T.C. Mem o. 2 01 6- 22 4

UNITED STAT ES TAX COURT

WASCO REAL PROPERTIES I, LLC, GARDINER FAMI LY TRUST, TAX

MATTERS PARTNER, ET AL., Pet it io ne rs v. 1 COMM ISSI ONER OF INTERNAL REVENUE, Resp on de nt

Doc ke t No s. 8 11 1- 12 , 81 12 -1 2, Fi le d Dec em be r 13 , 20 16
. 81 13 -1 2.

P1 , P2, an d P 3 a re treat edas p artne rs hi ps forFed eral tax pu rp os es an d a re i n t he bu si ne ss of f arm in g a lm on ds . Each P fin an cedth e p ur ch as e o f la nd , all or apo rti on of wh ic h i t u se d t o pl an t an d g ro w alm on d t rees forus e in it s b us in es s. Th e fi na nc in g was fro m th irdpa rti es , exc ep t tha t P1 als o b orro wedfun ds fro m P2 an d P 3, wh ic h c on te m

po ran eo us ly hadbo rro wedth os e fu nd s fr om a th irdpa rty. P2 an d P 3 p ai d i nt eres t t o t he th irdpa rty as t o t he fun ds th ey len t t o P 1, b utP1 di d n otpa y an y in te res t t o P 2 o r to P3 . Ps de du ct edth e in te res t tha t the y pa idto th e th irdpa rti es . P1 al so de du ct edpro pe rty tax es th atitpa idas t o i ts lan d. R d is al lo wedth e
Cas es of t he fol lo win g p et it io ne rs are co ns ol id at edhe rewi th : Ro se da le 1 Ran ch , A Gener al Part ne rs hi p, Ro se da le Farm in g Gro up , Tax M at te rs Partne r, do ck etNo. 8 11 2- 12 ; an d Ki ng an d Gar di ne r Farm s, LLC, Kei thGard in er, Tax Mat te rs Part ne r, do ck etNo. 8 11 3- 12
.- 2 -

[* 2] de du ct io ns on th e g ro un ds th atI.R.C. s ec. 2 63 A requi res th atth e ta xe s an d t he in te res t b e cap it al iz edrathe r th ande du ct ed . R als o m ad e ad jus tm en ts un de r I.R.C. s ec. 4 81 to refl ecta ch an ge inm etho d of acco un ti ng foreach P with re sp ectto th e ta xe s an d the in te res t. Held : I.R.C . sec . 26 3A( a)(2 )(B) requi res th atP1 cap it al iz e th e pr op erty tax es co rres po nd in g t o t he po rti on of i ts lan d o n wh ic h i t gr ew al m on d t rees inth atth is po rti on of t he tax es is anall oc ab le , in di rectco stof P 1’s g ro win g (a ndth us pro du ci ng ) th e al m on d t rees . Held , furth er, I.R.C. s ec. 2 63 A(a) an d (f )(1 ) an d (2 ) requi res th ateach P cap it al iz e th e in te res t co rres po nd in g t o t he po rti on of i ts la ndonwhi chitgre w alm on d t rees inth atth is po rti on of the in te res t is all oc ab le to th e al m on d t rees , th e p ro pe rty tha t ea chP pr oduc ed
. Held , furth er, the an ti ab us e ru le insec . 1.2 63 A-1 5( c), In co m e Tax Reg s., requi res to th e ex te ntst at edhe rei n t ha t P2 an d P 3 cap it al iz e th e in te res t the y pa idto th e th irdpa rty with res pe ctto th e fu nd s the y

co nt em po ran eo us ly len t t o P 1 i n t ha t the ir l oa ns to P1 were rel at edpa rty tran sa ct io ns th atav oi de d the in te res t capi ta li zat io n ru le s of sec s. 1 .26 3A- 8 t hr ou gh 1.2 63 A-1 5, In co m e Tax Reg s., an d d idno t carry ou t the pu rp os es of I .R.C. se c. 26 3A( f). Held , furth er, R’s ad

jus tm en ts un de r I.R.C. s ec. 4 81 are su st ai ne d t o t he ex te ntth atPs m us t ch an ge th ei r m etho ds of acco un ti ng to cap it al iz e th e ta xe s an d t he in te res t i n l ie u o f de du ct in g th os e it em s cu rren tl y .
St ev enR. Mat he r an d Lydia B . Turan ch ik , forpe ti ti on ers . Sh irl ey H. Mao an d R on al d M . Ros en , forres po nd en t.- 3 -

[* 3] MEMORANDUM FINDINGS OF FACT AND OPINION BUCH, Ju dg e: Thes e co ns ol id at edcas es are p artne rs hi p- le ve l p ro ceed in gs subjec t t o the un ifi edau di t an d l it ig at io n p ro cedur es of t he Tax Equi ty andFis cal Res po ns ib il it y

Act o f 19 82 , Pub . L. No. 97 -2 48 , sec . 40 1, 9 6 S ta t. at64 8. Th e rel ev an t “pa rtn ers hi ps ” are W as co Real Pro pe rti es I, LLC (WRP I); Ro se da le Ran ch , A Gener al Part ne rs hi p (R os ed al e Ran ch ); a ndKin g a ndGard in er Fa rm s, LLC (K&G) (co ll ect iv el y , ent it ie s, u nl es s the co nt ex t i nd ic at es ot he rwis e). The se cas es co nc ernth e en ti ti es ’ 20 08 an d 2 00 9 t ax ab le y ears an d fo r K&G it s 2 00 7 ta xabl e y ear a s wel l (we he rei na fte r us e th e te rm “ subjec t years” to refe r co ll ect iv el y

to 20 07 , 20 08 , and20 09 inth e cas e o f K&G an d t o 2 00 8 a nd20 09 in th e cas e o f eac h o f th e o th er two en ti ti es ). The en ti ti es were o wne d d ire ct ly or in di rect ly by a gr oup o f in di vi du al s wh o were i nv ol ve d i n t he bu si ne ss of f arm in g a lm on ds . The en ti ti es sep arat el y pu rch as edlan d b efo re the subjec t years, an d e ach en ti ty the reaf te r pl an te d a nd gr ew al m on d t rees onit s l an d. Th e en ti ti es pa idin te res t re la ti ng to de btin cu rred to pu rch as e th e la nd , andth ey de du ct edth e in te res t dur in g t he subjec t years. Fo r 20 08 an d 2 00 9 WRP I al so de du ct edpro pe rty tax es th atitpa idas t o i ts lan d.- 4 -

[* 4] Res po nd en t i ss ue d s ep arat e n ot ic es of f in al pa rtn ers hi p a dm in is tra ti ve ad jus tm en t (F PAAs) to th e ta x m at te rs partn ers (TMPs ) of th e en ti ti es , di sa ll owi ng th e d educ ti on s b ecau se , inres po nd en t’s v ie w, sec ti on 26 3A re qu ire d tha t the in te res t an d t he tax es be cap it al iz ed
. Res po nd en t al so m ad e ad jus tm en ts un de r 2
se ct io n 4 81 be cau se cap it al iz in g t ho se co st s re su lt edineach en ti ty’ s ch an gi ng it s acco un ti ng m etho d a s t o t he co st s. Th e am ou nt s o f res po nd en t’s ad jus tm en ts as t o th os e it em s ar e as fol lo ws: W RP I

Item 20 08 20 09 In te res t $7 92 ,64 5 $5 64 ,93 2 Tax es 11 7,2 32 14 1,0 22 Sec. 4 81 (a) a dju stm en t 61 ,31 3 ---

Ros ed al e Ran ch Item 20 08 200 9 In te res t $9 51 ,02 3 $1 ,22 0,0 04 Sec. 4 81 (a) a dju stm en t 76 5,9 75 ---

Unl es s o th erwi se in di cat ed , sec ti on refe ren ces are t o the Int ern al Rev enue 2 Co de (Co de ) in effe ctforth e subjec t years. Ru le refe ren ces are t o t he Tax C ou rt Ru le s o f Prac ti ce an d P ro cedur e.- 5 -

[* 5] K&G

Item 20 07 20 08 20 09 In te res t $8 0,8 55 $6 52 ,14 2 $2 23 ,56 3 Sec. 4 81 (a) a dju stm en t 23 9,9 35 --- --- W e m us t d eci de th e co rrec tn es s o f th es e ad jus tm en ts . W e h ol d t ha t WRP I

3
m us t capi ta li ze the pro pe rty tax es to th e ex te ntth atth e ta xe s ar e al lo cab le to th e po rti onof t he lan d o n wh ic h WRP I g rew i ts alm on d t rees . Each e nt it y m us t cap it al iz e th e in te res t o n t he de btall oc ab le to th e p orti onof i ts lan d o n wh ic h i t gr ew it s al m on d t rees . Purs ua ntto th e an ti ab us e ru le insec ti on 1.2 63 A-1 5( c), In co m e Tax Reg s., Ro se da le Ran chan d K& G to th e ex te ntst at edhe rei n m us t cap it al iz e in te res t tha t the y pa idon fun ds th atth ey

bo rro wedan d
co nt em po ran eo us ly len t t o WRP I. Andres po nd en t’s ad jus tm en ts un de r se ct io n 48 1 a re s us ta in edto th e ex te ntst at edhe rei n. FINDINGS OF FACT Each en ti ty in the se co ns ol id at edcas es is tre at edas apa rtn ers hi p fo r ta x pu rp os es an d u se s the cas h m etho d fo r ta x p ur po se s. Each ha d i ts pri nc ip al pl ace of bu si ne ss inCal ifo rn iawhen th e p et it io n re la ti ng to itwas fi le d.

Res po nd en t al so m ad e o th er ad jus tm en ts , no ne of wh ic h we n eedor d o 3 de ci de . W e d o n otli stth es e o th er ad jus tm en ts .- 6 -

[* 6] I. Ent it ie s The en ti ti es are al l o wne d d ire ct ly or in di rect ly by on e o r m or e m em

be rs of
a co m m on gro up of i nd iv idua ls an d t ru st s. Th e in di vi du al s an d t ru st s ar e Kei th Gard in er, J en ni fer T. Gard in er (wi fe o f Kei thGard in er), J effr ey H. Towns en d, Caro l S. To wns en d (n ow Ad am so n, ex -wif e o f Je ffre y

Town se ndan d s is te r of Keit h Gar di ne r), th e Mary D. King Trus t, an d t he Gard in er Fam il y Trus t. We de ta il be lo w th e sp eci fic m em be rs who owneach of t he en ti ti es an d o th er re le va nt
co nn ect io ns th atth e m em be rs ha ve to on e an ot he r. A. W RP I W RP I i s a l im it edli ab il it y co m pa ny regi st eredinth e St at e o f Cal ifo rn ia
. W RP I i s en ga ge d i n afarm in g b us in es s. WRP I was fo rm edin20 07 an d i s o wne d 50 % by the Gard in er Fa m il y Trus t, 3 0% b y

Ro se da le Farm in g Gro up , and20 % by th e Ma ry D. King Trus t. Keit h andJen ni fer Gar di ne r are tru st ees of t he Gard in er Fa mil y Trus t, whi chintu rnis th e TMP fo r W RP I. J effr ey an d C aro l To wns en d e qu al ly own Ro se da le Farm in g Gro up , a ge ne ral pa rtn ers hi p. Fra nkL. King , Jr., i s the tru st ee of th e Ma ry D. King Trus t.- 7 -

[* 7] B. Ro se da le Ran ch Ro se da le Ran chis a ge ne ral pa rtn ers hi p re gi st eredinth e St at e o f Cal ifo rn ia
. Ro se da le Ran chis en ga ge d i n afarm in g b us in es s. Ro se da le Ran chwas fo rm edin 20 02 an d i s equa ll y

own edby Ros ed al e Farm in g Gro up an d b y Gard in er Fa m il y , LLC. Gard in er Fa m il y , LLC, is e qu al ly owne d b y Keit h a ndJen ni fer Gar di ne r. Ro se da le Farm in g Gro up is th e TMP fo r Ro se da le Ran ch
. C. K&G K&G is a li m it edli ab il it y co m pa ny regi st eredinth e St at e o f Cal ifo rn ia
. K&G is en ga ge d i n fa rm in g a ndco m m erci al real est at e b us in es se s. K&G was fo rm edin19 95 an d i s equa ll y own edby K ei th Gard in er an d b y th e Ma ry D. King Trus t. Kei th Gard in er i s the TMP fo r K&G. II. W as co Pro pe rty Inearl y 20 07 Jac ks on & Perk in s l is te d fo r sa le ap pr ox im at el y 3,2 00 acre s o f farm la ndan d o th er as se ts (co ll ect iv el y , W as co pro pe rty) inW as co , Cal ifo rn ia
. Mr. Gard in er b el ie ve d t ha t the farm la nd(W as co lan d) was s om e o f th e b es t pr op erty inth e wor ld . Jac ks on & Perk in s ar e fam ou s fo r th ei r ro se s, an d t he y requi redth ata bu y er o f th e Wasco pro pe rty letth em fin is h g ro win g a ndha rv es ti ng th e ro se s tha t wer e al read y gro win g o n t he W as co lan d, i n e xc ha ng e fo r whi ch- 8 -

[* 8] Jac ks on & Perk in s wo ul d p ay ren t. Alo ng with the W as co lan d, J ack so n & Perk in s re qu ire d the bu y er t o p ur ch as e th e o th er as se ts , con si st in g o f se ve ral bu il di ng s o n t he pro pe rty anda si gn ifi can t am ou ntof e qu ip m en t. A. Pu rch as e o f W as co Pro pe rty In20 07 Mr. Gard in er an d h is bu si ne ss ass oc ia te s fo rm edW RP I an d Wasc o Rea l Pr op ert ie s II , LLC (WRP II) , forth e p ur po se of a cqui rin g t he W as co pr op erty . Mr. Gard in er h adbe enact iv e in alm on d fa rm in g fo r m any y ears . 4 Befo re WRP I was fo rm ed , abo ut70 % of t he bu si ne ss act iv it ie s o f vario us pa rtn ers hi ps own edby Mr. Gardi ne r an d h is ass oc ia te s i nv ol ve d a lm on d farm in g. On Ap ril 27 , 20 07 , WRP I an d WRP II p ur ch as edth e Wasco pro pe rty for $2 9,0 57 ,50 0. Of tha t am ou nt , WRP I co nt rib ut ed$2 4,5 50 ,00 0 a ndW RP II
co nt rib ut ed$4 ,50 7,5 00 . WRP I re cei ve d app ro xi m at el y 2,9 95 acre s o f th e Wasco la nd , andW RP II r ecei ve d t he rem ai ni ng ap pr ox im at el y 20 5 a cres . The $2 4,5 50 ,00 0 c on tri bu te d b y W RP I ca m e fro m

th e fo ll owi ng so ur ces : two di rectlo an s t ot al in g $ 12 ,30 0,0 00 fro m anin de pe nd en t thi rdpa rty, Farm Cred itW es t (F CW); two lo an s t ot al in g $ 7,3 50 ,00 0 fr om Ro se da le Ran ch ; an d t wo lo an s t ot al in g $ 4,9 00 ,00 0 fr om K&G. Ros ed al e Ran chan d K& G con tri bu te d t o W RP II i s o wne d e qu al ly by Ro se da le Farm in g Gro up an d t he Gard in er 4 Fam il y Trus t. WRP II was f

orm edbe cau se th e Ma ry

D. King Trus t d idno t wan t to tak e p artinpu rch as in g t he co m m erci al bu il di ng s.- 9 -

[* 9] th e acqui si ti on of t he W as co pro pe rty to a ll ow the rel at eden ti ti es to po ol th ei r al m on d c ro ps , whi chwou ldall ow the m to ob ta in pre m iu m

pri ci ng an d g en eral ly gi ve th em m or e le ve rag e in ne go ti at io ns . 1. Loa ns Fro m

FCW W RP I u se d t he en ti re $ 12 ,30 0,0 00 inlo an s fr om FCW to p ur ch as e th e W as co pro pe rty. In20 07 W RP I d idno t p ay an y in te res t t o F CW w it h re sp ectto th e bo rro win g o f th e $ 12 ,30 0,0 00 , andacco rd in gl y , WRP I d idno t cl ai m a de du ct io n fo r an y in te res t re la ti ng to th atbo rro win g o n i ts tax return fo r 20 07 . In 2 00 8 a nd 20 09 W RP I p ai d i nt eres t t o F CW on t he un de rlyin g l oa ns an d c la im edde du ct io ns fo r th e co rres po nd in g t ot al in te res t tha t i t p ai d t o F CW dur in g e ach of t ho se y ears on it s t ax returns for20 08 an d 2 00 9.

2. Loa n F ro m

Ro se da le Ran ch The $7 ,35 0,0 00 lo anto W RP I fr om Ro se da le Ran chco ns is te d o f $1 ,47 0,0 00 of i ts owncas h p lu s the pro ceed s o f a $ 5,8 80 ,00 0 l oa n i t re cei ve d fr om FCW. Ro se da le Ran chob ta in edth e FCW lo anonApri l 2 4, 2 00 7, an d i m m ed ia te ly le ntth e $ 5,8 80 ,00 0 t o WRP I to us e to pu rch as e th e Wasco pro pe rty. Becau se of
anov ers ig ht , WRP I an d R os ed al e Ran chdi d n otex ecu te a pr om is so ry no te forth e- 10 -

[* 10 ] lo anun ti l Ap ril 20 08 . WRP I d idno t p ay an y in te res t t o R os ed al e Ran ch du rin g t he subjec t years b ecau se th e Wasco pro pe rty didno t g en erat e in co m e su ffi ci en t fo r W RP I t o p ay th e in te res t due . In J ul y

20 10 Ro se da le Ran chan d W RP I am en de d t he pro m is so ry no te s t o d eferth e p aym en ts of a ccru edin te res t
an d p rin ci pa l u nt il Jan ua ry 1, 2 01 6, wh enW RP I’s al m on d trees were ex pe ct edto pr oduc e in co m e su ffi ci en t fo r itto pa y th e in te res t. In20 07 Ro se da le Ran chdi d n otpa y an y in te res t t o F CW w it h re sp ectto th e $5 ,88 0,0 00 lo an , andacco rd in gl y , itdi d n otcla im a de du ct io n fo r an y

in te res t rel at in g t o t ha t l oa n o n i ts tax return fo r 20 07 . In 2 00 8 a nd20 09 Ro se da le Ran ch pa idin te res t t o F CW andcla im edde du ct io ns forth e co rres po nd in g i nt eres t tha t i t pa idto FCW dur in g e ach of t ho se y ears on it s t ax returns for20 08 an d 2 00 9.

3. Loa n F ro m

K&G On Ap ril 24 , 20 07 , K&G bo rro wed$9 80 ,00 0 fr om a li ne of c red itth atitha d with F CW andals o o bt ai ne d fr om FCW an unr el at edlo anof $ 3,9 43 ,00 0. K&G lo an ed$4 ,90 0,0 00 of t he $4 ,92 3,0 00 ($9 80 ,00 0 + $3 ,94 3,0 00 ) to W RP I, as di sc us se d abo ve . WRP I d idno t m ak e an y of t he sch edul edin te res t p aym en ts . On Ju ly 1, 20 10 , WRP I an d K& G am en de d t he pro mis so ry no te s t o d eferth e pa ym en ts of t he accrue d i nt eres t an d p rin ci pa l u nt il Jan ua ry 1, 2 01 6, wh en- 11 -

[* 11 ] W RP I’s al m on d t rees were ex pe ct edto pro du ce i nc om e su ffi ci en t fo r W RP I to pa y th e in te res t. In20 07 K&G pa idin te res t t o F CW on t he li ne of c red itlo an . K&G clai m ed a d educ ti on forth e in te res t o n i ts tax return fo r 20 07 . In 2 00 8 a nd20 09 K&G pa id in te res t t o F CW on b ot h t he li ne of c red itlo anan d t he $3 ,94 3,0 00 lo anan d cl ai m edde du ct io ns forth e co rres po nd in g t ot al in te res t tha t i t p ai d t o F CW dur in g 20 08 an d 2 00 9 o n i ts tax returns forth os e y ears . B. W RP I Al m on d Tre e Dev el op m en t Lo an s The W as co lan d d idno t h av e an y alm on d t rees on itwhen W RP I p ur ch as ed it s p orti on of t ha t l an d i n 2 00 7. Atth e ti m e o f th atpu rch as e th e Wasco lan d h ad
ro w cro ps gro win g o n i t, i nc lu di ng ros es , corn, wh eat , andcarr ot s. Ro w cro ps are no np erm an en t cr op s tha t h av e a s pe ci fic gro win g s eas on . W RP I en de av or edto us e atlea stit s p orti on of the W as co lan d t o g ro w al m on d trees . To fi na nc e th e co st s as so ci at edwith p la nt in g a ndgro win g a lm on d tre es , WRP I i nc urredad di ti on al de bt . In 2 00 7 Tre eh ou se Alm on ds (Treeh ou se ) pr ov id eda rev ol vi ng li ne of c red itwith a$3 .5 m il li on li m it . W it h o ne ex cep ti on , W RP I’s p ro du ct io n e xp en di tures were fi na nc eden ti rel y by deb t. The ex cep ti on is th at$1 11 ,14 7 o f ex pe nd itur es was p ai d t hr ou gh ren ta l i nc om e in 20 07 . For e ach- 12 -

[* 12 ] of t he subjec t years i n i ss ue , WRP I capi ta li zedth e co rres po nd in g i nt eres t pa idon th e Treeh ou se li ne of c red itlo an . C. W RP I Al m on d Tre e Dev el op m en t Dur in g 2 00 7 WRP I b eg anth e fi rs t o f th ree p ha se s t o g ro w alm on d t rees on 25 4.1 acre s o f it s Wasco lan d. WRP I u se d t hi s p ha se d app ro ach be cau se ros es 5
were s ti ll gro win g o n p artof t he W as co lan d a ndbe cau se W RP I d idno t h av e th e res ou rces to pl an t the en ti re p ro pe rty with alm on d t rees at o nc e. Inth e fi rs t p ha se W RP I co ns tru ct edex te ns iv e und erg ro un d i rri ga ti on syste m s an d b ui ltres erv oi rs . W RP I al so rip pe d a ndde ep rip pe d t he so il as we ll as l ev el edan d tren ch edth e la nd
. W RP I l eas edth e res t o f it s Wasco lan d i n s ep arat e p orti on s t o Ja ck so n & Perk in s an d t o Gar di ne r Farm s. As pa rt o f th e p ur ch as e ag reem en t, Ja ck so n & Perk in s l eas edfro m W RP I J ack so n & Perk in s’ po rti on of the W as co la ndwhi le cy cl in g o utit s ro se s. Gard in er Fa rm s l eas edfro m W RP I Gar di ne r As ev id en ce o f whe n t he en ti ti es pl an te d a lm on d t rees on sp eci fic tra ct s o f 5 la nd , pet it io ne rs in cl ud edtwo ex hi bi ts . One i s an nu al m ap s o f th e la nd s wi th in co m pl et e n ot at io ns of wh enalm on d t rees were p lant ed . The o th er i s a t ab le li st in g wh enalm on d t rees were p la nt edon sp eci fic tra ct s o f la nd . Thattab le , ho wev er, was pre pa redaft er the factan d fo r acc ou nt in g p ur po se s. We fin d t he m ap s t o b e m or e rel iabl e. Acco rd in gl y , we hav e d et erm in edwhen alm on d t rees were p la nt edonva rio us tra ct s o f la ndby usi ng in fo rm at io n o n t he m ap s. Where th e in fo rm at io n o n t he m ap s i s i nc om pl et e, we have lo ok edto th e subs eque nt ly pr ep aredtab le
.- 13 -

[* 13 ] Farm s’ po rti onof the W as co lan d t o g ro w row cr op s. WRP I lea se d a po rti onof t he W as co lan d t o Gar di ne r Farm s, i n l ie u o f W RP I’s p la nt in g i ts own cro ps on th atlan d, b ecau se th e ren t tha t WRP I rece iv edon th atlea se pro vi de d i t with ane ces sa ry

cas hf lo w. WRP I al so di d n otha ve th e p ro pe r equi pm en t t o p la nt it s o wn ro w cro ps . In20 08 W RP I was gro win g a lm on d t rees on 2,0 34 .61 acre s o f th e Wasco la ndan d was gro win g ro w cro ps on ot he r pa rts of the W as co lan d. J ack so n & Perk in s an d Gar di ne r Farm s co nt in ue d t o l eas e th e rem ai ni ng po rti on s o f W RP I’s W as co lan d t o g ro w row cr op s. Fo r 20 08 W RP I’s p ro du ct io n d eb t ex ceed edit s pr oduc ti on ex pe nd itur es . In20 09 W RP I was gro win g a lm on d t rees on 2,2 59 .61 acre s o f th e Wasco la ndan d was gro win g ro w cro ps on ot he r pa rts of the W as co lan d. Th aty ear WRP I be ga n p ha se s 2 an d 3 of g ro win g a lm on d t rees . Pha se 2 i nc lu de d p la nt in g al m on d trees as we ll as g en eral m ai nt en an ce. Ph as e 3 in cl ud edad di ti on al tre e pl an ti ng an d v ari ou s o th er m ai nt en an ce ac ti vi ti es . For 2 00 9 WRP I’s pr oduc ti on de btex ceed edit s p ro du ct io n e xp en di tu res .- 14 -

[* 14 ] D. W RP I Pa ym en t o f Pro pe rty Taxes on W as co Land W RP I p ai d $ 61 ,31 3, $ 11 7,2 32 , and$1 41 ,02 2 i n p ro pe rty tax es on th e W as co lan d dur in g 2 00 7, 2 00 8, an d 2 00 9, re sp ect iv el y . WRP I cl ai m ed
co rres po nd in g d educ ti on s fo r th es e p aym en ts on it s t ax returns forth os e y ears . III. W ei de nb ach Pro pe rty In20 06 Ro se da le Ran chlea se d a ndpa idren t fo r a p orti onof l an d (Weid enba chpro pe rty) th atin cl ud es ap pr ox im at el y 24 0 a cres inSh aft er, Cal ifo rn ia . Ros ed al e Ran chown eda pi ece o f pr op erty ad jacen t t o t he W ei de nb ach pro pe rty tha t i t was att em pt in g t o d ev el op . If an ot he r bu y er h ad pu rch as edth e Weide nb achpro pe rty, it m ig htha ve affe ct edRo se da le Ran ch ’s
acce ss to th e p ro pe rty it al read y own ed . Ros ed al e Ran chbe ga n g ro win g a lm on d tre es onth e Weide nb ach pro pe rty durin g 2 00 6, an d i t u se d t he lan d o nl y for gr owi ng alm on d t rees . On Fe brua ry

13 , 20 07 , Ros ed al e Ran chpurch as edth e Weide nb ach pro pe rty
us in g t he pro ceed s o f a l oa n fr om FCW of $ 16 ,82 8,0 00 . Ros ed al e Ran chpa id in te res t t o F CW as to th e $ 16 ,82 8,0 00 lo anin20 07 , 20 08 , and20 09 . Ros ed al e Ran chcla im edde du ct io ns forth e co rres po nd in g i nt eres t tha t i t p ai d t o F CW for th os e y ears .- 15 -

[* 15 ] IV. W oo d S to ne Pro pe rty InMay 200 5 K& G purch as edap pr ox im at el y 1,6 85 acre s o f la nd(W oo d St on e p ro pe rty) from W oo d S to ne Ran ch es , LLP. A lm on d t rees were al read y pl an te d o n t he W oo d S to ne pro pe rty in 2 00 5, an d K& G eve ntua ll y pl an te d the W oo d S to ne pro pe rty with alm on d trees an d p is ta ch io tre es . The s el le r fi na nc ed $2 ,53 4,6 75 of t he pu rch as e p ric e, an d t he pri nc ip al an d i nt eres t wer e p ay ab le ov er 10 y ears . K&G pai d i nt eres t o n t he de btdu rin g 2 00 6, 2 00 7, 2 00 8, an d 2 00 9. K&G cl ai m edde du ct io ns forth e in te res t ex pe ns e o n i ts tax returns for th os e y ears . 6 In20 07 K&G als o b orro wedap pr ox im at el y $4 ,06 0,3 59 fro m

it s FC W li ne of cred itfor pro du ct io n e xp en di tu res rel at edto th e WoodSto ne pro pe rty. K &G pa idin te res t o n t hi s d eb t dur in g 2 00 7 a nd20 08 . K&G clai m edde du ct io ns forth is in te res t b utno w con ced es th atth e in te res t i s n otde du ct ib le an d m us t b e cap it al iz ed
.

Fo r 20 08 K&G m is ta ke nl y de du ct ed$1 29 ,26 8 o f th e p rin ci pa l p aym en ts as 6 anin te res t ex pe ns e. K&G co nc ed es th atth is am ou ntis no t d educ ti bl e. Res po nd en t co nc ed es th atth e in te res t tha t K&G p ai d dur in g 2 00 9 i s d educ ti bl e be cau se any

pre pr oduc ti ve pe rio d wo ul d h av e en de d o n Dec em be r 31 , 20 08
. Add it io na ll y , for20 09 K&G als o d educ te d an i nt eres t ex pe ns e o f $5 7,8 77 th atwas du e to anaccrua l t o c as h a dju st m en t re ve rs al . K&G con ced es th atth is is no t a de du ct ib le ex pe ns e.- 16 -

[* 16 ] V. FPAAs On J anua ry

9, 2 01 2, re sp on de ntis su eda to ta l o f se ve n F PAAs t o t he
en ti ti es ’ TMPs . Two FPAAs rel at edto W RP I. Two o th er FPAAs rel at edto Ro se da le Ran ch . The fi na l thr ee FP AAs rel at edto K&G. A. FPAAs Rel at in g t o WRP I The two FPAAs i ss ue d t o t he TMP o f W RP I i nc lu de d o ne for20 08 an d o ne fo r 20 09 . The FPAA fo r 20 08 di sa ll owe d m os t o f th e p ro pe rty tax ex pe ns e de du ct io n, d is al lo wedm os t o f th e in te res t ex pe ns e d educ ti on , m ad e a s ect io n 4 81 ad jus tm en t, an d m ad e co m

pu ta ti on al ad

jus tm en ts . The FPAA fo r 20 09 di sa ll owe d
m os t o f th e p ro pe rty tax expe ns e d educ ti on , di sa ll owe d m os t o f th e in te res t
ex pe ns e d educ ti on , andm ad e co m pu ta ti on al ad

jus tm en ts . B. FPAAs Rel at in g t o R os ed al e Ran ch The two FPAAs i ss ue d t o t he TMP o f Ro se da le Ran chin cl ud edon e fo r 20 08 an d o ne for20 09 . The FPAA fo r 20 08 di sa ll owe d m os t o f th e in te res t
ex pe ns e d educ ti on , m ad e a s ect io n 4 81 ad jus tm en t, an d m ad e co m

pu ta ti on al ad jus tm en ts . The FPAA fo r 20 09 di sa ll owe d m os t o f th e in te res t ex pe ns e de du ct io n a ndm ad e co m pu ta ti on al ad

jus tm en ts .- 17 -

[* 17 ] C. FPAAs Rel at in g t o K& G The th ree F PAAs i ss ue d t o t he TMP o f K&G in cl ud edon e fo r 20 07 , on e fo r 20 08 , andon e fo r 20 09 . The FPAA fo r 20 07 di sa ll owe d apo rti on of t he in te res t
ex pe ns e d educ ti on , m ad e a s ect io n 4 81 ad jus tm en t, an d m ad e co m

pu ta ti on al ad jus tm en ts . The FPAA fo r 20 08 di sa ll owe d m os t o f th e in te res t ex pe ns e de du ct io n a ndm ad e co m pu ta ti on al ad

jus tm en ts . The FPAA fo r 20 09 di sa ll owe d a po rti onof t he in te res t ex pe ns e d educ ti on , in crea se d ade pr eci at io n a m ou nt al lo wed , reduc edin co m e fo r am ou nt s at tri bu tabl e to po rtf ol io in co m e in te res t an d in ve st m en t i nc om e, an d m ad e co m pu ta ti on al ad

jus tm en ts . OPINION I. Cap it al iz at io n W e en te r th e v as t an d c om pl ex worl d o f un ifo rm

cap it al iz at io n, i n aset ti ng of va rio us pa ss th ro ug h e nt it ie s tha t p ur ch as edlan d o n wh ic h the y pl an te d a nd gr ew al m on d t rees as p artof t he ir b us in es se s o f farm in g a lm on ds . The p art ie s’ di sp ut e res ts no t o n wh ethe r th e p ro pe rty tax es an d the in te res t ar e d educ ti bl e. The ir d is pu te foc us es in st eadon when th os e co st s m ay be de du ct ed
. Res po nd en t d et erm in edth atth e en ti ti es were n oten ti tl edto de du ctcurren tl y an y of t he pro pe rty tax es or i nt eres t i n d is pu te . As to th e ta xe s re sp on de ntarg ue s, be cau se WRP I u se d i ts lan d t o g ro w it s al m on d t rees , WRP I m us t capi ta li ze the- 18 -

[* 18 ] tax es rel at edto th e la ndrathe r th ande du ctth os e ta xe s cu rren tl y . As to th e in te res t, re sp on de ntarg ue s, the factth ateach en ti ty use d i ts lan d t o g ro w it s al m on d trees m ean s tha t the lan d a ndth e al m on d t rees are s uf fic ie nt ly relat edto each ot he r to be co ns id ereda si ng le un itof p ro pe rty the ba si s o f whi chin cl ud es th e am ou ntof t he in te res t tha t the en ti ty pai d t o fi na nc e it s p ur ch as e o f th e la nd
. Res po nd en t ad ds th atRo se da le Ran chan d K& G als o m us t capi ta li ze the in te res t th atth ey pa idon th e fu nd s tha t the y bo rro wedan d t he n l en t t o WRP I b ecau se th ei r lo an s t o WRP I were r el at edpa rty tran sa ct io ns subjec t t o t he an ti ab us e ru le in
se ct io n 1 .26 3A- 15 (c), In co m e Tax Reg s. 7 Pet it io ne rs arg ue th atsec ti on 26 3A d oe s n otap pl y to eit he r th e p ro pe rty ta xe s o r th e in te res t. Thi s i s b ecau se , inpe ti ti on ers ’ vi ew, th e ta xe s an d t he in te res t re la te no t t o p ro du ct io n o f th e al m on d t rees bu t t o t he lan d, wh ic h t he
en ti ti es di d n otpro du ce. Pet it io ne rs ass ertth atth e an ti ab us e ru le is in ap pl ic ab le be cau se Ro se da le Ran chan d K& G lac ke d t he requi si te in te ntto tri gg er tha t ru le
.

Res po nd en t ad va nc es analt ern at iv e arg um en t i n s up po rt o f hi s v ie w th at 7 each en ti ty m

us t capi ta li ze the in te res t tha t i t p ai d. Th e al te rn at iv e arg um en t i s th ateach en ti ty is a p ro du cer o f rea l p ro pe rty tha t fa il edto pe rfo rm th e av oi de d co stm etho d c al cu la ti on th atsec . 1.2 63 A-9 (a), In co m e Tax Reg s., requi red . Giv en ou r ho ld in gs inth es e cas es , we nee d n otan d d o n otad dr es s thi s al te rn at iv e arg um en t.- 19 -

[* 19 ] Pet it io ne rs co nc lu de th atth e en ti ti es m ay curren tl y de du ctbo th th e p ro pe rty ta xe s an d t he in te res t i n d is pu te . A. Exp en se Dedu ct io n Ver su s C ap it al Exp en di tu re Fed eral in co m e ta x l aw di st in gu is he s b etweena pa ym en t tha t i s cu rren tl y de du ct ib le as a n e xp en se an d apa ym en t tha t i s capi ta li zedas acap it al ex pe nd itur e. Cap it al ex pe nd itur es are n otex haus ti ve ly enu m erat edinth e Co de . Dedu ct io ns , on th e o th er h an d, ar e ex cep ti on s t o t he no rm of c ap it al iz at io n a ndrequi re a s pe ci fic st atut ory pro vi si on . “ Inexpl or in g the rel at io ns hi p b etweende du ct io ns an d c ap it al
ex pe nd itur es , * * * [the Supr em e] Cou rt h as no te d t he ‘ fam il ia r ru le ’ th at‘ an in co m e ta x d educ ti on is a m at te r of leg is la ti ve gra ce an d t ha t the burd enof c le arl y sh owi ng th e ri gh t t o t he cla im edde du ct io n i s o n t he tax pa y er.’” INDOPCO, Inc
. v. Co m m is si on er, 5 03 U.S. 79 , 84 (19 92 ) (quo ti ng Int ers ta te Tran si t Li ne s v . Co m m is si on er, 3 19 U.S. 59 0, 5 93 (19 43 )). The di st in ct io n b etweena cu rren t ex pe ns e an d acap it al ex pe nd itur e is im po rta ntinth atitaffe ct s the ti m in g o f a t ax pa y er’s co streco ve ry of t he pa ym en t.

“ Whi le bu si ne ss expe ns es are cu rren tl y de du ct ib le , a cap it al ex pe nd itur e u su al ly is
am orti zedan d d ep reci at edov er the li fe o f th e rel ev an t as se t, o r, whe re n o s pe ci fic
as se t o r us efu l l ife canbe asc ert ai ne d, i s d educ te d upo n d is so lu ti on of t he
en te rp ris e.” Id . at 8 3- 84 ; s ee al so Sm it h v . Comm is si on er, 3 00 F.3d10 23 , 10 28
-- 20 -

[* 20 ] 10 29 (9t h C ir. 2 00 2) , aff’g Van al co , Inc . v. Co m m is si on er, T.C. Mem o. 19 99 -2 65 ; Ly ch ukv. Co m m is si on er, 1 16 T.C. 37 4, 4 10 (20 01 ). B. Rel ev an t St atut ory Pro vi si on s fo r Cap it al iz at io n 1. Bac kg ro un d Co ng res s p ro m

ul ga te d s ect io n 2 63 (a)( 1) (an d v ari ou s o th er s im il ar pr ov is io ns requi rin g c ap it al iz at io n) “ to m at chex pe ns es with t he rev enue s o f th e ta xabl e p eri odto whi chth ey are p ro pe rly attrib ut ab le , th ereb y res ul ti ng ina m or e accu rat e cal cu la ti onof n etin co m e fo r ta x p ur po se s.” INDOPC O, Inc . v. Co m m is si on er, 5 03 U.S. at 8 4; Hert z Co rp . v. Un it edSta te s, 3 64 U.S. 12 2, 1 26 (1 96 0) ; s ee al so Co m

m is si on er v . Ida ho Po wer Co ., 41 8 U.S. 1 , 10 -1 1 (1 97 4) ; Ly ch ukv. Co m

m is si on er, 1 16 T.C. at 4 10 . A tax pa y er’s cap it al iz at io n o f a co st th atpro du ces rev enue infutur e y ears m os t ac cu rat el y de pi ct s the tax pay er’s tru e ta xabl e in co m e in th e y ear o f cap it al iz at io n a ndineach en su in g year. See INDOPCO, In c. v. Co m

m is si on er, 5 03 U.S. at 8 4. A ta xp ay er’s rep orte d i nc om e m is rep res en ts it s ac tu al in co m e to th e ex te ntth atth e rep orte d i nc om e ta ke s i nt o acco un t ex pe ns es th atdo no t co rrel at e to th e rev enue th atth ey ge ne rat e. See Ly ch ukv. Co m

m is si on er, 1 16 T.C. at 4 10 ; s ee al so INDOPCO, In c. v. Co m m is si on er, 5 03 U.S. at 8 4. A m ajorob jecti ve of e ffi ci en t t ax po li cy is to
m at chinth e sa m e ta xabl e p eri odth e d educ ti on of e xp en se s wi th th e rec og ni ti on of- 21 -

[* 21 ] an y rel at edrev enue , andth e in accu rat e rep orti ng of e xp en se s thwa rts th at po li cy an d re su lt s i n areduc ti on inth e ta x re ve nu e th atis ot he rwis e earne d i n, an d
m or e acc ur at el y

att rib ut ab le to , each tax ab le y ear. Se e, e.g ., INDOPCO, Inc . v. Co m m is si on er, 5 03 U.S. at 8 4; Ly chukv. Co m mis si on er, 1 16 T.C. at 4 10
. The st atut ory

pro vi si on s fo r cap it al iz at io n tha t ar e rel ev an t t o o ur an al y si s are s ect io n 2 63 (a)( 1) , form er s ect io n 1 89 , andsec ti on 26 3A.

2. Sect io n 2 63 (a)( 1) Sect io n 2 63 (a)( 1) requi res tax pa y ers to cap it al iz e “ [a]ny am ou ntpa idou t fo r ne w bu il di ng s o r fo r pe rm an en t i m pr ov em en ts or b et te rm en ts m ad e to in crea se th e va lu e o f an y

pro pe rty”. Sect io n 2 63 (a)( 1) serve s g en eral ly to d is ti ng ui sh cap it al
ex pe nd itur es fro m

ex pe ns e d educ ti on s, s ee INDOPCO, In c. v. Co m m is si on er, 5 03 U.S. at 8 4; Co m

m is si on er v . Ida ho Po wer Co ., 41 8 U.S. at16 , andth ro ug h i ts br ead th , “pr ev en ts th e d is to rti on of i nc om e th atwou ldot he rwis e o ccur” fro m pr es en tl y de du ct in g an e xp en se th atdo es no t co rrel at e to th e p ro du ct io n o f cu rren t in co m e, Co m

m is si on er v . Ida ho Po wer Co ., 41 8 U.S. at14 ; s ee al so Uni te d S ta te s v. Hi ll , 50 6 U.S. 5 46 , 55 6 (1 99 3) . Alth ou gh sec ti on 26 3( a)(1 ) was in it ia ll y in cl ud edinth e In te rn al Rev enue Co de of 1 95 4, Ch . 73 6, 6 8A St at . at 7 7, s om e o f it s t ex t d at es ba ckto alm os t a c en tu ry be fo re tha t t o t he Rev enue Act o f 18 64 , Ch. 17 3, s ec. 1 17 , 13 Sta t. at28 1. Se e al so Hil l, 5 06 U.S. at 5 55 n.6 (no ti ng th atso m e- 22 -

[* 22 ] of t he tex t i n s ect io n 2 63 (a)( 1) ha s “ on e o f th e lo ng es t l in eag es of a ny pr ov is io n i n t he Int ern al Rev enue Co de ”).

3. Fo rm er Se ct io n 1 89 Co ng res s ev en tu al ly sup pl em en te d s ect io n 2 63 (a)( 1) with fo rm er s ect io n 18 9. Form er s ect io n 1 89 , whi chwas a dd edto th e Co de as p artof t he Tax R efo rm 8 Act o f 19 76 , Pub . L. No. 94 -4 55 , sec . 20 1( a), 9 0 S ta t. at15 25 , requi redtax pa y ers to cap it al iz e rea l p ro pe rty con stru ct io n p eri odin te res t an d t ax es .

4. Sect io n 2 63 A Afte r th e en act m en t o f fo rm er s ect io n 1 89 , andwith awork in g kno wled ge gl ean edfro m

th e p os te na ctm en t o pe rat io n o f th atform er s ect io n i n t an de m with
se ct io n 2 63 (a)( 1) , th e Dep art m en t o f th e Treas ury co nc lu de d t ha t the cap it al iz at io n ru le s l ack edun ifo rm ity . See Th e Treas ury Dep’t Re po rt t o t he Pres id en t, Tax Refo rm forFai rn es s, Si m

pl ic ity , andEcon om ic Growt h 1 25 -1 28 (19 84 ). The Dep artm en t o f th e Treas ury als o n ot edth e m is m at chbe twee n t he rep orti ng of in co m e an d the ex pe ns es rel at in g t o t ha t i nc om e, in th atso m e ta xp ay ers were de du ct in g e xp en se s b efo re the real iz at io n o f in co m e b ecau se th ey were n ot requi redto un ifo rm ly capi ta li ze al l i nd ire ctpro du ct io n c os ts . Id. at12 6- 12 8.
Fo rm er s ec. 1 89 was re pe al edby the Tax R efo rm Act o f 19 86 , Pub . L. No. 8 99 -5 14 , sec . 80 3( b) (1 ), 10 0 S ta t. at23 55
.- 23 -

[* 23 ] Sect io n 2 63 A was i nc lu de d i n t he Tax R efo rm Act o f 19 86 (TRA 86 ), Pub. L. No. 99 -5 14 , sec . 80 3, 1 00 Sta t. at23 50 , to ad dr es s, am on g o th er thi ng s, the
ex pr es se d c on cern s o f m is m at ch in g a ndlac k o f un ifo rm it y . See, e.g ., S. Rep t. No
. 99 -3 13 , at 1 40 (19 86 ), 19 86 -3 C.B. (Vo l. 3 ) 1, 1 40 . Sect io n 2 63 A gen eral ly requi res tax pa y ers who pro du ce re al pro pe rty to c ap it al iz e “ (A) th e d ire ctco st s o f
su chpro pe rty, and(B) s uc h p ro pe rty’ s p ro pe r sh are o f th os e in di rectco st s (in cl ud in g t ax es ) pa rt o r al l o f whi chare al lo cab le to su chpro pe rty.” Sec. 26 3A( a)
an d (b )(1 ). Forpu rp os es of t hi s p ro vi si on , “ cap it al iz e” m ean s, i n the cas e o f pr op erty th atis no t i nv en to ry

inth e h an ds of t he tax pa y er, tha t the co st s ar e ch arg edto a cap it al acco un t o r to th e b as is of t he pro pe rty. See sec . 1.2 63 A1( c)(3 ), In co m e Tax Reg s. Tax pa y ers canev en tu al ly recov er the cap it al iz edco st s th ro ug h “ de pr eci at io n, am orti zat io n, co stof g oo ds so ld , or b y anad jus tm en t t o ba si s atth e ti m e th e p ro pe rty is u se d, s ol d, p la cedinservi ce, o r othe rwis e d is po se d of by the tax pa y er.” TRA 8 6 s ec. 8 03 (b )(1 ), 10 0 S ta t. at23 55 ; s ec. 1 .26 3A1( c)(4 ), In co m e Tax Reg s. Co ng res s re pe al edform er s ect io n 1 89 co nt em po ran eo us ly w it h t he
en act m en t o f se ct io n 2 63 A.- 24 -

[* 24 ] C. Rel ev an t Re gu la to ry Pro vi si on s Co ng res s i ns tru ct edth e Sec ret ary to pre sc rib e reg ul at io ns to carry ou t the pu rp os es of s ect io n 2 63 A. Sec. 26 3A( i). Se ct io n 1 .26 3A- 0, In co m e Tax Reg s., se ts forth anou tl in e o f th e reg ul at io ns un de r se ct io n 2 63 A. Sect io ns 1.2 63 A-1 th ro ug h 1 .26 3A- 6, In co m e Tax Reg s., p ro vi de rul es as t o t he cap it al iz at io n u nd er se ct io n 2 63 A of c os ts ot he r th anin te res t. Sec ti on 1.2 63 A-7 , Inc om e Tax Reg s., se ts forth rul es forch an gi ng a m etho d o f acc ou nt in g t o c om pl y with s ect io n 2 63 A. The Secr et ary se t fo rth th es e ru le s as “ gu id an ce t o t ax pa y ers ch an gi ng th ei r m etho ds of a cco un ti ng forco st s s ub ject t o s ect io n 2 63 A.” See s ec. 1 .26 3A7( a)(1 ), In co m e Tax Reg s. Sec ti on s 1 .26 3A- 8 t hr ou gh 1.2 63 A-1 5, In co m e Tax Reg s., s etforth rul es th atge ne ral ly app ly to the cap it al iz at io n o f in te res t u nd er se ct io n 2 63 A. D. App li cab il it y

of S ect io n 2 63 A to th e Tax es an d In te res t i n Di sp ut e The tax es an d i nt eres t i n d is pu te ge ne ral ly relat e to th e la ndon whi chth e en ti ti es pl an te d a ndgre w th ei r al m on d t rees . Accor di ng ly, th e en ti ti es m us t cap it al iz e th e p ro pe rty tax es an d t he in te res t t o t he ex te ntst at edhe rei n.

1. Rel ev an t Pr oduc ti on Is Th atof t he Alm on d Tre es Pet it io ne rs arg ue th atsec ti on 26 3A d oe s n otap pl y inth es e cas es be cau se th e in te res t an d t he pro pe rty tax es rel at e to th e la nd , whi chth e en ti ti es di d n ot- 25 -

[* 25 ] pro du ce. We dis ag ree wi th th e p ro po si ti on th atth e ap pl ic ab il it y of s ect io n 26 3A turns on whet he r th e en ti ti es pro du cedth e la ndit se lf. The en ti ti es ’ gr owi ng of t he alm on d t rees is a pr oduc ti on of t ho se tre es withi n t he reac h o f se ct io n 2 63 A. The u ni fo rm cap it al iz at io n ru le s ap pl y to “ [r]eal * * * p ro pe rty pro du cedby the tax pa y er” fo r th e ta xp ay er’s u se ina tr ad e o r bu si ne ss or i n a n a ct iv ity co nduc te d fo r pr of

it . Sec. 2 63 A(b )(1 ), (c)( 1) . Whi le th e st atut e d oe s n otde fin e th e te rm “ real pro pe rty” forpu rp os es of s ect io n 2 63 A,
se ct io n 1 .26 3A- 8( c)(1 ) an d (2 ), In co m e Tax Reg s., d efi ne s the term to in cl ud e

“ la nd ” an d “ un se ve redna tu ral pro du ct s o f la nd ” an d s ta te s fu rth er tha t “ un se ve red
na tu ral pro du ct s o f la nd ” g en eral ly inc lu de “ [g ]rowin g c ro ps an d p la nt s” wher e th e pr ep ro du ct iv e p eri odof t he cro p o r pl an t ex ceed s two years. Th atde fin it io n, al th ou gh in cl ud edinth e reg ul at io ns ex pl ic it ly mad e ap pl ic ab le to th e cap it al iz at io n o f in te res t b utno t i nc lu de d i n t he reg ul at io ns expl ic it ly m ad e ap pl ic ab le to th e cap it al iz at io n o f ot he r co st s, i s co ns is te ntwith t he term ’s

“ or di na ry m ean in g.” See Nw. Fo res t Re s. Co un ci l v . Gli ckm an , 82 F.3d82 5, 8 33 (9 th Cir . 19 96 ) (o bs erv in g t ha t a s ta tu to ry term th atth e st atut e d oe s n otde fin e m ay be co ns tru edinacco rd an ce wi th it s “ or di na ry m ean in g” ). The o rd in ary m ean in g of th e te rm “ real pro pe rty” in cl ud es “pr op erty co ns is ti ng of l an d, b ui ld in gs , cro ps , orot he r res ou rces st il l at ta ch edto or wi th inth e la nd ”. Merr ia m -Webs te r’s Onl in e- 26 -

[* 26 ] Dict io nary , ht tp ://www.m erri am -web st er.co m /d ic ti on ary/pro pe rty (las t vi si te d No v. 1 5, 2 01 6) ; s ee al so Bla ck ’s Law Dict io na ry 14 12 (10 th ed . 20 14 ) (d efi ni ng th e te rm

“ real pro pe rty” to in cl ud e “ [l]an d a ndan yth in g g ro win g o n, at ta ch edto , or e rect edon it , exc lu di ng anyth in g t ha t m ay be sev eredwitho utin

jury to th e la nd ”). Inth atth e al m on d t rees gro w onth e la ndan d o th erwi se fitwithi n th e o rd in ary m ean in g o f th e te rm “ real pro pe rty”, we con cl ud e th atth e al m on d tre es are “ real pro pe rty” forall purp os es of s ect io n 2 63 A. 9 As t o t he reac h o f th e wor d “ pr oduc ed ”, whi le sec ti on 26 3A( g) (1 ) ge ne ral ly de fin es th e wor d “ pr oduc e” t o i nc lu de “ co ns tru ct , bu il d, i ns ta ll , m anuf actur e, de ve lo p, o r im

pr ov e”, the reg ul at io ns th ereu nd er i nt erp retth e wor d “ pr oduc e” al so to in cl ud e, in te r al ia , “ rai se ” o r “ gr ow” . Sec. 1 .26 3A- 2( a)(1 )(i ), In co m e Tax Reg s.; see als o i d. s ec. 1 .26 3A- 4( a)(1 ) (s ta ti ng th ata ta xp ay er en ga ge d i n ra is in g orgro win g a ny agri cu ltur al or h orti cu ltur al co m m od ity is en ga ge d i n t he Gro win g c ro ps an d p la nt s ar e rea l p ro pe rty on ly if th e p rep ro du ct iv e p eri od 9 of th e cro p o r pl an t ex ceed s two years. See sec . 1.2 63 A-8 (c)( 2) , Inc om e Tax Reg s.; see als o s ec. 2 63 A(e)(3 )(B) (m an da ti ng th atth e p rep ro du ct iv e p eri odfora pl an t g ro wn i n c omm erci al qu an ti ti es inth e Uni te d S ta te s re st s o n the na ti on wid e weig ht edav erag e p rep ro du ct iv e p eri odforth e p la nt ). The Se cret ary de te rm in ed on th e b as is of i nf

orm at io n p ro vi de d b y

th e U.S. Department o f Agr ic ul tu re tha t al m on d trees ha ve a na ti on wid e wei gh te d a ve rag e p rep ro du ct iv e p eri odex ceed in g two y ears . Not ic e 2 00 0- 45 , 20 00 -2 C.B. 2 56 . Andne it he r pa rty dis pu te s tha t al m on d trees ha ve a pr ep ro du ct iv e p eri odex ceed in g t wo years. Als o, p is ta ch io tre es are treat edth e sa m e as alm on d t rees ; the y have a pr ep ro du ct iv e p eri odth at ex ceed s two years. Id
.- 27 -

[* 27 ] pro du ct io n o f pr op erty ). Thi s re gu la to ry in te rp ret at io n o f th e wor d

“pr oduc e” t o i nc lu de th es e act iv it ie s i s co ns is te ntwith t he st atut e, whi ch pr es up po se s tha t s ect io n 2 63 A app li es to farm in g b us in es se s. See ge ne ral ly sec. 26 3A( d) . Andsec ti on 26 3A( e)(4 )(A) an d (B ) de fin es “ farm in g b us in es s” to in cl ud e a trad e o r bu si ne ss of “ th e rai si ng or h arv es ti ng of t rees be ari ng fru it , nu ts , orot he r cro ps ”. Acco rd in gl y , bec au se th e en ti ti es are p ro du ci ng real pro pe rty, tha t is , gro win g a lm on d t rees , th ey m us t capi ta li ze the ir d ire ctan d i nd ire ctco st s. Pet it io ne rs foc us on th e fac t tha t the tax es an d t he in te res t d ire ct ly relat e to th e o wne rs hi p a ndth e p ur ch as e o f th e land , res pe ct iv el y , to co nc lu de th atth es e ex pe ns es m ay

be cap it al iz edon ly if th e la ndis be in g p ro du ced . Peti ti on ers ’ fo cu s is bl urred . The en ti ti es gro w alm on d t rees as p artof the ir b us in es se s, an d t he al m on d trees gro w onth e land . The l an d i ts el f ne edno t b e p ro du cedinth atth e la ndan d t he alm on d trees are s uf fic ie nt ly int ertwin edinth e se ns e th atth e al m on d tre es can no t g ro w witho utth e und erl y in g l an d a ndth e en ti ti es ’ pl aci ng inservi ce of th e al m on d t rees requi res th atth e en ti ti es als o p la ce i n s erv ic e th e und erl y in g la nd . Thu s, wh il e th e p ro pe rty tax es an d t he in te res t m ay ha ve be enm or e cl os el y co nn ect edwith t he lan d t han wi th th e al m on d t rees , th e p aym en t o f th os e co st s, t o be su re, was bo th ne ces sa ry an d i nd is pe ns ab le to th e g ro win g o f th e al m on d t rees so as t o b e co ns id ereda co stof p ro du ci ng th os e tr ees . Our fi nd in g t ha t the lan d i s- 28 -

[* 28 ] a ne ces sa ry

an d i nd is pe ns ab le pa rt o f th e g ro win g o f th e al m on d t rees is fu rth er d em on st rat edby WRP I’s p ha se 1 l an d p rep arat io n c os ts . Thatph as e, in pa rt, i nc lu de d a na lyzin g t he so il , rip pi ng an d d eep rip pi ng th e so il , tre nc hi ng , and le ve li ng th e la nd
. W e al so are m in df

ul of s ect io n 1 .26 3A- 10 , Inc om e Tax Reg s. Th atsec ti on se ts forth rul es de fin in g t he “un itof p ro pe rty * * * us edas the ba si s t o d et erm in e accu m ul at edpro du ct io n e xp en di tu res un de r § 1 .26 3A- 11 an d t he be gi nn in g a nd
en d o f th e p ro du ct io n p eri odun de r § 1 .26 3A- 12 .” See s ec. 1 .26 3A- 10 (a)( 1) , In co m e Tax Reg s.; see als o i d. s ec. 1 .26 3A- 11 (a) (s ta ti ng th ataccu m ul at ed pr oduc ti on ex pe nd itur es are “ th e cu m ul at iv e am ou ntof d ire ctan d i nd ire ctco st s de sc rib edinsec ti on 26 3A( a) tha t ar e requi redto be cap it al iz edwith re sp ectto th e un itof p ro pe rty * * * , in cl ud in g i nt eres t capi ta li zedinpri orco m pu ta ti on pe rio ds , pl us th e ad

jus te d b as es of a ny ass et s * * * th atare u se d t o p ro du ce the un itof pr op erty du rin g t he pe rio d o f th ei r us e”). Ou r fi nd in g o f th e su ffi ci en t n ex us be twee n the lan d a ndth e al m on d t rees is co ns is te ntwith t ho se rul es . Sect io n 1.2 63 A-1 0( b) (1 ), In co m e Tax Reg s., p ro vi de s tha t “ [a] un itof r eal pro pe rty in cl ud es an y

co m po ne nt s o f rea l p ro pe rty owne d b y th e ta xp ay er * * * th atare fu nc ti on al ly int erd ep en de nt ” an d t ha t “ [t]he po rti on of l an d i nc lu de d i n aun itof real pro pe rty inc lu de s l an d o n wh ic h re al pro pe rty (in cl ud in g aco m m on featur e)- 29 -

[* 29 ] in cl ud edinth e uni t i s s itua te d * * * an d any oth er co nt ig uo us po rti on of t he tra ctof l an d o th er than l an d t ha t the tax pa y er h ol ds fora pu rp os e unr el at edto th e un itbe in g p ro du ced ”. See al so sec . 1.2 63 A-1 0( b) (2 ), In co m e Tax Reg s. (s ta ti ng th atco m po ne nt s o f rea l p ro pe rty “ are fu nc ti on al ly int erd ep en de ntif t he pl aci ng in
se rv ic e o f on e co m

po ne ntis de pe nd en t o n the pl aci ng inservi ce o f th e o th er co m po ne nt ” an d t ha t “ th e rea l p ro pe rty com po ne nt s o f a s in gl e-fa mil y ho us e (e.g ., th e la nd , fou nd at io n, an d wal ls ) are fun ct io na ll y in te rd ep en de nt )”. Pet it io ne rs als o are m in df ul of t he se pro vi si on s. Th ey att em ptto fitwithi n t he m

by con te nd in g th atth e landan d t he alm on d t rees m us t b e m utua ll y de pe nd en t t o fa ll withi n t he
reac h o f th attex t. The factth atth e la ndcanbe pl acedinservi ce wi th ou t the al m on d trees , pet it io ne rs arg ue , m ean s tha t the lan d a ndth e al m on d t rees are n ot
m utua ll y in te rd ep en de nt , andth us , th atth ey are n ota un itof p ro pe rty with in th e co nt ex t o f se ct io n 1 .26 3A- 10 , Inc om e Tax Reg s. 1 0 The reg ul at io ns do no t re qu ire m utua l i nt erd ep en de nc e. W it h re ga rdto bu il di ng s, the reg ul at io ns co nt em pl at e th ata bu il di ng an d i ts lan d a re co m po ne nt s of th e sa m e uni t o f pr op erty . See i d. p ara. (b )(1 ) an d (2 ); s ee al so id . subp ara. (6 ), Pet it io ne rs als o arg ue th atsec . 1.2 63 A-1 0, In co m e Tax Reg s., i s i nv al idto 1 0 th e ex te ntth atitrequi res cap it al iz at io n o f in te res t re la te d t o p ro pe rty tha t i s n ot be in g p ro du ced . W e d is ag ree. Bu t the reg ul at io ns are co ns is te ntwith t he le gi sl at or s’ in te ntth atexpe ns es be m at ch edwith t he rev enue th atth ey ge ne rat e an d t ha t the en ti ti es ’ la ndwas n eces sa ry to gro w th e al m on d t rees .- 30 -

[* 30 ] Exam

pl es (1) th ro ug h (7 ). Lik ewis e as to th e la ndan d t he alm on d t rees . For th e la ndan d t he alm on d t rees to be ch arac te riz edas aun itof p ro pe rty, the reg ul at io ns requi re tha t the alm on d t rees are g ro win g o n t he lan d a ndth atth e pl aci ng inservi ce o f ei th er the lan d o r th e al m on d trees is de pe nd en t o n t he ot he r pi ece o f pr op erty ’s als o b ei ng inservi ce. Su chis th e cas e h ere.

2. Dire ctan d In di rectCo st s Sect io n 2 63 A do es no t d efi ne “ di rectco st s” or “ in di rectco st s” . Purs ua ntto hi s re gu la to ry

au th or it y , th e Sec ret ary ha s p res cri be d ru le s i n s ect io n 1 .26 3A- 1( e), In co m e Tax Reg s., tha t cl ari fy th e m ean in gs of t ho se term s. As t o t he pro pe rty tax es indi sp ut e, we do no t re adth e reg ul at io ns on “ di rect
co st s” to in cl ud e th os e ta xe s. Fo r di rectco st s, s ect io n 1 .26 3A- 1( e)(2 )(i ), In co m e Tax Reg s., d is ti ng ui sh es be twee n p ro du cers an d re se ll ers an d p ro vi de s tha t

“ [p ]roduc ers m

us t capi ta li ze d ire ctm at eri al co st s an d d ire ctlab orco st s.” Se ct io n 1.2 63 A-1 (e)( 2) (i) , Inc om e Tax Reg s., fu rth er d es cri be s i n t he cas e o f pr oduc ers th e co st s tha t ar e in cl ud edwithi n t he bre ad th of t he term s “ di rectlab orco st s” an d

“ di rectm at eri al co st s” . “ Dire ctco st s” in cl ud es on ly “ di rectlab orco st s” an d

“ di rectm at eri al co st s” . Accor d i d. s ub pa ra. (3 )(i )(A), In co m e Tax Reg s. (s ta ti ng th atco st s o th er tha n d ire ctm at eri al co st s an d d ire ctlab orco st s ar e ch arac te riz ed
as “ in di rectco st s” ); s ee Hel ve rin g v . Mo rg an ’s, Inc ., 29 3 U.S. 1 21 , 12 5 n .1- 31 -

[* 31 ] (19 34 ); s ee al so W al tn er v . Comm is si on er, T.C. Mem o. 2 01 4- 35 , at * 50 -* 51 (n ot in g t ha t a c on gr es si on al ly pres cri be d s pe ci fic li stof t erm s i s p res um edto be
ex haus ti ve ), aff’d, _

__F. App ’x __

_, 2 01 6 WL 58 00 49 2 (9 th Cir . Oct. 5 , 20 16 ). Neit he r pa rty ass ert s tha t the pro pe rty tax es are ei th er a d ire ctlab orco stor adi rect
m at eri al co st . W e co nf

in e o ur se lv es to de te rm in in g wh ethe r th e p ro pe rty tax es are anin di rectco st . Sect io n 1 .26 3A- 1( e)(3 )(i )(A), In co m e Tax Reg s., d efi ne s the term “ in di rect
co st s” to m ean inth e cas e o f pr oduc ers “ al l co st s o th er than d ire ctm at eri al co st s an d d ire ctlab or

co st s” . Tho se reg ul at io ns furth er re qu ire th attax pa y ers cap it al iz e al l i nd ire ctco st s “pr op erl y all oc ab le to pro pe rty pro du ced ”, a s ta nd ardth atis m et

“ whe n the co st s d ire ct ly ben efi t o r are in curredby reaso n o f th e p erfo rm an ce o f pr oduc ti on ”. Id . A cos t m eet s thi s s ta nd ardwhen th e und erl y in g e xp en se is a bu tfo r cau se of t he tax pa y er’s p ro du ct io n a ct iv it ie s. See Cit y Lin e Can dy & Tob acco Co rp . v. Co m

m is si on er, 1 41 T.C. 41 4, 4 31 -4 33 (20 13 ) (requi rin g t ha t the tax pa y er cap it al iz e th e co stof c ig aret te tax st am ps as a n i nd ire ctco stof i nv en to ry be cau se

“ [i]f * * * [th e ta xp ay er] di d n otpu rch as e th e ci ga ret te tax st am ps an d a ffi x t he m to th e ci garette pa ck ag es , itco ul d n otoff er the cig aret te s fo r sa le ”), aff ’d, 62 4 F
. App ’x 78 4 (2 d C ir. 2 01 5) ; s ee al so Ro bi ns on Kni fe Mf g. Co . v. Co m

m is si on er, 60 0 F .3d12 1, 1 29 (2dCir . 20 10 ) (n otrequi rin g t he tax pa y er t o c ap it al iz e th e co st- 32 -

[* 32 ] of r oyalty

pa ym en ts on us in g atra de m arkas a n i nd ire ctco stbe cau se th e ta xp ay er co ul d h av e p ro du cedth e p ro pe rty so ldwitho uta tr ad em arkan d a vo id ed pa y in g t he royalty

co st ), rev ’g T.C. Mem o. 2 00 9- 9. Sect io n 1 .26 3A- 1( e)(3 )(i i), In co m e Tax Reg s., g oe s o n t o l is t ex am pl es to il lu st rat e th e types of i nd ire ctco st s tha t ar e requi redto be cap it al iz ed . One
ex am pl e is “ [t]ax es ”, whi chth e reg ul at io ns ex pl ai n “ in cl ud e th os e ta xe s * * * th at
are o th erwi se all owabl e as a de du ct io n t o t he ex te ntsu chtax es are at tri bu tabl e to labo r, m at eri al s, s up pl ie s, equi pm en t, l an d, o r fac il it ie s u se d i n p ro du ct io n” . Id.
subd iv . (ii )(L). Thi s p ro vi si on is co ns is te ntwith apri m ary pu rp os e o f se ct io n 26 3A t o m or e acc ur at el y

refl ectin co m e th ro ug h acal cu la ti onof i nc om e th attak es in to acco un t re la te d e xp en se s. See , e.g., Su zy ’s Zoo v. Co m m is si on er, 2 73 F.3d 87 5, 8 79 (9t h C ir. 2 00 1) , aff’g 1 14 T.C. 1 (2 00 0) . Alth ou gh W RP I d educ te d i ts pr op erty tax es , th os e ta xe s d ire ct ly ben efi t the gro win g o f th e al m on d t rees an d a re al lo cab le to th e p ro du cedpro pe rty (th e al m on d t rees ) th atwil l p ro du ce i nc om e in th e fu tu re. All owi ng a cu rren t d educ ti on of t he pro pe rty tax es wou lddi st ort WRP I’s actua l i nc om e fo r th e subjec t years an d wo ul d o th erwi se all ow WRP I to off se t it s unr el at edin co m e. Thi s i s p reci se ly the m is m at chof e xp en se s an d re ve nu es th at
se ct io n 2 63 A was en act edto pre ve nt .- 33 -

[* 33 ] Pet it io ne rs arg ue furth er tha t the pro pe rty tax es ne it he r di rect ly ben efi te d W RP I’s al m on d t rees no r were i nc urredas t o t ho se tre es inth atth e ta xe s re la te di rect ly to the W as co lan d, wh ic h WRP I d idno t p ro du ce. Pet it io ne rs ad d t ha t the pr op erty tax es wou ldbe du e reg ard le ss of wh ethe r th e en ti ti es were g ro win g al m on d trees . W e are unpe rs ua de d b y pe ti ti on ers ’ arg um en t. The W as co lan d was
us edto gro w th e al m on d t rees , andth e p ro pe rty tax es ass es se d a s t o t ha t l an d di rect ly ben efi t the alm on d trees inth atth e ta xe s wer e in cu rredinth e co ur se of W RP I’s u si ng th e la ndto gro w th e al m on d trees . WRP I i s o bl ig at edto pa y th e pr op erty tax es on it s p orti onof t he W as co lan d, g iv enth atW RP I i s the own er o f th atlan d fo r whi chth e ta x i s as se ss ed . In ad di ti on , WRP I co ul d h av e b een pr ecl ud edfro m

gro win g t he alm on d t rees on th e la ndif t he pro pe rty tax es were no t p ai d. We als o b ear i n m in d t ha t the Co urt h as pre vi ou sl y requi redreal est at e de ve lo pe rs to cap it al iz e p ro pe rty tax es as i nd ire ctco st s p ro pe rly all oc ab le to th ei r pr op ert ie s. See Von -Lus k v . Commis si on er, 1 04 T.C. 20 7, 2 09 , 21 7 (1 99 5) (requi rin g t ha t a p artne rs hi p c ap it al iz e p ro pe rty tax es wher e th e p artne rs hi p was or ga ni zedto m an ag e, ho ld , andde ve lo p p ro pe rty for i nv es tm en t); see als o R ei ch el v. Co m m is si on er, 1 12 T.C. 14 , 19 -2 0 (1 99 9) (requi rin g t ha t a r eal est at e d ev el op er cap it al iz e p ro pe rty tax es on pro pe rty tha t was no t d ev el op ed ).- 34 -

[* 34 ] W e co nc lu de th atWRP I m us t capi ta li ze the pro pe rty tax es th atitpa idas t o it s Wasco lan d t o the ex te ntth atth e ta xe s re la te to th e p orti on of t he lan d o n whi chW RP I g rew i ts alm on d t rees . To th e ex te ntth atth e p ro pe rty tax es di d n ot rel at e to th e p orti onof t he lan d o n wh ic h WRP I g rew i ts alm on d t rees , th os e ta xe s are n otall oc ab le to th e la nd(an d t hu s ar e n otall oc ab le to th e al m on d t rees ) fo r pu rp os es of s ect io n 2 63 A(b )(1 ). Sect io n 2 63 A, th eref or e, do es no t re qu ire th at W RP I capi ta li ze tha t l at te r po rti on of t he tax es .

3. In te res t Ex pe ns es Whi le sec ti on 26 3A( a) i s the ge ne ral rul e fo r cap it al iz in g c os ts , sec ti on 26 3A( f) i s a s pe ci al rul e th atap pl ie s s pe ci fic al ly to the cap it al iz at io n o f in te res t
un de r se ct io n 2 63 A. Sect io n 2 63 A(f)(1 ) pr ov id es inrel ev an t p artth atin te res t i s cap it al iz edwher e (1 ) th e in te res t i s p ai d dur in g t he pro du ct io n p eri odan d (2 ) th e in te res t i s al lo cab le to real pro pe rty tha t the tax pa y er p ro du cedan d t ha t h as a lo ng us efu l l ife , an e st im at edpro du ct io n p eri odex ceed in g t wo years, o r anest im at ed pr oduc ti on pe rio d e xc eed in g o ne y ear a nda co stex ceed in g $ 1 m il li on . The
co rres po nd in g re gu la ti on s p ro vi de th at“ [c]api ta li zat io n o f in te res t u nd er the
av oi de d c os t m etho d d es cri be d i n § 1.2 63 A-9 is requi redwith re sp ectto th e pr oduc ti on of d es ig na te d p ro pe rty des cri be d i n p arag rap h (b ) of th is sec ti on .” Sec. 1.2 63 A-8 (a)( 1) , Inc om e Tax Reg s.; see als o i d. s ec. 1 .26 3A- 9( a)(1 ) (requi rin g t ha t- 35 -

[* 35 ] th e av oi de d c os t m etho d g en eral ly be u se d t o c al cu la te th e am ou ntof in te res t capi ta li zedun de r se ct io n 2 63 A(f)). The re gu la ti on s fu rth er p ro vi de th at 1 1

“ de si gn at edpro pe rty” gen eral ly inc lu de s an y real pro pe rty tha t i s p ro du ced . See
se c. 1.2 63 A-8 (b )(1 )(i ), In co m e Tax Reg s.

a. Pro du ct iv e Per io d W e h av e h el d t ha t the alm on d t rees are re al pro pe rty tha t the en ti ti es pr oduc edan d tha t the pre pr oduc ti ve pe rio d o f th e al m on d t rees ex ceed s two years. Fo r th e rea so ns th atwe ha ve pre vi ou sl y di sc us se d, thi s h ol di ng ap pl ie s equa ll y to th e in te res t co st s an d t o the othe r co st s (h ere, the pro pe rty tax es ). Giv enou r ho ld in g, we co nc lu de th atth e al m on d t rees als o a re “ de si gn at edpro pe rty” with in th e co nt ex t o f se ct io n 1 .26 3A- 8( b) , Inc om e Tax Reg s.; i.e., the alm on d t rees are real pro pe rty tha t i s p ro du ced . W e fu rth er co nc lu de th atsec ti on 26 3A( a) an d (f)(1 ) requi res th atth e en ti ti es cap it al iz e th e in te res t tha t the y pa iddu rin g t he pr oduc ti on pe rio d o f th ei r al m on d t rees to th e ex te ntth atth e in te res t i s al lo cab le to th os e tr ees . W e fu rth er co nc lu de th atth e en ti ti es m us t u se th e av oi de d c os t
m etho d o f se ct io n 1 .26 3A- 9, In co m e Tax Reg s., t o d et erm in e th e in te res t tha t i s
Gen eral ly stat ed , th e av oi de d c os t m etho d re qu ire s tha t i nt eres t b e 1 1 cap it al iz edto th e ex te ntth atth e in te res t wo ul d t he or et ic al ly hav e b eenav oi de d i f accu m ul at edpro du ct io n e xp en di tu res ha d b eenus edto rep ay or r educ e th e ta xp ay er’s o ut st an di ng de bt . See s ec. 1 .26 3A- 9( a)(1 ), In co m e Tax Reg s.- 36 -

[* 36 ] all oc ab le to th e al m on d t rees an d t ha t ea chgro ve of a lm on d t rees an d i ts
co rres po nd in g l an d i s ch arac te riz edas asi ng le un itof p ro pe rty. i. Len gt h o f Pro du ct io n P eri od The “pr oduc ti on pe rio d” is th e p eri od“be gi nn in g o n t he da te on whi ch pr oduc ti on of t he pro pe rty beg in s” an d “ en di ng on th e d at e o n wh ic h t he pro pe rty is ready to be pl acedinservi ce o r is ready to be he ldfor

sal e.” Sec
. 26 3A( f)(4 )(B) . The p ro du ct io n p eri odforreal pro pe rty beg in s wh enany ph y si cal pr oduc ti on act iv it y

is pe rfo rm edwith re sp ectto a un itof r eal pro pe rty. See sec
. 1.2 63 A-1 2( c)(2 ), In co m e Tax Reg s. Ph y si cal pro du ct io n a ct iv it ie s as to real pr op erty in cl ud e “ [c]lea rin g, g rad in g, o r ex cav at in g o f raw l an d” . See i d. p ara. (e)( 2) (i)
. ii
. App li cat io n W RP I b eg anph y si cal pro du ct io n a ct iv it ie s fo r it s al m on d t rees in20 07 whe n i t s ta rte d t he fir stof i ts th ree p ha se s o f gr owi ng th e tr ees . Spe ci fic al ly, in th atph as e, W RP I b eg anrip pi ng an d d eep rip pi ng th e so il , tre nc hi ng , lev el in g t he la nd , andpl an ti ng alm on d t rees . See s ec. 1 .26 3A- 12 (c)( 2) , (e)(2 )(i ), In co m e Tax Reg s.; see als o i d. s ec. 1 .26 3A- 10 (b )(1 ) (s ta ti ng th atth e st artof the pro du ct io n pe rio d fo r a fu nc ti on al ly int erd ep en de ntco m po ne ntof aun itof r eal pro pe rty sta rts th e p ro du ct io n p eri odforth e en ti re u ni t o f pr op erty ). K&G be gan p hysic al- 37 -

[* 37 ] pro du ct io n a ct iv it ie s fo r it s al m on d t rees in20 05 when itpl an te d t ho se tre es . Ro se da le Ran chbe ga n p hysic al pro du ct io n a ct iv it ie s fo r it s al m on d t rees in20 06 whe n i t p la nt edth os e tr ees . Each en ti ty con ti nu edus in g i ts lan d t o g ro w alm on d t rees th ro ug ho utth e subjec t years, an d t he reco rdco nt ai ns no ev id en ce fr om whi chwe fin d t ha t the pr oduc ti on pe rio d fo r an y of t he en ti ti es en de d b efo re the clo se of t he subjec t y ears . See g en eral ly sec. 1 .26 3A- 12 (d ), In co m e Tax Reg s. (p ro vi di ng rul es to de te rm in e whe n apro du ct io n p eri oden ds ). W e co nc lu de th atW RP I, Ro se da le Ran ch , andK&G be ga n t he ir p ro du ct io n p eri od s i n 2 00 7, 2 00 6, an d 2 00 5,
res pe ct iv el y . b. All oc at io n R ul es Sect io n 2 63 A(f)(2 )(A) s et s fo rth th e g en eral rul es forall oc at in g i nt eres t t o pr op erty th atis subjec t t o t he in te res t capi ta li zat io n ru le s o f se ct io n 2 63 A. Firs t, a ta xp ay er m

us t capi ta li ze an d a ss ig n t o t he pro pe rty the “ in te res t o n a ny in de bt edne ss di rect ly attr ib ut ab le to pro du ct io n e xp en di tu res with re sp ectto su ch pr op erty ”. See s ec. 2 63 A(f)(2 )(A)(i ); s ee al so sec . 1.2 63 A-9 (a)( 2) (i) (A), (b ), In co m e Tax Reg s. (r equi rin g c ap it al iz at io n o f in te res t i nc urredon “ tra cedde bt ”, de fin edas t he ou ts ta nd in g e li gi bl e d eb t tha t i s al lo cat edto accu m ul at edpro du ct io n ex pe nd itur es with re sp ectto th e uni t o f pr op erty on th e m eas ur em en t d at e). The- 38 -

[* 38 ] en ti ti es , th eref

or e, m us t capi ta li ze the in te res t o n d eb t d ire ct ly attr ib ut ab le to pr oduc ti on ex pe nd itur es with re sp ectto th e al m on d t rees . Seco nd , a tax pa y er m

us t capi ta li ze an d a ss ig n t o t he pro pe rty the “ in te res t
on an y ot he r in de bt edne ss * * * t o t he ex te ntth atth e ta xp ay er’s i nt eres t co st s co ul d h av e b eenreduc edif p ro du ct io n e xp en di tu res (no t at tri bu tabl e to in de bt edne ss de sc rib edinclaus e (i )) h adno t b eenin curred .” See s ec. 26 3A( f)(2 )(A)(i i); see als o s ec. 1 .26 3A- 9( a)(2 )(i )(B) , (c), In co m e Tax Reg s. (requi rin g c ap it al iz at io n o f in te res t i nc urredon “ ex ces s ex pe nd itur e am ou nt ”, de fin edas a ccu m

ul at edpro du ct io n e xp en di tu res inex ces s o f tr acedde btwith
res pe ctto a un itof d es ig na te d p ro pe rty). The en ti ti es , th eref or e, al so m

us t cap it al iz e in te res t o n the am ou ntof t he ir u nr el at edde btequa l t o t he am ou ntof pr oduc ti on ex pe nd itur es th atwou ldha ve be enav ai labl e to pa y do wn the ir g en eral de bt
. i. Pro du ct io n Ex pe nd itur es Sect io n 2 63 A(f)(2 )(A) m an da te s tha t i nt eres t b e cap it al iz edif i t i s p ai d o n de btdi rect ly attr ib ut ab le to pro du ct io n e xp en di tu res with re sp ectto th e p ro du ced pr op erty . Thatsec ti on do es no t re qu ire th atth e d eb t b e d ire ct ly attr ib ut ab le to th e pr oduc edpro pe rty. T he term “pr oduc ti on ex pe nd itur es ” d en ot es “ th e co st s (wh ethe r orno t i nc urreddu rin g t he pro du ct io n p eri od ) requi redto be cap it al iz ed- 39 -

[* 39 ] un de r * * * [s ect io n 2 63 A(a)] with res pe ctto th e p ro pe rty.” Sec. 26 3A( f)(4 )(C) . Sect io n 2 63 A(a)(2 ) requi res th atth e ta xp ay er capi ta li ze the di rect
co st s o f th e p ro du cedpro pe rty andth e p ro pe rty’ s p ro pe r sh are o f th e in di rectco st s th atare al lo cab le to th e p ro pe rty. See als o s ec. 2 63 A(b )(1 ). The lan d d oe s n otha ve to be th e p ro pe rty tha t i s b ei ng pro du cedto bri ng in te res t o n afin an ci ng of t he lan d wi th in th e rea chof s ect io n 2 63 A. Rath er, pu rs ua ntto th e co m

m an d o f se ct io n 2 63 A(f)(2 )(A)(i ), th e in te res t tha t the en ti ti es pa idon th ei r fi na nc in g o f th ei r landm us t b e cap it al iz edas aco stof t he ir a lm on d tre es if the co stof the lan d i s a p ro du ct io n e xp en di ture wi th res pe ctto th e al m on d tre es . Our rel ia nc e o n t he us e o f th e te rm “pr oduc ti on ex pe nd itur es ” in sec ti on 26 3A( f)(2 )(A)(i ) to reac h thi s co nc lu si on do es no t m eanth atth e te rm “ di rect ly at tri bu tabl e” i s o f no co ns eque nc e. The l at te r te rm co m es in to pl ay

aft er the pr oduc ti on ex pe nd itur es ha ve be enid en ti fie d t o s etth e rel ev an t d eb t as th e d eb t th atis di rect ly attr ib ut ab le to th e p ro du ct io n e xp en di tu res . Sect io n 1 .26 3A- 1( a)(1 ), In co m e Tax Reg s., p ro vi de s tha t the ge ne ral rul es se t fo rth insec ti on s 1 .26 3A- 1 t hr ou gh 1.2 63 A-6 , Inc om e Tax Reg s., d o n otap pl y to th e cap it al iz at io n o f in te res t. Ho wev er, the reg ul at io ns th atap pl y to in te res t cap it al iz at io n re fer u s b ackto sec ti on 26 3A( a) t o d et erm in e th e d ire ctan d i nd ire ct
co st s tha t ar e requi redto be cap it al iz ed . Sec. 1 .26 3A- 11 (a), In co m e Tax Reg s.- 40 -

[* 40 ] Acco rd in gl y , we return t o t he cap it al iz at io n re gu la ti on s u nd er the ge ne ral
ru le s t o d et erm in e whe th er the co stof t he lan d i s a p ro du ct io n e xp en di tu re. The en ti ti es ’ la ndis no t a d ire ctco stof t he ir g ro win g o f th e al m on d t rees un de r th e g en eral rul es forcap it al iz at io n. Se e id . sec . 1.2 63 A-1 (e)( 2) (i) , (3) (ii )(L) (p ro vi di ng inth e cas e o f pr oduc ers su chas t he en ti ti es th atdi rectco st s ar e d ire ct
m at eri al co st s an d d ire ctlab orco st s an d, i n t he set ti ng of i nd ire ctco st s, di st in gu is hi ng be twee n “ m at eri al s” an d “ land ”, whi chlea ds us to co nc lu de th at

“ la nd ” is no t a “ m at eri al ” in th e co nt ex t o f se ct io n 1 .26 3A- 1( e), In co m e Tax Reg s.). Bu t the co stof l an d c anbe anin di rectco stof g ro win g the alm on d t rees if th e la nddi rect ly ben efi ts , or the co stis in curredby reaso n o f th e g ro win g, the tre es . See i d. s ub para. (3 )(i )(A). The lan d a ll ows th e en ti ti es to gro w th e al m on d tre es an d, as we have di sc us se d, i s n eces sa ry an d i nd eedin di sp en sabl e to th at pr oc es s. We con cl ud e th atth e la nddi rect ly ben efi ts th e en ti ti es ’ gr owi ng of t he ir al m on d trees an d t ha t the co stof t he lan d t he refo re i s an in di rectco stof t ha t pr oc es s t o t he ex te ntth atth e la ndis us edto gro w th e tr ees . W e h ol d t ha t ea ch
en ti ty’ s l an d c os t i s a p ro du ct io n e xp en di tu re wi th res pe ctto it s g ro win g o f it s al m on d trees an d, ac co rd in gl y , th atsec ti on 26 3A re qu ire s tha t the in te res t p ai d o n th e fi nanc in g o f th atpo rti onof t he lan d b e cap it al iz edas “ in te res t o n a ny in de bt edne ss di rect ly attr ib ut ab le to pro du ct io n e xp en di tu res with re sp ectto su ch- 41 -

[* 41 ] pro pe rty” (i.e., the alm on d t rees , th e p ro du ced/d es ig na te d p ro pe rty). See
se c. 26 3A( f)(2 )(A)(i ). The capi ta li zedin te res t i s treat edas aco stof ( an d a dd edto th e b as is of) th e al m on d t rees (th e d es ig na te d p ro pe rty) andno t o f th e la nd(th e as se t u se d t o p ro du ce the de si gn at edpro pe rty) to whi chth e in te res t m or e d ire ct ly rel at es . See s ec. 1 .26 3A- 8( a)(2 ), In co m e Tax Reg s.

ii
. Pro pe r Po rti on of Lan d
a. Ro se da le Ran chan d K& G Ro se da le Ran chgre w on ly alm on d trees onit s l an d, an d K& G gre w on ly al m on d trees an d p is ta ch io tre es on it s l an d. Al l o f th e in te res t tha t the y pa idas t o th ei r fi na nc in g o f th atlan d, the refo re, i s at tri bu tabl e to th ei r gr owi ng of the ir al m on d trees an d p is ta ch io tre es . W e su st ai n re sp on de nt ’s det erm in at io n t ha t Ro se da le Ran chan d K& G m us t capi ta li ze al l o f th e in te res t tha t the y pa idon th ei r fin an ci ng of t he pu rch as es of t he ir l an d. b. W RP I Each pa rty lik ewis e urg es us to tak e anall -o r-n ot hi ng ap pr oa chas t o W RP I’s p aym en t o f in te res t. Res po nd en t as ks us to fin d tha t WRP I m us t cap it al iz e th e in te res t p ai d o n t he en ti re p orti on of i ts W as co pro pe rty (in cl ud in g th e la ndth atwas u se d t o g ro w row cr op s) be cau se , he s ta te s, the en ti re l an d i s co ns id eredpa rt o f a u ni t o f pr op erty . Peti ti on ers arg ue th atth e la ndcan no t b e- 42 -

[* 42 ] vi ewedas asi ng le un itbe cau se pl an ti ng on e tr ee s ho ul d n otne ces sa ril y requi re the en ti re p orti on of i nt eres t o n t he lan d t o b e cap it al iz ed . Peti ti on ers co nc lu de th atW RP I i s n otrequi redto cap it al iz e an y of t he in te res t tha t i t p ai d. W e co nc lu de th atWRP I m us t capi ta li ze s om e, bu t n otall , of t he in te res t tha t i t pa id
. Sect io n 1 .26 3A- 10 (b )(1 ), In co m e Tax Reg s., s et s fo rth ge ne ral rul es for de te rm in in g e ach un itof r eal pro pe rty andpro vi de s tha t “ [t]he po rti on of l an d in cl ud edina un itof r eal pro pe rty inc lu de s l an d o n wh ic h re al pro pe rty (in cl ud in g a co m m on featur e) i nc lu de d i n t he un itis si tu at ed* * * an d a ny oth er co nt ig uo us po rti onof t he tra ctof l an d o th er tha n l an d tha t the tax pa y er h ol ds fora pu rp os e un rel at edto th e uni t b ei ng pro du ced ”. The re gu la ti on s d o n otex pl ai n wh ethe r th e te xt“ ho ld s fo r a p ur

po se un rel at edto th e uni t b ei ng pro du ced ” is ap pl ie d o n t he ba si s o f th e curren t u se of t he pro pe rty or o f th e in te nd edus e o f th e p ro pe rty. T hi s di st in ct io n i s i m

po rta nthe re, wh ere we f

in d t ha t i n 2 00 8 a nd20 09 W RP I u se d
so m e o f it s Wasco lan d fo r ro w cro ps bu t i nt en de d e ve ntua ll y to us e al l o f th at la ndto gro w alm on d trees . The hi st ory

of s ect io n 2 63 A andform er s ect io n 1 89 de m on st rat es th at ta xp ay ers m

us t capi ta li ze the co stof c on ti gu ou s p orti on s o f la ndon th e b as is of th ei r cu rren t u se . Allo win g atax pa y er t o d educ t i nt eres t o n l an d t o t he ex te ntth at- 43 -

[* 43 ] th e la ndis curren tl y pro du ci ng in co m e d oe s n otcrea te th e m at ch in g pr ob le m s tha t s ect io n 2 63 A andform er s ect io n 1 89 were i nt en de d t o p rev en t. Sp eci fic al ly, de du ct in g t he in te res t o n t he po rti onof l an d t ha t i s p ro du ci ng curren t in co m e d oe s n otall ow t axpa y ers to us e th atin te res t t o o ffs etin co m e fro m an un rel at edso ur ce. In st ead , itall ows tax pa y ers to accu rat el y refl ectth ei r curren t in co m e b y

de du ct in g t he ir e xp en se s at tri bu tabl e to th atin co m e. Giv enth atW RP I u se d apo rti on of i ts lan d fo r ro w cro ps du rin g 2 00 8 a nd 20 09 , th e co stof the po rti on of l an d g ro win g ro w cro ps is no t a c os t o f gr owi ng al m on d trees . Accor di ng ly, th e in te res t tha t WRP I pa idas t o i ts part o f fi na nc in g of th e p ur ch as e o f th atpo rti on of the W as co lan d i s n otrequi redto be cap it al iz ed
. The rem ai nd er o f th e in te res t p ai d fo r 20 08 an d 2 00 9, at tri bu tabl e to th e p ur ch as e of lan d o n wh ic h a lm on d trees were g ro win g, m us t b e cap it al iz edas “ in te res t o n an y in de bt edne ss di rect ly attr ib ut ab le to pro du ct io n e xp en di tu res with re sp ectto
su chpro pe rty”. See se c. 26 3A( f)(2 )(A)(i ).

c. In te res t Co st s Th atCo ul d Hav e Bee n R educ ed Sect io n 2 63 A(f)(2 )(A)(i i) r equi res tax pa y ers to cap it al iz e th ei r “ in te res t o n an y ot he r in de bt edne ss * * * t o t he ex te ntth atth e ta xp ay er’s i nt eres t co st s co ul d ha ve be enreduc edif p ro du ct io n e xp en di tu res * * * h adno t b eenin cu rred .” Pet it io ne rs arg ue th atth e en ti ti es ’ tre atm en t o f th e in te res t o n t he ir t ax returns is- 44 -

[* 44 ] acce pt ab le forFed eral in co m e ta x p ur po se s b ecau se th attre atm en t i s co ns is te ntwith t he rel ev an t s ta nd ard s o f fi nanc ia l ac co un ti ng . Butth e m ere f act th ata ta xp ay er’s m an ne r of acco un ti ng co m

pl ie s wi th th e st an da rd s o f fi nanc ia l
acco un ti ng do es no t n eces sa ril y m eanth atitis ap pr op ria te forFed eral in co m e ta x pu rp os es . See Th orPo wer Too l Co . v. Un it edSta te s, 4 39 U.S. 52 2, 5 41 -5 44 (1 97 9) ; Am . Aut o. As s’n v . Uni te d S ta te s, 3 67 U.S. 68 7, 6 90 -6 93 (19 61 ). Mo reo ve r, th e g ov ern in g re gu la ti on s ar e ex pl ic itth ata ta xp ay er’s co m pl ianc e wit h fin an ci al acco un ti ng st an dard s ca rri es no weig ht : “ The av oi de d c os t m etho d i s ap pl ie d u nd er thi s s ect io n wi th ou t re ga rdto an y fin an ci al or r eg ul at ory

acco un ti ng pr in ci pl es forth e cap it al iz at io n o f in te res t.” Se c. 1.2 63 A-9 (g )(4 ), In co m e Tax Reg s. W RP I’s d eb t ex ceed edit s p ro du ct io n e xp en di tu res for20 08 an d 2 00 9. Sect io n 2 63 A(f)(2 )(A)(i i) t he refo re d oe s n otrequi re fo r th os e y ears th atW RP I cap it al iz e an y

po rti on of t he in te res t at tri bu tabl e to th e p orti on of t he W as co lan d
us edfor th e g ro win g o f ro w cro ps . See s ec. 1 .26 3A- 9( c)(1 ), In co m e Tax Reg s. 1 2 Res po nd en t ar gu es th atsec . 26 3A( f)(2 )(A)(i i) r equi res th atW RP I 1 2 cap it al iz e ad di ti on al in te res t fo r 20 07 be cau se it s p rep ro du ct iv e ex pe nd itur es ex ceed edit s d eb t dur in g t ha t year. See s ec. 1 .26 3A- 11 (b ), In co m e Tax Reg s. (s ta ti ng th ata ta xp ay er’s co st s tha t ar e in cu rredan d c ap it al iz edwith re sp ectto a un itof p ro pe rty befo re the be gi nn in g o f th e p ro du ct io n p eri odare t ak enin to acco un t as accu m

ul at edpro du ct io n e xp en di tu res when th e p ro du ct io n p eri odof (co nt in ue d...)- 45 -

[* 45 ] E. Ant iabu se Ru le Sect io n 2 63 A(i) (1 ) ex pl ic it ly dire ct s the Secr et ary to is su e reg ul at io ns to pr ev en t the us e o f rel at edpa rti es to av oi d t he ap pl ic at io n o f se ct io n 2 63 A. The Secr et ary pr es cri be d an a nt iabu se rul e in sec ti on 1.2 63 A-1 5( c), In co m e Tax Reg s., pu rs ua ntto th is auth or it y . Thatsec ti on pro vi de s: The in te res t capi ta li zat io n ru le s co nt ai ne d i n § § 1 .26 3A- 8 t hr ou gh 1.2 63 A-1 5 m

us t b e ap pl ie d b y

th e ta xp ay er i n am an ne r th atis co ns is te ntwith a ndreas on ab ly carrie s o utth e p ur po se s o f se ct io n 26 3A( f). * * * Fo r pu rp os es of t hi s p arag rap h (c ), th e p res en ce o f ba ck -to -b acklo an s wi th di ffer en t ra te s o f in te res t, an d o th er u se s o f rel at edpa rti es to faci li ta te anav oi da nc e o f in te res t capi ta li zat io n, ev id en ces ab us e. Insu chcas es , th e Dis tri ctDire ct orm ay , bas edup on al l the fact s an d c irc um st an ces , det erm in e th e am ou ntof i nt eres t tha t m us t b e cap it al iz edina m an ne r th atis co ns is te ntwith andreas on ab ly carr ie s o utth e p ur

po se s o f se ct io n 2 63 A(f). Res po nd en t d et erm in edth atth e an ti ab us e ru le requi res th atRo se da le Ran ch
an d K& G cap it al iz e th e in te res t the y pa idto FCW on t he ir b orro win gs fro m FCW, whi chRo se da le Ran chan d K& G con te m po ran eo us ly len t t o WRP I to pu rch as e th e Wasco pro pe rty. A cco rd in g t o re sp on de nt , th e an ti ab us e ru le ap pl ie s b ecau se W RP I av oi de d c ap it al iz in g a dd it io na l i nt eres t co st s b y bo rro win g fr om

it s re la te d pa rti es who di d n otrequi re cu rren t i nt eres t p aym en ts . (...co nt in ue d) 1 2 th e p ro pe rty beg in s) . W e d is ag ree. Fo r 20 07 WRP I d idno t d educ t an y in te res t on lo an s fo r th e p ur ch as e o f th e Wasco lan d. Thus , no in te res t fo r th aty ear c ou ld be av oi de d.- 46 -

[* 46 ] Pet it io ne rs arg ue th atRo se da le Ran chan d K& G are n otrequi redto cap it al iz e ad di ti on al in te res t u nd er the an ti ab us e ru le be cau se th ey lac ke d t he requi si te in te ntto ab us e th e in te res t capi ta li zat io n ru le s. As pe ti ti on ers see it , Not ic e 8 8- 99 , 19 88 -2 C.B. 4 22 , 42 8, 4 31 , requi res a fi nd in g o f a “pu rp os efu l
av oi da nc e” o n t he pa rts of R os ed al e Ran chan d K& G forth e an ti ab us e ru le to ap pl y inth e m an ne r th atres po nd en t as se rts . Pet it io ne rs ’ rel ia nc e o n No ti ce 8 8- 99 , supr a, to supp ort the ir p os it io n i s m is pl aced . Thatno ti ce was is su ed“ to pro vi de gu id an ce t o t ax pa y ers co nc ern in g fo rth co m in g re gu la ti on s i nt erp ret in g t he in te res t capi ta li zat io n re qu ire m en ts
co nt ai ne d i n t he un ifo rm

cap it al iz at io n ru le s” . Id., 1 98 8- 2 C .B. at 4 22 . The n ot ic e st at es th atth e “ rel at edpa rty avo id edco strul es * * * al so ap pl y inany othe r cas e in whi chth e p ro du ci ng tax pa y er * * * an d a ny pers on(orpe rs on s) en ga ge inan y tra ns act io n * * * with apri nc ip al pu rp os e o f av oi di ng th e in te res t capi ta li zat io n requi rem en ts of s ect io n 2 63 A(f)” a ndli st s s ev eral co ns id erat io ns to de te rm in e whe th er the tra ns act io n h as a pr in ci pa l p ur po se of avo id in g c ap it al iz in g i nt eres t. Id ., 19 88 -2 C.B. at42 8; see als o i d. at43 1 (s im il ar wo rd in g)
. Bu t s ect io n 1 .26 3A- 15 (c), In co m e Tax Reg s., d idno t ad op t a r equi rem en t o f pu rp os efu l av oi da nc e o r ot he rwis e su gg es t tha t the Secr et ary was ret ai ni ng su chan av oi da nc e requi rem en t. The Secr et ary’ s o m is si on of a ny referen ce i n t he- 47 -

[* 47 ] ap pl ic ab le reg ul at io ns to a pu rp os efu l av oi da nc e requi rem en t m ean s tha t the Secr et ary op te d n otto in co rp or at e th atrequi rem en t i nt o t ho se reg ul at io ns . See Kru ko wsk i v . Commis si on er, 1 14 T.C. 36 6, 3 74 (20 00 ) (an d c as es cit edth erea t), aff’d, 2 79 F.3d54 7 (7 th Cir . 20 02 ). W e th eref or e wil l n otad dr es s the
co ns id erat io ns li st edinth e n ot ic e b utin st eadfoc us on whet he r th e lo an s b etween W RP I an d t he ot he r two en ti ti es requi re capi ta li zi ng th e in te res t tha t Ro se da le Ran chan d K& G pai d t o F CW to “ reas on ab ly carr[y ] ou t the pu rp os es of s ect io n 26 3A( f).” See sec . 1.2 63 A-1 5( c), In co m e Tax Reg s. The en ti ti es are re la te d p art ie s i n t ha t Kei th an d J en ni fer Gar di ne r own di rect ly or in di rect ly 50% o r m or e o f eac h e nt it y . See i d. s ec. 1 .26 3A- 8( a)(4 )(i ) (“ Exc ep t as ot he rwis e p ro vi de d, fo r pu rp os es of § § 1 .26 3A- 8 t hr ou gh 1.2 63 A-1 5, a p ers on is rel at edto a ta xp ay er i f th ei r rel at io ns hi p i s d es cri be d i n s ect io n 2 67 (b )
or70 7( b) .”); see als o s ecs . 26 7( b) , 70 7( b) . In ad di ti on , if WRP I ha d fi na nc edit s pu rch as e o f th e Wasco pro pe rty ent ire ly w it h l oa ns fro m un rel at edpa rti es , WRP I
wou ldm os t l ik el y

ha ve be enrequi redto m ak e in te res t p aym en ts an d wo ul d h av e ha d t o c ap it al iz e th e p orti on s o f th os e p aym en ts th atwere al lo cab le to th e p orti on of th atlan d o n wh ic h i t was gro win g a lm on d t rees . WRP I, h owe ve r, ob ta in ed lo an s fr om

Ro se da le Ran chan d fr om K&G, andRo se da le Ran chan d K& G de ferr edall in te res t p aym en ts un ti l the W as co pro pe rty was g en erat in g i nc om e- 48 -

[* 48 ] fro m

th e al m on d t rees . Alth ou gh W RP I wo ul d h av e b eenrequi redto cap it al iz e m os t o f th e in te res t p aym en ts , Ros ed al e Ran chan d K& G deduc te d t he ir in te res t co st s i n fu ll . This is pre ci se ly the si tu at io n t ha t the an ti ab us e ru le
co nt em pl at es . Accor di ng ly, Ro se da le Ran chan d K& G m us t capi ta li ze the in te res t th ey pa idto FCW on t he fun ds th ey bo rro wedfro m

FCW andlen t t o WRP I to pu rch as e th e Wasco pro pe rty to t he ex te ntth atth e in te res t i s al lo cab le to th e po rti onof t he W as co lan d o n wh ic h WRP I was gro win g i ts alm on d t rees . II. Sect io n 4 81 Adju st m en t Sect io n 4 81 (a) re qu ire s tha t t ax pa y ers who ch an ge a m etho d o f acc ou nt in g ad jus t the ir i nc om e to pre ve nttax it em s fr om be in g dup li cat edor o mit te d. A ch an ge inth e m etho d o f acc ou nt in g i nc lu de s a c ha ng e in th e o ve ral l p la n o f
acco un ti ng forgro ss in co m e o r de du ct io ns or ach an ge inth e tr eat m en t o f an y m at eri al it em

us edinth atov eral l p la n. Se e se c. 1.4 81 -1 (a)( 1) , Inc om e Tax Reg s.; se e al so id . sec . 1.4 46 -1 (e)( 2) (ii )(a) . An it em is m at eri al if i t i nv ol ve s the ap pr op ria te ti m e fo r in cl us io n o f th e it em inin co m e o r th e taki ng of ade du ct io n. See P rimo Pan ts Co . v. Co m mis si on er, 7 8 T.C. 7 05 , 72 0- 72 2 (1 98 2) ; s ec. 1 .44 6- 1( e)(2 )(i i)( a), In co m e Tax Reg s. The pri m ary di st in ct io n b etweencla ss ifyin g apa ym en t as a de du ct ib le
ex pe ns e o r as a cap it al ex pe nd itur e co nc ern s the ti m in g o f th e ta xp ay er’s co st- 49 -

[* 49 ] reco ve ry . INDOPCO, Inc . v. Co m m is si on er, 5 03 U.S. at 8 3- 84 . Thu s, o ur de ci si on requi rin g t he en ti ti es to cap it al iz e rat he r th ande du ctth ei r in te res t pa ym en ts , andinth e cas e o f W RP I i ts pa ym en t o f th e p ro pe rty tax es , in vo lv es m at eri al it em s. See Pel aez & So ns , Inc . v. Co m m is si on er, 1 14 T.C. 47 3, 4 89 (2 00 0) , aff’d wit ho utpubl is he d o pi ni on , 25 3 F .3d71 1 (1 1t h C ir. 2 00 1) . At tri al pe ti ti on ers ’ co un se l ag reedwith t hi s p ro po si ti on , ackno wled gi ng th atad jus tm en ts
un de r se ct io n 4 81 are re qu ire d i n t he se cas es if t he Co urt s us ta in s re sp on de nt ’s ad jus tm en ts as t o t he pro pe rty tax es an d t he in te res t. Pet it io ne rs , ho wev er, t oo k a
m or e nua nc edpo si ti onon bri ef. Pet it io ne rs no w arg ue th atth e dut y of c on si st en cy pr ecl ud es res po nd en t fr om ap pl y in g s ect io n 4 81 , no twi th st an di ng whet he r th e se ct io n wo ul d o th erwi se ap pl y . W e d is ag ree. The du ty of co ns is te nc y

is well est ab li sh edinth e Nin thCir cu it , th e ci rcu it in whi chth es e cas es are ap pe al ab le (ab se ntth e p art ie s’ st ip ul at io n t o t he co nt rary). Ja ni s v . Commis si on er, 4 61 F.3d10 80 , 10 84 -1 08 5 (9 th Cir . 20 06 ), aff’g T.C. Mem o. 2 00 4- 11 7. Itpre ve nt s a t ax pay er fro m tak in g apo si ti onforon e y ear a nd th ench an gi ng th atpo si ti on fora la te r y ear wh enanad jus tm en t i s b arre d b y

th e st atut e o f li m it at io ns . See i d. at10 85 -1 08 7; Est at e o f Ash m anv. Co m m is si on er, 23 1 F .3d54 1, 5 44 (9t h C ir. 2 00 0) , aff’g T.C. Mem o. 1 99 8- 14 5. Pe ti ti on ers ass ert th atth e Co urt’s s us ta in in g re sp on de nt ’s adju st m en ts un de r se ct io n 4 81 wou ldgi ve- 50 -

[* 50 ] th e en ti ti es a do ub le be ne fit ; i .e., am orti zat io n o f th e cap it al iz edin te res t an d th e cap it al iz edpro pe rty tax es an d t he de du ct io n o f th e sa m e in te res t an d t ax es for pr io r y ears th atare n ow b arre d b y th e st atut e o f li m it at io ns . Peti ti on ers co nc lu de th atbe cau se th e en ti ti es are p recl ud edfro m tak in g t he do ub le be ne fiton acco un t of th e dut y of c on si st en cy , th e p la in lan gu ag e o f se ct io n 4 81 (a) i s i napp li cab le to th em be cau se itsee ks to pre ve nta do ub le be ne fit
. As we u nd ers ta ndpe ti ti on ers ’ arg um en t, the y co nt en d t ha t the du ty of
co ns is te nc y

tru m ps th e ap pl ic ab il it y

of t he st atut e. They are m is ta ke n. Co ng res s ha s m an da te d t hr ou gh it s en act m en t o f se ct io n 4 81 th atanad jus tm en t u nd er se ct io n 4 81 ge ne ral ly m

us t b e m ad e to rem ov e th e th reatof ado ub le be ne fitor om is si on when ev er the re i s a c ha ng e in a m etho d o f acc ou nt in g. Se e Su zy ’s Zoo v. Co m m is si on er, 1 14 T.C. at 1 2- 13 . W e d ecl in e to letth e jud ic ia ll y est ab li sh ed do ctrin e o f a dut y

of c on si st en cy

de featth atleg is la ti ve act . Giv enth atan ad jus tm en t t o c om

pl y with s ect io n 2 63 A is a ch an ge of am etho d o f acc ou nt in g, se e se c. 1.2 63 A-7 , Inc om e Tax Reg s.; see als o S uz y ’s Zoo v. Co m m is si on er, 2 73 F.3 d a t 8 83 -8 84 ; Pe la ez & S on s, In c. v. Co m m is si on er, 1 14 T.C. at 4 86 -4 89 , a se ct io n 4 81 ad

jus tm en t i s re qu ire d b y

th e st atut e to eli m in at e an y dupl ic at io ns or om is si on s caus edby the m etho d c ha ng e, se e al so Pri m o P an ts Co . v.- 51 -

[* 51 ] Co m

m is si on er, 7 8 T.C. at72 0- 72 1 (h ol di ng th ata ch an ge inm etho d o f
acco un ti ng requi res anap pl ic at io n o f se ct io n 4 81 ). Res po nd en t’s s ect io n 4 81 ad jus tm en t i s co rrec t as to Ro se da le Ran chan d K&G, gi ve n t ha t tho se en ti ti es m us t capi ta li ze the ir i nt eres t co st s o nt o t he alm on d tre es . Res po nd en t’s s ect io n 4 81 ad jus tm en t i s l ik ewis e co rrec t as to WRP I t o t he
ex te ntth atitrefl ect s o urho ld in g t ha t WRP I is requi redto cap it al iz e th e p ro pe r sh are o f pr op erty

tax es an d i nt eres t. To re fle ctth e fo reg oi ng , Deci si on s wi ll be en te red
un de r Ru le 15 5.