Rev. Rul. 69-249

Advice has been requested as to the extent the capitalized cost basis of citrus trees is qualified investment in "section 38 property" for investment credit purposes under the circumstances described below.

The taxpayer, the owner and developer of an orchard, purchased young citrus trees during the latter part of 1961. A part of these trees were planted in 1961, and their cost was capitalized in that year. The remainder of the trees acquired in 1961 were planted in early 1962, and their cost was capitalized in that year.

During the development period, the costs of cultivating, spraying, and pruning, and other costs necessary to bring the citrus trees to a producing stage were capitalized by the taxpayer as part of the depreciable basis of the trees. Some of these development costs were incurred prior to 1962. The citrus trees reached the income-producing stage in 1966 and had a useful life of four years or more.

Section 38 of the Internal Revenue Code of 1954 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 the provisions of sections 46 and 48 of the Code.

An orchard of citrus trees is other tangible property that qualifies as section 38 property if it is depreciable property having a useful life (determined as of the time it is placed in service) of 4 years or more. See section 1.48-1(d)(2) of the Income Tax Regulations. Also see Revenue Ruling 65-104, C.B. 1965-1, 28, which distinguishes between "new" and "used" section 38 property as those terms relate to a grove of citrus trees.

Section 48(b) of the Code defines the term "new section 38 property" to mean section 38 property--(1) the construction, reconstruction, or erection of which is completed by the taxpayer after December 31, 1961, or (2) acquired after December 31, 1961, if the original use of such property commences with the taxpayer and commences after such date. This section further provides, however, that in the case of construction, reconstruction, or erection of property commenced before January 1, 1962, and completed after December 31, 1961, there shall be taken into account as the basis of new section 38 property only that portion of the basis properly attributable to construction, reconstruction, or erection after December 31, 1961.

Section 1.48-2(b) of the regulations sets forth special rules for determining date of acquisition, original use, and the basis attributable to construction, reconstruction, or erection of depreciable property. This provision states, among other things, that the portion of the basis of property attributable to construction, reconstruction, or erection after December 31, 1961, consists of all costs of construction, reconstruction, or erection allocable to the period after December 31, 1961, including the cost or other basis of materials entering into such work. However, it is not necessary that materials entering into construction, reconstruction, or erection be acquired after December 31, 1961, or that such materials be new in use in order for the property to be "new section 38 property."

In this case, the underlying purpose and principles of "construction" as used in section 48(b) of the Code and section 1.48-2 of the regulations are equally applicable to the planting and development of the orchard of citrus trees. Thus, the young trees are "materials" used and the actual planting of the young trees is one of the first steps in the planting and development (construction) of the orchard within the meaning of those regulations.

Accordingly, it is held that the cost of the young trees planted by the taxpayer prior to January 1, 1962, and the costs of planting and development thereof prior to that date, are not qualified investments in "section 38 property."

However, the cost of the young trees purchased prior to January 1, 1962, but planted after December 31, 1961, and the cost of planting and development thereof after December 31, 1961, are considered as qualified investments in "new section 38 property." Furthermore, with respect to the trees planted by the taxpayer before January 1, 1962, any expenditure made and properly capitalized during that part of the development period occurring after December 31, 1961, is a qualified investment in "new section 38 property."

The taxable year in which such "new section 38 property" is considered to be placed in service for purposes of determining the amount of the investment credit allowable to the taxpayer is the taxable year the citrus trees first reach the income-producing stage, which, in the instant case, is 1966. See section 1.46-3(d) of the regulations.