Revenue Ruling 66-18
REV-RUL, Capital expenditures; in general., Rev. Rul. 66-18, 1966-1
CB 59, (Jan. 01, 1966)
Rev. Rul. 66-18, 1966-1 CB 59
SECTION 263.--CAPITAL EXPENDITURES
26 CFR 1.263(a)-1: Capital expenditures; in general. (Also Section 162, 611; 1.162-1, 1.611-3.) In connection with the cultivation, as a trade or business, of Christmas trees for purposes of sale when they are more than six years old, the expenditures incurred for planting, basal pruning, stump culture and shearing must be capitalized. Expenditures incurred for silvicultural practices, such as weeding, or cleaning, and noncommercial thinning are deductible as ordinary and necessary trade or business expenses. The cost of land improvements is capitalized in the land account or depreciated, depending on whether the useful life of such improvements is determinable. The cost of equipment purchased and other depreciable assets, such as culverts and fences, should be capitalized and recovered through the allowance for depreciation. Advice has been requested relative to the Federal income tax treatment of certain expenditures incurred in connection with the cultivation of Christmas trees as a trade or business.
The taxpayer grows and sells Christmas trees. In some areas he plants the trees, in other areas he cultivates and cuts trees that have been naturally seeded. The taxpayer in all instances sells only those trees more than six years old, whether planted or naturally seeded trees. In planting seedlings, the taxpayer usually prepares the land prior to the actual planting. However, there are instances when the seedlings may be planted in one year and competing hardwood brush removed a year or two later to prevent suppression of seedlings.
In connection with the cultivation of both planted and naturally seeded trees, the taxpayer incurs certain expenditures before the cutting of such trees; for example, expenditures for basal pruning, stump culture, shearing and silvicultural practices, such as weeding, or cleaning, and noncommercial thinning. Basal pruning involves the removal of the lower limbs to stimulate heavier growth on the remainder of the top portion of the tree. It is more commonly applied in natural stands and in many cases makes a marketable tree of one which otherwise would be too thin at the top. Stump culture involves careful pruning of the stump to promote the growth of additional trees from the same stump. Hormones are sometimes used on the stump to stimulate sprouting. The pruning operation may be repeated each time a tree is cut from the stump. Shearing is a practice in which the terminal leader and the side branches are pruned to shape the tree. It is done primarily in planted stands and is usually done more than once to improve the shape and proportions of the tree.
Weeding, or cleaning, is a silvicultural operation employed in young established stands to free small trees from weeds, vines, etc., and to provide better growing conditions by liberating crop trees from other trees of a similar age but of less desirable species. It is sometimes done, especially in plantations, by cultivating between the rows or sometimes by spraying with selective herbicides. Noncommercial thinning is the removal of excess trees in immature stands to give the remaining trees room to grow.
In addition to the above, the taxpayer incurs other expenditures for road grading, ditching, fire breaks, culverts and fences.
The general rules regarding capital expenditures, as set forth in section 1.446-1(a)(4)(ii) and (iii) of the Income Tax Regulations, provide (1) that expenditures shall be properly classified as between capital and expense and (2) that in any case in which there is allowable with respect to an asset a deduction for depreciation, amortization, or depletion, any expenditure (other than ordinary repairs) made to restore the asset or to prolong its useful life shall be added to the asset account.
Section 1.263(a)-1(a) and (b) of the regulations provides, in part, that no deduction shall be allowed for amounts paid or incurred to add to the value, or substantially prolong the useful life, of property owned by the taxpayer, or to adapt property to a new or different use.
Therefore, in general, it may be said that expenditures, paid or incurred in the business of growing Christmas trees for purposes of sale when they are more than six years old, must be capitalized when they (1) are for the acquisition of property having a useful life of more than one year; (2) add to the value of property owned by the taxpayer; (3) prolong the useful life of property owned by the taxpayer; or (4) adapt property to a new or different use.
Such capital expenditures are to be treated in one of the following ways: (1) As an increase in the basis of the trees, recoverable through allowance for depletion as the trees are cut or as adjusted basis if the standing trees are sold; or (2) as part of the cost of depreciable property, recoverable through allowance for depreciation as provided in section 167 of the Internal Revenue Code of 1954; or (3) as not subject to depletion or depreciation.
Section 1.162-1(a) of the regulations provides that the ordinary and necessary expenditures directly connected with or pertaining to the taxpayer's trade or business, except items which are used as the basis for a deduction or credit under provisions of the law other than section 162 of the Code, may be deducted from gross income as business expenses.
Section 1.611-3(a) of the regulations provides that amounts paid or incurred in connection with the planting of timber (including planting for Christmas tree purposes) shall be capitalized and recoverable through depletion allowances.
Revenue Ruling 55-252, C.B. 1955-1, 319, holds that direct costs incurred in connection with reforestation by planting are capital expenditures. The ruling enumerates the following planting costs: (a) Preparation of the site, including any girdling or brush removal work to afford good growing conditions; (b) cost of seedlings; and (c) labor and tool expense, including depreciation of equipment used in planting, such as trucks, tree planters, etc.
Brush removal work performed a year or two after planting is considered to be proximately related to the establishment of the seedlings. Such work is essentially a part of the planting operation, and its cost should be capitalized. The cost of seedlings includes the amount expended for those purchased and those planted and raised by the taxpayer. The labor and tool expense includes all costs involved in planting the seedlings, including all amounts expended for transportation, supervision and labor, equipment rental and depreciation of owned equipment and tools used in connection with the planting. The portion of the depreciated cost of equipment thus added to the basis of the seedlings should be proportionate to the use of the equipment or tools in planting as compared with the use of such equipment or tools in other activities of the taxpayer.
Other expenditures that are capital in character include expenditures for basal pruning, stump culture and shearing. Capitalized costs, such as the aforementioned, attributable to the planting and cultivation of Christmas trees, are recoverable (1) as adjusted basis when the standing trees are sold or (2) through allowances for depletion as the trees are cut.
The cost of land improvements which have a useful life substantially beyond the taxable year, such as road grading, ditching and fire breaks, should be capitalized. If such improvements do not have a determinable useful life, then the cost should be added to the basis of the land, to be recovered when the land is disposed of, as in a sale. If they do have a determinable useful life, then the cost should be recovered through annual depreciation. In no case should their cost be added to the basis of the trees.
The cost of equipment purchased and other assets having a limited and determinable life such as culverts and fences, should be capitalized and recovered through annual allowances for depreciation. But compare Revenue Ruling 55-252 for the rule concerning the treatment of depreciation of equipment used in planting as a planting cost and therefore a capital expenditure to be added to the basis of the seedlings.
The expenditures for silvicultural practices such as weeding and noncommercial thinning are incurred after the trees become established and before they are ready to be cut. Such expenditures are in the nature of maintenance charges and are deductible as ordinary and necessary trade or business expenses. In the case of a thinning operation which produces marketable trees, any amount received from the sale of the trees so removed is includible in gross income.
Accordingly, in the planting and cultivation of Christmas trees as a
trade or business the expenditures incurred for planting, basal pruning,
stump culture, and shearing must be capitalized and added to the basis of
the standing trees. These expenditures are recoverable as adjusted basis
when the standing trees are sold or through depletion allowances as the
trees are cut. Expenditures incurred for silvicultural practices, such as
weeding, or cleaning, and noncommercial thinning are deductible expenses. The
cost of land improvements is capitalized in the land account or depreciated,
depending on whether the useful life of such improvements is determinable.
The cost of equipment purchased and other depreciable assets (to the extent
not used in connection with the planting of Christmas trees) such as
culverts and fences, should be capitalized and recovered through allowances for depreciation.