Rev. Rul. 80-25

ISSUE

Under section 278 of the Internal Revenue Code, may a taxpayer who is developing a citrus grove take a depreciation deduction for the cost of citrus trees and an irrigation system before the close of the fourth taxable year beginning with the taxable year in which the trees were planted?

FACTS

In 1974, a taxpayer who was developing a citrus grove planted citrus trees and installed and placed in service an irrigation system with a useful life of 20 years. In 1977, the citrus trees first produced fruit. The taxpayer took deductions for depreciation of the cost of the irrigation system beginning in 1974 when the system was placed in service. The taxpayer also took deductions for depreciation of the cost of the citrus trees beginning in 1977, the year the trees first began to bear fruit.

LAW AND ANALYSIS

Section 263(a) of the Code provides in pertinent part that no deduction is allowed for any amount paid out for new buildings or for permanent improvements made to increase the value of any property or estate. Instead, these nondeductible capital expenditures must be charged to capital account.

Section 167(a) of the Code allows as a depreciation deduction a reasonable allowance for the exhaustion, wear and tear (including a reasonable allowance for obsolescence) of property used in a trade or business, or held for the production of income.

Section 278(a) of the Code, however, provides that any amount otherwise allowable as a deduction that is attributable to the planting, cultivation, maintenance, or development of any citrus or almond grove and is incurred before the close of the fourth taxable year beginning with the taxable year in which the trees were planted, shall be charged to capital account.

Section 1.278-1(a)(2)(iii) of the Income Tax Regulations states that the provisions of section 278(a) of the Code apply only to expenditures allowable as deductions without regard to section 278(a) and have no application to expenditures otherwise chargeable to capital account, such as the cost of the land and preparatory expenditures incurred in connection with a citrus or almond grove.

Section 278(a) of the Code requires a taxpayer to capitalize for four years the daily out-of-pocket expenses that would otherwise be deductible under section 162 of the Code as ordinary and necessary expenses paid or incurred during the taxable year in carrying on a trade or business. Section 278(a) does not apply, however, to expenditures otherwise chargeable to capital account. Accordingly, section 278(a) does not prevent a taxpayer from taking depreciation deductions that may be allowable under section 167 with respect to capital assets held, and nondeductible capital expenditures made, in connection with a citrus grove.

The cost of the citrus trees that must be capitalized includes the cost of land preparation and planting expenses. This cost is recovered through depreciation when the trees first reach an income producing stage. See Rev. Rul. 69-249, 1969-1 C.B. 31.

HOLDING

The taxpayer may take a depreciation deduction for the cost of the citrus trees beginning in the year the trees first reach an income producing stage and may take a depreciation deduction for the cost of the irrigation system beginning in the year the system is placed in service.