Rev. Rul. 83-28

ISSUE

Are the costs of raising pistachio seedlings from seed through the first budding of the trees in the field deductible business expenses under section 162(a) of the Internal Revenue Code?

FACTS

The taxpayer, who is not a farming syndicate described in section 464(c) of the Code or a taxpayer required to use the accounting method specified in section 447, is engaged in the business of producing and selling pistachio nuts. The taxpayer develops the nut trees by planting purchased seeds in small pots and later transplanting each resulting seedling into a larger pot. After the trees have grown in the larger pots for up to one year and have attained sufficient girth, the trees are transplanted again, this time to their permanent orchard location.

Soon after the seedlings have been transplanted to the orchard, each seedling is individually budded by grafting onto the seedling a small portion of a producing tree. After it is budded, the tree will grow partly from the bud and partly from the original seedling. This budding procedure is necessary for the tree to produce commercial variety pistachios because an unbudded tree will not produce a marketable product.

LAW AND ANALYSIS

Section 162(a) of the Code allows a deduction for all the ordinary and necessary expenses paid or incurred during the taxable year in carrying on any trade or business.

Section 1.162-12(a) of the Income Tax Regulations provides that amounts expended in the development of farms, orchards and ranches prior to the time when the productive state is reached may, at the election of the taxpayer, be regarded as investments of capital.

Section 263 of the Code and related regulations disallow deductions for capital expenditures made to increase the value of any property whose useful life exceeds one year.

Rev. Rul. 75-405, 1975-2 C.B. 63, holds that all costs incurred by a taxpayer in raising pistachio seedlings from seed through the first budding of the trees in the orchard are nondeductible capital expenditures because they are preparatory costs necessary to begin growing pistachios. The ruling states that the Internal Revenue Service will not follow Maple v. Commissioner, T.C.M. 1968-194, aff'd 440 F. 2d. 1055 (9th Cir. 1971), and Wagner Mills, Inc. v. Commissioner, T.C.M. 1974-274, aff'd without opinion, 530 F. 2d 827 (8th Cir. 1976). Both decisions held that the costs of caring for seedlings before permanent planting were deductible under section 162 of the Code.

In Maple, the court distinguished "preparatory expenses," which are nondeductible capital expenditures, and "developmental expenditures," which are deductible business expenses if the grower does not elect to capitalize them under section 1.162-12 of the regulations. Preparatory expenditures are expenditures incurred prior to raising agricultural commodities or that otherwise enable a grower to begin the growing process. The costs of purchasing and initial planting of seeds or seedlings are preparatory expenditures. The cost of budding the trees, although it occurs after the initial planting, is also a preparatory cost. After it is budded, part of the tree will grow from the bud and part of it from the original seedling; therefore, budding is in effect the planting of part of the tree. Developmental expenditures, on the other hand, are incurred by a grower so that the growing process may continue in a desired manner. Expenses for fertilizer, cultivation, pruning and spraying for growing plants, and transplanting growing plants are examples of deductible developmental expenditures. The analysis used in Maple was again used by the Tax Court in Wagner Mills and in Vinson v. Commissioner, T.C.M. 1979-75, aff'd per curiam, 621 F. 2d 173 (5th Cir., 1980).

The Service has reconsidered its position stated in Rev. Rul. 75-405 and will now follow Maple, Wagner Mills and Vinson to the effect that a preparatory cost incurred by a grower is a nondeductible capital expenditure, while a developmental cost incurred by a grower is a deductible business expense.

HOLDING

A grower of pistachio nuts may currently deduct the costs of maintaining and transplanting pistachio seedlings both before and after the first budding of the trees in the field. The grower is required to capitalize, rather than deduct, the costs of initial planting and budding of the trees.

The principles of this ruling also apply to growers of other types of nuts (except for growers of almonds, who are subject to the capitalization requirements of section 278(a) of the Code).

This ruling does not apply to farming syndicates (as defined in section 464(c) of the Code), because section 278(b) generally requires farming syndicates to capitalize expenses incurred before the first taxable year in which the grove produces a yield in commercial quantities. This ruling also does not apply to any corporation or partnership that is required by section 447 to use the accrual method of accounting and to capitalize preproductive period expenses.

EFFECT ON OTHER REVENUE RULINGS

Rev. Rul. 75-405 is revoked.