Rev. Rul. 65-104

Advice has been requested whether citrus trees purchased by a citrus grower, under the circumstances described below, will qualify for the investment credit allowed by section 38 of the Internal Revenue Code of 1954.

In 1964, the taxpayer, a citrus grower, purchased two groves of citrus trees. At the time of the purchase the trees in one citrus grove were income-producing trees which had a remaining income-producing life of 10 years and the trees in the other grove were saplings which could not be expected to reach the income-producing stage until 1967, at which time they would have an expected income-producing life in excess of 20 years.

Section 38 of the Code, in effect, allows a credit against Federal income tax for qualified investment in `section 38 property' for the taxable year such property is placed in service. The amount of this credit is computed in accordance with sections 46 through 48 of the Code.

Section 48((a)(1) of the Code provides, in part, that the term `section 38 property' means property which is tangible personal property or other tangible property, but only if such other property is used as an integral part of manufacturing, production, or extraction. That section further provides that such property must be depreciable property and must have a useful life of four years or more.

Section 1.48-1(d) of the Income Tax Regulations provides, in part, that the terms `manufacturing,' `production' and `extraction' include the cultivation of orchards.

Section 46(c)(1) of the Code provides, in effect, that, for purposes of computing the amount of credit allowed under section 38 of the Code, the term `qualified investment' means, with respect to any taxable year, the aggregate of the applicable percentage of the basis of each new section 38 property placed in service by the taxpayer during such taxable year, plus the applicable percentage of the cost of each used section 38 property placed in service by the taxpayer during such taxable year.

Section 48(b) of the Code provides that the term `new section 38 property' means section 38 property acquired after December 31, 1961, if the original use of that property commences with the taxpayer and commences after such date.

Section 48(c)(1) of the Code provides, in part, that the term `used section 38 property' means section 38 property acquired by purchase after December 31, 1961, which is not `new section 38 property.'

Section 1.48-1(a) of the regulations provides, in effect, that the determination of whether property qualifies as `section 38 property' in the hands of the taxpayer must be made with respect to the first taxable year in which such property is placed in service by the taxpayer.

Section 1.46-3(d)(1)(i) of the regulations provides, in effect, that for purposes of the credit allowed by section 38 of the Code, property will be considered as placed in service in the taxable year in which (under the taxpayer's depreciation practice) depreciation with respect to such property begins, or in the taxable year in which the property is placed in a condition or state of readiness and availability for a specifically assigned function, whichever is earlier.

Section 1.46-3(d)(2)(iii) of the regulations provides, in part, that fruit bearing trees and vines shall not be considered in a condition or state of readiness and availability for a specifically assigned function until they have reached an income-producing stage.

Solicitor's Law Opinion 797, C.B. 1, 130 (1919), holds, in pertinent part, that all expenditures necessary to bring orchard trees to a producing state should be capitalized and that, thereafter, a fair and reasonable annual allowance for depreciation should be permitted.

The citrus trees which had reached a productive stage prior to the year of purchase will qualify as `used section 38 property' in that year. The trees which had not reached a productive stage at the time of purchase will not qualify as `section 38 property' until 1967, the year in which they reach an income-producing stage. Since that year will be the year of original use by the taxpayer, the citrus trees will qualify as `new section 38 property' at that time.

Accordingly, it is held in the instant case that the citrus trees which had reached a productive stage at the time of purchase will qualify as `used section 38 property' in the year of purchase for purposes of the investment credit allowed by section 38 of the Code. The basis of the trees for purposes of the investment credit is their cost.

It is further held that the citrus trees which had not reached the income-producing stage at the time of purchase will qualify as `new section 38 property' for purposes of the investment credit in the year in which they reach the income-producing stage. At that time the basis of these citrus trees, for purposes of the investment credit, will include the original cost of the trees, plus all capital expenditures made by the taxpayer to develop them to an income-producing stage.