• Home
• Federal Income Taxes
• State Tax Laws
• Estate Planning
• Publications
  • Ag. Handbook #731
  • Internal Revenue service
  • Tax Articles
  • Historical Documents
  • Forest Service Publications
• Professional Research
• Tax Workshops/Education
• Tax Policy
• Links

Capitalizing Reforestation Costs

Note: This ISP Paper was Decoordinated on July 31, 1995

ISSUE

Should the portions of the salaries of foresters engaged in the planning and supervision of reforestation be capitalized?

BACKGROUND

The taxpayer employs foresters to manage its forest properties on which it grows and cuts timber. An "area forester" is responsible for all forestry activities on a particular area, including reforesting cutover timberland. Reforesting of cutover timberland is a significant responsibility of an area forester.

The area forester determines the necessary site preparation (for example, removal of brush and preparation of seedling beds with disk equipment to afford good growing conditions) for each tract to be planted and the tree species to plant. After these decisions are made, the area foresters orders the seedlings and arranges for company crews to perform the site preparation and plant the seedlings. ¹ The area forester supervises these operations to ensure the work is completed satisfactorily.

LAW AND ANALYSIS

Section 446(a) of the Internal Revenue Code provides that taxable income must be computed under the method of accounting on the basis of which the taxpayer regularly computes income in keeping its books. Expenditures made during the year must be properly classified as either capital or expense as provided by section 1.446-1(a)(4)(ii) of the Income Tax Regulations.

Section 461(a) of the Code provides that the amount of any deduction or credit allowed must be for the tax year that is proper under the method of accounting used in computing taxable income. If any expenditure results in the creation of an asset having a useful life that extents substantially beyond the close of the tax year, that expenditure may not be deductible, or may be deductible only in part, for the tax year in which make or incurred as provided by section 1.461-1 of the regulations.

Section 162(a) of the Code generally allows as a deduction all the ordinary and necessary expenses paid or incurred during the tax year in carrying on a trade or business, including a reasonable allowance for salaries.

Section 261 of the Code provides that in computing taxable income no deduction is allowed in respect to the items specified in part IX, which includes section 263.

Section 263(a) of the Code disallows, with exceptions that are not pertinent in the present case, any deductions for amounts paid out for permanent improvements or betterments made to increase the value of any property or estate.

Section 1.263(a)-1(a) of the regulations provides that except as otherwise provided in chapter 1 of the Code, no deduction is allowed for any amount paid out for permanent improvements or betterments made to increase the value of any property.

Section 611 of the Code allows as a deduction in computing taxable income a reasonable allowance for depletion of timber. The reasonable allowance is to be made under prescribed regulations.

Section 1.611-3(a) of the regulations provides that with respect to capital invested in timber that is recoverable through depletion allowances, the capital remaining in any year is the basis provided by section 612 of the Code and its regulations. It also provides that amounts paid or incurred in connection with the planting of timber are to be capitalized and recoverable through depletion allowances. Such amounts include, for example, expenditures for the preparation of the timber site for planting and the cost of seedlings.

Rev. Rul. 75-467, 1975-2 C.B. 93, holds that generally, direct costs incurred in connection with reforestation are capital expenditures. These costs include amounts paid or incurred for (a) preparation of the site; (b) seedlings; and (c) labor and tools, including depreciation of equipments used in reforestation.

Amounts paid or incurred in connection with the planting of timber generally are to be capitalized according to the broad rule in section 1.611-3(a) of the regulations. Examples of these are expenditures made to prepare the timber site for planting and for seedlings. Amounts paid or incurred for labor, supervision, tools, and depreciation of equipment, to prepare and plant a timber site must also be capitalized. Rev. Rul. 75-467.

Amounts paid or incurred for reforestation are capitalized because they are for the creation of a stand of timber, an asset that will yield income in the future. The deduction for these should be taken when income is received from the timber. See, Commissioner v. Idaho Power Co., 418 U.S. 1 (1974), 1974-2 C.B. 85, in which the Supreme Court concluded that section 263(a) of the Code required that the amounts of depreciation allocable to transportation equipment used by the taxpayer for self-constructing capital facilities must be capitalized and recovered over the lives of the self-constructed assets. The Court reasoned that the deductions allowable under section 162 through 196 are subject to the general capitalization rule of section 263(a).

CONCLUSION

The taxpayer should use a reasonable method to allocate the forester salaries attributable to reforestation and capitalize these amounts as part of its reforestation costs.