Rev. Rul. 65-265

Advice has been requested whether certain costs incurred by a taxpayer in connection with the construction of an industrial complex are subject to an allowance for depreciation under the circumstances described below.

A taxpayer constructed a processing and storage complex, consisting of groups of buildings situated to achieve economical handling and transportation between the processing and storage buildings. Safety requirements necessitated a separation of storage buildings at distances of 70 to 80 feet, and in groups of not more than 16 buildings in a group, with a separation of 500 feet between groups. A system of roads provides access to all buildings. The roads are traversed by fork-lift trucks which transport material from the processing plant to the storage buildings. A level system of road and buildings is required to properly utilize the transport vehicles. Substantial costs were incurred in grading the land, excavation, and removal costs for leveling of the land for general purposes. Some of such costs were directly associated with construction of buildings and roadways.

The issue in this case is whether the involved costs are depreciable or are nondepreciable as part of the cost of the land.

Section 167(a) of the Internal Revenue Code of 1954 sets forth the general rule that there shall be allowed as a depreciation deduction a reasonable allowance for the exhaustion, wear and tear, and obsolescence of property used either in the trade or business or held for the production of income.

Section 1.167(a)-2 of the Income Tax Regulations provides, in pertinent part, that the depreciation allowance does not apply to land apart from the improvements or physical development added to it. When an expenditure relates to an improvement or physical development added to the land, it may be subject to a depreciation allowance if the property meets all the requirements necessary for application of the depreciation deduction.

The grading of land involves moving soil for the purpose of changing the ground surface. It produces a more level surface and generally provides an improvement which adds value to the land. Such expenditures are `inextricably associated with the land' and, therefore, fall within the rule that land is a nondepreciable asset. See Algernon Blair, Inc. , v. Commissioner , 29 T.C. 1205 (1958), C.B. 1958-2, 4.

However, excavating, grading and removal costs directly associated with the construction of buildings and the paved roadways, are not `inextricably associated with the land' itself. These costs, since they have a direct association with such construction, are part of the costs of construction of the buildings and the paved roadways.

Accordingly, under the circumstances of this case, the costs attributable to general grading of the land are capital expenditures and become a part of the cost base of the land which is not subject to depreciation allowances. The costs attributable to excavation, grading and removing soil necessary for the proper setting of the buildings and paving of the roadways are part of the cost of those assets and should be included in the depreciable base for the buildings and roadways.