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Rev. Rul. 81-2, 1981-1 CB 78

REV-RUL, Losses; death of tree seedlings; timber producer., Rev. Rul. 81-2, 1981-1 CB 78, (Jan. 01, 1981)

Section 165.--Losses

26 CFR 1.165-1: Losses.
(Also Sections 194, 611; 1.611-3.)

[IRS Headnote] Losses; death of tree seedlings; timber producer.--
A timber producer sustains no deductible loss on the death, not due to casualty, of tree seedlings planted to reforest land from which it has harvested the mature timber. Amounts paid or incurred in replanting to replace the lost seedlings must be capitalized in accordance with section 1.611-3(a) of the regulations.

ISSUE

Does the death of planted tree seedlings, under the circumstances described below, give rise to a deductible loss under section 165 of the Internal Revenue Code, and must the costs incurred as a result of the death of the seedlings be capitalized and recovered through the depletion allowance under section 611?

FACTS

The corporate taxpayer owns forested lands which it manages for the continuous production of timber for use in its business of manufacturing lumber.

After harvesting the mature timber on a portion of its lands by clear-cutting, the taxpayer reforested the clear-cut area by planting nursery grown tree seedlings at a cost of 30x dollars. In reforesting areas that have been clear-cut, the taxpayer attempts to grow 600 well-spaced seedlings per acre. If 300 well-spaced seedlings per acre survive, the area has enough trees growing on it to produce a satisfactory stand of mature timber. If less than 300 seedlings survive the reforestation is unsatisfactory and the understocked portion of the area has to be replanted to utilize the productive capability of the land economically.

Generally, the first two growing seasons are critical to seedling survival. It is, therefore, the taxpayer's practice to examine planted areas at the end of the second growing season to determine the number and spacing of the surviving seedlings. The examination of the reforested area in question showed that many of the seedlings had died and that portions of the area were not satisfactorily reforested. Later in 1979 the taxpayer replanted the understocked portions of the tract.

The seedling deaths were not due to a casualty and were not covered by any type of insurance. The taxpayer continued to use the area for growing timber for eventual use in its lumber mill.

LAW AND ANALYSIS

Section 1.165-1(a) of the Income Tax Regulations provides that any loss actually sustained during the taxable year and not made good by insurance or some other form of compensation shall be allowed as a deduction subject to any provision of the Code which prohibits or limits the amount of the deduction.

Section 1.165-1(b) of the regulations provides that, to be allowable as a deduction under section 165(a) of the Code, a loss must be fixed by identifiable events. Only a bona fide loss is allowable. Substance, not mere form, shall govern in determining a deductible loss.

Section 1.611-3(a) of the regulations provides that amounts paid or incurred for the planting of timber shall be capitalized and recovered through a depletion allowance.

Rev. Rul. 61-206, 1961-2 C.B. 57, holds that when a test hole or holes are drilled to determine the existence of water and a well is thereafter drilled to accommodate the taxpayer's business needs, the mere abandonment of the test hole or holes does not give rise to a deductible loss when the drilling of the test hole or holes is an integral part of the development of the water well in a particular area.

Section 1.611-3(a) of the regulations applies to replanting costs as well as the cost of the original planting. Rev. Rul. 75-467, 1975-2 C.B. 93. Whether the taxpayer is successful in its initial reforestation effort or whether it must replant in order to achieve satisfactory stocking, all amounts paid or incurred are capital costs incurred in connection with the planting of timber. The aggregate of these costs becomes part of the taxpayer's adjusted basis in the timber grown on the tract. Gain or loss on the timber grown on the tract is generally determined at the time the timber is cut and depletion takes place or when the tract is abandoned for the purpose of growing timber.

HOLDING

The taxpayer did not sustain any deductible loss attributable to the seedings that died even though portions of the tract had to be replanted. Furthermore, the cost of replanting must be capitalized in accordance with the provisions of section 1.611-3(a) of the regulations. However, if such additions to the capital account are made after December 31, 1979, all or a portion of such cost may be subjected to an allowance for amortization under the provisions of section 194 of the Code and to investment credit under section 48(a)(1)(F).