[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