproductive period are not required to be capitalized by section
263A.
Example 2. (i) Assume the same facts as in Example 1 except that
Farmer T decides to replant the seedlings on parcel 2 rather than on
parcel 1. Accordingly, Farmer T installs the new irrigation and
drainage systems on 100 acres of parcel 2 and plants seedlings on
those 100 acres.
(ii) The costs of the irrigation and drainage systems and the
seedlings must be capitalized under section 263A. Because the
acreage of the related portion of parcel 2 does not exceed the
acreage of the destroyed orchard on parcel 1, the costs of planting,
cultivating, developing, and maintaining the seedlings during their
preproductive period are not required to be capitalized by section
263A. See paragraph (e)(1) of this section.
Example 3. (i) Assume the same facts as in Example 1 except that
Farmer T replants the seedlings on parcel 2 rather than on parcel 1,
and Farmer T additionally decides to expand its operations by
growing 125 rather than 100 acres of trees. Accordingly, Farmer T
installs new irrigation and drainage systems on 125 acres of parcel
2 and plants seedlings on those 125 acres.
(ii) The costs of the irrigation and drainage systems and the
seedlings must be capitalized under section 263A. The costs of
planting, cultivating, developing, and maintaining 100 acres of the
trees during their preproductive period are not required to be
capitalized by section 263A. The costs of planting, cultivating,
maintaining, and developing the additional 25 acres are, however,
subject to capitalization. See paragraph (e)(1) of this section.
(4) Special rule for citrus and almond groves--(i) In general. The
exception in this paragraph (e) is available with respect to a citrus
or almond grove, notwithstanding the taxpayer's election not to have
section 263A apply (described in paragraph (d) of this section).
(ii) Example. The following example illustrates the provisions of
this paragraph (e)(4):
Example. (i) Farmer A, an individual, is engaged in the trade or
business of farming. Farmer A grows citrus trees that have a
preproductive period of 5 years. Farmer A elects, under paragraph
(d) of this section, not to have section 263A apply to the
preproductive period costs. This election, however, is unavailable
with respect to the preproductive period costs of a citrus grove
incurred within the first 4 years after the trees were planted. See
paragraph (d)(2) of this section. After the citrus grove has become
productive in marketable quantities, the citrus grove is destroyed
by a casualty within the meaning of paragraph (e)(1) of this
section.
(ii) Farmer A must capitalize the preproductive period costs
incurred before the close of the fourth taxable year beginning with
the year in which the trees were permanently planted. As a result of
the election not to have section 263A apply to preproductive period
costs, Farmer A may deduct the preproductive period costs incurred
in the fifth year. The costs of replanting, cultivating,
maintaining, and developing the trees destroyed by a casualty are
exempted from capitalization under this paragraph (e).
(f) Effective date and transition rule. In the case of property
that is not inventory in the hands of the taxpayer, this section is
generally effective for costs incurred on or after August 22, 1997, in
taxable years ending after such date. In the case of inventory
property, this section is generally effective for taxable years
beginning after August 22, 1997. However, taxpayers in compliance with
Sec. 1.263A-4T in effect prior to August 22, 1997 (See 26 CFR part 1
edition revised as of April 1, 1997.), and other administrative
guidance, that continue to comply with Sec. 1.263A-4T in effect prior
to August 22, 1997 (See 26 CFR part 1 edition revised as of April 1,
1997.), and other administrative guidance, will not be required to
apply these new temporary rules until final regulations are published
in the Federal Register.
Sec. 1.471-6 [Amended]
Par. 7. Section 1.471-6 is amended as follows:
1. Adding two sentences to the end of paragraph (c).
2. Removing the second sentence in paragraph (d) and adding two
sentences in its place.
3. Revising the last three sentences of paragraph (f).
The additions and revision read as follows:
Sec. 1.471-6 Inventories of livestock raisers and other farmers.
* * * * *
(c) * * * In addition, these inventory methods may be used to
account for the costs of property produced in a farming business that
are required to be capitalized under section 263A regardless of whether
the property being produced is otherwise treated as inventory by the
taxpayer, and regardless of whether the taxpayer is otherwise using the
cash or an accrual method of accounting. Thus, for example, the unit
livestock method may be utilized by a taxpayer in accounting under
section 263A for the costs of raising animals that will be used for
draft, breeding, or dairy purposes.
(d) * * * If this method of valuation is used, it generally must be
applied to all property produced by the taxpayer in the trade or
business of farming, except as to livestock accounted for, at the
taxpayer's election, under the unit livestock method of accounting.
However, see Sec. 1.263A-4T(c)(3) for an exception to this rule. * * *
* * * * *
(f) * * * Except as otherwise provided in this paragraph, once
established, the unit prices and classifications selected by the
taxpayer must be consistently applied in all subsequent taxable years.
For taxable years beginning after August 22, 1997, a taxpayer using the
unit livestock method must, however, annually reevaluate the unit
livestock prices and must adjust the prices upward to reflect increases
in the costs of raising livestock. The consent of the Commissioner is
not required to make such upward adjustments. No other changes in the
classification of animals or unit prices shall be made without the
consent of the Commissioner. See Sec. 1.263A-4T for rules regarding the
computation of costs for purposes of the unit livestock method.
* * * * *
Michael P. Dolan,
Acting Commissioner of Internal Revenue.
Approved: July 28, 1997.
Donald C. Lubick,
Acting Assistant Secretary of the Treasury.
[FR Doc. 97-21772 Filed 8-21-97; 8:45 am]
BILLING CODE 4830-01-U