[Federal Register Volume 65, Number 162 (Monday, August 21, 2000)]
[Rules and Regulations]
[Pages 50638-50650]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 00-21103]


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DEPARTMENT OF THE TREASURY

Internal Revenue Service

26 CFR Part 1

[TD 8897]
RIN 1545-AQ91


Rules for Property Produced in a Farming Business

AGENCY: Internal Revenue Service (IRS), Treasury.

ACTION: Final regulations.

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SUMMARY: This document contains final regulations relating to the 
application of section 263A of the Internal Revenue Code to property 
produced in the trade or business of farming. These regulations also 
provide guidance regarding the election available to certain taxpayers 
to not have section 263A apply to any plant produced by the electing 
taxpayers in each taxpayer's farming trade or business. These 
regulations affect taxpayers engaged in the trade or business of 
farming.

DATES: Effective Date: These regulations are effective August 21, 2000.
    Applicability Date: For dates of applicability, see Sec. 1.263A-
4(f) of these regulations.

FOR FURTHER INFORMATION CONTACT: Grant D. Anderson, (202) 622-4970 (not 
a toll-free call).

SUPPLEMENTARY INFORMATION:

Background

    On March 30, 1987, the IRS published in the Federal Register a 
notice of proposed rulemaking (REG-208151-91) (52 FR 10118) by cross 
reference to temporary regulations published the same day (TD 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 (TD 8148, 52 
FR 29375). Notice 88-24 (1988-1 C.B. 491), provided that forthcoming 
regulations would modify the proposed 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 members of 
family 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 
(TD 8559, 59 FR 39958). On August 22, 1997, proposed and revised 
temporary regulations were issued and published in the Federal Register 
(TD 8729, 62 FR 44542). A public hearing was held on November 19, 1997.
    Written comments responding to the notice of proposed rulemaking 
were received. After consideration of all the public comments, the 
regulations are adopted as revised by this Treasury decision and the 
corresponding temporary regulations are withdrawn.

Explanation of Provisions and Summary of Comments

    Section 263A 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 generally requires

[[Page 50639]]

taxpayers to capitalize the direct costs and an allocable portion of 
indirect costs of producing property in a farming business (including 
both plants and animals). However, taxpayers that are neither required 
to use an accrual method by section 447 nor prohibited by section 
448(a)(3) from using the cash receipts and disbursements method 
(qualified taxpayers) are eligible for two exceptions provided in 
section 263A(d). First, under section 263A(d)(1), section 263A does not 
apply to a qualified taxpayer's cost of producing plants with a 
preproductive period of two years or less or animals in a farming 
business. Second, pursuant to section 263A(d)(3), a qualified taxpayer 
may elect to have section 263A not apply to the cost of producing 
plants in a farming business.

Property Produced in a Farming Business

    Consistent with sections 263A(d)(1)(A) and 263A(d)(3)(A), the 
proposed regulations provided that the special rules of section 263A(d) 
apply only to property produced by a taxpayer in a farming business. 
The term farming business means the cultivation of land or the raising 
or harvesting of any agricultural or horticultural commodity. Examples 
include 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.
    The proposed regulations explained that taxpayers engaged in 
contract harvesting, reselling of plants or animals that are not 
produced by the taxpayer, and processing that is not incident to 
growing, raising, or harvesting of agricultural or horticultural 
commodities, are not producing property in a farming business. Several 
commentators requested that the final regulations permit some of these 
taxpayers to use the special rules of section 263A(d). However, 
sections 263A(d)(1)(A) and 263A(d)(3)(A) limit the special rules of 
section 263A(d) to property produced by the taxpayer in a farming 
business. As discussed below, the IRS and Treasury Department continue 
to believe that taxpayers that merely contract harvest, resell plants 
or animals that they do not raise or grow, or engage in processing 
agricultural or horticultural commodities that is not incident to 
growing, raising, or harvesting of these commodities, are not producing 
property in a farming business and therefore do not meet this 
requirement. Accordingly, the final regulations do not adopt these 
suggestions.
    The proposed regulations provided that, for purposes of the 
definition of farming business, harvesting, does not include contract 
harvesting of an agricultural or horticultural commodity that is not 
grown or raised by the taxpayer. Some commentators were concerned that 
this language may be used to disqualify otherwise legitimate farmers 
who make arrangements with their neighbors to harvest each others 
crops. First, the IRS and Treasury Department believe that whether and 
to what extent a taxpayer is engaged in a farming business is to be 
determined based on all the facts and circumstances. No inference is 
intended that merely because a taxpayer engages in nonfarm activities, 
such as contract harvesting, in addition to farm activities, that such 
taxpayer is not engaged in a farming business. Further, the exception 
under section 263A(d) is relevant only to taxpayers whose costs are 
otherwise subject to capitalization under section 263A. Thus, for 
example, while taxpayers that grow plants are generally subject to 
section 263A with respect to that production activity, taxpayers that 
contract harvest horticultural commodities are not, because they are 
engaged in a service activity. A taxpayer that harvests crops grown by 
the taxpayer and contract harvests crops grown by another is subject to 
section 263A (and the exception contained in section 263A(d)), but only 
for the costs of harvesting its own crops. Accordingly, the final 
regulations do not adopt the commentators' suggestion to include 
contract harvesting in the special rules of section 263A(d).
    Similarly, the proposed regulations provided 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 taxpayer. The 
preamble to the proposed regulations indicated that in evaluating 
whether the 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.
    Many commentators expressed concern that the proposed regulations' 
concept of ``merely buying and reselling plants grown by another'' 
could be interpreted to mean that only taxpayers growing a plant from 
seed would be regarded as engaged in a farming business. For example, 
the commentators were concerned that a taxpayer that buys a partially 
grown plant, grows the plant to a larger size, and then sells the plant 
would not be engaged in a farming business. The final regulations 
clarify that a taxpayer is engaged in the production of property in a 
farming business, rather than the mere resale of plants or animals, if 
the plant or animal is held for further cultivation and development 
prior to sale. In addition, the final regulations include an example 
illustrating that a taxpayer that buys plants, grows them, and sells 
them, is producing property in a farming business; whereas a taxpayer 
that buys plants and, without further cultivation and development, 
resells them is not producing property in a farming business. The 
example also illustrates that a taxpayer engaged in both farming 
activities and resale activities is not required to capitalize costs 
under section 263A with respect to the resale activities if the 
taxpayer has average annual gross receipts of less than $10 million. 
See also, Ann. 97-120 (1997-50 I.R.B. 61 (Dec. 15, 1997)) (confirming 
that nursery growers using the farming exception may deduct the costs 
of young plants purchased for further development and cultivation prior 
to sale as well as the costs of growing the plants).
    Some commentators suggested that the final regulations disregard 
whether a plant is kept in its container out of concern that taxpayers 
who grow plants in containers would not be considered to be producing 
property in a farming business. The IRS and Treasury Department 
continue to believe that this is a factor to be considered in addition 
to all the other facts and circumstances. Accordingly, the final 
regulations retain this factor. However, the final regulations have 
been clarified to explain that a plant that is grown by a taxpayer in a 
container is regarded as a plant produced in a farming business.
    One commentator requested that the value added to a plant or animal 
by a taxpayer also be a factor in determining whether a taxpayer is 
engaged in the production, or the mere resale, of plants or animals. 
The final regulations provide that a taxpayer's addition of value to 
plants or animals through agricultural or horticultural processes is a 
factor to be considered in evaluating whether a taxpayer is producing 
property in a farming business.
    Some commentators requested that the list of factors contained in 
the preamble be included in the regulations.

[[Page 50640]]

In response to these comments, the final regulations contain a list of 
factors, modified as discussed above, to assist in the determination of 
whether a plant or animal is held for further cultivation and 
development prior to sale or merely held for resale.
    One commentator expressed concern that under the proposed 
regulations a farming business only includes processing activities that 
are normally incident to the growing, raising, or harvesting of 
agricultural or horticultural commodities. This commentator also 
suggested that farmers are engaging in processing activities as the 
result of new technology and changes in the market for agricultural or 
horticultural products. The IRS and Treasury Department believe that 
processing activities that are not normally incident to the growing, 
raising, or harvesting of agricultural or horticultural products, such 
as the canning of an agricultural product or the combination of an 
agricultural product with other ingredients to produce a different 
edible item, are not farming activities. Accordingly, the final 
regulations, like the proposed regulations, include in the definition 
of farming business only those processing activities that are normally 
incident to the growing, raising, or harvesting of agricultural or 
horticultural products, such as the washing, inspecting, and packaging 
of those products.

Exceptions to Section 263A for Certain Property

    Taxpayers generally must capitalize direct costs and an allocable 
portion of indirect costs of producing all plants (without regard to 
the length of the preproductive period) and animals. Qualified 
taxpayers, however, are eligible for an exception to this general rule. 
Under this exception, qualified taxpayers are not required to 
capitalize under section 263A the costs of producing plants that have a 
preproductive period of 2 years or less or with respect to animals. 
Thus, under this exception, qualified taxpayers are required to 
capitalize only those costs of producing plants that have a 
preproductive period in excess of 2 years.
    A few commentators suggested that, for purposes of determining the 
application of section 263A, the preproductive period of a plant should 
be determined with reference to the length of time a particular 
taxpayer grows a plant rather than with reference to how long it takes 
the plant to reach a productive stage. The commentators suggested this 
method would, in essence, supplant the nationwide weighted average 
preproductive period used for plants grown in commercial quantities in 
the United States and the reasonable estimate of the preproductive 
period used for all other plants. For example, a qualified taxpayer 
grows bushes that have a preproductive period of 3 years and 3 months. 
If the taxpayer purchases and plants the bushes when they are 2 years 
old, the commentators suggest that the preproductive period of the 
bushes should be regarded as 2 years or less (and the taxpayer would, 
therefore, not be required to capitalize the costs associated with 
growing the bushes) because this taxpayer grows the bushes for only 15 
months before the bushes become productive in marketable quantities. 
If, however, another qualified taxpayer purchased the same type of 
bushes when the bushes were 14 months old and grew them for 2 years and 
1 month, the preproductive period of the bushes would be regarded as in 
excess of 2 years, and this taxpayer would be required to capitalize 
the costs of growing the bushes.
    The final regulations do not adopt this recommendation. First, the 
statute requires that the preproductive period of a plant grown in 
commercial quantities in the United States be based on the nationwide 
weighted average preproductive period of the plant. See Pelaez and 
Sons, Inc., et al. v. Commissioner, 114 T.C. No. 28 (No. 18049-97 May 
30, 2000). Further, the IRS and Treasury Department continue to believe 
that, for purposes of determining whether section 263A applies, the 
preproductive period of a plant not grown in commercial quantities in 
the United States also should be determined on a plant-by-plant basis 
rather than on a taxpayer-by-taxpayer basis.
    In the case of a plant that is not produced in commercial 
quantities in the United States, the proposed regulations provided 
that, at or before the time the seed or plant is acquired or planted, 
the taxpayer is required to reasonably estimate whether the plant has a 
preproductive period in excess of 2 years. One commentator suggested 
that the regulations provide that if the United States Department of 
Agriculture (USDA) or a state department of agriculture certifies that 
a plant is not grown in commercial quantities in the United States, the 
plant will be deemed to have a preproductive period of 2 years or less. 
The effect of this suggestion would be to provide an exemption from 
section 263A for all qualified taxpayers growing plants that are not 
grown in commercial quantities in the United States. The IRS and 
Treasury Department believe that such a rule would be inconsistent with 
the statutory language of section 263A. Accordingly, the final 
regulations do not adopt this suggestion.
    The proposed regulations provided 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. One commentator requested that a list of plants with nationwide 
weighted average preproductive periods in excess of 2 years be 
published and kept current as needed. Notice 2000-45 (2000-36 I.R.B. 
(Sept. 5, 2000)) issued contemporaneously with the publication of these 
final regulations, provides a list of plants grown in commercial 
quantities in the United States that have a nationwide weighted average 
preproductive period in excess of 2 years. Notice 2000-45 will be 
modified and superseded as needed.
    Tax shelters, within the meaning of section 448(a)(3), are not 
qualified taxpayers and are therefore not eligible for the special 
rules of section 263A(d). A tax shelter, for purposes of section 
448(a)(3), means a farming business that is a farming syndicate as 
defined under section 464(c) or any partnership, entity, plan or 
arrangement that is a tax shelter within the meaning of section 
6662(d)(2)(C)(iii) (that is, its principal purpose is to avoid or evade 
Federal income tax). See Sec. 1.448-1T(b)(1)(iii). There is a 
presumption under section 448 that marketed arrangements, in which 
persons carry on farming activities using the services of a common 
managerial or administrative service, will fall within the meaning of a 
tax shelter if a substantial portion of farming expenses are prepaid 
with borrowed funds. See Sec. 1.448-1T(b)(4). The proposed regulations 
repeated the text of Sec. 1.448-1T(b)(1)(iii) and (4) to explain which 
farming businesses are tax shelters.
    A commentator suggested that the marketed arrangement presumption 
set forth in Sec. 1.448-1T(b)(4) and the proposed regulations is too 
broad in scope and should be modified. The commentator is concerned 
that this provision of the regulations will cause taxpayers 
participating in farming cooperatives to be treated as tax shelters 
and, therefore, require them to use an accrual method of accounting and 
to capitalize the direct costs and an allocable portion of indirect 
costs of producing all plants and animals. The commentator explained 
that such a result is unwarranted with respect to

[[Page 50641]]

individual farmers and farming businesses that join together to form 
farming cooperatives for non-tax reasons, such as to obtain supplies at 
lower prices and have a steady market for their farm products.
    The IRS and Treasury Department believe that the marketed 
arrangement presumption is necessary to preclude taxpayers from 
investing in farming operations in order to generate losses, often 
without making economic outlays, that may be used to shelter income 
from other sources. However, the IRS and Treasury Department do not 
believe that the marketed arrangement presumption, as described in the 
temporary Income Tax Regulations under section 448 and the proposed 
section 263A regulations, would cause a taxpayer producing property in 
a farming business to be regarded as a tax shelter merely because the 
taxpayer joined a farming cooperative. Therefore, the marketed 
arrangement presumption is not modified in the final regulations.

Preparatory and Preproductive Period Costs

    The IRS and Treasury Department believe that, in general, section 
263A does not change the rules under section 263 regarding the need to 
capitalize preparatory costs (that is, costs incurred prior to raising 
agricultural or horticultural commodities or that otherwise enable a 
farmer to begin the farming process). Thus, the proposed regulations 
clarified that, as under prior law, taxpayers generally must capitalize 
preparatory expenditures (for example, the cost of seeds, seedlings, 
and animals; clearing, leveling and grading land; drilling and 
equipping wells; irrigation systems; budding trees, etc.). However, 
because section 263A requires the capitalization of certain additional 
costs, the amount of preparatory expenditures capitalized to property 
that is subject to section 263A may be greater than under prior law. By 
requiring the capitalization of all the direct costs and the allocable 
portion of indirect costs incurred during the preparatory period, 
section 263A ensures that the income from farming will be appropriately 
matched with all of the costs of producing property in a farming 
business.
    Section 263A expanded the circumstances under which costs that were 
once termed developmental expenditures or cultural practices 
expenditures (that is, costs incurred by a taxpayer so that the growing 
process can continue in the desired manner) must be capitalized. The 
proposed regulations clarified that these costs are included in the 
category of preproductive period costs that are required to be 
capitalized under section 263A. Thus, the proposed regulations provided 
that all appropriate costs incurred during the preproductive period of 
property subject to section 263A must be capitalized, including the 
costs of certain soil and water conservation expenditures and 
fertilizing incurred during the preproductive period.
    One commentator requested that expenditures for soil and water 
conservation, described in section 175, and fertilizer, described in 
section 180, be excepted from capitalization under section 263A. 
However, the legislative history of former section 447(b) indicates 
that Congress believed that soil and water conservation expenditures 
incurred during the preproductive period were required to be 
capitalized into the basis of the plants produced. See H.R. Rep. No. 
658, 94th Cong., 1st Sess. 95 (1975), 1976-3 (Vol. 2) C.B. 787. See 
also, Staff of the Joint Committee on Taxation, General Explanation of 
the Tax Reform Act of 1976, H.R. Rep. No. 10612, 94th Cong., 2nd Sess. 
55 (1976), 1976-3 (Vol. 2) C.B. 67. In addition, the legislative 
history to section 464 indicates that Congress believed that the costs 
of fertilizer incurred during the preproductive period was capitalized 
under former section 278. See Senate Report No. 938, 94th Cong., 2nd 
Sess. 62 (1976), 1976-3 (Vol. 3) C.B. 100. See also, Staff of the Joint 
Committee on Taxation, General Explanation of the Tax Reform Act of 
1976, H.R. Rep. No. 10612, 94th Cong., 2nd Sess. 49 (1976), 1976-3 
(Vol. 2) C.B. 61. Because section 263A was intended to continue the 
principles of sections 447 and 278, the IRS and Treasury Department 
believe that expenditures for soil and water conservation and 
fertilizer incurred during the preproductive period are costs of 
producing those plants. Further, the IRS and Treasury Department 
believe that providing a single rule regarding when expenditures for 
soil and water conservation and fertilizer incurred during the 
preproductive period must be capitalized is consistent with the intent 
of Congress to provide uniform capitalization rules. Accordingly, the 
final regulations retain the proposed regulations' provision that these 
costs incurred during the preproductive period are included in the 
category of costs that are required to be capitalized under section 
263A. However, the IRS and Treasury Department do not believe that 
Congress intended to require capitalization of expenditures for soil 
and water conservation deductible under section 175 and fertilizer 
deductible under section 180 that are not incurred during the 
preproductive period. Accordingly, the final regulations clarify that 
these expenditures are not subject to capitalization under section 263A 
except to the extent they are required to be capitalized as a 
preproductive period cost.

Capitalization Period

    Preproductive period costs (for example, irrigating, fertilizing, 
real estate taxes) are capitalized during the actual preproductive 
period of a plant or animal. A taxpayer that grows a plant that will 
have more than 1 crop or yield is engaged in the production of two 
types of property, the plant and the crop or yield of the plant (for 
example, the orange tree and the orange). The proposed regulations 
clarified the capitalization period for plants that will have more than 
1 crop or yield, for crops or yields of plants that will have more than 
1 crop or yield, and for other plants.
    The proposed regulations provided that the preproductive period of 
a plant generally begins when a taxpayer first incurs costs with 
respect to the plant, for example, when the plant is acquired or the 
seed is planted. In the case of crops or yields of a plant that has 
more than 1 crop or yield, the preproductive period of the crop or 
yield begins when the plant has become productive in marketable 
quantities and the crop or yield first appears, whether in the form of 
a sprout, bloom, blossom, bud, etc.
    One commentator suggested that the preproductive period for crops 
or yields that require several years of growth (for example, biennial 
crops) begins upon first appearance of the crop in the year the crop 
actually develops. For example, a biennial plant produces fruit buds in 
the first year, but the buds do not develop until the second year. In 
the second year, the plant produces blossoms, which subsequently grow 
into an edible food product that is harvested and sold in that year. 
However, if weather conditions are harsh, the buds produced in the 
first year may not blossom and develop in the second year. The 
commentator suggests that the preproductive period begin not when the 
buds first appear in the first year but when the blossoms appear in the 
second year as that is the first sign of actual development. The IRS 
and Treasury Department are concerned that the suggested rule would be 
difficult to apply because a taxpayer may not know in any case whether 
the appearance of a crop will actually develop.

[[Page 50642]]

Accordingly, the final regulations do not adopt this suggestion.
    In the case of a plant that will have more than 1 crop or yield, 
the preproductive period of the plant ends when the plant becomes 
productive in marketable quantities. In the case of the crop or yield 
of a plant that has more than 1 crop or yield 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.
    One commentator requested that the proper tax treatment of field 
costs (such as the costs of irrigating, fertilizing, etc.) that are 
incurred after a crop or yield is harvested but before the crop or 
yield is disposed of, which do not benefit and are unrelated to the 
crop or yield that has been harvested, be clarified. The commentator is 
concerned that the proposed regulations subject such field costs to 
capitalization under the general principles of section 263A. The IRS 
and Treasury Department agree with the commentator's concerns. 
Accordingly, the final regulations provide that field costs incurred 
after a crop or yield is harvested but before the crop or yield is 
disposed of do not have to be capitalized to the harvested crop or 
yield because such costs relate to the plant or a future crop or yield 
rather than to the harvested crop or yield.
    One commentator requested that the definition of when a plant that 
will have more than 1 crop or yield becomes productive in marketable 
quantities be clarified. Under the proposed regulations such a plant 
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). The commentator noted that some 
taxpayers regard a plant as being placed in service for purposes of 
depreciation at the time the preproductive period ends for purposes of 
section 263A. The commentator requested that the final regulations 
adopt a rule that provides more guidance with respect to the end of the 
preproductive period.
    The IRS and Treasury Department agree with the commentator's 
concerns. Accordingly, the final regulations provide that a plant 
becomes productive in marketable quantities once a crop or yield is 
produced in sufficient quantities to be harvested and marketed in the 
ordinary course of the taxpayer's business. Factors that are relevant 
in determining whether the crop or yield is produced in sufficient 
quantities to be harvested and marketed in the ordinary course include: 
whether a crop or yield is harvested that is more than de minimis, 
although it may be less than expected at the maximum bearing stage, 
based on a comparison of the quantities per acre harvested in the year 
in question to the quantities per acre expected to be harvested when 
the plant reaches full maturity; and whether the sales proceeds exceed 
the costs of harvest and make a reasonable contribution to an allocable 
share of farm expenses.

Election Not To Capitalize Costs

    Qualified taxpayers may elect not to capitalize under section 263A 
the costs of producing 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 Internal Revenue Code) the costs that were 
deductible under the rules in effect before the enactment of section 
263A.
    A taxpayer may make this election automatically on its original 
federal income tax return for the first taxable year in which the 
taxpayer would otherwise be required to capitalize costs under section 
263A. The final regulations provide that if a taxpayer does not make 
this election in this first taxable year, the taxpayer may make this 
election by filing Form 3115, ``Application for Change in Accounting 
Method,'' using the appropriate procedures that govern the filing of 
the Form 3115.
    A taxpayer and any person related to the taxpayer (including a 
member of the taxpayer's family) electing to not capitalize costs under 
section 263A for certain plants are required to 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. In Notice 88-86, the 
IRS noted that commentators had suggested that guidance be provided 
clarifying the definition of members of a family. This guidance was 
provided in the proposed regulations. One commentator suggested that 
this proposed guidance be modified so that elections made by some 
family members do not bind other family members. The statutory language 
provides that an election affects family members and defines family 
members for this purpose. Thus, the IRS and Treasury Department believe 
that Congress's intent was to bind all family members when one member 
makes an election not to capitalize costs under section 263A. 
Accordingly, the final regulations do not adopt the suggestion.

Casualty Loss Exception

    Section 263A(d)(2) provides an exception from capitalization under 
section 263A for costs incurred with respect to plants that are 
replacing certain plants that were lost by reason of certain 
casualties. The proposed regulations clarified that this exception does 
not apply to preparatory expenditures or the costs of capital assets. 
In addition, the regulations clarified 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 regulations additionally clarified 
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.
    One commentator requested that the casualty loss exception be 
expanded to allow a current deduction for the expenditures incurred for 
replacing capital assets. The final regulations do not adopt this 
recommendation. Prior to the enactment of section 263A, preparatory 
expenditures as well as acquisition costs incurred during the 
preparatory period were generally capitalized under section 263. Also, 
prior to the enactment of section 263A, certain preproductive period 
costs were capitalized under former sections 447(b) and 278. Former 
section 278(c) provided an exception to the capitalization of 
preproductive period costs where such costs were incurred to replant a 
grove, orchard, or vineyard which had been lost or destroyed by reason 
of a casualty. However, this exception only applied to preproductive 
period costs capitalized under former section 278 and did not apply to 
preparatory expenditures and acquisition costs capitalized under 
section 263. The special exception in section 263A(d)(2) was intended 
to be a continuation, as modified to include all plants bearing an 
edible crop for human consumption, of the exception found in former 
section 278(c). Nothing in the statute or legislative history of 
section 263A indicates an intention to expand the exception to include 
other costs, such as the costs of replacing capital assets, in addition 
to the preproductive period costs.

Unit Livestock Price Method

    The unit livestock price method provides for the valuation of 
different classes of animals in inventory at a standard unit price for 
each animal within a class. A taxpayer who elects to

[[Page 50643]]

use the unit livestock price method must apply it to all livestock 
raised, whether for sale or for draft, breeding, or dairy purposes. In 
Notice 88-24, the IRS indicated that forthcoming regulations would 
modify the rule contained in Sec. 1.471-6 and require that taxpayers 
adjust the unit prices upward, from time to time as specified by those 
regulations, to reflect increases in costs taxpayers experience in 
raising livestock. Contemporaneous with the section 263A proposed 
regulations published August 22, 1997, Sec. 1.471-6 was modified to 
require a taxpayer to annually reevaluate the unit livestock prices and 
adjust the prices upward to reflect increases in the costs of raising 
livestock. Under this regulation, the consent of the Commissioner is 
not required to make such upward adjustments; however, consent is 
required to make any other change in animal classification or unit 
prices.
    One commentator expressed concern that if taxpayers are required to 
annually reevaluate their unit prices, they should be able to both 
increase and decrease the unit price to reflect all changes in the cost 
of raising livestock. In addition, this commentator suggested that the 
unit livestock price method should be modified to allow a taxpayer to 
remove from inventory animals that have been raised for use in the 
taxpayer's trade or business (such as a breeding cow) and depreciate 
the inventory value of the animal.
    Although these comments are outside the scope of this regulation, 
the IRS and Treasury Department understand the commentator's concerns. 
In addition, the IRS and Treasury Department recognize a broader 
concern that the requirement to annually reevaluate unit prices may 
have eliminated much of the simplicity of the unit livestock price 
method, especially for farmers neither required to use an accrual 
method by section 447 nor prohibited from using the cash method by 
section 448(a)(3). Accordingly, the IRS and Treasury Department intend 
to study the unit livestock price method to determine whether the 
method may be made simpler to apply and will take into account the 
commentator's suggestions as part of this study.

Record Keeping Requirements

    Pursuant to 26 U.S.C. 7805(f)(1), copies of the 1997 notice of 
proposed rulemaking and temporary rule were provided to the Chief 
Counsel for Advocacy of the Small Business Administration for comment. 
The Chief Counsel for Advocacy submitted comments requesting that the 
IRS conduct a regulatory flexibility analysis under the Regulatory 
Flexibility Act (5 U.S.C. chapter 6) (RFA) on how the notice of 
proposed rulemaking would affect recordkeeping burdens imposed on small 
business taxpayers engaged in a farming business.
    Under the RFA, the IRS is required to prepare a regulatory 
flexibility analysis if the proposed rule imposes a collection of 
information requirement (including a recordkeeping requirement) on 
small entities and that requirement is likely to have a significant 
economic impact on a substantial number of small entities (5 U.S.C 
603(a)). The RFA defines a recordkeeping requirement as a ``requirement 
imposed by an agency on persons to maintain specified records'' (5 
U.S.C. 601(7) and (8)). Since neither the proposed nor final regulation 
contain a collection of information requirement (including a 
requirement that persons maintain specified records), an analysis is 
not required by the RFA.

Effective Date and Method Changes

    The final regulations provide that, in the case of property that is 
not inventory in the hands of the taxpayer, the regulations are 
applicable to costs incurred after August 21, 2000 in taxable years 
ending after such date. In the case of inventory property, the final 
regulations are applicable to taxable years beginning after August 21, 
2000.
    For property that is not inventory, a taxpayer is granted the 
consent of the Commissioner to change its method of accounting to 
comply with the provisions of these final regulations for costs 
incurred after August 21, 2000, provided the change is made for the 
first taxable year ending after August 21, 2000. For inventory 
property, a taxpayer is granted the consent of the Commissioner to 
change its method of accounting to comply with the provisions of these 
final regulations for the first taxable year beginning after August 21, 
2000. To make such a change, a taxpayer must follow the automatic 
consent procedures in Rev. Proc. 99-49 (1999-2 I.R.B. 725) (see 
Sec. 601.601(d)(2) of this chapter), as modified by these regulations.

Effect on Other Documents

    The following publications are obsolete as of August 22, 2000: 
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 Executive Order 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 
notice of proposed rulemaking that preceded these regulations was 
submitted to the Chief Counsel for Advocacy of the Small Business 
Administration for comment on their impact on small business.

Drafting Information

    The principal authors of these final regulations are Jan Skelton 
and Richard C. Farley, Jr. previously of the Office of the Associate 
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 * * *


    Par. 2. Section 1.162-12 is amended by revising the ninth sentence 
of paragraph (a) to read as follows:


Sec. 1.162-12  Expenses for farmers.

    (a) * * * For rules regarding the capitalization of expenses of 
producing property in the trade or business of farming, see section 
263A of the Internal Revenue Code and Sec. 1.263A-4. * * *
* * * * *

    Par. 3. Section 1.263A-0 is amended by revising the introductory 
text and adding entries for Sec. 1.263A-4 to read as follows:


Sec. 1.263A-0  Outline of regulations under section 263A.

    This section lists the paragraphs in Secs. 1.263A-1 through 1.263A-
4 and Secs. 1.263A-7 through 1.263A-15 as follows:
* * * * *


Sec. 1.263A-4  Rules for property produced in a farming business.

    (a) Introduction.

[[Page 50644]]

    (1) In general.
    (2) Exception.
    (i) In general.
    (ii) Tax shelter.
    (A) In general.
    (B) Presumption.
    (iii) Examples.
    (3) Costs required to be capitalized or inventoried under another 
provision.
    (4) Farming business.
    (i) In general.
    (A) Plant.
    (B) Animal.
    (ii) Incidental activities.
    (A) In general.
    (B) Activities that are not incidental.
    (iii) 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.
    (i) Automatic election.
    (ii) Nonautomatic 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 change in method of accounting.
    (1) Effective date.
    (2) Change in method of accounting.
* * * * *


Sec. 1.263A-0T  [Removed]

    Par. 4. Section 1.263A-0T is removed.

    Par. 5. Section 1.263A-1 is amended as follows:
    1. The last sentence of paragraph (b)(3) is revised.
    2. The last sentence of paragraph (b)(4) is revised.
    The revisions read as follows:


Sec. 1.263A-1  Uniform capitalization of costs.

* * * * *
    (b) * * *
    (3) * * * See Sec. 1.263A-4 for specific rules relating to 
taxpayers engaged in the trade or business of farming.
    (4) * * * See Sec. 1.263A-4, however, for rules relating to 
taxpayers producing certain trees to which section 263A applies.
* * * * *

    Par. 6. Section 1.263A-4 is revised to read as follows:


Sec. 1.263A-4  Rules for property produced in a farming business.

    (a) Introduction--(1) In general. This section provides guidance 
with respect to the application of section 263A to property produced in 
a farming business as defined in paragraph (a)(4) 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 Secs. 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 directly benefit or are incurred by reason of the 
production of this property. The direct and indirect costs of producing 
plants or animals generally include preparatory costs allocable to the 
plant or animal and preproductive period costs of the plant or animal. 
Except as provided in paragraphs (a)(2) and (e) of this section, 
taxpayers must capitalize the costs of producing all plants and animals 
unless the election described in paragraph (d) of this section is made.
    (2) Exception--(i) In general. Section 263A does not apply to the 
costs of producing plants with a preproductive period of 2 years or 
less or the costs of producing animals in a farming business, 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 prohibited from using the cash receipts and 
disbursements method under section 448(a)(3).
    (ii) Tax shelter--(A) In general. A farming business is considered 
a tax shelter, and thus a taxpayer prohibited from using the cash 
method under section 448(a)(3), if the farming business is--
    (1) A farming syndicate as defined in section 464(c); or
    (2) A tax shelter, within the meaning of section 
6662(d)(2)(C)(iii).
    (B) 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.
    (iii) 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 to use an accrual method or prohibited 
by section 448(a)(3) from using the cash 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 directly 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 producing the crops.
    Example 2. Assume the same facts as Example 1, except that 
Farmer A is required by section 447 to use an accrual method or 
prohibited by 448(a)(3) from using the cash 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 directly benefit or are incurred 
by reason of the production of the trees and crops.

    (3) Costs required to be capitalized or inventoried under another 
provision. The exceptions from capitalization provided in paragraphs 
(a)(2), (d) and (e) of this section do not apply to any cost that is 
required to be capitalized or inventoried under another Internal 
Revenue Code or regulatory provision, such as section 263 or 471.

[[Page 50645]]

    (4) 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, merely buying and 
reselling plants or animals grown or raised entirely by another is not 
raising an agricultural or horticultural commodity. A taxpayer is 
engaged in raising a plant or animal, rather than the mere resale of a 
plant or animal, if the plant or animal is held for further cultivation 
and development prior to sale. In determining whether a plant or animal 
is held for further cultivation and development prior to sale, 
consideration will be given to all of the facts and circumstances, 
including: the value added by the taxpayer to the plant or animal 
through agricultural or horticultural processes; the length of time 
between the taxpayer's acquisition of the plant or animal and the time 
that the taxpayer makes the plant or animal available for sale; and in 
the case of a plant, whether the plant is kept in the container in 
which purchased, replanted in the ground, or replanted in a series of 
larger containers as it is grown to a larger size.
    (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 raised by the taxpayer. 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. A farming business 
includes processing activities that are normally incident to the 
growing, raising, or harvesting of agricultural or horticultural 
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. 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.
    (iii) Examples. The following examples illustrate the provisions of 
this paragraph (a)(4):

    Example 1. Individual A operates a retail nursery. Individual A 
has three categories of plants. The first category is comprised of 
plants that Individual A grows from seeds or cuttings. The second 
category is comprised of plants that Individual A purchases in 
containers and grows for a period of from several months to several 
years. Individual A replants some of these plants in the ground. The 
others are replanted in a series of larger containers as they grow. 
The third category is comprised of plants that are purchased by 
Individual A in containers. Individual A does not grow these plants 
to a larger size before making them available for resale. Instead, 
Individual A makes these plants available for resale, in the 
container in which purchased, shortly after receiving them. Thus, no 
value is added to these plants by Individual A through horticultural 
processes. Individual A also sells soil, mulch, chemicals, and yard 
tools. Individual A is producing property in the farming business 
with respect to the first two categories of plants because these 
plants are held for further cultivation and development prior to 
sale. The plants in the third category are not held for further 
cultivation and development prior to sale and, therefore, are not 
regarded as property produced in a farming business for purposes of 
section 263A. Accordingly, Individual A must account for the third 
category of plants, along with the soil, mulch, chemicals, and yard 
tools, as property acquired for resale. If Individual A's average 
annual gross receipts are less than $10 million, Individual A will 
not be required to capitalize costs with respect to its resale 
activities under section 263A.
    Example 2. Individual B is in the business of growing and 
harvesting wheat and other grains. Individual B also processes grain 
that Individual B has harvested in order to produce breads, cereals, 
and other similar food products, which Individual B then sells to 
customers in the course of its business. Although Individual B is in 
the farming business with respect to the growing and harvesting of 
grain, Individual B is not in the farming business with respect to 
the processing of such grain to produce the food products.
    Example 3. Individual C is in the business of raising poultry 
and other livestock. Individual C 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 C's customers. Although Individual C is in the 
farming business with respect to the raising of poultry and other 
livestock, Individual C 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 directly 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). Section 1.263A-1(e) describes the types of 
direct and indirect costs that generally must be capitalized by 
taxpayers under section 263A and paragraphs (b)(1)(i) and (ii) of this 
section provide specific examples of the types of costs typically 
incurred in the trade or business of farming. For purposes of this 
section, soil and water conservation expenditures that a taxpayer has 
elected to deduct under section 175 and fertilizer that a taxpayer has 
elected to deduct under section 180 are not subject to capitalization 
under section 263A, except to the extent these costs are required to be 
capitalized as a preproductive period cost of a plant or animal.
    (i) Plants. The costs of producing a plant typically required to be 
capitalized under section 263A include the costs incurred so that the 
plant's growing process may begin (preparatory costs), such as the 
acquisition costs of the seed, seedling, or plant, and the costs of 
planting, cultivating, maintaining, or developing the plant during the 
preproductive period (preproductive period costs). Preproductive period 
costs include, but are not limited to, management, irrigation, pruning, 
soil and water conservation (including costs that the taxpayer has 
elected to deduct under section 175), fertilizing (including costs that 
the taxpayer has elected to deduct under section 180), frost 
protection, spraying, harvesting, storage and handling, upkeep, 
electricity, tax depreciation and repairs on buildings

[[Page 50646]]

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. The costs of producing an animal typically required 
to be capitalized under section 263A include the costs incurred so that 
the animal's raising process may begin (preparatory costs), such as the 
acquisition costs of the animal, and the costs of raising or caring for 
such animal during the preproductive period (preproductive period 
costs). Preproductive period costs include, but are not limited to, 
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 (for example, an orange tree), 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 (for example, the orange), 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. The Commissioner will publish a noninclusive 
list of plants with a nationwide weighted average preproductive period 
in excess of 2 years. In the case of other plants grown in commercial 
quantities in the United States, the nationwide weighted average 
preproductive period must be determined based on available statistical 
data. 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 plant. If the taxpayer estimates a 
preproductive period in excess of 2 years, the taxpayer must capitalize 
the costs of producing the plant. 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. The nationwide weighted average preproductive period or the 
estimated preproductive period is 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 permanently 
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, the 
actual preproductive period begins when the plant has become productive 
in marketable quantities and 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. Field costs, such as irrigating, 
fertilizing, spraying and pruning, that are incurred after the harvest 
of a crop or yield but before the crop or yield is sold or otherwise 
disposed of are not required to be included in the preproductive period 
costs of the harvested crop or yield because they do not benefit and 
are unrelated to the harvested crop or yield.
    (ii) Marketable quantities. A plant that will have more than one 
crop or yield becomes productive in marketable quantities once a crop 
or yield is produced in sufficient quantities to be harvested and 
marketed in the ordinary course of the taxpayer's business. Factors 
that are relevant to determining whether a crop or yield is produced in 
sufficient quantities to be harvested and marketed in the ordinary 
course include: whether the crop or yield is harvested that is more 
than de minimis, although it may be less than expected at the maximum 
bearing stage, based on a comparison of the quantities per acre 
harvested in the year in question to the quantities per acre expected 
to be harvested when the plant reaches full maturity; and whether the 
sales proceeds exceed the costs of harvest and make a reasonable 
contribution to an allocable share of farm expenses.
    (D) Examples. The following examples illustrate the provisions of 
this paragraph (b)(2):

    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 1 
year-old 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 3 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 costs 
of producing 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 the preproductive period 
costs when the plants are planted. In accordance with paragraph 
(b)(2)(i)(C)(2) of this section, Farmer A must continue to 
capitalize preproductive period costs to the plants until the plants 
begin to produce in marketable quantities. Thus, Farmer A must 
capitalize the preproductive period costs for a period of 3 years 
and 6 months (that is, until the plants are 4 years and 6 months 
old), 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 1 month-old plants by purchasing them from an 
unrelated party, Corporation B. Farmer B enters into a contract with 
Corporation B

[[Page 50647]]

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 costs 
of producing 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 the preproductive period 
costs when the purchase occurs. In accordance with paragraph 
(b)(2)(i)(C)(2) of this section, Farmer B must continue to 
capitalize the preproductive period 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), that is, until the plants are 2 years and 7 
months old, 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 8 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 costs 
of producing 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 the preproductive period 
costs when the plants are planted. In accordance with paragraph 
(b)(2)(i)(C)(2) of this section, Farmer B must continue to 
capitalize the preproductive period 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 1 
month-old 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 costs of producing 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 the preproductive 
period 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 (that is, 1 year and 10 months 
after they are planted, which is when they are 1 year and 11 months 
old).
    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. Farmer D acquires and 
plants the plants when they are 1 year old and estimates that they 
will become productive in marketable quantities 3 years after 
planting. Thus, at the time the plants are acquired and 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 3 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 costs of 
producing 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 the preproductive period costs when it 
acquires and plants the plants. In accordance with paragraph 
(b)(2)(i)(C)(2) of this section, Farmer D must continue to 
capitalize the preproductive period 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 3 years and 
6 months (that is, until the plants are 4 years and 6 months old), 
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 from 
seed. The plants 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 seeds 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 costs of 
producing the plants under section 263A, 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. (i) 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, Year 1. On October 1, Year 6, the trees 
become productive in marketable quantities.
    (ii) The costs of producing the plant, including the 
preproductive period costs incurred by Farmer F on or before October 
1, Year 6, are capitalized to the trees. Preproductive period costs 
incurred after October 1, Year 6, are capitalized to a crop when 
incurred during the preproductive period of the crop and deducted as 
a cost of maintaining the tree 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.
    Example 8. (i) Farmer G, a taxpayer that qualifies for the 
exception in paragraph (a)(2) of this section, produces fig trees on 
10 acres of land. The fig trees are grown in commercial quantities 
in the United States and have a nationwide weighted average 
preproductive period in excess of 2 years. Farmer G acquires and 
plants the fig trees in their permanent grove during Year 1. When 
the fig trees are mature, Farmer G expects to harvest 10x tons of 
figs per acre. At the end of Year 4, Farmer G harvests .5x tons of 
figs per acre that it sells for $100x. During Year 4, Farmer G 
incurs expenses related to the fig operation of: $50x to harvest the 
figs and transport them to market and other direct and indirect 
costs related to the fig operation in the amount of $1000x.
    (ii) Since the fig trees have a preproductive period in excess 
of 2 years, Farmer G is required to capitalize the costs of 
producing the fig trees. See paragraphs (a)(2) and (b)(2)(i)(B) of 
this section. In accordance with paragraph (b)(2)(i)(C)(2) of this 
section, Farmer G must continue to capitalize preproductive period 
costs to the trees until they become productive in marketable 
quantities. The following factors weigh in favor of a determination 
that the fig trees did not become productive in Year 4: the quantity 
of harvested figs is de minimis based on the fact that the yield is 
only 5 percent of the expected yield at maturity and the proceeds 
from the sale of the figs are sufficient, after covering the costs 
of harvesting and transporting the figs, to cover only a negligible 
portion of the allocable farm expenses. Based on these facts and 
circumstances, the fig trees did not become productive in marketable 
quantities in Year 4.
    (ii) Animal. An animal's actual preproductive period is used to 
determine the period that the taxpayer must capitalize preproductive 
period costs 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 (for example, a dairy 
cow), the preproductive period generally ends when the animal is (or 
would be considered) placed in service for

[[Page 50648]]

purposes of section 168 (without regard to the applicable convention). 
However, in the case of an animal that will have more than one yield 
(for example, a breeding cow), the preproductive period ends when the 
animal produces (for example, 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 yields. 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 using any reasonable method. Any 
depreciation allowance on the animal may be allocated entirely to the 
yield. Costs incurred after the beginning of the preproductive period 
of the second yield, but before the first yield is weaned from the 
animal must be allocated between the first and second yield using any 
reasonable method. However, a taxpayer may elect to allocate these 
costs entirely to the second yield. An 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). 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 to use an accrual 
method or prohibited by section 448(a)(3) from using the cash 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-price method.
    (2) Available for property used in a trade or business. The farm-
price method or the unit-livestock-price 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-price method to account for the costs of raising 
livestock that will be used in the trade or business of farming (for 
example, 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 prohibited from using the cash method by 
section 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 prohibited from using the cash method by section 
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 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--(i) Automatic election. 
A taxpayer makes the election under this paragraph (d) by not applying 
the rules of section 263A to determine the capitalized costs of plants 
produced in a farming business and by applying the special rules in 
paragraph (d)(4) of this section on its original return for the first 
taxable year in which the taxpayer is otherwise required to capitalize 
section 263A costs. 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) 
(for example, it is necessary to use the alternative depreciation 
system as provided in paragraph (d)(4)(ii) of this section). For 
example, a farmer who deducts 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.
    (ii) Nonautomatic election. A taxpayer that does not make the 
election under this paragraph (d) as provided in paragraph (d)(3)(i) 
must obtain the consent of the Commissioner to make the election by 
filing a Form 3115, Application for Change in Method of Accounting, in 
accordance with Sec. 1.446-1(e)(3).
    (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).

[[Page 50649]]

    (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 (that is, 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), 
the terms ``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 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 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 A 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 A 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 A also owns a 150 
acre parcel of land (parcel 2) that Farmer A holds for future use. 
Both parcels are in the United States. In 2000, 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 A 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. 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 A decides to

[[Page 50650]]

replant the seedlings on parcel 2 rather than on parcel 1. 
Accordingly, Farmer A 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. 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 A replants the seedlings on parcel 2 rather than on parcel 1, 
and Farmer A additionally decides to expand its operations by 
growing 125 rather than 100 acres of trees. Accordingly, Farmer A 
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. 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 under section 263A. 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 replanting 
costs of a citrus or almond grove incurred prior to the close of the 
fourth taxable year after replanting, notwithstanding the taxpayer's 
election to have section 263A not 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. This election, 
however, is unavailable with respect to the costs of producing a 
citrus grove incurred within the first 4 years beginning with the 
year the trees were planted. See paragraph (d)(2) of this section. 
In year 10, 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. In year 10, 
Farmer A acquires and plants young citrus trees in the same grove to 
replace those destroyed by the casualty.
    (ii) Farmer A must capitalize the costs of producing the citrus 
grove 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, Farmer A may 
deduct the preproductive period costs incurred in the fifth year. In 
year 10, Farmer A must capitalize the acquisition cost of the young 
trees. However, the costs of planting, cultivating, developing, and 
maintaining the young trees that replace those destroyed by the 
casualty are exempted from capitalization under this paragraph (e).
    (f) Effective date and change in method of accounting--(1) 
Effective date. In the case of property that is not inventory in the 
hands of the taxpayer, this section is applicable to costs incurred 
after August 21, 2000 in taxable years ending after August 21, 2000. In 
the case of inventory property, this section is applicable to taxable 
years beginning after August 21, 2000.
    (2) Change in method of accounting. Any change in a taxpayer's 
method of accounting necessary to comply with this section is a change 
in method of accounting to which the provisions of sections 446 and 481 
and the regulations thereunder apply. For property that is not 
inventory in the hands of the taxpayer, a taxpayer is granted the 
consent of the Commissioner to change its method of accounting to 
comply with the provisions of this section for costs incurred after 
August 21, 2000, provided the change is made for the first taxable year 
ending after August 21, 2000. For inventory property, a taxpayer is 
granted the consent of the Commissioner to change its method of 
accounting to comply with the provisions of this section for the first 
taxable year beginning after August 21, 2000. A taxpayer changing its 
method of accounting under this paragraph (f)(2) must file a Form 3115, 
``Application for Change in Accounting Method,'' in accordance with the 
automatic consent procedures in Rev. Proc. 99-49 (1999-2 I.R.B. 725) 
(see Sec. 601.601(d)(2) of this chapter). However, the scope 
limitations in section 4.02 of Rev. Proc. 99-49 do not apply, provided 
the taxpayer's method of accounting for property produced in a farming 
business is not an issue under consideration within the meaning of 
section 3.09 of Rev. Proc. 99-49. If the taxpayer is under examination, 
before an appeals office, or before a federal court at the time that a 
copy of the Form 3115 is filed with the national office, the taxpayer 
must provide a duplicate copy of the Form 3115 to the examining agent, 
appeals officer, or counsel for the government, as appropriate, at the 
time the copy of the Form 3115 is filed. The Form 3115 must contain the 
name(s) and telephone number(s) of the examining agent, appeals 
officer, or counsel for the government, as appropriate. Further, in the 
case of property that is not inventory in the hands of the taxpayer, a 
change under this paragraph (f)(2) is made on a cutoff basis as 
described in section 2.06 of Rev. Proc. 99-49 and without the audit 
protection provided in section 7 of Rev. Proc. 99-49. However, a 
taxpayer may receive such audit protection for non-inventory property 
by taking into account any section 481(a) adjustment that results from 
the change in method of accounting to comply with this section. A 
taxpayer that opts to determine a section 481(a) adjustment (and, thus, 
obtain audit protection) for non-inventory property must take into 
account only additional section 263A costs incurred after December 31, 
1986, in taxable years ending after December 31, 1986. Any change in 
method of accounting that is not made for the taxpayer's first taxable 
year ending or beginning after August 21, 2000, whichever is 
applicable, must be made in accord with the procedures in Rev. Proc. 
97-27 (1997-1 C.B. 680) (see Sec. 601.601(d)(2) of this chapter).


Sec. 1.263A-4T  [Removed]

    Par. 7. Section 1.263A-4T is removed.

    Par. 8. Section 1.471-6 is amended as follows:
    1. The third sentence of paragraph (d) is revised.
    2. The last sentence of paragraph (f) is revised. The revisions 
read as follows:


Sec. 1.471-6  Inventories of livestock raisers and other farmers.

* * * * *
    (d) * * * However, see Sec. 1.263A-4(c)(3) for an exception to this 
rule. * * *
* * * * *
    (f) * * * See Sec. 1.263A-4 for rules regarding the computation of 
costs for purposes of the unit-livestock-price-method.
* * * * *

Robert E. Wenzel,
Deputy Commissioner of Internal Revenue.
    Approved: August 10, 2000.
Jonathan Talisman,
Acting Assistant Secretary of the Treasury (Tax Policy).
[FR Doc. 00-21103 Filed 8-18-00; 8:45 am]
BILLING CODE 4830-01-P