44542 Federal Register / Vol. 62, No. 163 / Friday, August 22, 1997 / Rules and Regulations

Ames, IA, Ames Muni, NDB RWY 31, Amdt

10A, Cancelled

Aurora, MO, Aurora Memorial Muni, VOR/

DME OR GPS–A, Amdt 3

Aurora, MO, Aurora Mrmorial Muni, GPS

RWY 36, Orig

Scribner, NE, Scribner State, VOR RWY 35,

Amdt 1

Columbia, SC, Columbia Owens Downtown,

RNAV RWY 31, Orig, Cancelled

***Effective November 6, 1997

Anchorage, AK, Anchorage Intl, ILS RWY 6L,

Amdt 9

Anchorage, AK, Anchorage Intl, ILS RWY 6R,

Amdt 11

Bay Minette, AL, Bay Minette Muni, GPS

RWY 8, Orig

Mobile, AL, Mobile Downtown, RADAR-A,

Orig-A, Cancelled

Gainesville, FL, Gainesville Regional, GPS

RWY 6, Orig

Gainesville, FL, Gainesville Regional, GPS

RWY 24, Orig

Billings, MT, Billings Logan Intl, GPS RWY

10L, Orig

Billings, MT, Billings Logan Intl, GPS RWY

28R, Orig

Clinton, NC, Sampson County, GPS RWY 6,

Orig

Clinton, NC, Sampson County, GPS RWY 24,

Orig

Coshocton, OH, Richard Downing, GPS RWY

22, Orig

Conway, SC, Conway-Horry County, GPS

RWY 4, Orig

Conway, SC, Conway-Horry County, GPS

RWY 22, Orig

Bremerton, WA, Bremerton National, GPS

RWY 1, Orig

Wisconsin Rapids, WI, Alexander Field

South Wood County, GPS RWY 20, Orig

Lewisburg, WV, Greenbrier Valley, GPS RWY

4, Orig

Lewisburg, WV, Greenbrier Valley, GPS RWY

22, Orig

[FR Doc. 97–22355 Filed 8–21–97; 8:45 am]

BILLING CODE 4910–13–M

DEPARTMENT OF THE TREASURY

Internal Revenue Service

26 CFR Part 1

[TD 8729]

RIN 1545–AV37

Rules for Property Produced in a

Farming Business

AGENCY: Internal Revenue Service (IRS),

Treasury.

ACTION: Final and temporary

regulations.

SUMMARY: This document contains final

and temporary regulations relating to

the application of section 263A of the

Internal Revenue Code to property

produced in a farming business. These

regulations affect certain taxpayers

engaged in the trade or business of

farming. These regulations are necessary

to provide guidance with respect to

section 263A(d).

The text of the temporary regulations

also serves as the text of the proposed

regulations set forth in the notice of

proposed rulemaking on this subject in

the Proposed Rules section of this issue

of the Federal Register.

DATES: These regulations are effective

August 22, 1997. For dates of

applicability, see § 1.263A–4T(f) of

these regulations.

FOR FURTHER INFORMATION CONTACT: Jan

Skelton, (202) 622–4970 (not a toll-free

call).

SUPPLEMENTARY INFORMATION:

Background

Prior to the enactment of section

263A, the rules that governed the

deduction or capitalization of costs

incurred with respect to property

produced in the trade or business of

farming were set forth in several

different statutory and regulatory

provisions. Costs regarded as

preparatory expenditures were required

to be capitalized under section 263.

Preparatory expenditures are

expenditures incurred prior to raising

agricultural or horticultural

commodities or that otherwise enable a

farmer to begin the farming process. See,

e.g., Rev. Rul. 83–28, 1983–1 C.B. 47.

Preparatory expenditures include the

costs of clearing land, leveling and

grading land, drilling and equipping

wells, acquiring irrigation systems,

acquiring seeds or seedlings, budding

trees, and acquiring animals.

Costs regarded as developmental

expenditures (sometimes referred to as

cultural practices expenditures) were

generally permitted to be deducted, or,

at a taxpayer’s election, could be

capitalized. See, e.g.,Wilbur v.

Commissioner, 43 T.C. 322 (1964), acq.,

1965–2 C.B. 7. Developmental

expenditures are those expenditures

incurred by a taxpayer so that the

growing process may continue in the

desired manner. Developmental

expenditures are expenditures that, if

incurred while the plant or animal was

in a productive state, would be

deductible. See, Maple v.

Commissioner, 27 T.C.M. 944 (1968),

aff’d, 440 F.2d 1055 (9th Cir. 1971).

Developmental expenditures include

the costs of irrigating, fertilizing,

spraying, cultivating, pruning, feeding,

providing veterinary services, rent on

land, and depreciation allowances on

irrigation systems or structures.

Former sections 278 and 447 provided

special rules requiring the capitalization

of certain developmental expenditures.

Former section 278(a) provided special

rules for citrus and almond groves.

Under former section 278(a), all

otherwise deductible costs of

developing citrus or almond groves

incurred before the end of the fourth

taxable year after permanent planting

were required to be capitalized. Rev.

Rul. 83–128, 1983–2 C.B. 57, clarified

that the costs incurred prior to

permanent planting were also required

to be capitalized.

Former sections 278(b) and 447(b)

provided special rules for farming

syndicates, corporations, and

partnerships with a corporate partner.

Section 447 requires certain

corporations and partnerships with a

corporate partner to use an accrual

method of accounting (accrual method).

Former section 447(b) required these

taxpayers to capitalize preproductive

period expenses. Preproductive period

expenses were defined as any expenses

attributable to crops, animals, trees, or

other property having a crop or yield

and that are incurred during the

preproductive period of such property.

Soil and water conservation

expenditures, as defined in section 175,

and land-clearing expenditures as

defined in former section 182, are

preproductive period expenses if they

are incurred in a preproductive period

of an agricultural or horticultural

activity and if the taxpayer elects to

deduct these expenses rather than

capitalize them. House Comm. on Ways

and Means, Tax Reform Act of 1975,

H.R. Rep. No. 94–658, 94th Cong., 1st

Sess. 93 (1975).

In the case of a farming syndicate

engaged in planting, cultivating,

maintaining, or developing an orchard,

vineyard, or grove, former section 278(b)

required the capitalization of all

otherwise deductible expenditures

incurred with respect to the orchard,

vineyard, or grove, if incurred prior to

the first taxable year in which there was

a crop or yield in commercial quantities.

Former section 278(c) provided a

relief provision. Under this provision,

sections 278 (a) or (b) would not require

the capitalization of developmental

expenditures attributable to an orchard,

vineyard, or grove that was replanted

after having been lost or damaged by

reason of freezing temperatures, disease,

drought, pests, or casualty.

Section 263A, enacted in the Tax

Reform Act of 1986, Public Law 99–514,

100 Stat. 2085, 1986–3 C.B. Vol. 1 (the

1986 Act), provides uniform

capitalization rules that govern the

treatment of costs incurred in the

production of property or the

acquisition of property for resale.

Section 263A was enacted, in part, to
Federal Register / Vol. 62, No. 163 / Friday, August 22, 1997 / Rules and Regulations 44543

prevent the inappropriate mismatching

of income and expense that results from

the current deduction of the costs of

producing property. Section 263A

generally incorporates and expands

upon the rules set forth in several code

and regulatory sections, including

section 263, and former sections 278

and 447.

Section 263A(b) generally provides

that the uniform capitalization rules

apply to the taxpayer’s production of

real or tangible personal property.

Section 1.263A–2(a)(1)(i) clarifies that

for purposes of section 263A, produce

includes the following: construct, build,

install, manufacture, develop, improve,

create, raise, or grow. Sections 263A (d)

and (e) provide special rules for

property produced in a farming

business.

Section 263A, as enacted in 1986,

generally required taxpayers to

capitalize the costs of producing plants

and animals. Taxpayers not required by

section 447 or 448(a)(3) to use an

accrual method were excepted from

capitalizing the preproductive period

costs of plants and animals (except

animals held for slaughter) that had a

preproductive period of 2 years or less.

Section 263A was amended as part of

the Omnibus Budget Reconciliation Act

of 1987, Pub. L. 100–203, 101 Stat. 1330,

1987–3 C.B. Vol. 1 (the 1987 Act), the

Technical and Miscellaneous Revenue

Act of 1988, Pub. L. 100–647, 102 Stat.

3342, 1988–3 C.B. Vol. 1 (the 1988 Act),

and the Omnibus Budget Reconciliation

Act of 1989, Pub. L. 101–239, 103 Stat.

2106 (the 1989 Act). Under the 1988

Act, the scope of the exception for these

taxpayers is expanded to include all

animals irrespective of the length of the

preproductive period.

In addition, taxpayers not required by

section 447 or 448(a)(3) to use an

accrual method may elect not to

capitalize the costs of plants (other than

certain costs of producing citrus and

almond trees) with a preproductive

period in excess of 2 years. If a taxpayer

makes this election, the taxpayer must

treat such plants as section 1245

property and upon disposition of these

plants any amount allowable as a

deduction that would, but for the

election, have been capitalized must be

recaptured and treated as a deduction

allowed for depreciation with respect to

such property. See section 263A(e)(1).

Also, if the taxpayer makes the election,

the taxpayer and related persons must

apply the alternative depreciation

system provided in section 168(g)(2) to

all property used by the taxpayer or

related person predominantly in a

farming business and placed in service

in any taxable year in which the

election out of section 263A is in effect.

See section 263A(e)(2).

On March 30, 1987, the IRS published

in the Federal Register a notice of

proposed rulemaking (52 FR 10118) by

cross reference to temporary regulations

published the same day (T.D. 8131, 52

FR 10052). Amendments to the notice of

proposed rulemaking and temporary

regulations were published in the

Federal Register on August 7, 1987, by

a notice of proposed rulemaking (52 FR

29391) that cross referenced to

temporary regulations published the

same day (T.D. 8148, 52 FR 29375).

Notice 88–24, 1988–1 C.B. 491,

provided that forthcoming regulations

would modify the temporary regulations

and the regulations under § 1.471–6.

Notice 88–86, 1988–2 C.B. 401,

provided that forthcoming regulations

would clarify the definition of a related

person for purposes of the election out

of section 263A. In addition, Notice 88–

86 provided that forthcoming

regulations would provide that certain

taxpayers could elect to use the

simplified production method for

property used in the trade or business

of farming. On August 5, 1994, the

temporary regulations relating to

property produced in a farming business

were reissued and published in the

Federal Register (T.D. 8559, 59 FR

39958). Because substantial changes are

being made from the 1994 temporary

regulations, the IRS and Treasury

Department have decided to issue, in

part, new proposed and temporary,

rather than final, regulations.

Explanation of Provisions

Property Produced in the Trade or

Business of Farming

The temporary regulations clarify that

the special rules of section 263A(d)

apply only to property produced in a

farming business. The temporary

regulations provide that for purposes of

section 263A, the term farming means

the cultivation of land or the raising or

harvesting of any agricultural or

horticultural commodity. Examples

include the trade or business of

operating a nursery or sod farm; the

raising or harvesting of trees bearing

fruit, nuts, or other crops; the raising of

ornamental trees (other than evergreen

trees that are more than six years old at

the time they are severed from their

roots); and the raising, shearing, feeding,

caring for, training, and management of

animals. The regulations clarify that for

this purpose harvesting does not

include contract harvesting of an

agricultural or horticultural commodity

grown or raised by another taxpayer.

Accordingly, while a taxpayer that

grows a plant may apply the special

rules of section 263A(d) to the costs of

growing and harvesting the plant, the

special rules of section 263A(d) do not

apply to a taxpayer that merely contract

harvests agricultural or horticultural

commodities grown or raised by another

taxpayer. Similarly, the temporary

regulations clarify that the special rules

of section 263A(d) do not apply to a

taxpayer that merely buys and resells

plants or animals grown or raised by

another. In evaluating whether a

taxpayer is engaged in the production,

or merely the resale, of plants or

animals, it is anticipated that

consideration will be given to factors

including: The length of time between

the taxpayer’s acquisition of a plant or

animal and the time the plant or animal

is made available for sale to the

taxpayer’s customers, and, in the case of

plants, whether plants acquired by the

taxpayer are planted in the ground or

kept in temporary containers.

The temporary regulations provide

that a farming business does not include

the processing of commodities or

products beyond those activities that are

incident to the growing, raising, or

harvesting of such products.

Preparatory and Developmental Costs

The IRS and Treasury Department

believe that, in general, section 263A

does not change the rules regarding

capitalization of costs during the

preparatory period. Thus, the temporary

regulations clarify that, as under prior

law, taxpayers generally must capitalize

preparatory expenditures, including the

cost of seeds, seedlings, and animals;

clearing, leveling and grading land;

drilling and equipping wells; irrigation

systems; and budding trees. However,

because section 263A requires the

capitalization of certain indirect costs as

well as direct costs, the amount of

preparatory expenditures capitalized

may be greater under section 263A than

under prior law.

Section 263A expands the

circumstances under which costs that

were once termed developmental

expenditures must be capitalized. The

temporary regulations clarify that costs

that were, in years prior to the

enactment of section 263A, regarded as

developmental are included in the

category of preproductive period costs.

Section 263A generally requires the

capitalization of preproductive period

costs including the costs of irrigating,

fertilizing, spraying, cultivating,

pruning, feeding, providing veterinary

services, rent on land, and depreciation

allowances on irrigation systems or

structures. Preproductive period costs

also include real estate taxes, interest,
44544 Federal Register / Vol. 62, No. 163 / Friday, August 22, 1997 / Rules and Regulations

and soil and water conservation

expenditures incurred during the

preproductive period of a plant.

Taxpayers that are required by section

447 or 448(a)(3) to use an accrual

method must capitalize all

preproductive period costs of plants

(without regard to the length of the

preproductive period) and animals.

Taxpayers that are not required by

section 447 or 448(a)(3) to use an

accrual method qualify for an exception

to this general rule. Under this

exception, taxpayers are not required to

capitalize preproductive period costs

incurred with respect to animals, or

with respect to plants that have a

preproductive period of 2 years or less.

Thus, under this exception, taxpayers

are required to capitalize only those

preproductive period costs incurred

with respect to plants that have a

preproductive period in excess of 2

years. The temporary regulations clarify

that, for purposes of determining

whether a plant has a preproductive

period in excess of 2 years, in the case

of a plant grown in commercial

quantities in the United States, the

nationwide weighted average

preproductive period of such plant is

used.

The IRS and Treasury Department are

considering the publication of guidance

with respect to the length of the

preproductive period of certain plants

that will have more than one crop or

yield. At the present time, the IRS and

Treasury Department anticipate that

such guidance would provide that

plants producing the following crops or

yields have a nationwide weighted

average preproductive period in excess

of 2 years: almonds, apples, apricots,

avocados, blueberries, blackberries,

cherries, chestnuts, coffee beans,

currants, dates, figs, grapefruit, grapes,

guavas, kiwifruit, kumquats, lemons,

limes, macadamia nuts, mangoes,

nectarines, olives, oranges, peaches,

pears, pecans, persimmons, pistachio

nuts, plums, pomegranates, prunes,

raspberries, tangelos, tangerines,

tangors, and walnuts. The IRS and

Treasury Department invite comments

on this issue.

Capitalization Period

Preproductive period costs (e.g.,

irrigating, fertilizing, real estate taxes,

etc.) are capitalized during the

preproductive period of a plant or

animal. A taxpayer that grows a plant

that will have more than one crop or

yield is engaged in the production of

two types of property, the plant and the

crop or yield of the plant (e.g., the

orange tree and the orange). The

temporary regulations clarify the

capitalization period for plants that will

have more than one crop or yield, for

crops or yields of plants that will have

more than one crop or yield, and for

other plants.

The temporary regulations clarify that

the preproductive period of a plant

generally begins when a taxpayer first

incurs costs with respect to the plant,

e.g., when the plant is acquired or the

seed is planted. In the case of the crop

or yield of a plant that has become

productive in marketable quantities, the

preproductive period of the crop or

yield begins when the crop or yield first

appears, whether in the form of a

sprout, bloom, blossom, bud, etc.

In the case of a plant that will have

more than one crop or yield, the

preproductive period of the plant ends

when the plant becomes productive in

marketable quantities (i.e., when the

plant is placed in service for purposes

of depreciation). In the case of the crop

or yield of a plant that has become

productive in marketable quantities, the

preproductive period of the crop or

yield ends when the crop or yield is

disposed of. Finally, in the case of other

plants, the preproductive period ends

when the plant is disposed of.

The temporary regulations provide

that the preproductive period of an

animal begins at the time of acquisition,

breeding, or embryo implantation. The

temporary regulations clarify that, in the

case of an animal that will be used in

the trade or business of farming, the

preproductive period generally ends

when the animal is placed in service for

purposes of depreciation. However, in

the case of an animal that will have

more than one yield, the preproductive

period ends when the animal produces

(e.g., gives birth to) its first yield. In the

case of any other animal, the

preproductive period ends when the

animal is sold or otherwise disposed of.

The temporary regulations additionally

clarify that, in the case of an animal that

will have more than one yield, the costs

incurred after the beginning of the

preproductive period of the first yield

but before the end of the preproductive

period of the animal must be allocated

between the animal and the yield on a

reasonable and consistent basis. Any

depreciation allowance on the animal

may be allocated entirely to the yield.

Method of Capitalizing Costs

The temporary regulations provide

that the costs required to be capitalized

with respect to farming property may, if

the taxpayer chooses, be determined

using any reasonable inventory

valuation method, such as the farmprice method of accounting (farm-price

method) or the unit-livestock-price

method of accounting (unit-livestockprice method). The use of these

inventory valuation methods avoids the

necessity of accounting for the costs of

raising plants or animals by tracing

costs to each separate plant or animal.

In addition, under the temporary

regulations, these inventory methods

may be used by a taxpayer regardless of

whether the farming property being

produced is otherwise treated as

inventory by the taxpayer, and

regardless of whether the taxpayer is

otherwise using the cash method or an

accrual method.

The temporary regulations clarify that

notwithstanding a taxpayer’s use of the

farm-price method with respect to

farming property to which the

provisions of section 263A apply, the

taxpayer is not required, solely by such

use, to use the same method of

accounting with respect to farming

property to which the provisions of

section 263A do not apply.

Under the unit-livestock-price

method, the taxpayer adopts a standard

unit price for each animal within a

particular class. This standard unit price

is used by the taxpayer in lieu of

specifically identifying and tracing the

costs of raising each animal in the

taxpayer’s farming business. Taxpayers

using the unit-livestock-price method

must adopt a reasonable method of

classifying animals with respect to their

age and kind so that the unit prices

assigned by the taxpayer to animals in

each class are reasonable. Thus,

taxpayers using the unit-livestock-price

method typically classify livestock

based on their age (for example, a

separate class will typically be

established for calves, yearlings, and 2-

year olds).

The temporary regulations under

section 263A modify the rule set forth

in § 1.471–6 providing that no increase

in unit cost is required under the unitlivestock-price method with respect to

the taxable year in which certain

animals are purchased, if the purchases

occur in the last 6 months of the taxable

year. The temporary regulations provide

that any taxpayer required to use an

accrual method under section 448(a)(3)

must include in inventory the annual

standard unit price for all animals

purchased during the taxable year,

regardless of when in the taxable year

the purchases are made. The temporary

regulations further amend this rule and

provide that all taxpayers using the

unit-livestock-price method must

modify the annual standard price to

reasonably reflect the particular period

in the taxable year in which purchases

of livestock are made, if such

modification is necessary in order to
Federal Register / Vol. 62, No. 163 / Friday, August 22, 1997 / Rules and Regulations 44545

avoid significant distortions in income

that would otherwise occur through

operation of the unit-livestock-price

method. The temporary regulations do

not specify the particular modification

that must be made to the annual

standard price for any particular

taxpayer, but rather allow any

reasonable modification made by the

taxpayer to the annual standard price to

avoid significant distortions in income.

For example, assume a taxpayer

purchases and raises cattle for slaughter.

Assume further that the taxpayer is

required to use an accrual method under

section 447 so that section 263A applies

to the taxpayer’s costs of raising the

cattle. The temporary regulations

provide that the taxpayer may not

expense the costs of raising cattle that

are purchased in the latter half of the

taxpayer’s taxable year. Instead, the

taxpayer must modify the annual

standard price so as to reasonably

capitalize the costs of raising the cattle,

based on the date of their purchase.

In Notice 88–86, the IRS noted that

commentators had inquired as to the

availability of the simplified production

method of accounting (simplified

production method) for farmers using

the unit-livestock-price method for the

costs of raising livestock. The temporary

regulations clarify that farmers using the

unit-livestock-price method are

permitted to elect the simplified

production method, as well as the

simplified service cost method of

accounting, under section 263A. In such

a situation, section 471 costs are the

costs taken into account by the taxpayer

under the unit-livestock-price method

using the taxpayer’s standard unit price

determined under these temporary and

final regulations. The term additional

section 263A costs includes all

additional costs required to be

capitalized under section 263A

including costs that are required to be

capitalized under section 263A that are

not reflected in the standard unit prices

(e.g., general and administrative costs

and depreciation, including

depreciation on a calf’s mother).

In light of the additional costs

required to be capitalized under section

263A, taxpayers should not adopt unit

prices utilized under pre-section 263A

unit-livestock-price rules without

carefully analyzing whether these unit

prices reflect all of the costs required to

be capitalized under section 263A.

Election Not To Capitalize Costs

Certain taxpayers, other than those

required to use an accrual method by

section 447 or 448(a)(3), may elect not

to capitalize the preproductive period

costs of certain plants even though such

plants have a preproductive period in

excess of 2 years and would otherwise

be subject to the capitalization

requirements of section 263A.

Taxpayers making this election may

continue to deduct (subject to other

limitations of the Code) the

preproductive period costs that were

deductible under the rules in effect

before the enactment of section 263A.

The temporary regulations clarify that

although a taxpayer producing a citrus

or almond grove may make this election,

the election does not apply to the

preproductive period costs of a citrus or

almond grove that are incurred before

the close of the fourth taxable year

beginning with the taxable year in

which the trees were planted.

If a taxpayer makes this election with

respect to any plant, the taxpayer must

treat the plant as section 1245 property.

In addition, the taxpayer, and any

person related to the taxpayer, must use

the alternative depreciation system of

section 168(g)(2) for any property used

predominantly in a farming business

that is placed in service in a taxable year

for which the election is in effect.

Casualty Loss Exception

Section 263A(d) provides an

exception from capitalization for

preproductive period costs incurred

with respect to plants that are replacing

certain plants that were lost by reason

of certain casualties. The temporary

regulations clarify that this exception

for preproductive period costs does not

apply to preparatory expenditures or the

costs of capital assets. In addition, the

temporary regulations clarify that the

casualty loss exception applies whether

the plants are replanted on the same

parcel of land as the plants destroyed by

casualty or a parcel of land of the same

acreage in the United States. The

temporary regulations additionally

clarify that the exception applies to all

plants replanted on such acreage, even

if the plants are replanted in greater

density than the plants destroyed by the

casualty.

Final Regulations

In final regulations, cross references

to § 1.263A–4T are provided in §§ 1.61–

4, 1.162–12, 1.263A–1, and 1.471–6.

Under § 1.471–6(f), taxpayers using

the unit livestock method may not

subsequently change the classification

or unit costs they initially adopted

without obtaining the approval of the

Commissioner. As provided in Notice

88–24, the final regulations modify the

rule in § 1.471–6(f) and require that

taxpayers adjust the unit prices upward

from time to time, to reflect increases in

costs taxpayers experience in raising

livestock. Any other changes in the

classification or unit prices used in the

unit-livestock-price method will

continue to be allowed only with the

consent of the Commissioner.

Effective Date and Transitional Rule

The temporary regulations provide

that, in the case of property that is not

inventory in the hands of the taxpayer,

the regulations are generally effective

for costs incurred on or after August 22,

1997, in taxable years ending after such

date. In the case of inventory property,

the temporary regulations are generally

effective for taxable years beginning

after August 22, 1997. However,

taxpayers in compliance with § 1.263A–

4T in effect prior to August 22, 1997

(See 26 CFR part 1 edition revised as of

April 1, 1997.), as modified by other

administrative guidance, that continue

to comply with § 1.263A–4T in effect

prior to August 22, 1997 (See 26 CFR

part 1 edition revised as of April 1,

1997.), as modified by other

administrative guidance, will not be

required to apply these new temporary

rules until the notice of proposed

rulemaking that cross-references these

temporary regulations is finalized. The

amendment to § 1.471–6(f) is effective

for taxable years beginning after August

22, 1997.

Effect on Other Documents

The following publications will be

obsolete when the notice of proposed

rulemaking that cross-references these

temporary regulations is finalized:

Notice 87–76, 1987–2 C.B. 384; Notice

88–24, 1988–1 C.B. 491; and section V

of Notice 88–86, 1988–2 C.B. 401.

Special Analyses

It has been determined that this

Treasury decision is not a significant

regulatory action as defined in EO

12866. Therefore, a regulatory

assessment is not required. It has also

been determined that section 553(b) of

the Administrative Procedure Act (5

U.S.C. chapter 5) does not apply to these

regulations, and because the regulations

do not impose a collection of

information on small entities, the

Regulatory Flexibility Act (5 U.S.C.

chapter 6) does not apply. Pursuant to

section 7805(f) of the Internal Revenue

Code, the temporary regulations will be

submitted, and the notice of proposed

rulemaking that preceded the final

regulations were submitted, to the Chief

Counsel for Advocacy of the Small

Business Administration for comment

on their impact on small business.

Drafting Information: The principal

author of these temporary regulations is

Jan Skelton of the Office of Assistant
44546 Federal Register / Vol. 62, No. 163 / Friday, August 22, 1997 / Rules and Regulations

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 * * *.

§ 1.61–4 [Amended]

Par. 2. Section 1.61–4 is amended by:

1. Adding a new sentence ‘‘See

section 263A for rules regarding costs

that are required to be capitalized.’’ at

the end of the concluding text of

paragraph (a).

2. Adding a new sentence ‘‘See

section 263A for rules regarding costs

that are required to be capitalized.’’ after

the fourth sentence of the concluding

text of paragraph (b).

§ 1.162–12 [Amended]

Par. 3. Section 1.162–12(a) is

amended by:

1. Removing the eighth sentence, and

adding the sentence ‘‘For rules

regarding the capitalization of expenses

of producing property in the trade or

business of farming, see section 263A

and § 1.263A–4T.’’ in its place.

2. Adding a new sentence ‘‘For rules

regarding the capitalization of expenses

of producing property in the trade or

business of farming, see section 263A

and the regulations thereunder.’’ after

the third sentence.

Par. 4. Section 1.263A–0T is added to

read as follows:

§ 1.263A–0T Outline of regulations under

section 263A (temporary).

This section lists the paragraphs in

§ 1.263A–4T.

§ 1.263A–4T Rules for property produced in

a farming business (temporary).

(a) Introduction.

(1) In general.

(2) Exception.

(i) In general.

(ii) Tax shelter.

(iii) Presumption.

(iv) Costs required to be capitalized or

inventoried under another provision.

(v) Examples.

(3) Farming business.

(i) In general.

(A) Plant.

(B) Animal.

(ii) Incidental activities.

(A) In general.

(B) Activities that are not incidental.

(1) In general.

(2) Examples.

(b) Application of section 263A to property

produced in a farming business.

(1) In general.

(i) Plants.

(ii) Animals.

(2) Preproductive period.

(i) Plant.

(A) In general.

(B) Applicability of section 263A.

(C) Actual preproductive period.

(1) Beginning of the preproductive period.

(2) End of the preproductive period.

(i) In general.

(ii) Marketable quantities.

(D) Examples.

(ii) Animal.

(A) Beginning of the preproductive period.

(B) End of the preproductive period.

(C) Allocation of costs between animal and

first yield.

(c) Inventory methods.

(1) In general.

(2) Available for property used in a trade

or business.

(3) Exclusion of property to which section

263A does not apply.

(d) Election not to have section 263A

apply.

(1) Introduction.

(2) Availability of the election.

(3) Time and manner of making the

election.

(4) Special rules.

(i) Section 1245 treatment.

(ii) Required use of alternative depreciation

system.

(iii) Related person.

(A) In general.

(B) Members of family.

(5) Examples.

(e) Exception for certain costs resulting

from casualty losses.

(1) In general.

(2) Ownership.

(3) Examples.

(4) Special rule for citrus and almond

groves.

(i) In general.

(ii) Example.

(f) Effective date and transition rule.

§ 1.263A–1 [Amended]

Par. 5. Section 1.263A–1 is amended

by:

1. Removing the last sentence of

paragraph (b)(3) and adding the

sentence ‘‘See § 1.263A–4T for specific

rules relating to taxpayers engaged in

the trade or business of farming.’’ in its

place.

2. Removing the last sentence of

paragraph (b)(4) and adding the

sentence ‘‘See § 1.263A–4T, however,

for rules relating to taxpayers producing

certain trees to which section 263A

applies.’’ in its place.

Par. 6. Section 1.263A–4T is revised

to read as follows:

§ 1.263A–4T Rules for property produced

in a farming business (temporary).

(a) Introduction—(1) In general. The

regulations under this section provide

guidance with respect to the application

of section 263A to property produced in

a farming business as defined in

paragraph (a)(3) of this section. Except

as otherwise provided by the rules of

this section, the general rules of

§§ 1.263A–1 through 1.263A–3 and

1.263A–7 through 1.263A–15 apply to

property produced in a farming

business. A taxpayer that engages in the

raising or growing of any agricultural or

horticultural commodity, including both

plants and animals, is engaged in the

production of property. Section 263A

generally requires the capitalization of

the direct costs and an allocable portion

of the indirect costs that benefit or are

incurred by reason of the production of

this property. Taxpayers that do not

qualify for the exception described in

paragraph (a)(2) of this section must

capitalize these costs of producing all

plants and animals unless the election

described in paragraph (d) of this

section is made.

(2) Exception—(i) In general. A

taxpayer is not required to capitalize the

preproductive period costs of producing

plants with a preproductive period of 2

years or less or the costs of producing

animals, if the taxpayer is not—

(A) A corporation or partnership

required to use an accrual method of

accounting (accrual method) under

section 447 in computing its taxable

income from farming; or

(B) A tax shelter required to use an

accrual method under section 448(a)(3).

(ii) Tax shelter. A farming business is

considered a tax shelter, and thus a

taxpayer required to use an accrual

method under section 448(a)(3), if the

farming business is—

(A) A farming syndicate as defined in

section 464(c); or

(B) A tax shelter, within the meaning

of section 6662(d)(2)(C)(iii).

(iii) Presumption. Marketed

arrangements in which persons carry on

farming activities using the services of

a common managerial or administrative

service will be presumed to have the

principal purpose of tax avoidance,

within the meaning of section

6662(d)(2)(C)(iii), if such persons prepay

a substantial portion of their farming

expenses with borrowed funds.

(iv) Costs required to be capitalized or

inventoried under another provision.

The exception from capitalization

provided in this paragraph (a)(2) does

not apply to any cost that is required to

be capitalized or inventoried under

another Code or regulatory provision,

such as section 263 or section 471.
Federal Register / Vol. 62, No. 163 / Friday, August 22, 1997 / Rules and Regulations 44547

(v) Examples. The following examples

illustrate the provisions of this

paragraph (a)(2):

Example 1. Farmer A grows trees that have

a preproductive period in excess of 2 years,

and that produce an annual crop. Farmer A

is not required by section 447 or 448(a)(3) to

use an accrual method. Accordingly, Farmer

A qualifies for the exception described in this

paragraph (a)(2). Since the trees have a

preproductive period in excess of 2 years,

Farmer A must capitalize the direct costs and

an allocable portion of the indirect costs that

benefit or are incurred by reason of the

production of the trees. Since the annual

crop has a preproductive period of 2 years or

less, Farmer A is not required to capitalize

the costs of the crops.

Example 2. Assume the same facts as

Example 1, except that Farmer A is required

by section 447 or 448(a)(3) to use an accrual

method. Farmer A does not qualify for the

exception described in this paragraph (a)(2).

Farmer A is required to capitalize the direct

costs and an allocable portion of the indirect

costs that benefit or are incurred by reason

of the production of the trees and crops,

including all preproductive period costs.

(3) Farming business—(i) In general.

A farming business means a trade or

business involving the cultivation of

land or the raising or harvesting of any

agricultural or horticultural commodity.

Examples include the trade or business

of operating a nursery or sod farm; the

raising or harvesting of trees bearing

fruit, nuts, or other crops; the raising of

ornamental trees (other than evergreen

trees that are more than 6 years old at

the time they are severed from their

roots); and the raising, shearing, feeding,

caring for, training, and management of

animals. For purposes of this section,

the term harvesting does not include

contract harvesting of an agricultural or

horticultural commodity grown or

raised by another. Similarly, the trade or

business of merely buying and reselling

plants or animals grown or raised by

another is not a farming business.

(A) Plant. A plant produced in a

farming business includes, but is not

limited to, a fruit, nut, or other crop

bearing tree, an ornamental tree, a vine,

a bush, sod, and the crop or yield of a

plant that will have more than one crop

or yield. Sea plants are produced in a

farming business if they are tended and

cultivated as opposed to merely

harvested.

(B) Animal. An animal produced in a

farming business includes, but is not

limited to, any stock, poultry or other

bird, and fish or other sea life raised by

the taxpayer. Thus, for example, the

term animal may include a cow,

chicken, emu, or salmon raised by the

taxpayer. Fish and other sea life are

produced in a farming business if they

are raised on a fish farm.

A fish farm is an area where fish or

other sea life are grown or raised as

opposed to merely caught or harvested.

(ii) Incidental activities—(A) In

general. Farming business includes

processing activities that are normally

incident to the growing, raising, or

harvesting of agricultural products. For

example, a taxpayer in the trade or

business of growing fruits and

vegetables may harvest, wash, inspect,

and package the fruits and vegetables for

sale. Such activities are normally

incident to the raising of these crops by

farmers. The taxpayer will be

considered to be in the trade or business

of farming with respect to the growing

of fruits and vegetables and the

processing activities incident to their

harvest.

(B) Activities that are not incidental—

(1) In general. Farming business does

not include the processing of

commodities or products beyond those

activities that are normally incident to

the growing, raising, or harvesting of

such products.

(2) Examples. The following examples

illustrate the provisions of this

paragraph (a)(3)(ii):

Example 1. Individual A is in the business

of growing and harvesting wheat and other

grains. Individual A also processes grain that

Individual A has harvested in order to

produce breads, cereals, and other similar

food products, which Individual A then sells

to customers in the course of its business.

Although Individual A is in the farming

business with respect to the growing and

harvesting of grain, Individual A is not in the

farming business with respect to the

processing of such grain to produce the food

products.

Example 2. Individual B is in the business

of raising poultry and other livestock.

Individual B also operates a meat processing

operation in which the poultry and other

livestock are slaughtered, processed, and

packaged or canned. The packaged or canned

meat is sold to Individual B’s customers.

Although Individual B is in the farming

business with respect to the raising of poultry

and other livestock, Individual B is not in the

farming business with respect to the

slaughtering, processing, packaging, and

canning of such animals to produce the food

products.

(b) Application of section 263A to

property produced in a farming

business—(1) In general. Unless

otherwise provided in this section,

section 263A requires the capitalization

of the direct costs and an allocable

portion of the indirect costs that benefit

or are incurred by reason of the

production of any property in a farming

business (including animals and plants

without regard to the length of their

preproductive period).

(i) Plants. Costs typically required to

be capitalized under section 263A

include the acquisition costs of the seed,

seedling, or plant, and the costs of

planting, cultivating, maintaining, or

developing such plant during the

preproductive period. These costs

include, but are not limited to,

management, irrigation, pruning,

fertilizing (including costs that the

taxpayer has elected to deduct under

section 180), soil and water

conservation (including costs that the

taxpayer has elected to deduct under

section 175), frost protection, spraying,

upkeep, electricity, tax depreciation and

repairs on buildings and equipment

used in raising the plants, farm

overhead, taxes (except state and federal

income taxes), and interest required to

be capitalized under section 263A(f).

(ii) Animals. Costs typically required

to be capitalized under section 263A

include the acquisition cost of the

animal, and the costs of raising or caring

for such animal during the

preproductive period. Preproductive

period costs include, but are not limited

to, the costs of management, feed (such

as grain, silage, concentrates,

supplements, haylage, hay, pasture and

other forages), maintaining pasture or

pen areas (including costs that the

taxpayer has elected to deduct under

sections 175 or 180), breeding, artificial

insemination, veterinary services and

medicine, livestock hauling, bedding,

fuel, electricity, hired labor, tax

depreciation and repairs on buildings

and equipment used in raising the

animals (for example, barns, trucks, and

trailers), farm overhead, taxes (except

state and federal income taxes), and

interest required to be capitalized under

section 263A(f).

(2) Preproductive period—(i) Plant—

(A) In general. The preproductive

period of property produced in a

farming business means—

(1) In the case of a plant that will have

more than one crop or yield, the period

before the first marketable crop or yield

from such plant;

(2) In the case of the crop or yield of

a plant that will have more than one

crop or yield, the period before such

crop or yield is disposed of; or

(3) In the case of any other plant, the

period before such plant is disposed of.

(B) Applicability of section 263A. For

purposes of determining whether a

plant has a preproductive period in

excess of 2 years, the preproductive

period of plants grown in commercial

quantities in the United States is based

on the nationwide weighted average

preproductive period for such plant. For

all other plants, the taxpayer is required,

at or before the time the seed or plant

is acquired or planted, to reasonably

estimate the preproductive period of the
44548 Federal Register / Vol. 62, No. 163 / Friday, August 22, 1997 / Rules and Regulations

plant. If the taxpayer estimates a

preproductive period in excess of 2

years, the taxpayer must capitalize

preproductive period costs. If the

estimate is reasonable, based on the

facts in existence at the time it is made,

the determination of whether section

263A applies is not modified at a later

time even if the actual length of the

preproductive period differs from the

estimate. The actual length of the

preproductive period will, however, be

considered in evaluating the

reasonableness of the taxpayer’s future

estimates. Thus, the nationwide

weighted average preproductive period

or the estimated preproductive period

are only used for purposes of

determining whether the preproductive

period of a plant is greater than 2 years.

(C) Actual preproductive period. The

plant’s actual preproductive period is

used for purposes of determining the

period during which a taxpayer must

capitalize preproductive period costs

with respect to a particular plant.

(1) Beginning of the preproductive

period. The actual preproductive period

of a plant begins when the taxpayer first

incurs costs that directly benefit or are

incurred by reason of the plant.

Generally, this occurs when the

taxpayer plants the seed or plant. In the

case of a taxpayer that acquires plants

that have already been planted, or

plants that are tended, by the taxpayer

or another, prior to permanent planting,

the actual preproductive period of the

plant begins upon acquisition of the

plant by the taxpayer. In the case of the

crop or yield of a plant that will have

more than one crop or yield and that has

become productive in marketable

quantities, the actual preproductive

period begins when the crop or yield

first appears, for example, in the form of

a sprout, bloom, blossom, or bud.

(2) End of the preproductive period—

(i) In general. In the case of a plant that

will have more than one crop or yield,

the actual preproductive period ends

when the plant first becomes productive

in marketable quantities. In the case of

any other plant (including the crop or

yield of a plant that will have more than

one crop or yield), the actual

preproductive period ends when the

plant, crop, or yield is sold or otherwise

disposed of.

(ii) Marketable quantities. A plant that

will have more than one crop or yield

becomes productive in marketable

quantities when it is (or would be

considered) placed in service for

purposes of section 168 (without regard

to the applicable convention).

(D) Examples. The following

examples illustrate the provisions of

this paragraph (b)(2)(i):

Example 1. (i) Farmer A, a taxpayer that

qualifies for the exception in paragraph (a)(2)

of this section, grows plants that will have

more than one crop or yield. The plants are

grown in commercial quantities in the United

States. Farmer A acquires the plants by

purchasing them from an unrelated party,

Corporation B, and plants them immediately.

The nationwide weighted average

preproductive period of the plant is 4 years.

The particular plants grown by Farmer A do

not begin to produce in marketable quantities

until 4 years and 6 months after they are

planted by Farmer A.

(ii) Since the plants are deemed to have a

preproductive period in excess of 2 years,

Farmer A is required to capitalize the

preproductive period costs of the plants. See

paragraphs (a)(2) and (b)(2)(i)(B) of this

section. In accordance with paragraph

(b)(2)(i)(C)(1) of this section, Farmer A must

begin to capitalize such costs when the

plants are planted. In accordance with

paragraph (b)(2)(i)(C)(2) of this section,

Farmer A must continue to capitalize costs to

the plants until the plants begin to produce

in marketable quantities. Thus, Farmer A

must capitalize the preproductive period

costs of the plants for a period of 4 years and

6 months, notwithstanding the fact that the

plants, in general, have a nationwide

weighted average preproductive period of 4

years.

Example 2. (i) Farmer B, a taxpayer that

qualifies for the exception in paragraph (a)(2)

of this section, grows plants that will have

more than one crop or yield. The plants are

grown in commercial quantities in the United

States. The nationwide weighted average

preproductive period of the plant is 2 years

and 5 months. Farmer B acquires the plants

by purchasing them from an unrelated party,

Corporation B. Farmer B enters into a

contract with Corporation B under which

Corporation B will retain and tend the plants

for 7 months following the sale. At the end

of 7 months, Farmer B takes possession of the

plants and plants them in the permanent

orchard. The plants become productive in

marketable quantities 1 year and 11 months

after they are planted by Farmer B.

(ii) Since the plants are deemed to have a

preproductive period in excess of 2 years,

Farmer B is required to capitalize the

preproductive period costs of the plants. See

paragraphs (a)(2) and (b)(2)(i)(B) of this

section. In accordance with paragraph

(b)(2)(i)(C)(1) of this section, Farmer B must

begin to capitalize such costs when the

purchase occurs. In accordance with

paragraph (b)(2)(i)(C)(2) of this section,

Farmer B must continue to capitalize costs to

the plants until the plants begin to produce

in marketable quantities. Thus, Farmer B

must capitalize the preproductive period

costs of the plants for a period of 2 years and

6 months (the 7 months the plants are tended

by Corporation B and the 1 year and 11

months after the plants are planted by Farmer

B), notwithstanding the fact that the plants,

in general, have a nationwide weighted

average preproductive period of 2 years and

5 months.

Example 3. (i) Assume the same facts as in

Example 2, except that Farmer B acquires the

plants by purchasing them from Corporation

B when the plants are 7 months old and that

the plants are planted by Farmer B upon

acquisition.

(ii) Since the plants are deemed to have a

preproductive period in excess of 2 years,

Farmer B is required to capitalize the

preproductive period costs of the plants. See

paragraphs (a)(2) and (b)(2)(i)(B) of this

section. In accordance with paragraph

(b)(2)(i)(C)(1) of this section, Farmer B must

begin to capitalize such costs when the

plants are planted. In accordance with

paragraph (b)(2)(i)(C)(2) of this section,

Farmer B must continue to capitalize costs to

the plants until the plants begin to produce

in marketable quantities. Thus, Farmer B

must capitalize the preproductive period

costs of the plants for a period of 1 year and

11 months.

Example 4. (i) Farmer C, a taxpayer that

qualifies for the exception in paragraph (a)(2)

of this section, grows plants that will have

more than one crop or yield. The plants are

grown in commercial quantities in the United

States. Farmer C acquires the plants from an

unrelated party and plants them

immediately. The nationwide weighted

average preproductive period of the plant is

2 years and 3 months. The particular plants

grown by Farmer C begin to produce in

marketable quantities 1 year and 10 months

after they are planted by Farmer C.

(ii) Since the plants are deemed to have a

nationwide weighted average preproductive

period in excess of 2 years, Farmer C is

required to capitalize the preproductive

period costs of the plants, notwithstanding

the fact that the particular plants grown by

Farmer C become productive in less than 2

years. See paragraph (b)(2)(i)(B) of this

section. In accordance with paragraph

(b)(2)(i)(C)(1) of this section, Farmer C must

begin to capitalize such costs when it plants

the plants. In accordance with paragraph

(b)(2)(i)(C)(2) of this section, Farmer C

properly ceases capitalization of

preproductive period costs when the plants

become productive in marketable quantities

(i.e., after 1 year and 10 months).

Example 5. (i) Farmer D, a taxpayer that

qualifies for the exception in paragraph (a)(2)

of this section, grows plants that will have

more than one crop or yield. The plants are

not grown in commercial quantities in the

United States. At the time the plants are

planted Farmer D reasonably estimates that

the plants will have a preproductive period

of 4 years. The actual plants grown by Farmer

D do not begin to produce in marketable

quantities until 4 years and 6 months after

they are planted by Farmer D.

(ii) Since the plants have an estimated

preproductive period in excess of 2 years,

Farmer D is required to capitalize the

preproductive period costs of the plants. See

paragraph (b)(2)(i)(B) of this section. In

accordance with paragraph (b)(2)(i)(C)(1) of

this section, Farmer D must begin to

capitalize such costs when it plants the

plants. In accordance with paragraph

(b)(2)(i)(C)(2) of this section, Farmer D must

continue to capitalize costs until the plants

begin to produce in marketable quantities.

Thus, Farmer D must capitalize the

preproductive period costs of the plants for

a period of 4 years and 6 months,
Federal Register / Vol. 62, No. 163 / Friday, August 22, 1997 / Rules and Regulations 44549

notwithstanding the fact that Farmer D

estimated that the plants would become

productive after 4 years.

Example 6. (i) Farmer E, a taxpayer that

qualifies for the exception in paragraph (a)(2)

of this section grows plants that are not

grown in commercial quantities in the United

States. The plants do not have more than 1

crop or yield. At the time the plants are

planted Farmer E reasonably estimates that

the plants will have a preproductive period

of 1 year and 10 months. The actual plants

grown by Farmer E are not ready for

harvesting and disposal until 2 years and 2

months after the seeds are planted by Farmer

E.

(ii) Because Farmer E’s estimate of the

preproductive period (which was 2 years or

less) was reasonable at the time made based

on the facts, Farmer E will not be required

to capitalize the preproductive period costs

of the plants notwithstanding the fact that the

actual preproductive period of the plants

exceeded 2 years. See paragraph (b)(2)(i)(B)

of this section. However, Farmer E must take

the actual preproductive period of the plants

into consideration when making future

estimates of the preproductive period of such

plants.

Example 7. Farmer F, a calendar year

taxpayer that does not qualify for the

exception in paragraph (a)(2) of this section,

grows trees that will have more than one

crop. Farmer F acquires and plants the trees

in April, 1998. On October 1, 2003, the trees

are placed in service within the meaning of

section 168. Under paragraph

(b)(2)(i)(C)(2)(ii) of this section, the trees

become productive in marketable quantities

on October 1, 2003. The preproductive

period costs incurred by Farmer F on or

before October 1, 2003, are capitalized to the

trees. Preproductive period costs incurred

after October 1, 2003, are capitalized to a

crop when incurred during the preproductive

period of the crop and expensed when

incurred between the disposal of one crop

and the appearance of the next crop. See

paragraphs (b)(2)(i)(A), (b)(2)(i)(C)(1) and

(b)(2)(i)(C)(2) of this section.

(ii) Animal. An animal’s actual

preproductive period is used to

determine the period that the taxpayer

must capitalize preproductive period

expenses with respect to a particular

animal.

(A) Beginning of the preproductive

period. The preproductive period of an

animal begins at the time of acquisition,

breeding, or embryo implantation.

(B) End of the preproductive period.

In the case of an animal that will be

used in the trade or business of farming

(e.g., a dairy cow), the preproductive

period generally ends when the animal

is (or would be considered) placed in

service for purposes of section 168

(without regard to the applicable

convention). However, in the case of an

animal that will have more than one

yield (e.g., a breeding cow), the

preproductive period ends when the

animal produces (e.g., gives birth to) its

first yield. In the case of any other

animal, the preproductive period ends

when the animal is sold or otherwise

disposed of.

(C) Allocation of costs between

animal and first yield. In the case of an

animal that will have more than one

yield, the costs incurred after the

beginning of the preproductive period of

the first yield but before the end of the

preproductive period of the animal must

be allocated between the animal and the

yield on a reasonable basis. Any

depreciation allowance on the animal

may be allocated entirely to the yield.

The allocation method used by a

taxpayer is a method of accounting that

must be used consistently and is subject

to the rules of section 446 and the

regulations thereunder.

(c) Inventory methods—(1) In general.

Except as otherwise provided, the costs

required to be allocated to any plant or

animal under this section may be

determined using reasonable inventory

valuation methods such as the farmprice method or the unit-livestock-price

method. See § 1.471–6. Under the unitlivestock-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 § 1.263A–1(f) or

1.263A–2(b) to allocate its direct and

indirect costs to the property produced

in the business of farming. In such a

situation, section 471 costs are the costs

taken into account by the taxpayer

under the unit-livestock-price method

using the taxpayer’s standard unit price

as modified by this paragraph (c)(1). The

term additional section 263A costs

includes all additional costs required to

be capitalized under section 263A. Tax

shelters, as defined in paragraph

(a)(2)(ii) of this section, that use the

unit-livestock-price method for

inventories must include in inventory

the annual standard unit price for all

animals that are acquired during the

taxable year, regardless of whether the

purchases are made during the last 6

months of the taxable year. Taxpayers

required by section 447 or 448(a)(3) to

use an accrual method that use the unitlivestock-price method must modify the

annual standard price in order to

reasonably reflect the particular period

in the taxable year in which purchases

of livestock are made, if such

modification is necessary in order to

avoid significant distortions in income

that would otherwise occur through

operation of the unit livestock method.

(2) Available for property used in a

trade or business. The farm price

method or the unit livestock method

may be used by any taxpayer to allocate

costs to any plant or animal under this

section, regardless of whether the plant

or animal is held or treated as inventory

property by the taxpayer. Thus, for

example, a taxpayer may use the unit

livestock method to account for the

costs of raising livestock that will be

used in the trade or business of farming

(e.g., a breeding animal or a dairy cow)

even though the property in question is

not inventory property.

(3) Exclusion of property to which

section 263A does not apply.

Notwithstanding a taxpayer’s use of the

farm price method with respect to farm

property to which the provisions of

section 263A apply, that taxpayer is not

required, solely by such use, to use the

farm price method with respect to farm

property to which the provisions of

section 263A do not apply. Thus, for

example, assume Farmer A raises fruit

trees that have a preproductive period

in excess of 2 years and to which the

provisions of section 263A, therefore,

apply. Assume also that Farmer A raises

cattle and is not required to use an

accrual method by section 447 or

448(a)(3). Because Farmer A qualifies

for the exception in paragraph (a)(2) of

this section, Farmer A is not required to

capitalize the costs of raising the cattle.

Although Farmer A may use the farm

price method with respect to the fruit

trees, Farmer A is not required to use

the farm price method with respect to

the cattle. Instead, Farmer A’s

accounting for the cattle is determined

under other provisions of the Code and

regulations.

(d) Election not to have section 263A

apply—(1) Introduction. This paragraph

(d) permits certain taxpayers to make an

election not to have the rules of this

section apply to any plant produced in

a farming business conducted by the

electing taxpayer. The election is a

method of accounting under section

446, and once an election is made, it is

revocable only with the consent of the

Commissioner.

(2) Availability of the election. The

election described in this paragraph (d)

is available to any taxpayer that

produces plants in a farming business,

except that no election may be made by

a corporation, partnership, or tax shelter

required to use the accrual method

under section 447 or 448(a)(3).

Moreover, the election does not apply to

the costs of planting, cultivation,

maintenance, or development of a citrus

or almond grove (or any part thereof)

incurred prior to the close of the fourth

taxable year beginning with the taxable

year in which the trees were planted in

the permanent grove (including costs

incurred prior to the permanent

planting). If a citrus or almond grove is
44550 Federal Register / Vol. 62, No. 163 / Friday, August 22, 1997 / Rules and Regulations

planted in more than one taxable year,

the portion of the grove planted in any

one taxable year is treated as a separate

grove for purposes of determining the

year of planting.

(3) Time and manner of making the

election. A taxpayer makes the election

under this paragraph (d) by not

capitalizing the preproductive period

costs of producing property in a farming

business and by applying the special

rules in paragraph (d)(4) of this section,

on its timely filed original return

(including extensions) for the first

taxable year in which the taxpayer is

otherwise required to capitalize

preproductive period costs under

section 263A. Thus, in order to be

treated as having made the election

under this paragraph (d), it is necessary

to report both income and expenses in

accordance with the rules of this

paragraph (d) (e.g., it is necessary to use

the alternative depreciation system as

provided in paragraph (d)(4)(ii) of this

section). Thus, for example, a farmer

who deducts preproductive period costs

that are otherwise required to be

capitalized under section 263A but fails

to use the alternative depreciation

system under section 168(g)(2) for

applicable property placed in service

has not made an election under this

paragraph (d) and is not in compliance

with the provisions of section 263A. In

the case of a partnership or S

corporation, the election must be made

by the partner, shareholder, or member.

(4) Special rules. If the election under

this paragraph (d) is made, the taxpayer

is subject to the special rules in this

paragraph (d)(4).

(i) Section 1245 treatment. The plant

produced by the taxpayer is treated as

section 1245 property and any gain

resulting from any disposition of the

plant is recaptured (i.e., treated as

ordinary income) to the extent of the

total amount of the deductions that, but

for the election, would have been

required to be capitalized with respect

to the plant. In calculating the amount

of gain that is recaptured under this

paragraph (d)(4)(i), a taxpayer may use

the farm price method or another

simplified method permitted under

these regulations in determining the

deductions that otherwise would have

been capitalized with respect to the

plant.

(ii) Required use of alternative

depreciation system. If the taxpayer or a

related person makes an election under

this paragraph (d), the alternative

depreciation system (as defined in

section 168(g)(2)) must be applied to all

property used predominantly in any

farming business of the taxpayer or

related person and placed in service in

any taxable year during which the

election is in effect. The requirement to

use the alternative depreciation system

by reason of an election under this

paragraph (d) will not prevent a

taxpayer from making an election under

section 179 to deduct certain

depreciable business assets.

(iii) Related person—(A) In general.

For purposes of this paragraph (d)(4),

related person means—

(1) The taxpayer and members of the

taxpayer’s family;

(2) Any corporation (including an S

corporation) if 50 percent or more of the

stock (in value) is owned directly or

indirectly (through the application of

section 318) by the taxpayer or members

of the taxpayer’s family;

(3) A corporation and any other

corporation that is a member of the

same controlled group (within the

meaning of section 1563(a)(1)); and

(4) Any partnership if 50 percent or

more (in value) of the interests in such

partnership is owned directly or

indirectly by the taxpayer or members of

the taxpayer’s family.

(B) Members of family. For purposes

of this paragraph (d)(4)(iii), members of

the taxpayer’s family, and members of

family (for purposes of applying section

318(a)(1)), means the spouse of the

taxpayer (other than a spouse who is

legally separated from the individual

under a decree of divorce or separate

maintenance) and any of the taxpayer’s

children (including legally adopted

children) who have not reached the age

of 18 as of the last day of the taxable

year in question.

(5) Examples. The following examples

illustrate the provisions of this

paragraph (d):

Example 1. (i) Farmer A, an individual, is

engaged in the trade or business of farming.

Farmer A grows apple trees that have a

preproductive period greater than 2 years. In

addition, Farmer A grows and harvests wheat

and other grains. Farmer A elects under this

paragraph (d) not to have the rules of section

263A apply to the preproductive period costs

of growing the apple trees.

(ii) In accordance with paragraph (d)(4) of

this section, Farmer A is required to use the

alternative depreciation system described in

section 168(g)(2) with respect to all property

used predominantly in any farming business

in which Farmer A engages (including the

growing and harvesting of wheat) if such

property is placed in service during a year for

which the election is in effect. Thus, for

example, all assets and equipment (including

trees and any equipment used to grow and

harvest wheat) placed in service during a

year for which the election is in effect must

be depreciated as provided in section

168(g)(2).

Example 2. Assume the same facts as in

Example 1, except that Farmer A and

members of Farmer A’s family (as defined in

paragraph (d)(4)(iii)(B) of this section) also

own 51 percent (in value) of the interests in

Partnership P, which is engaged in the trade

or business of growing and harvesting corn.

Partnership P is a related person to Farmer

A under the provisions of paragraph

(d)(4)(iii) of this section. Thus, the

requirements to use the alternative

depreciation system under section 168(g)(2)

also apply to any property used

predominantly in a trade or business of

farming which Partnership P places in

service during a year for which an election

made by Farmer A is in effect.

(e) Exception for certain costs

resulting from casualty losses—(1) In

general. Section 263A does not require

the capitalization of costs that are

attributable to the replanting,

cultivating, maintaining, and

developing of any plants bearing an

edible crop for human consumption

(including, but not limited to, plants

that constitute a grove, orchard, or

vineyard) that were lost or damaged

while owned by the taxpayer by reason

of freezing temperatures, disease,

drought, pests, or other casualty

(replanting costs). Such replanting costs

may be incurred with respect to

property other than the property on

which the damage or loss occurred to

the extent the acreage of the property

with respect to which the replanting

costs are incurred is not in excess of the

acreage of the property on which the

damage or loss occurred. This paragraph

(e) applies only to the replanting of

plants of the same type as those lost or

damaged. This paragraph (e) applies to

plants replanted on the property on

which the damage or loss occurred or

property of the same or lesser acreage in

the United States irrespective of

differences in density between the lost

or damaged and replanted plants. Plants

bearing crops for human consumption

are those crops normally eaten or drunk

by humans. Thus, for example, costs

incurred with respect to replanting

plants bearing jojoba beans do not

qualify for the exception provided in

this paragraph (e) because that crop is

not normally eaten or drunk by humans.

(2) Ownership. Replanting costs

described in paragraph (e)(1) of this

section generally must be incurred by

the taxpayer that owned the property at

the time the plants were lost or

damaged. Paragraph (e)(1) of this section

will apply, however, to costs incurred

by a person other than the taxpayer that

owned the plants at the time of damage

or loss if—

(i) The taxpayer that owned the plants

at the time the damage or loss occurred

owns an equity interest of more than 50

percent in such plants at all times

during the taxable year in which the
Federal Register / Vol. 62, No. 163 / Friday, August 22, 1997 / Rules and Regulations 44551

replanting costs are paid or incurred;

and

(ii) Such other person owns any

portion of the remaining equity interest

and materially participates in the

replanting, cultivating, maintaining, or

developing of such plants during the

taxable year in which the replanting

costs are paid or incurred. A person will

be treated as materially participating for

purposes of this provision if such

person would otherwise meet the

requirements with respect to material

participation within the meaning of

section 2032A(e)(6).

(3) Examples. The following examples

illustrate the provisions of this

paragraph (e):

Example 1. (i) Farmer T grows cherry trees

that have a preproductive period in excess of

2 years and produce an annual crop. These

cherries are normally eaten by humans.

Farmer T grows the trees on a 100 acre parcel

of land (parcel 1) and the groves of trees

cover the entire acreage of parcel 1. Farmer

T also owns a 150 acre parcel of land (parcel

2) that Farmer T holds for future use. Both

parcels are in the United States. In 1998, the

trees and the irrigation and drainage systems

that service the trees are destroyed in a

casualty (within the meaning of paragraph

(e)(1) of this section). Farmer T installs new

irrigation and drainage systems on parcel 1,

purchases young trees (seedlings), and plants

the seedlings on parcel 1.

(ii) The costs of the irrigation and drainage

systems and the seedlings must be

capitalized under section 263A. In

accordance with paragraph (e)(1) of this

section, the costs of planting, cultivating,

developing, and maintaining the seedlings

during their preproductive period are not

required to be capitalized by section 263A.

Example 2. (i) Assume the same facts as in

Example 1 except that Farmer T decides to

replant the seedlings on parcel 2 rather than

on parcel 1. Accordingly, Farmer T installs

the new irrigation and drainage systems on

100 acres of parcel 2 and plants seedlings on

those 100 acres.

(ii) The costs of the irrigation and drainage

systems and the seedlings must be

capitalized under section 263A. Because the

acreage of the related portion of parcel 2 does

not exceed the acreage of the destroyed

orchard on parcel 1, the costs of planting,

cultivating, developing, and maintaining the

seedlings during their preproductive period

are not required to be capitalized by section

263A. See paragraph (e)(1) of this section.

Example 3. (i) Assume the same facts as in

Example 1 except that Farmer T replants the

seedlings on parcel 2 rather than on parcel

1, and Farmer T additionally decides to

expand its operations by growing 125 rather

than 100 acres of trees. Accordingly, Farmer

T installs new irrigation and drainage

systems on 125 acres of parcel 2 and plants

seedlings on those 125 acres.

(ii) The costs of the irrigation and drainage

systems and the seedlings must be

capitalized under section 263A. The costs of

planting, cultivating, developing, and

maintaining 100 acres of the trees during

their preproductive period are not required to

be capitalized by section 263A. The costs of

planting, cultivating, maintaining, and

developing the additional 25 acres are,

however, subject to capitalization. See

paragraph (e)(1) of this section.

(4) Special rule for citrus and almond

groves—(i) In general. The exception in

this paragraph (e) is available with

respect to a citrus or almond grove,

notwithstanding the taxpayer’s election

not to have section 263A apply

(described in paragraph (d) of this

section).

(ii) Example. The following example

illustrates the provisions of this

paragraph (e)(4):

Example. (i) Farmer A, an individual, is

engaged in the trade or business of farming.

Farmer A grows citrus trees that have a

preproductive period of 5 years. Farmer A

elects, under paragraph (d) of this section,

not to have section 263A apply to the

preproductive period costs. This election,

however, is unavailable with respect to the

preproductive period costs of a citrus grove

incurred within the first 4 years after the

trees were planted. See paragraph (d)(2) of

this section. After the citrus grove has

become productive in marketable quantities,

the citrus grove is destroyed by a casualty

within the meaning of paragraph (e)(1) of this

section.

(ii) Farmer A must capitalize the

preproductive period costs incurred before

the close of the fourth taxable year beginning

with the year in which the trees were

permanently planted. As a result of the

election not to have section 263A apply to

preproductive period costs, Farmer A may

deduct the preproductive period costs

incurred in the fifth year. The costs of

replanting, cultivating, maintaining, and

developing the trees destroyed by a casualty

are exempted from capitalization under this

paragraph (e).

(f) Effective date and transition rule.

In the case of property that is not

inventory in the hands of the taxpayer,

this section is generally effective for

costs incurred on or after August 22,

1997, in taxable years ending after such

date. In the case of inventory property,

this section is generally effective for

taxable years beginning after August 22,

1997. However, taxpayers in compliance

with § 1.263A–4T in effect prior to

August 22, 1997 (See 26 CFR part 1

edition revised as of April 1, 1997.), and

other administrative guidance, that

continue to comply with § 1.263A–4T in

effect prior to August 22, 1997 (See 26

CFR part 1 edition revised as of April 1,

1997.), and other administrative

guidance, will not be required to apply

these new temporary rules until final

regulations are published in the Federal

Register.

§ 1.471–6 [Amended]

Par. 7. Section 1.471–6 is amended as

follows:

1. Adding two sentences to the end of

paragraph (c).

2. Removing the second sentence in

paragraph (d) and adding two sentences

in its place.

3. Revising the last three sentences of

paragraph (f).

The additions and revision read as

follows:

§ 1.471–6 Inventories of livestock raisers

and other farmers.

* * * * *

(c) * * * In addition, these inventory

methods may be used to account for the

costs of property produced in a farming

business that are required to be

capitalized under section 263A

regardless of whether the property being

produced is otherwise treated as

inventory by the taxpayer, and

regardless of whether the taxpayer is

otherwise using the cash or an accrual

method of accounting. Thus, for

example, the unit livestock method may

be utilized by a taxpayer in accounting

under section 263A for the costs of

raising animals that will be used for

draft, breeding, or dairy purposes.

(d) * * * If this method of valuation

is used, it generally must be applied to

all property produced by the taxpayer in

the trade or business of farming, except

as to livestock accounted for, at the

taxpayer’s election, under the unit

livestock method of accounting.

However, see § 1.263A–4T(c)(3) for an

exception to this rule. * * *

* * * * *

(f) * * * Except as otherwise provided

in this paragraph, once established, the

unit prices and classifications selected

by the taxpayer must be consistently

applied in all subsequent taxable years.

For taxable years beginning after August

22, 1997, a taxpayer using the unit

livestock method must, however,

annually reevaluate the unit livestock

prices and must adjust the prices

upward to reflect increases in the costs

of raising livestock. The consent of the

Commissioner is not required to make

such upward adjustments. No other

changes in the classification of animals

or unit prices shall be made without the

consent of the Commissioner. See

§ 1.263A–4T for rules regarding the

computation of costs for purposes of the

unit livestock method.

* * * * *

Michael P. Dolan,

Acting Commissioner of Internal Revenue.

Approved: July 28, 1997.

Donald C. Lubick,

Acting Assistant Secretary of the Treasury.

[FR Doc. 97–21772 Filed 8–21–97; 8:45 am]

BILLING CODE 4830–01–U