IRS issues capitalization guidance for certain farming activities
TAX ALERT |
Section 263A and the regulations thereunder (the UNICAP rules) generally require certain taxpayers to capitalize direct labor and direct material costs, as well as certain allocable indirect costs, to inventory. Generally, growing crops are not required to be included in inventory unless they have a pre-productive period of more than two years. If a farmer’s crop has a pre-productive period of more than two years, the farmer may generally elect not to have the UNICAP rules apply unless (1) the farmer is required to use the accrual method of accounting, or (2) the costs relate to citrus or almond groves during their first four years of development. If such an election is made, the farmer must treat the plants as section 1245 property and use the alternative depreciation system to depreciate farming equipment placed in service during a year for which the election out of UNICAP is effective.
Importantly, the UNICAP rules do not apply in the case of any plant with a pre-productive period of two years or less produced by farmers that are not prohibited from using the cash method of accounting. Since the pre-productive period of plants is based on a nationwide weighted average rather than an individual farmer’s experience, Notice 2000-45 previously provided the nonexclusive list of plants with a pre-productive period in excess of two years. More recently, the IRS issued Notice 2013-18, superseding Notice 2000-45, to remove blackberry, raspberry and papaya plants from the list of plants that have been determined to have an average pre-productive period in excess of two years. The updated nonexclusive list of plants with a pre-productive period in excess of two years includes:
Rev. Proc. 2013-20 was simultaneously released to provide farmers affected by Notice 2013-18 with the ability to make an automatic accounting method change to either not apply the UNICAP rules to any plant that is no longer listed as having a pre-productive period in excess of two years, or to revoke an election not to apply the UNICAP rules to the production of a plant that has been removed from such list. The revocation of such election would also favorably result in a change in depreciation from the alternative depreciation system to the general depreciation system for farming assets affected by such revocation.
As previously noted, certain farmers producing plants with a pre-productive period in excess of two years generally are not exempt from the UNICAP rules absent an election out (if eligible). The removal of blackberry, raspberry and papaya plants from the list of plants with a pre-productive period in excess of two years means that affected farmers may be exempt from the requirement to apply the UNICAP rules to capitalize the costs of producing such plants. Furthermore, with the release of Rev. Proc. 2013-20, such farmers may be eligible to request automatic consent to favorably change their accounting method(s) accordingly for any taxable year that ends after Feb. 15, 2013. Rev. Proc. 2013-20 also very favorably provides audit protection for certain farmers who did not previously apply the UNICAP rules to their blackberry, raspberry or papaya plants in taxable years that ended on or before Feb. 15, 2013.