Internal Revenue Bulletin 1997-38 (PDF rendition): IRS Revenue Rulings

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INCOME TAX
Rev. Rul. 97–38, page 14.
Calculation of a partner’s limited deficit restoration
obligation. This ruling holds that the amount of a partner’s
limited deficit restoration obligation is the amount of money
that the partner would be required to contribute to the part-
nership to satisfy partnership liabilities if all partnership prop-
erty were sold for the amount of the partnership’s book
basis in the property.
T.D. 8729, page 4.
REG–208151–91, page 21.
Final, temporary, and proposed regulations relate to the
application of section 263A of the Code to property pro-
duced in a farming business. A public hearing on the pro-
posed regulations will be held on November 19, 1997.
T.D. 8730, page 16.
Final regulations under section 1245 of the Code relate to
the allocation of depreciation recapture among partners in a
partnership.
EMPLOYEE PLANS
Notice 97–51, page 20.
Weighted average interest rate update.Guidelines are
set forth for determining for September 1997, the weighted
average interest rate and the resulting permissible range of
interest rates used to calculate current liability for purposes
of the full funding limitation of section 412(c)(7) of the Code
as amended by the Omnibus Budget Reconciliation Act of
1987 and by the Uruguay Round Agreements Act (GATT).
EXEMPT ORGANIZATIONS
Announcement 97–97, page 22.
A list is given of organizations now classified as private foun-
dations.
ADMINISTRATIVE
Notice 97–52, page 20.
Qualified state tuition programs (QSTPs).This notice
extends the relief for reporting requirements that apply to
QSTPs.
Internal Revenue
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Bulletin No. 1997–38
September 22, 1997
HIGHLIGHTS
OF THIS ISSUE
These synopses are intended only as aids to the reader in
identifying the subject matter covered. They may not be
relied upon as authoritative interpretations.
Department of the Treasury
Internal Revenue Service
Finding Lists begin on page 25.

Mission of the Service
The purpose of the Internal Revenue Service is to collect
the proper amount of tax revenue at the least cost; serve
the public by continually improving the quality of our prod-
ucts and services; and perform in a manner warranting
the highest degree of public confidence in our integrity, effi-
ciency, and fairness.
2
Statement of Principles
of Internal Revenue
Tax Administration
The function of the Internal Revenue Service is to adminis-
ter the Internal Revenue Code. Tax policy for raising revenue
is determined by Congress.
With this in mind, it is the duty of the Service to carry out that
policy by correctly applying the laws enacted by Congress;
to determine the reasonable meaning of various Code provi-
sions in light of the Congressional purpose in enacting them;
and to perform this work in a fair and impartial manner, with
neither a government nor a taxpayer point of view.
At the heart of administration is interpretation of the Code. It
is the responsibility of each person in the Service, charged
with the duty of interpreting the law, to try to find the true
meaning of the statutory provision and not to adopt a
strained construction in the belief that he or she is “protect-
ing the revenue.” The revenue is properly protected only
when we ascertain and apply the true meaning of the statute.
The Service also has the responsibility of applying and
administering the law in a reasonable, practical manner.
Issues should only be raised by examining officers when
they have merit, never arbitrarily or for trading purposes.
At the same time, the examining officer should never hesi-
tate to raise a meritorious issue. It is also important that
care be exercised not to raise an issue or to ask a court to
adopt a position inconsistent with an established Service
position.
Administration should be both reasonable and vigorous. It
should be conducted with as little delay as possible and
with great courtesy and considerateness. It should never
try to overreach, and should be reasonable within the
bounds of law and sound administration. It should, howev-
er, be vigorous in requiring compliance with law and it
should be relentless in its attack on unreal tax devices and
fraud.

The Internal Revenue Bulletin is the authoritative instrument
of the Commissioner of Internal Revenue for announcing offi-
cial rulings and procedures of the Internal Revenue Service
and for publishing Treasury Decisions, Executive Orders, Tax
Conventions, legislation, court decisions, and other items of
general interest. It is published weekly and may be obtained
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on a single-copy basis.
It is the policy of the Service to publish in the Bulletin all sub-
stantive rulings necessary to promote a uniform application
of the tax laws, including all rulings that supersede, revoke,
modify, or amend any of those previously published in the
Bulletin. All published rulings apply retroactively unless other-
wise indicated. Procedures relating solely to matters of in-
ternal management are not published; however, statements
of internal practices and procedures that affect the rights
and duties of taxpayers are published.
Revenue rulings represent the conclusions of the Service on
the application of the law to the pivotal facts stated in the
revenue ruling. In those based on positions taken in rulings
to taxpayers or technical advice to Service field offices,
identifying details and information of a confidential nature
are deleted to prevent unwarranted invasions of privacy and
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Rulings and procedures reported in the Bulletin do not have
the force and effect of Treasury Department Regulations,
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will not be relied on, used, or cited as precedents by Service
personnel in the disposition of other cases. In applying pub-
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islation, regulations, court decisions, rulings, and proce-
dures must be considered, and Service personnel and oth-
ers concerned are cautioned against reaching the same con-
clusions in other cases unless the facts and circumstances
are substantially the same.
The Bulletin is divided into four parts as follows:
Part I.—1986 Code.
This part includes rulings and decisions based on provisions
of the Internal Revenue Code of 1986.
Part II.—Treaties and Tax Legislation.
This part is divided into two subparts as follows: Subpart A,
Tax Conventions, and Subpart B, Legislation and Related
Committee Reports.
Part III.—Administrative, Procedural, and Miscellaneous.
To the extent practicable, pertinent cross references to
these subjects are contained in the other Parts and Sub-
parts. Also included in this part are Bank Secrecy Act Admin-
istrative Rulings. Bank Secrecy Act Administrative Rulings
are issued by the Department of the Treasury’s Office of the
Assistant Secretary (Enforcement).
Part IV.—Items of General Interest.
With the exception of the Notice of Proposed Rulemaking
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succeeding quarterly and semiannual period, respectively.
3
Introduction
The contents of this publication are not copyrighted and may be reprinted freely. Acitation of the Internal Revenue Bulletin as the source would be appropriate.
For sale by the Superintendent of Documents, U.S. Government Printing Office, Washington, DC 20402.

September 22, 199741997–38 I.R.B.
Section 263A.—Capitalization
and Inclusion in Inventory Costs
of Certain Expenses
26 CFR 1.263A–4T: Rules for property produced in
a farming business (temporary).
T.D. 8729
DEPARTMENT OF THE TREASURY
Internal Revenue Service
26 CFR Part 1
Rules for Property Produced in
a Farming Business
AGENCY: Internal Revenue Service
(IRS), Treasury
ACTION: Final and temporary regula-
tions.
SUMMARY: This document contains
final and temporary regulations relating to
the application of section 263Aof the In-
ternal Revenue Code to property pro-
duced in a farming business. These regu-
lations affect certain taxpayers engaged in
the trade or business of farming. These
regulations are necessary to provide guid-
ance with respect to section 263A(d).
The text of the temporary regulations
also serves as the text of REG–208151–
91 on page 21 of this Bulletin.
DATES: These regulations are effective
August 22, 1997. For dates of applicabil-
ity, see §1.263A–4T(f) of these regula-
tions.
FOR FURTHER INFORMATION CON-
TACT: Jan Skelton, (202) 622-4970 (not
a toll-free call).
SUPPLEMENTARYINFORMATION:
Background
Prior to the enactment of section 263A,
the rules that governed the deduction or
capitalization of costs incurred with re-
spect to property produced in the trade or
business of farming were set forth in sev-
eral different statutory and regulatory pro-
visions. Costs regarded as preparatory
expenditures were required to be capital-
ized under section 263. Preparatory ex-
penditures are expenditures incurred prior
to raising agricultural or horticultural
commodities or that otherwise enable a
farmer to begin the farming process. See,
e.g., Rev. Rul. 83–28, 1983–1 C.B. 47.
Preparatory expenditures include the
costs of clearing land, leveling and grad-
ing land, drilling and equipping wells, ac-
quiring irrigation systems, acquiring
seeds or seedlings, budding trees, and ac-
quiring animals.
Costs regarded as developmental ex-
penditures (sometimes referred to as cul-
tural practices expenditures) were gener-
ally permitted to be deducted, or, at a
taxpayer’s election, could be capitalized.
See, e.g.,
Wilbur v. Commissioner,43 T.C.
322 (1964), acq., 1965–2 C.B. 7. Devel-
opmental expenditures are those expendi-
tures incurred by a taxpayer so that the
growing process may continue in the de-
sired manner. Developmental expendi-
tures are expenditures that, if incurred
while the plant or animal was in a produc-
tive state, would be deductible. See,
Maple v. Commissioner, 27 T.C.M. 944
(1968), aff’d,440 F.2d 1055 (9th Cir.
1971). Developmental expenditures in-
clude the costs of irrigating, fertilizing,
spraying, cultivating, pruning, feeding,
providing veterinary services, rent on
land, and depreciation allowances on irri-
gation systems or structures.
Former sections 278 and 447 provided
special rules requiring the capitalization
of certain developmental expenditures.
Former section 278(a) provided special
rules for citrus and almond groves. Under
former section 278(a), all otherwise de-
ductible costs of developing citrus or al-
mond groves incurred before the end of
the fourth taxable year after permanent
planting were required to be capitalized.
Rev. Rul. 83–128, 1983–2 C.B. 57, clari-
fied that the costs incurred prior to perma-
nent planting were also required to be
capitalized.
Former sections 278(b) and 447(b) pro-
vided special rules for farming syndi-
cates, corporations, and partnerships with
a corporate partner. Section 447 requires
certain corporations and partnerships with
a corporate partner to use an accrual
method of accounting (accrual method).
Former section 447(b) required these tax-
payers to capitalize preproductive period
expenses. Preproductive period expenses
were defined as any expenses attributable
to crops, animals, trees, or other property
having a crop or yield and that are in-
curred during the preproductive period of
such property. Soil and water conserva-
tion expenditures, as defined in section
175, and land-clearing expenditures as
defined in former section 182, are prepro-
ductive period expenses if they are in-
curred in a preproductive period of an
agricultural or horticultural activity and if
the taxpayer elects to deduct these ex-
penses rather than capitalize them. House
Comm. on Ways and Means, Tax Reform
Act of 1975, H.R. Rep. No. 94–658, 94th
Cong., 1st Sess. 93 (1975).
In the case of a farming syndicate en-
gaged in planting, cultivating, maintain-
ing, or developing an orchard, vineyard,
or grove, former section 278(b) required
the capitalization of all otherwise de-
ductible expenditures incurred with re-
spect to the orchard, vineyard, or grove, if
incurred prior to the first taxable year in
which there was a crop or yield in com-
mercial quantities.
Former section 278(c) provided a relief
provision. Under this provision, sections
278(a) or (b) would not require the capi-
talization of developmental expenditures
attributable to an orchard, vineyard, or
grove that was replanted after having
been lost or damaged by reason of freez-
ing temperatures, disease, drought, pests,
or casualty.
Section 263A, enacted in the Tax Re-
form Act of 1986, Pub. L. 99–514, 100
Stat. 2085, 1986–3 C.B. Vol. 1 (the 1986
Act), provides uniform capitalization
rules that govern the treatment of costs in-
curred in the production of property or the
acquisition of property for resale. Section
263Awas enacted, in part, to prevent the
inappropriate mismatching of income and
expense that results from the current de-
duction of the costs of producing prop-
erty. Section 263Agenerally incorporates
and expands upon the rules set forth in
several code and regulatory sections, in-
cluding section 263, and former sections
278 and 447.
Section 263A(b) generally provides
that the uniform capitalization rules apply
to the taxpayer’s production of real or tan-
gible personal property. Section 1.263A–
2(a)(1)(i) clarifies that for purposes of
Part I. Rulings and Decisions Under the Internal Revenue Code of 1986

section 263A, produce includes the fol-
lowing: construct, build, install, manu-
facture, develop, improve, create, raise, or
grow. Sections 263A(d) and (e) provide
special rules for property produced in a
farming business.
Section 263A, as enacted in 1986, gen-
erally required taxpayers to capitalize the
costs of producing plants and animals.
Taxpayers not required by section 447 or
448(a)(3) to use an accrual method were
excepted from capitalizing the preproduc-
tive period costs of plants and animals
(except animals held for slaughter) that
had a preproductive period of 2 years or
less. Section 263Awas amended as part
of the Omnibus Budget Reconciliation
Act of 1987, Pub. L. 100–203, 101 Stat.
1330, 1987–3 C.B. Vol. 1 (the 1987 Act),
the Technical and Miscellaneous Revenue
Act of 1988, Pub. L. 100–647, 102 Stat.
3342, 1988–3 C.B. Vol. 1 (the 1988 Act),
and the Omnibus Budget Reconciliation
Act of 1989, Pub. L. 101–239, 103 Stat.
2106 (the 1989 Act). Under the 1988 Act,
the scope of the exception for these tax-
payers is expanded to include all animals
irrespective of the length of the prepro-
ductive period.
In addition, taxpayers not required by
section 447 or 448(a)(3) to use an accrual
method may elect not to capitalize the
costs of plants (other than certain costs of
producing citrus and almond trees) with a
preproductive period in excess of 2 years.
If a taxpayer makes this election, the tax-
payer must treat such plants as section
1245 property and upon disposition of
these plants any amount allowable as a
deduction that would, but for the election,
have been capitalized must be recaptured
and treated as a deduction allowed for de-
preciation with respect to such property.
See section 263A(e)(1). Also, if the tax-
payer makes the election, the taxpayer
and related persons must apply the alter-
native depreciation system provided in
section 168(g)(2) to all property used by
the taxpayer or related person predomi-
nantly in a farming business and placed in
service in any taxable year in which the
election out of section 263Ais in effect.
See section 263A(e)(2).
On March 30, 1987, the IRS published
in the
Federal Registera notice of pro-
posed rulemaking (52 FR 10118) by cross
reference to temporary regulations pub-
lished the same day (T.D. 8131, 52 FR
10052). Amendments to the notice of
proposed rulemaking and temporary regu-
lations were published in the Federal
Registeron August 7, 1987, by a notice of
proposed rulemaking (52 FR 29391) that
cross referenced to temporary regulations
published the same day (T.D. 8148, 52 FR
29375). Notice 88–24, 1988–1 C.B. 491,
provided that forthcoming regulations
would modify the temporary regulations
and the regulations under §1.471–6. No-
tice 88–86, 1988–2 C.B. 401, provided
that forthcoming regulations would clarify
the definition of a related person for pur-
poses of the election out of section 263A.
In addition, Notice 88–86 provided that
forthcoming regulations would provide
that certain taxpayers could elect to use
the simplified production method for
property used in the trade or business of
farming. On August 5, 1994, the tempo-
rary regulations relating to property pro-
duced in a farming business were reissued
and published in the Federal Register
(T.D. 8559, 59 FR 39958). Because sub-
stantial changes are being made from the
1994 temporary regulations, the IRS and
Treasury Department have decided to
issue, in part, new proposed and tempo-
rary, rather than final, regulations.
Explanation of Provisions
Property Produced In The Trade Or
Business Of Farming
The temporary regulations clarify that
the special rules of section 263A(d) apply
only to property produced in a farming
business. The temporary regulations pro-
vide that for purposes of section 263A,
the term farming means the cultivation of
land or the raising or harvesting of any
agricultural or horticultural commodity.
Examples include the trade or business of
operating a nursery or sod farm; the rais-
ing or harvesting of trees bearing fruit,
nuts, or other crops; the raising of orna-
mental trees (other than evergreen trees
that are more than six years old at the time
they are severed from their roots); and the
raising, shearing, feeding, caring for,
training, and management of animals.
The regulations clarify that for this pur-
pose harvesting does not include contract
harvesting of an agricultural or horticul-
tural commodity grown or raised by an-
other taxpayer. Accordingly, while a tax-
payer that grows a plant may apply the
special rules of section 263A(d) to the
costs of growing and harvesting the plant,
the special rules of section 263A(d) do
not apply to a taxpayer that merely con-
tract harvests agricultural or horticultural
commodities grown or raised by another
taxpayer. Similarly, the temporary regu-
lations clarify that the special rules of sec-
tion 263A(d) do not apply to a taxpayer
that merely buys and resells plants or ani-
mals grown or raised by another. In eval-
uating whether a taxpayer is engaged in
the production, or merely the resale, of
plants or animals, it is anticipated that
consideration will be given to factors in-
cluding: the length of time between the
taxpayer’s acquisition of a plant or animal
and the time the plant or animal is made
available for sale to the taxpayer’s cus-
tomers, and, in the case of plants, whether
plants acquired by the taxpayer are
planted in the ground or kept in temporary
containers.
The temporary regulations provide that
a farming business does not include the
processing of commodities or products
beyond those activities that are incident to
the growing, raising, or harvesting of such
products.
Preparatory And Developmental Costs
The IRS and Treasury Department be-
lieve that, in general, section 263Adoes
not change the rules regarding capitaliza-
tion of costs during the preparatory pe-
riod. Thus, the temporary regulations
clarify that, as under prior law, taxpayers
generally must capitalize preparatory ex-
penditures, including the cost of seeds,
seedlings, and animals; clearing, leveling
and grading land; drilling and equipping
wells; irrigation systems; and budding
trees. However, because section 263Are-
quires the capitalization of certain indirect
costs as well as direct costs, the amount of
preparatory expenditures capitalized may
be greater under section 263Athan under
prior law.
Section 263Aexpands the circum-
stances under which costs that were once
termed developmental expenditures must
be capitalized. The temporary regulations
clarify that costs that were, in years prior
to the enactment of section 263A, re-
garded as developmental are included in
the category of preproductive period
costs. Section 263Agenerally requires
the capitalization of preproductive period
1997–38 I.R.B.5September 22, 1997

September 22, 199761997–38 I.R.B.
costs including the costs of irrigating, fer-
tilizing, spraying, cultivating, pruning,
feeding, providing veterinary services,
rent on land, and depreciation allowances
on irrigation systems or structures. Pre-
productive period costs also include real
estate taxes, interest, and soil and water
conservation expenditures incurred dur-
ing the preproductive period of a plant.
Taxpayers that are required by section
447 or 448(a)(3) to use an accrual
method must capitalize all preproductive
period costs of plants (without regard to
the length of the preproductive period)
and animals. Taxpayers that are not re-
quired by section 447 or 448(a)(3) to use
an accrual method qualify for an excep-
tion to this general rule. Under this ex-
ception, taxpayers are not required to
capitalize preproductive period costs in-
curred with respect to animals, or with
respect to plants that have a preproduc-
tive period of 2 years or less. Thus,
under this exception, taxpayers are re-
quired to capitalize only those preproduc-
tive period costs incurred with respect to
plants that have a preproductive period in
excess of 2 years. The temporary regula-
tions clarify that, for purposes of deter-
mining whether a plant has a preproduc-
tive period in excess of 2 years, in the
case of a plant grown in commercial
quantities in the United States, the na-
tionwide weighted average preproductive
period of such plant is used.
The IRS and Treasury Department are
considering the publication of guidance
with respect to the length of the prepro-
ductive period of certain plants that will
have more than one crop or yield. At the
present time, the IRS and Treasury De-
partment anticipate that such guidance
would provide that plants producing the
following crops or yields have a nation-
wide weighted average preproductive pe-
riod in excess of 2 years: almonds, ap-
ples, apricots, avocados, blueberries,
blackberries, cherries, chestnuts, coffee
beans, currants, dates, figs, grapefruit,
grapes, guavas, kiwifruit, kumquats,
lemons, limes, macadamia nuts, man-
goes, nectarines, olives, oranges,
peaches, pears, pecans, persimmons, pis-
tachio nuts, plums, pomegranates,
prunes, raspberries, tangelos, tangerines,
tangors, and walnuts. The IRS and Trea-
sury Department invite comments on this
issue.
Capitalization Period
Preproductive period costs (e.g., irri-
gating, fertilizing, real estate taxes, etc.)
are capitalized during the preproductive
period of a plant or animal. Ataxpayer
that grows a plant that will have more
than one crop or yield is engaged in the
production of two types of property, the
plant and the crop or yield of the plant
(e.g., the orange tree and the orange). The
temporary regulations clarify the capital-
ization period for plants that will have
more than one crop or yield, for crops or
yields of plants that will have more than
one crop or yield, and for other plants.
The temporary regulations clarify that
the preproductive period of a plant gener-
ally begins when a taxpayer first incurs
costs with respect to the plant, e.g., when
the plant is acquired or the seed is
planted. In the case of the crop or yield of
a plant that has become productive in
marketable quantities, the preproductive
period of the crop or yield begins when
the crop or yield first appears, whether in
the form of a sprout, bloom, blossom,
bud, etc.
In the case of a plant that will have
more than one crop or yield, the prepro-
ductive period of the plant ends when the
plant becomes productive in marketable
quantities (i.e., when the plant is placed in
service for purposes of depreciation). In
the case of the crop or yield of a plant that
has become productive in marketable
quantities, the preproductive period of the
crop or yield ends when the crop or yield
is disposed of. Finally, in the case of
other plants, the preproductive period
ends when the plant is disposed of.
The temporary regulations provide that
the preproductive period of an animal be-
gins at the time of acquisition, breeding,
or embryo implantation. The temporary
regulations clarify that, in the case of an
animal that will be used in the trade or
business of farming, the preproductive
period generally ends when the animal is
placed in service for purposes of depreci-
ation. However, in the case of an animal
that will have more than one yield, the
preproductive period ends when the ani-
mal produces (e.g., gives birth to) its first
yield. In the case of any other animal, the
preproductive period ends when the ani-
mal is sold or otherwise disposed of. The
temporary regulations additionally clarify
that, in the case of an animal that will
have more than one yield, the costs in-
curred after the beginning of the prepro-
ductive period of the first yield but before
the end of the preproductive period of the
animal must be allocated between the ani-
mal and the yield on a reasonable and
consistent basis. Any depreciation al-
lowance on the animal may be allocated
entirely to the yield.
Method Of Capitalizing Costs
The temporary regulations provide that
the costs required to be capitalized with
respect to farming property may, if the
taxpayer chooses, be determined using
any reasonable inventory valuation
method, such as the farm-price method of
accounting (farm-price method) or the
unit-livestock-price method of accounting
(unit-livestock-price method). The use of
these inventory valuation methods avoids
the necessity of accounting for the costs
of raising plants or animals by tracing
costs to each separate plant or animal. In
addition, under the temporary regulations,
these inventory methods may be used by a
taxpayer regardless of whether the farm-
ing property being produced is otherwise
treated as inventory by the taxpayer, and
regardless of whether the taxpayer is oth-
erwise using the cash method or an ac-
crual method.
The temporary regulations clarify that
notwithstanding a taxpayer’s use of the
farm-price method with respect to farm-
ing property to which the provisions of
section 263Aapply, the taxpayer is not re-
quired, solely by such use, to use the same
method of accounting with respect to
farming property to which the provisions
of section 263Ado not apply.
Under the unit-livestock-price method,
the taxpayer adopts a standard unit price
for each animal within a particular class.
This standard unit price is used by the tax-
payer in lieu of specifically identifying
and tracing the costs of raising each ani-
mal in the taxpayer’s farming business.
Taxpayers using the unit-livestock-price
method must adopt a reasonable method
of classifying animals with respect to
their age and kind so that the unit prices
assigned by the taxpayer to animals in
each class are reasonable. Thus, taxpay-
ers using the unit-livestock-price method
typically classify livestock based on their

age (for example, a separate class will
typically be established for calves, year-
lings, and 2-year olds).
The temporary regulations under sec-
tion 263Amodify the rule set forth in
§1.471–6 providing that no increase in
unit cost is required under the unit-live-
stock-price method with respect to the
taxable year in which certain animals are
purchased, if the purchases occur in the
last 6 months of the taxable year. The
temporary regulations provide that any
taxpayer required to use an accrual
method under section 448(a)(3) must in-
clude in inventory the annual standard
unit price for all animals purchased dur-
ing the taxable year, regardless of when in
the taxable year the purchases are made.
The temporary regulations further amend
this rule and provide that all taxpayers
using the unit-livestock-price method
must modify the annual standard price to
reasonably reflect the particular period in
the taxable year in which purchases of
livestock are made, if such modification
is necessary in order to avoid significant
distortions in income that would other-
wise occur through operation of the unit-
livestock-price method. The temporary
regulations do not specify the particular
modification that must be made to the an-
nual standard price for any particular tax-
payer, but rather allow any reasonable
modification made by the taxpayer to the
annual standard price to avoid significant
distortions in income. For example, as-
sume a taxpayer purchases and raises cat-
tle for slaughter. Assume further that the
taxpayer is required to use an accrual
method under section 447 so that section
263Aapplies to the taxpayer’s costs of
raising the cattle. The temporary regula-
tions provide that the taxpayer may not
expense the costs of raising cattle that are
purchased in the latter half of the tax-
payer’s taxable year. Instead, the tax-
payer must modify the annual standard
price so as to reasonably capitalize the
costs of raising the cattle, based on the
date of their purchase.
In Notice 88–86, the IRS noted that
commentators had inquired as to the
availability of the simplified production
method of accounting (simplified produc-
tion method) for farmers using the unit-
livestock-price method for the costs of
raising livestock. The temporary regula-
tions clarify that farmers using the unit-
livestock-price method are permitted to
elect the simplified production method, as
well as the simplified service cost method
of accounting, under section 263A. In
such a situation, section 471 costs are the
costs taken into account by the taxpayer
under the unit-livestock-price method
using the taxpayer’s standard unit price
determined under these temporary and
final regulations. The term additional
section 263Acosts includes all additional
costs required to be capitalized under sec-
tion 263Aincluding costs that are re-
quired to be capitalized under section
263Athat are not reflected in the standard
unit prices (e.g., general and administra-
tive costs and depreciation, including de-
preciation on a calf’s mother).
In light of the additional costs required
to be capitalized under section 263A, tax-
payers should not adopt unit prices uti-
lized under pre-section 263Aunit-live-
stock-price rules without carefully
analyzing whether these unit prices reflect
all of the costs required to be capitalized
under section 263A.
Election Not To Capitalize Costs
Certain taxpayers, other than those re-
quired to use an accrual method by sec-
tion 447 or 448(a)(3), may elect not to
capitalize the preproductive period costs
of certain plants even though such plants
have a preproductive period in excess of 2
years and would otherwise be subject to
the capitalization requirements of section
263A. Taxpayers making this election
may continue to deduct (subject to other
limitations of the Code) the preproductive
period costs that were deductible under
the rules in effect before the enactment of
section 263A. The temporary regulations
clarify that although a taxpayer producing
a citrus or almond grove may make this
election, the election does not apply to the
preproductive period costs of a citrus or
almond grove that are incurred before the
close of the fourth taxable year beginning
with the taxable year in which the trees
were planted.
If a taxpayer makes this election with
respect to any plant, the taxpayer must
treat the plant as section 1245 property.
In addition, the taxpayer, and any person
related to the taxpayer, must use the alter-
native depreciation system of section
168(g)(2) for any property used predomi-
nantly in a farming business that is placed
in service in a taxable year for which the
election is in effect.
Casualty Loss Exception
Section 263A(d) provides an exception
from capitalization for preproductive pe-
riod costs incurred with respect to plants
that are replacing certain plants that were
lost by reason of certain casualties. The
temporary regulations clarify that this ex-
ception for preproductive period costs
does not apply to preparatory expendi-
tures or the costs of capital assets. In ad-
dition, the temporary regulations clarify
that the casualty loss exception applies
whether the plants are replanted on the
same parcel of land as the plants de-
stroyed by casualty or a parcel of land of
the same acreage in the United States.
The temporary regulations additionally
clarify that the exception applies to all
plants replanted on such acreage, even if
the plants are replanted in greater density
than the plants destroyed by the casualty.
Final Regulations
In final regulations, cross references to
§1.263A–4Tare provided in §§1.61–4,
1.162–12, 1.263A–1, and 1.471–6.
Under §1.471–6(f), taxpayers using the
unit livestock method may not subse-
quently change the classification or unit
costs they initially adopted without ob-
taining the approval of the Commissioner.
As provided in Notice 88–24, the final
regulations modify the rule in §1.471–6(f)
and require that taxpayers adjust the unit
prices upward from time to time, to re-
flect increases in costs taxpayers experi-
ence in raising livestock. Any other
changes in the classification or unit prices
used in the unit- livestock-price method
will continue to be allowed only with the
consent of the Commissioner.
Effective Date And Transitional Rule
The temporary regulations provide
that, in the case of property that is not in-
ventory in the hands of the taxpayer, the
regulations are generally effective for
costs incurred on or after August 22,
1997, in taxable years ending after such
date. In the case of inventory property,
the temporary regulations are generally
effective for taxable years beginning after
August 22, 1997. However, taxpayers in
compliance with §1.263A–4Tin effect
1997–38 I.R.B.7September 22, 1997

prior to August 22, 1997 (See 26 CFR
part 1 edition revised as of April 1,
1997.), as modified by other administra-
tive guidance, that continue to comply
with §1.263A–4Tin effect prior to August
22, 1997 (See 26 CFR part 1 edition re-
vised as of April 1, 1997.), as modified by
other administrative guidance, will not be
required to apply these new temporary
rules until the notice of proposed rulemak-
ing that cross-references these temporary
regulations is finalized. The amendment
to §1.471–6(f) is effective for taxable
years beginning after August 22, 1997.
Effect on Other Documents
The following publications will be
obsolete when the notice of proposed
rulemaking that cross-references these
temporary regulations is finalized: Notice
87–76, 1987–2 C.B. 384; Notice 88–24,
1988–1 C.B. 491; and section Vof Notice
88–86, 1988–2 C.B. 401.
Special Analyses
It has been determined that this Trea-
sury decision is not a significant regula-
tory action as defined in EO 12866.
Therefore, a regulatory assessment is not
required. It has also been determined that
section 553(b) of the Administrative Pro-
cedure Act (5 U.S.C. chapter 5) does not
apply to these regulations, and because
the regulations do not impose a collection
of information on small entities, the Reg-
ulatory Flexibility Act (5 U.S.C. chapter
6) does not apply. Pursuant to section
7805(f) of the Internal Revenue Code, the
temporary regulations will be submitted,
and the notice of proposed rulemaking
that preceded the final regulations were
submitted, to the Chief Counsel for Advo-
cacy of the Small Business Administra-
tion for comment on their impact on small
business.
Drafting Information
The principal author of these temporary
regulations is Jan Skelton of the Office of
Assistant Chief Counsel (Income Tax and
Accounting). However, other personnel
from the IRS and Treasury Department
participated in their development.
* * * * *
Adoption of Amendments to the
Regulations
Accordingly, 26 CFR Part 1 is
amended as follows:
PART1—INCOME TAXES
Paragraph 1. The authority citation for
part 1 continues to read in part as follows:
Authority: 26 U.S.C. 7805 * * *
§1.61–4 [Amended]
Par. 2. Section 1.61–4 is amended by:
1. Adding a new sentence “See section
263Afor rules regarding costs that are re-
quired to be capitalized.” at the end of the
concluding text of paragraph (a).
2. Adding a new sentence “See section
263Afor rules regarding costs that are re-
quired to be capitalized.” after the fourth
sentence of the concluding text of para-
graph (b).
§1.162–12 [Amended]
Par. 3. Section 1.162-12(a) is amended
by:
1. Removing the eighth sentence, and
adding the sentence “For rules regarding
the capitalization of expenses of produc-
ing property in the trade or business of
farming, see section 263Aand §1.263A–
4T.” in its place.
2. Adding a new sentence “For rules
regarding the capitalization of expenses
of producing property in the trade or busi-
ness of farming, see section 263Aand the
regulations thereunder.” after the third
sentence.
Par. 4. Section 1.263A-0Tis added to
read as follows:
§1.263A–0TOutline of regulations under
section 263A(temporary).
This section lists the paragraphs in
§1.263A–4T.
§1.263A–4TRules for property produced
in a farming business (temporary).
(a)Introduction.
(1)In general.
(2)Exception.
(i)In general.
(ii)Tax shelter.
(iii)Presumption.
(iv)Costs required to be capitalized or
inventoried under another provision.
(v)Examples.
(3)Farming business.
(i)In general.
(A)Plant.
(B)Animal.
(ii)Incidental activities.
(A)In general.
(B)Activities that are not incidental.
(1)In general.
(2)Examples.
(b)Application of section 263Ato
property produced in a farming business.
(1)In general.
(i)Plants.
(ii)Animals.
(2)Preproductive period.
(i)Plant.
(A)In general.
(B)Applicability of section 263A.
(C)Actual preproductive period.
(1)Beginning of the preproductive
period.
(2)End of the preproductive period.
(i)In general.
(ii)Marketable quantities.
(D)Examples.
(ii)Animal.
(A)Beginning of the preproductive
period.
(B)End of the preproductive period.
(C)Allocation of costs between ani-
mal and first yield.
(c)Inventory methods.
(1)In general.
(2)Available for property used in a
trade or business.
(3)Exclusion of property to which
section 263Adoes not apply.
(d)Election not to have section 263A
apply.
(1)Introduction.
(2)Availability of the election.
(3)Time and manner of making the
election.
(4)Special rules.
(i)Section 1245 treatment.
(ii)Required use of alternative depre-
ciation system.
(iii)Related person.
(A)In general.
(B)Members of family.
(5)Examples.
(e)Exception for certain costs result-
ing from casualty losses.
(1)In general.
(2)Ownership.
(3)Examples.
September 22, 199781997–38 I.R.B.

(4)Special rule for citrus and almond
groves.
(i)In general.
(ii)Example.
(f)Effective date and transition rule.
§1.263A–1 [Amended]
Par. 5. Section 1.263A–1 is amended
by:
1. Removing the last sentence of para-
graph (b)(3) and adding the sentence “See
§1.263A–4Tfor specific rules relating to
taxpayers engaged in the trade or business
of farming.” in its place.
2. Removing the last sentence of para-
graph (b)(4) and adding the sentence “See
§1.263A–4T, however, for rules relating
to taxpayers producing certain trees to
which section 263Aapplies.” in its place.
Par. 6. Section 1.263A–4Tis revised to
read as follows:
§1.263A–4TRules for property produced
in a farming business (temporary).
(a) Introduction—(1) In general.The
regulations under this section provide
guidance with respect to the application
of section 263Ato property produced in a
farming business as defined in paragraph
(a)(3) of this section. Except as otherwise
provided by the rules of this section, the
general rules of §§1.263A–1 through
1.263A–3 and 1.263A–7 through 1.263A–
15 apply to property produced in a farm-
ing business. Ataxpayer that engages in
the raising or growing of any agricultural
or horticultural commodity, including
both plants and animals, is engaged in the
production of property. Section 263A
generally requires the capitalization of the
direct costs and an allocable portion of the
indirect costs that benefit or are incurred
by reason of the production of this prop-
erty. Taxpayers that do not qualify for the
exception described in paragraph (a)(2) of
this section must capitalize these costs of
producing all plants and animals unless
the election described in paragraph (d) of
this section is made.
(2) Exception—(i) In general.Atax-
payer is not required to capitalize the pre-
productive period costs of producing
plants with a preproductive period of 2
years or less or the costs of producing ani-
mals, if the taxpayer is not—
(A) Acorporation or partnership re-
quired to use an accrual method of ac-
counting (accrual method) under section
447 in computing its taxable income from
farming; or
(B) Atax shelter required to use an ac-
crual method under section 448(a)(3).
(ii) Tax shelter.Afarming business is
considered a tax shelter, and thus a tax-
payer required to use an accrual method
under section 448(a)(3), if the farming
business is—
(A) Afarming syndicate as defined in
section 464(c); or
(B) Atax shelter, within the meaning
of section 6662(d)(2)(C)(iii).
(iii) Presumption.Marketed arrange-
ments in which persons carry on farming
activities using the services of a common
managerial or administrative service will
be presumed to have the principal purpose
of tax avoidance, within the meaning of
section 6662(d)(2)(C)(iii), if such persons
prepay a substantial portion of their farm-
ing expenses with borrowed funds.
(iv) Costs required to be capitalized or
inventoried under another provision. The
exception from capitalization provided in
this paragraph (a)(2) does not apply to
any cost that is required to be capitalized
or inventoried under another Code or reg-
ulatory provision, such as section 263 or
section 471.
(v) Examples.The following exam-
ples illustrate the provisions of this para-
graph (a)(2):
Example 1.Farmer Agrows trees that have a
preproductive period in excess of 2 years, and that
produce an annual crop. Farmer Ais not required by
section 447 or 448(a)(3) to use an accrual method.
Accordingly, Farmer Aqualifies for the exception
described in this paragraph (a)(2). Since the trees
have a preproductive period in excess of 2 years,
Farmer Amust capitalize the direct costs and an al-
locable portion of the indirect costs that benefit or
are incurred by reason of the production of the trees.
Since the annual crop has a preproductive period of
2 years or less, Farmer Ais not required to capitalize
the costs of the crops.
Example 2. Assume the same facts as Example 1,
except that Farmer Ais required by section 447 or
448(a)(3) to use an accrual method. Farmer Adoes
not qualify for the exception described in this para-
graph (a)(2). Farmer Ais required to capitalize the
direct costs and an allocable portion of the indirect
costs that benefit or are incurred by reason of the
production of the trees and crops, including all pre-
productive period costs.
(3) Farming business—(i) In general.
Afarming business means a trade or busi-
ness involving the cultivation of land or
the raising or harvesting of any agricul-
tural or horticultural commodity. Exam-
ples include the trade or business of oper-
ating a nursery or sod farm; the raising or
harvesting of trees bearing fruit, nuts, or
other crops; the raising of ornamental
trees (other than evergreen trees that are
more than 6 years old at the time they are
severed from their roots); and the raising,
shearing, feeding, caring for, training, and
management of animals. For purposes of
this section, the term harvesting does not
include contract harvesting of an agricul-
tural or horticultural commodity grown or
raised by another. Similarly, the trade or
business of merely buying and reselling
plants or animals grown or raised by an-
other is not a farming business.
(A) Plant.Aplant produced in a farm-
ing business includes, but is not limited
to, a fruit, nut, or other crop bearing tree,
an ornamental tree, a vine, a bush, sod,
and the crop or yield of a plant that will
have more than one crop or yield. Sea
plants are produced in a farming business
if they are tended and cultivated as op-
posed to merely harvested.
(B) Animal.An animal produced in a
farming business includes, but is not lim-
ited to, any stock, poultry or other bird,
and fish or other sea life raised by the tax-
payer. Thus, for example, the term ani-
mal may include a cow, chicken, emu, or
salmon raised by the taxpayer. Fish and
other sea life are produced in a farming
business if they are raised on a fish farm.
Afish farm is an area where fish or other
sea life are grown or raised as opposed to
merely caught or harvested.
(ii) Incidental activities—(A) In gen-
eral.Farming business includes process-
ing activities that are normally incident to
the growing, raising, or harvesting of
agricultural products. For example, a tax-
payer in the trade or business of growing
fruits and vegetables may harvest, wash,
inspect, and package the fruits and veg-
etables for sale. Such activities are nor-
mally incident to the raising of these
crops by farmers. The taxpayer will be
considered to be in the trade or business
of farming with respect to the growing of
fruits and vegetables and the processing
activities incident to their harvest.
(B) Activities that are not incidental—
(1) In general.Farming business does not
include the processing of commodities or
products beyond those activities that are
normally incident to the growing, raising,
or harvesting of such products.
(2) Examples.The following exam-
ples illustrate the provisions of this para-
graph (a)(3)(ii):
1997–38 I.R.B.9September 22, 1997

Example 1.Individual Ais in the business of
growing and harvesting wheat and other grains. In-
dividual Aalso processes grain that Individual Ahas
harvested in order to produce breads, cereals, and
other similar food products, which Individual Athen
sells to customers in the course of its business. Al-
though Individual Ais in the farming business with
respect to the growing and harvesting of grain, Indi-
vidual Ais not in the farming business with respect
to the processing of such grain to produce the food
products.
Example 2.Individual B is in the business of
raising poultry and other livestock. Individual B
also operates a meat processing operation in which
the poultry and other livestock are slaughtered,
processed, and packaged or canned. The packaged
or canned meat is sold to Individual B’s customers.
Although Individual B is in the farming business
with respect to the raising of poultry and other live-
stock, Individual B is not in the farming business
with respect to the slaughtering, processing, packag-
ing, and canning of such animals to produce the food
products.
(b) Application of section 263Ato
property produced in a farming busi-
ness—(1) In general.Unless otherwise
provided in this section, section 263Are-
quires the capitalization of the direct costs
and an allocable portion of the indirect
costs that benefit or are incurred by rea-
son of the production of any property in a
farming business (including animals and
plants without regard to the length of their
preproductive period).
(i) Plants.Costs typically required to
be capitalized under section 263Ainclude
the acquisition costs of the seed, seedling,
or plant, and the costs of planting, culti-
vating, maintaining, or developing such
plant during the preproductive period.
These costs include, but are not limited to,
management, irrigation, pruning, fertiliz-
ing (including costs that the taxpayer has
elected to deduct under section 180), soil
and water conservation (including costs
that the taxpayer has elected to deduct
under section 175), frost protection,
spraying, upkeep, electricity, tax depreci-
ation and repairs on buildings and equip-
ment used in raising the plants, farm over-
head, taxes (except state and federal
income taxes), and interest required to be
capitalized under section 263A(f).
(ii) Animals.Costs typically required
to be capitalized under section 263Ain-
clude the acquisition cost of the animal,
and the costs of raising or caring for such
animal during the preproductive period.
Preproductive period costs include, but
are not limited to, the costs of manage-
ment, feed (such as grain, silage, concen-
trates, supplements, haylage, hay, pasture
and other forages), maintaining pasture or
pen areas (including costs that the tax-
payer has elected to deduct under sections
175 or 180), breeding, artificial insemina-
tion, veterinary services and medicine,
livestock hauling, bedding, fuel, electric-
ity, hired labor, tax depreciation and re-
pairs on buildings and equipment used in
raising the animals (for example, barns,
trucks, and trailers), farm overhead, taxes
(except state and federal income taxes),
and interest required to be capitalized
under section 263A(f).
(2) Preproductive period—(i) Plant—
(A) In general.The preproductive period
of property produced in a farming busi-
ness means —
(1) In the case of a plant that will have
more than one crop or yield, the period
before the first marketable crop or yield
from such plant;
(2) In the case of the crop or yield of a
plant that will have more than one crop or
yield, the period before such crop or yield
is disposed of; or
(3) In the case of any other plant, the
period before such plant is disposed of.
(B) Applicability of section 263A.For
purposes of determining whether a plant
has a preproductive period in excess of 2
years, the preproductive period of plants
grown in commercial quantities in the
United States is based on the nationwide
weighted average preproductive period
for such plant. For all other plants, the
taxpayer is required, at or before the time
the seed or plant is acquired or planted, to
reasonably estimate the preproductive pe-
riod of the plant. If the taxpayer estimates
a preproductive period in excess of 2
years, the taxpayer must capitalize pre-
productive period costs. If the estimate is
reasonable, based on the facts in existence
at the time it is made, the determination of
whether section 263Aapplies is not modi-
fied at a later time even if the actual
length of the preproductive period differs
from the estimate. The actual length of
the preproductive period will, however,
be considered in evaluating the reason-
ableness of the taxpayer’s future esti-
mates. Thus, the nationwide weighted av-
erage preproductive period or the
estimated preproductive period are only
used for purposes of determining whether
the preproductive period of a plant is
greater than 2 years.
(C) Actual preproductive period.The
plant’s actual preproductive period is used
for purposes of determining the period
during which a taxpayer must capitalize
preproductive period costs with respect to
a particular plant.
(1) Beginning of the preproductive pe-
riod.The actual preproductive period of a
plant begins when the taxpayer first in-
curs costs that directly benefit or are in-
curred by reason of the plant. Generally,
this occurs when the taxpayer plants the
seed or plant. In the case of a taxpayer
that acquires plants that have already been
planted, or plants that are tended, by the
taxpayer or another, prior to permanent
planting, the actual preproductive period
of the plant begins upon acquisition of the
plant by the taxpayer. In the case of the
crop or yield of a plant that will have
more than one crop or yield and that has
become productive in marketable quanti-
ties, the actual preproductive period be-
gins when the crop or yield first appears,
for example, in the form of a sprout,
bloom, blossom, or bud.
(2) End of the preproductive period—
(i) In general.In the case of a plant that
will have more than one crop or yield, the
actual preproductive period ends when
the plant first becomes productive in mar-
ketable quantities. In the case of any
other plant (including the crop or yield of
a plant that will have more than one crop
or yield), the actual preproductive period
ends when the plant, crop, or yield is sold
or otherwise disposed of.
(ii) Marketable quantities.Aplant that
will have more than one crop or yield be-
comes productive in marketable quanti-
ties when it is (or would be considered)
placed in service for purposes of section
168 (without regard to the applicable con-
vention).
(D) Examples.The following exam-
ples illustrate the provisions of this para-
graph (b)(2)(i):
Example 1.(i) Farmer A, a taxpayer that quali-
fies for the exception in paragraph (a)(2) of this sec-
tion, grows plants that will have more than one crop
or yield. The plants are grown in commercial quan-
tities in the United States. Farmer Aacquires the
plants by purchasing them from an unrelated party,
Corporation B, and plants them immediately. The
nationwide weighted average preproductive period
of the plant is 4 years. The particular plants grown
by Farmer Ado not begin to produce in marketable
quantities until 4 years and 6 months after they are
planted by Farmer A.
(ii) Since the plants are deemed to have a prepro-
ductive period in excess of 2 years, Farmer Ais re-
quired to capitalize the preproductive period costs of
the plants. See paragraphs (a)(2) and (b)(2)(i)(B) of
this section. In accordance with paragraph
September 22, 1997101997–38 I.R.B.

(b)(2)(i)(C)(1) of this section, Farmer Amust begin
to capitalize such costs when the plants are planted.
In accordance with paragraph (b)(2)(i)(C)(2) of this
section, Farmer Amust continue to capitalize costs
to the plants until the plants begin to produce in mar-
ketable quantities. Thus, Farmer Amust capitalize
the preproductive period costs of the plants for a pe-
riod of 4 years and 6 months, notwithstanding the
fact that the plants, in general, have a nationwide
weighted average preproductive period of 4 years.
Example 2. (i) Farmer B, a taxpayer that quali-
fies for the exception in paragraph (a)(2) of this sec-
tion, grows plants that will have more than one crop
or yield. The plants are grown in commercial quan-
tities in the United States. The nationwide weighted
average preproductive period of the plant is 2 years
and 5 months. Farmer B acquires the plants by pur-
chasing them from an unrelated party, Corporation
B. Farmer B enters into a contract with Corporation
B under which Corporation B will retain and tend
the plants for 7 months following the sale. At the
end of 7 months, Farmer B takes possession of the
plants and plants them in the permanent orchard.
The plants become productive in marketable quanti-
ties 1 years and 11 months after they are planted by
Farmer B.
(ii) Since the plants are deemed to have a prepro-
ductive period in excess of 2 years, Farmer B is re-
quired to capitalize the preproductive period costs of
the plants. See paragraphs (a)(2) and (b)(2)(i)(B) of
this section. In accordance with paragraph
(b)(2)(i)(C)(1) of this section, Farmer B must begin
to capitalize such costs when the purchase occurs.
In accordance with paragraph (b)(2)(i)(C)(2) of this
section, Farmer B must continue to capitalize costs
to the plants until the plants begin to produce in mar-
ketable quantities. Thus, Farmer B must capitalize
the preproductive period costs of the plants for a pe-
riod of 2 years and 6 months (the 7 months the
plants are tended by Corporation B and the 1 year
and 11 months after the plants are planted by Farmer
B), notwithstanding the fact that the plants, in gen-
eral, have a nationwide weighted average prepro-
ductive period of 2 years and 5 months.
Example 3.(i) Assume the same facts as in Ex-
ample 2, except that Farmer B acquires the plants by
purchasing them from Corporation B when the
plants are 7 months old and that the plants are
planted by Farmer B upon acquisition.
(ii) Since the plants are deemed to have a prepro-
ductive period in excess of 2 years, Farmer B is re-
quired to capitalize the preproductive period costs of
the plants. See paragraphs (a)(2) and (b)(2)(i)(B) of
this section. In accordance with paragraph
(b)(2)(i)(C)(1) of this section, Farmer B must begin
to capitalize such costs when the plants are planted.
In accordance with paragraph (b)(2)(i)(C)(2) of this
section, Farmer B must continue to capitalize costs
to the plants until the plants begin to produce in mar-
ketable quantities. Thus, Farmer B must capitalize
the preproductive period costs of the plants for a pe-
riod of 1 year and 11 months.
Example 4.(i) Farmer C, a taxpayer that quali-
fies for the exception in paragraph (a)(2) of this sec-
tion, grows plants that will have more than one crop
or yield. The plants are grown in commercial quan-
tities in the United States. Farmer C acquires the
plants from an unrelated party and plants them im-
mediately. The nationwide weighted average pre-
productive period of the plant is 2 years and 3
months. The particular plants grown by Farmer C
begin to produce in marketable quantities 1 year and
10 months after they are planted by Farmer C.
(ii) Since the plants are deemed to have a nation-
wide weighted average preproductive period in ex-
cess of 2 years, Farmer C is required to capitalize the
preproductive period costs of the plants, notwith-
standing the fact that the particular plants grown by
Farmer C become productive in less than 2 years.
See paragraph (b)(2)(i)(B) of this section. In accor-
dance with paragraph (b)(2)(i)(C)(1) of this section,
Farmer C must begin to capitalize such costs when it
plants the plants. In accordance with paragraph
(b)(2)(i)(C)(2) of this section, Farmer C properly
ceases capitalization of preproductive period costs
when the plants become productive in marketable
quantities (i.e., after 1 year and 10 months).
Example 5.(i) Farmer D, a taxpayer that quali-
fies for the exception in paragraph (a)(2) of this sec-
tion, grows plants that will have more than one crop
or yield. The plants are not grown in commercial
quantities in the United States. At the time the plants
are planted Farmer D reasonably estimates that the
plants will have a preproductive period of 4 years.
The actual plants grown by Farmer D do not begin to
produce in marketable quantities until 4 years and 6
months after they are planted by Farmer D.
(ii) Since the plants have an estimated prepro-
ductive period in excess of 2 years, Farmer D is re-
quired to capitalize the preproductive period costs of
the plants. See paragraph (b)(2)(i)(B) of this sec-
tion. In accordance with paragraph (b)(2)(i)(C)(1)
of this section, Farmer D must begin to capitalize
such costs when it plants the plants. In accordance
with paragraph (b)(2)(i)(C)(2) of this section,
Farmer D must continue to capitalize costs until the
plants begin to produce in marketable quantities.
Thus, Farmer D must capitalize the preproductive
period costs of the plants for a period of 4 years and
6 months, notwithstanding the fact that Farmer D es-
timated that the plants would become productive
after 4 years.
Example 6.(i) Farmer E, a taxpayer that quali-
fies for the exception in paragraph (a)(2) of this sec-
tion grows plants that are not grown in commercial
quantities in the United States. The plants do not
have more than 1 crop or yield. At the time the
plants are planted Farmer E reasonably estimates
that the plants will have a preproductive period of 1
year and 10 months. The actual plants grown by
Farmer E are not ready for harvesting and disposal
until 2 years and 2 months after the seeds are planted
by Farmer E.
(ii) Because Farmer E’s estimate of the prepro-
ductive period (which was 2 years or less) was rea-
sonable at the time made based on the facts, Farmer
E will not be required to capitalize the preproductive
period costs of the plants notwithstanding the fact
that the actual preproductive period of the plants ex-
ceeded 2 years. See paragraph (b)(2)(i)(B) of this
section. However, Farmer E must take the actual
preproductive period of the plants into consideration
when making future estimates of the preproductive
period of such plants.
Example 7.Farmer F, a calendar year taxpayer
that does not qualify for the exception in paragraph
(a)(2) of this section, grows trees that will have more
than one crop. Farmer F acquires and plants the
trees in April, 1998. On October 1, 2003, the trees
are placed in service within the meaning of section
168. Under paragraph (b)(2)(i)(C)(2)(ii) of this sec-
tion, the trees become productive in marketable
quantities on October 1, 2003. The preproductive
period costs incurred by Farmer F on or before Oc-
tober 1, 2003, are capitalized to the trees. Prepro-
ductive period costs incurred after October 1, 2003,
are capitalized to a crop when incurred during the
preproductive period of the crop and expensed when
incurred between the disposal of one crop and the
appearance of the next crop. Seeparagraphs
(b)(2)(i)(A), (b)(2)(i)(C)(1) and (b)(2)(i)(C)(2) of
this section.
(ii) Animal.An animal’s actual pre-
productive period is used to determine the
period that the taxpayer must capitalize
preproductive period expenses with re-
spect to a particular animal.
(A) Beginning of the preproductive pe-
riod.The preproductive period of an ani-
mal begins at the time of acquisition,
breeding, or embryo implantation.
(B) End of the preproductive period.
In the case of an animal that will be used
in the trade or business of farming (e.g., a
dairy cow), the preproductive period gen-
erally ends when the animal is (or would
be considered) placed in service for pur-
poses of section 168 (without regard to
the applicable convention). However, in
the case of an animal that will have more
than one yield (e.g., a breeding cow), the
preproductive period ends when the ani-
mal produces (e.g., gives birth to) its first
yield. In the case of any other animal, the
preproductive period ends when the ani-
mal is sold or otherwise disposed of.
(C) Allocation of costs between animal
and first yield.In the case of an animal
that will have more than one yield, the
costs incurred after the beginning of the
preproductive period of the first yield but
before the end of the preproductive period
of the animal must be allocated between
the animal and the yield on a reasonable
basis. Any depreciation allowance on the
animal may be allocated entirely to the
yield. The allocation method used by a
taxpayer is a method of accounting that
must be used consistently and is subject to
the rules of section 446 and the regula-
tions thereunder.
(c) Inventory methods—(1) In gen-
eral.Except as otherwise provided, the
costs required to be allocated to any plant
or animal under this section may be deter-
mined using reasonable inventory valua-
tion methods such as the farm-price
method or the unit-livestock-price
method. See §1.471–6. Under the unit-
livestock-price method, unit prices must
include all costs required to be capitalized
under section 263A. Ataxpayer using the
unit-livestock-price method may elect to
use the cost allocation methods in
§1.263A–1(f) or 1.263A–2(b) to allocate
its direct and indirect costs to the property
produced in the business of farming. In
such a situation, section 471 costs are the
costs taken into account by the taxpayer
under the unit-livestock-price method
using the taxpayer’s standard unit price as
modified by this paragraph (c)(1). The
1997–38 I.R.B.11September 22, 1997

term additional section 263Acosts in-
cludes all additional costs required to be
capitalized under section 263A. Tax shel-
ters, as defined in paragraph (a)(2)(ii) of
this section, that use the unit-livestock-
price method for inventories must include
in inventory the annual standard unit price
for all animals that are acquired during
the taxable year, regardless of whether the
purchases are made during the last 6
months of the taxable year. Taxpayers re-
quired by section 447 or 448(a)(3) to use
an accrual method that use the unit-live-
stock-price method must modify the an-
nual standard price in order to reasonably
reflect the particular period in the taxable
year in which purchases of livestock are
made, if such modification is necessary in
order to avoid significant distortions in in-
come that would otherwise occur through
operation of the unit livestock method.
(2) Available for property used in a
trade or business.The farm price method
or the unit livestock method may be used
by any taxpayer to allocate costs to any
plant or animal under this section, regard-
less of whether the plant or animal is held
or treated as inventory property by the
taxpayer. Thus, for example, a taxpayer
may use the unit livestock method to ac-
count for the costs of raising livestock
that will be used in the trade or business
of farming (e.g., a breeding animal or a
dairy cow) even though the property in
question is not inventory property.
(3) Exclusion of property to which sec-
tion 263Adoes not apply. Notwithstand-
ing a taxpayer’s use of the farm price
method with respect to farm property to
which the provisions of section 263A
apply, that taxpayer is not required, solely
by such use, to use the farm price method
with respect to farm property to which the
provisions of section 263Ado not apply.
Thus, for example, assume Farmer A
raises fruit trees that have a preproductive
period in excess of 2 years and to which
the provisions of section 263A, therefore,
apply. Assume also that Farmer Araises
cattle and is not required to use an accrual
method by section 447 or 448(a)(3). Be-
cause Farmer Aqualifies for the exception
in paragraph (a)(2) of this section, Farmer
Ais not required to capitalize the costs of
raising the cattle. Although Farmer A
may use the farm price method with re-
spect to the fruit trees, Farmer Ais not re-
quired to use the farm price method with
respect to the cattle. Instead, Farmer A’s
accounting for the cattle is determined
under other provisions of the Code and
regulations.
(d) Election not to have section 263A
apply—(1) Introduction.This paragraph
(d) permits certain taxpayers to make an
election not to have the rules of this sec-
tion apply to any plant produced in a
farming business conducted by the elect-
ing taxpayer. The election is a method of
accounting under section 446, and once
an election is made, it is revocable only
with the consent of the Commissioner.
(2) Availability of the election.The
election described in this paragraph (d) is
available to any taxpayer that produces
plants in a farming business, except that
no election may be made by a corpora-
tion, partnership, or tax shelter required to
use the accrual method under section 447
or 448(a)(3). Moreover, the election does
not apply to the costs of planting, cultiva-
tion, maintenance, or development of a
citrus or almond grove (or any part
thereof) incurred prior to the close of the
fourth taxable year beginning with the
taxable year in which the trees were
planted in the permanent grove (including
costs incurred prior to the permanent
planting). If a citrus or almond grove is
planted in more than one taxable year, the
portion of the grove planted in any one
taxable year is treated as a separate grove
for purposes of determining the year of
planting.
(3) Time and manner of making the
election.Ataxpayer makes the election
under this paragraph (d) by not capitaliz-
ing the preproductive period costs of pro-
ducing property in a farming business and
by applying the special rules in paragraph
(d)(4) of this section, on its timely filed
original return (including extensions) for
the first taxable year in which the tax-
payer is otherwise required to capitalize
preproductive period costs under section
263A. Thus, in order to be treated as hav-
ing made the election under this para-
graph (d), it is necessary to report both in-
come and expenses in accordance with
the rules of this paragraph (d) (e.g., it is
necessary to use the alternative deprecia-
tion system as provided in paragraph
(d)(4)(ii) of this section). Thus, for exam-
ple, a farmer who deducts preproductive
period costs that are otherwise required to
be capitalized under section 263Abut
fails to use the alternative depreciation
system under section 168(g)(2) for applic-
able property placed in service has not
made an election under this paragraph (d)
and is not in compliance with the provi-
sions of section 263A. In the case of a
partnership or S corporation, the election
must be made by the partner, shareholder,
or member.
(4) Special rules.If the election under
this paragraph (d) is made, the taxpayer is
subject to the special rules in this para-
graph (d)(4).
(i) Section 1245 treatment.The plant
produced by the taxpayer is treated as sec-
tion 1245 property and any gain resulting
from any disposition of the plant is recap-
tured (i.e., treated as ordinary income) to
the extent of the total amount of the de-
ductions that, but for the election, would
have been required to be capitalized with
respect to the plant. In calculating the
amount of gain that is recaptured under
this paragraph (d)(4)(i), a taxpayer may
use the farm price method or another sim-
plified method permitted under these reg-
ulations in determining the deductions
that otherwise would have been capital-
ized with respect to the plant.
(ii) Required use of alternative depre-
ciation system.If the taxpayer or a re-
lated person makes an election under this
paragraph (d), the alternative depreciation
system (as defined in section 168(g)(2))
must be applied to all property used pre-
dominantly in any farming business of the
taxpayer or related person and placed in
service in any taxable year during which
the election is in effect. The requirement
to use the alternative depreciation system
by reason of an election under this para-
graph (d) will not prevent a taxpayer from
making an election under section 179 to
deduct certain depreciable business as-
sets.
(iii) Related person—(A) In general.
For purposes of this paragraph (d)(4), re-
lated person means —
(1) The taxpayer and members of the
taxpayer’s family;
(2) Any corporation (including an S
corporation) if 50 percent or more of the
stock (in value) is owned directly or indi-
rectly (through the application of section
318) by the taxpayer or members of the
taxpayer’s family;
(3) Acorporation and any other corpo-
ration that is a member of the same con-
September 22, 1997121997–38 I.R.B.

trolled group (within the meaning of sec-
tion 1563(a)(1)); and
(4) Any partnership if 50 percent or
more (in value) of the interests in such
partnership is owned directly or indirectly
by the taxpayer or members of the tax-
payer’s family.
(B) Members of family.For purposes
of this paragraph (d)(4)(iii), members of
the taxpayer’s family,and members of
family(for purposes of applying section
318(a)(1)), means the spouse of the tax-
payer (other than a spouse who is legally
separated from the individual under a de-
cree of divorce or separate maintenance)
and any of the taxpayer’s children (in-
cluding legally adopted children) who
have not reached the age of 18 as of the
last day of the taxable year in question.
(5) Examples.The following exam-
ples illustrate the provisions of this para-
graph (d):
Example 1.(i) Farmer A, an individual, is en-
gaged in the trade or business of farming. Farmer A
grows apple trees that have a preproductive period
greater than 2 years. In addition, Farmer Agrows
and harvests wheat and other grains. Farmer A
elects under this paragraph (d) not to have the rules
of section 263Aapply to the preproductive period
costs of growing the apple trees.
(ii) In accordance with paragraph (d)(4) of this
section, Farmer Ais required to use the alternative
depreciation system described in section 168(g)(2)
with respect to all property used predominantly in
any farming business in which Farmer Aengages
(including the growing and harvesting of wheat) if
such property is placed in service during a year for
which the election is in effect. Thus, for example,
all assets and equipment (including trees and any
equipment used to grow and harvest wheat) placed
in service during a year for which the election is in
effect must be depreciated as provided in section
168(g)(2).
Example 2.Assume the same facts as in Example
1,except that Farmer Aand members of Farmer A’s
family (as defined in paragraph (d)(4)(iii)(B) of this
section) also own 51 percent (in value) of the inter-
ests in Partnership P, which is engaged in the trade
or business of growing and harvesting corn. Part-
nership Pis a related person to Farmer Aunder the
provisions of paragraph (d)(4)(iii) of this section.
Thus, the requirements to use the alternative depre-
ciation system under section 168(g)(2) also apply to
any property used predominantly in a trade or busi-
ness of farming which Partnership Pplaces in ser-
vice during a year for which an election made by
Farmer Ais in effect.
(e) Exception for certain costs result-
ing from casualty losses—(1) In general.
Section 263Adoes not require the capital-
ization of costs that are attributable to the
replanting, cultivating, maintaining, and
developing of any plants bearing an edi-
ble crop for human consumption (includ-
ing, but not limited to, plants that consti-
tute a grove, orchard, or vineyard) that
were lost or damaged while owned by the
taxpayer by reason of freezing tempera-
tures, disease, drought, pests, or other ca-
sualty (replanting costs). Such replanting
costs may be incurred with respect to
property other than the property on which
the damage or loss occurred to the extent
the acreage of the property with respect to
which the replanting costs are incurred is
not in excess of the acreage of the prop-
erty on which the damage or loss oc-
curred. This paragraph (e) applies only to
the replanting of plants of the same type
as those lost or damaged. This paragraph
(e) applies to plants replanted on the prop-
erty on which the damage or loss occurred
or property of the same or lesser acreage
in the United States irrespective of differ-
ences in density between the lost or dam-
aged and replanted plants. Plants bearing
crops for human consumption are those
crops normally eaten or drunk by humans.
Thus, for example, costs incurred with re-
spect to replanting plants bearing jojoba
beans do not qualify for the exception
provided in this paragraph (e) because
that crop is not normally eaten or drunk
by humans.
(2) Ownership.Replanting costs de-
scribed in paragraph (e)(1) of this section
generally must be incurred by the tax-
payer that owned the property at the time
the plants were lost or damaged. Para-
graph (e)(1) of this section will apply,
however, to costs incurred by a person
other than the taxpayer that owned the
plants at the time of damage or loss if—
(i) The taxpayer that owned the plants
at the time the damage or loss occurred
owns an equity interest of more than 50
percent in such plants at all times during
the taxable year in which the replanting
costs are paid or incurred; and
(ii) Such other person owns any por-
tion of the remaining equity interest and
materially participates in the replanting,
cultivating, maintaining, or developing of
such plants during the taxable year in
which the replanting costs are paid or in-
curred. Aperson will be treated as materi-
ally participating for purposes of this pro-
vision if such person would otherwise
meet the requirements with respect to ma-
terial participation within the meaning of
section 2032A(e)(6).
(3) Examples.The following exam-
ples illustrate the provisions of this para-
graph (e):
Example 1.(i) Farmer Tgrows cherry trees that
have a preproductive period in excess of 2 years and
produce an annual crop. These cherries are nor-
mally eaten by humans. Farmer Tgrows the trees
on a 100 acre parcel of land (parcel 1) and the
groves of trees cover the entire acreage of parcel 1.
Farmer Talso owns a 150 acre parcel of land (parcel
2) that Farmer Tholds for future use. Both parcels
are in the United States. In 1998, the trees and the
irrigation and drainage systems that service the trees
are destroyed in a casualty (within the meaning of
paragraph (e)(1) of this section). Farmer Tinstalls
new irrigation and drainage systems on parcel 1,
purchases young trees (seedlings), and plants the
seedlings on parcel 1.
(ii) The costs of the irrigation and drainage sys-
tems and the seedlings must be capitalized under
section 263A. In accordance with paragraph (e)(1)
of this section, the costs of planting, cultivating, de-
veloping, and maintaining the seedlings during their
preproductive period are not required to be capital-
ized by section 263A.
Example 2.(i) Assume the same facts as in Ex-
ample 1except that Farmer Tdecides to replant the
seedlings on parcel 2 rather than on parcel 1. Ac-
cordingly, Farmer Tinstalls the new irrigation and
drainage systems on 100 acres of parcel 2 and plants
seedlings on those 100 acres.
(ii) The costs of the irrigation and drainage sys-
tems and the seedlings must be capitalized under
section 263A. Because the acreage of the related
portion of parcel 2 does not exceed the acreage of
the destroyed orchard on parcel 1, the costs of plant-
ing, cultivating, developing, and maintaining the
seedlings during their preproductive period are not
required to be capitalized by section 263A. See
paragraph (e)(1) of this section.
Example 3.(i) Assume the same facts as in Ex-
ample 1except that Farmer Treplants the seedlings
on parcel 2 rather than on parcel 1, and Farmer Tad-
ditionally decides to expand its operations by grow-
ing 125 rather than 100 acres of trees. Accordingly,
Farmer Tinstalls new irrigation and drainage sys-
tems on 125 acres of parcel 2 and plants seedlings
on those 125 acres.
(ii) The costs of the irrigation and drainage sys-
tems and the seedlings must be capitalized under
section 263A. The costs of planting, cultivating, de-
veloping, and maintaining 100 acres of the trees dur-
ing their preproductive period are not required to be
capitalized by section 263A. The costs of planting,
cultivating, maintaining, and developing the addi-
tional 25 acres are, however, subject to capitaliza-
tion. See paragraph (e)(1) of this section.
(4) Special rule for citrus and almond
groves—(i) In general. The exception in
this paragraph (e) is available with respect
to a citrus or almond grove, notwithstand-
ing the taxpayer’s election not to have
section 263Aapply (described in para-
graph (d) of this section).
(ii) Example.The following example
illustrates the provisions of this paragraph
(e)(4):
Example.(i) Farmer A, an individual, is en-
gaged in the trade or business of farming. Farmer A
grows citrus trees that have a preproductive period
of 5 years. Farmer Aelects, under paragraph (d) of
this section, not to have section 263Aapply to the
preproductive period costs. This election, however,
is unavailable with respect to the preproductive pe-
riod costs of a citrus grove incurred within the first 4
years after the trees were planted. See paragraph
1997–38 I.R.B.13September 22, 1997

(d)(2) of this section. After the citrus grove has be-
come productive in marketable quantities, the citrus
grove is destroyed by a casualty within the meaning
of paragraph (e)(1) of this section.
(ii) Farmer Amust capitalize the preproductive
period costs incurred before the close of the fourth
taxable year beginning with the year in which the
trees were permanently planted. As a result of the
election not to have section 263Aapply to prepro-
ductive period costs, Farmer Amay deduct the pre-
productive period costs incurred in the fifth year.
The costs of replanting, cultivating, maintaining, and
developing the trees destroyed by a casualty are ex-
empted from capitalization under this paragraph (e).
(f) Effective date and transition rule.
In the case of property that is not inven-
tory in the hands of the taxpayer, this sec-
tion is generally effective for costs in-
curred on or after August 22, 1997, in
taxable years ending after such date. In
the case of inventory property, this sec-
tion is generally effective for taxable
years beginning after August 22, 1997.
However, taxpayers in compliance with
§1.263A–4Tin effect prior to August 22,
1997 (See 26 CFR part 1 edition revised
as of April 1, 1997.), and other adminis-
trative guidance, that continue to comply
with §1.263A–4Tin effect prior to August
22, 1997 (See 26 CFR part 1 edition re-
vised as of April 1, 1997.), and other ad-
ministrative guidance, will not be re-
quired to apply these new temporary rules
until final regulations are published in the
Federal Register.
§1.471–6 [Amended]
Par. 7. Section 1.471–6 is amended as
follows:
1. Adding two sentences to the end of
paragraph (c).
2. Removing the second sentence in
paragraph (d) and adding two sentences in
its place.
3. Revising the last three sentences of
paragraph (f).
The additions and revision read as fol-
lows:
§1.471–6 Inventories of livestock raisers
and other farmers.
* * * * *
(c) * * * In addition, these inventory
methods may be used to account for the
costs of property produced in a farming
business that are required to be capital-
ized under section 263Aregardless of
whether the property being produced is
otherwise treated as inventory by the tax-
payer, and regardless of whether the tax-
payer is otherwise using the cash or an ac-
crual method of accounting. Thus, for ex-
ample, the unit livestock method may be
utilized by a taxpayer in accounting under
section 263Afor the costs of raising ani-
mals that will be used for draft, breeding,
or dairy purposes.
(d) * * * If this method of valuation is
used, it generally must be applied to all
property produced by the taxpayer in the
trade or business of farming, except as to
livestock accounted for, at the taxpayer’s
election, under the unit livestock method
of accounting. However, see §1.263A–
4T(c)(3) for an exception to this rule. * * *
* * * * *
(f) * * * Except as otherwise provided
in this paragraph, once established, the
unit prices and classifications selected by
the taxpayer must be consistently applied
in all subsequent taxable years. For tax-
able years beginning after August 22,
1997, a taxpayer using the unit livestock
method must, however, annually reevalu-
ate the unit livestock prices and must ad-
just the prices upward to reflect increases
in the costs of raising livestock. The con-
sent of the Commissioner is not required
to make such upward adjustments. No
other changes in the classification of ani-
mals or unit prices shall be made without
the consent of the Commissioner. See
§1.263A–4Tfor rules regarding the com-
putation of costs for purposes of the unit
livestock method.
* * * * *
Michael P. Dolan,
Acting Commissioner of
Internal Revenue.
Approved July 28, 1997.
Donald C. Lubick,
Acting Assistant Secretary of
the Treasury.
(Filed by the Office of the Federal Register on Au-
gust 21, 1997, 8:45 a.m., and published in the issue
of the Federal Register for August 22, 1997, 62 F.R.
44542)
Section 704.—Partner’s
Distributive Share
26 CFR 1.704–1: Determination of partner’s dis-
tributive share.
(Also § 752; 1.752–2.)
Calculation of a partner’s limited
deficit restoration obligation. This rul-
ing holds that the amount of a partner’s
limited deficit restoration obligation is the
amount of money that the partner would
be required to contribute to the partner-
ship to satisfy partnership liabilities if all
partnership property were sold for the
amount of the partnership’s book basis in
the property.
Rev. Rul. 97–38
ISSUE
If a partner is treated as having a lim-
ited deficit restoration obligation under
§ 1.704–1(b)(2)(ii)(c) of the Income Tax
Regulations by reason of the partner’s lia-
bility to the partnership’s creditors, how is
the amount of that obligation calculated?
FACTS
In year 1, GPand LP,general partner
and limited partner, each contribute $100x
to form limited partnership LPRS. In gen-
eral, GPand LPshare LPRS’s income and
loss 50 percent each. However, LPRSal-
locates to GPall depreciation deductions
and gain from the sale of depreciable as-
sets up to the amount of those deductions.
LPRSmaintains capital accounts accord-
ing to the rules set forth in § 1.704– 1(b)-
(2)(iv), and the partners agree to liquidate
according to positive capital account bal-
ances under the rules of§ 1.704–1(b)(2)-
(ii)(b)(2).
Under applicable state law, GPis liable
to creditors for all partnership recourse li-
abilities, but LPhas no personal liability.
GPand LPdo not agree to unconditional
deficit restoration obligations as de-
scribed in § 1.704–1(b)(2)(ii)(b)(3) (in
general, a deficit restoration obligation re-
quires a partner to restore any deficit cap-
ital account balance following the liquida-
tion of the partner’s interest in the
partnership); GPis obligated to restore a
deficit capital account only to the extent
necessary to pay creditors. Thus, if LPRS
were to liquidate after paying all creditors
and LPhad a positive capital account bal-
ance, GPwould not be required to restore
GP’s deficit capital account to permit a
liquidating distribution to LP. In addi-
tion, GPand LPagree to a qualified in-
come offset, thus satisfying the require-
ments of the alternate test for economic
effect of § 1.704–1(b)(2)(ii)(d). GPand
LPalso agree that no allocation will be
made that causes or increases a deficit
September 22, 1997141997–38 I.R.B.

balance in any partner’s capital account in
excess of the partner’s obligation to re-
store the deficit.
LPRSpurchases depreciable property
for $1,000xfrom an unrelated seller, pay-
ing $200xin cash and borrowing the
$800xbalance from an unrelated bank that
is not the seller of the property. The note
is recourse to LPRS. The principal of the
loan is due in 6 years; interest is payable
semi-annually at the applicable federal
rate. GPbears the entire economic risk of
loss for LPRS’s recourse liability, and
GP’s basis in LPRS(outside basis) is in-
creased by $800x. See§ 1.752–2.
In each of years 1 through 5, the prop-
erty generates $200xof depreciation. All
other partnership deductions and losses
exactly equal income, so that in each of
years 1 through 5 LPRShas a net loss of
$200x.
LAWAND ANALYSIS
Under § 704(b) of the Internal Revenue
Code and the regulations thereunder, a
partnership’s allocations of income, gain,
loss, deduction, or credit set forth in the
partnership agreement are respected if
they have substantial economic effect. If
allocations under the partnership agree-
ment would not have substantial eco-
nomic effect, the partnership’s allocations
are determined according to the partners’
interests in the partnership. The funda-
mental principles for establishing eco-
nomic effect require an allocation to be
consistent with the partners’underlying
economic arrangement. Apartner allo-
cated a share of income should enjoy any
corresponding economic benefit, and a
partner allocated a share of losses or de-
ductions should bear any corresponding
economic burden. See§ 1.704–1(b)-
(2)(ii)(a).
To come within the safe harbor for es-
tablishing economic effect in § 1.704–
1(b)(2)(ii), partners must agree to main-
tain capital accounts under the rules of
§ 1.704–1(b)(2)(iv), liquidate according to
positive capital account balances, and
agree to an unconditional deficit restora-
tion obligation for any partner with a
deficit in that partner’s capital account, as
described in § 1.704–1(b)(2)(ii)(b)(3).
Alternatively, the partnership may satisfy
the requirements of the alternate test for
economic effect provided in § 1.704–
1(b)(2)(ii)(d). LPRS’s partnership agree-
ment complies with the alternate test for
economic effect.
The alternate test for economic effect
requires the partners to agree to a quali-
fied income offset in lieu of an uncondi-
tional deficit restoration obligation. If the
partners so agree, allocations will have
economic effect to the extent that they do
not create a deficit capital account for any
partner (in excess of any limited deficit
restoration obligation of that partner) as
of the end of the partnership taxable year
to which the allocation relates. Section
1.704–1(b)(2)(ii)(d)(3) (flush language).
Apartner is treated as having a limited
deficit restoration obligation to the extent
of: (1) the outstanding principal balance
of any promissory note contributed to the
partnership by the partner, and (2) the
amount of any unconditional obligation of
the partner (whether imposed by the part-
nership agreement or by state or local
law) to make subsequent contributions to
the partnership. Section 1.704–1(b)(2)-
(ii)(c).
LPhas no obligation under the partner-
ship agreement or state or local law to
make additional contributions to the part-
nership and, therefore, has no deficit
restoration obligation. Under applicable
state law, GPmay have to make addi-
tional contributions to the partnership to
pay creditors. However, GP’s obligation
only arises to the extent that the amount
of LPRS’s liabilities exceeds the value of
LPRS’s assets available to satisfy the lia-
bilities. Thus, the amount of GP’s limited
deficit restoration obligation each year is
equal to the difference between the
amount of the partnership’s recourse lia-
bilities at the end of the year and the value
of the partnership’s assets available to sat-
isfy the liabilities at the end of the year.
To ensure consistency with the other
requirements of the regulations under
§ 704(b), where a partner’s obligation to
make additional contributions to the part-
nership is dependent on the value of the
partnership’s assets, the partner’s deficit
restoration obligation must be computed
by reference to the rules for determining
the value of partnership property con-
tained in the regulations under § 704(b).
Consequently, in computing GP’s limited
deficit restoration obligation, the value of
the partnership’s assets is conclusively
presumed to equal the book basis of those
assets under the capital account mainte-
nance rules of § 1.704–1(b)(2)(iv). See
§ 1.704–1(b)(2)(ii)(d)(value equals basis
presumption applies for purposes of de-
termining expected allocations and distri-
butions under the alternate test for eco-
nomic effect); § 1.704–1(b)(2)(iii)(value
equals basis presumption applies for pur-
poses of the substantiality test); § 1.704–
1(b)(3)(iii) (value equals basis presump-
tion applies for purposes of the partner’s
interest in the partnership test); § 1.704–
2(d) (value equals basis presumption ap-
plies in computing partnership minimum
gain).
The LPRSagreement allocates all de-
preciation deductions and gain on the sale
of depreciable property to the extent of
those deductions to GP. Because LPRS’s
partnership agreement satisfies the alter-
nate test for economic effect, the alloca-
tions of depreciation deductions to GP
will have economic effect to the extent
that they do not create a deficit capital ac-
count for GPin excess of GP’s obligation
to restore the deficit balance. At the end
of year 1, the basis of the depreciable
property has been reduced to $800x. If
LPRSliquidated at the beginning of year
2, selling its depreciable property for its
basis of $800x, the proceeds would be
used to repay the $800xprincipal on
LPRS’s recourse liability. All of LPRS’s
creditors would be satisfied and GP
would have no obligation to contribute to
pay them. Thus, at the end of year 1, GP
has no obligation to restore a deficit in its
capital account.
Because GPhas no obligation to re-
store a deficit balance in its capital ac-
count at the end of year 1, an allocation
that reduces GP’s capital account below
$0 is not permitted under the partnership
agreement and would not satisfy the alter-
nate test for economic effect. An alloca-
tion of $200xof depreciation deductions
to GPwould reduce GP’s capital account
to negative $100x. Because the allocation
would result in a deficit capital account
balance in excess of GP’s obligation to re-
store, the allocation is not permitted under
the partnership agreement, and would not
satisfy the safe harbor under the alternate
test for economic effect. Therefore, the
deductions for year 1 must be allocated
1997–38 I.R.B.15September 22, 1997

September 22, 1997161997–38 I.R.B.
$100xeach to GPand LP(which is in ac-
cordance with their interests in the part-
nership).
The allocation of depreciation of $200x
to GPin year 2 has economic effect. Al-
though the allocation reduces GP’s capital
account to negative $200x, while LP’s
capital account remains $0, the allocation
to GPdoes not create a deficit capital ac-
count in excess of GP’s limited deficit
restoration obligation. If LPRSliquidated
at the beginning of year 3, selling the de-
preciable property for its basis of $600x,
the proceeds would be applied toward the
$800xLPRSliability. Because GPis ob-
ligated to restore a deficit capital account
to the extent necessary to pay creditors,
GPwould be required to contribute $200x
to LPRSto satisfy the outstanding liabil-
ity. Thus, at the end of year 2, GPhas a
deficit restoration obligation of $200x,
and the allocation of depreciation to GP
does not reduce GP’s capital account
below its obligation to restore a deficit
capital account.
This analysis also applies to the alloca-
tion of $200xof depreciation to GPin
years 3 through 5. At the beginning of year
6, when the property is fully depreciated,
the $800xprincipal amount of the partner-
ship liability is due. The partners’capital
accounts at the beginning of year 6 will
equal negative $800xand $0, respectively,
for GPand LP. Because value is conclu-
sively presumed to equal basis, the depre-
ciable property would be worthless and
could not be used to satisfy LPRS’s $800x
liability. As a result, GPis deemed to be
required to contribute $800xto LPRS. A
contribution by GPto satisfy this limited
deficit restoration obligation would in-
crease GP’s capital account balance to $0.
HOLDING
When a partner is treated as having a
limited deficit restoration obligation by
reason of the partner’s liability to the part-
nership’s creditors, the amount of that
obligation is the amount of money that the
partner would be required to contribute to
the partnership to satisfy partnership lia-
bilities if all partnership property were
sold for the amount of the partnership’s
book basis in the property.
DRAFTING INFORMATION
The principal author of this revenue
ruling is Robert Honigman of the Office
of Assistant Chief Counsel (Passthroughs
and Special Industries). For further infor-
mation regarding this revenue ruling, con-
tact Robert Honigman on (202) 622-3050
(not a toll-free call).
Section 1245.—Gain From
Dispositions of Certain
Depreciable Property
26 CFR 1.1245–1: General rule for treatment
of gain from dispositions of certain depreciable
property.
T.D. 8730
DEPARTMENT OF THE TREASURY
Internal Revenue Service
26 CFR Part 1
Allocations of Depreciation
Recapture Among Partners in a
Partnership
AGENCY: Internal Revenue Service
(IRS), Treasury.
ACTION: Final regulations.
SUMMARY: This document contains
final regulations relating to the allocation
of depreciation recapture among partners
in a partnership. The final regulations
amend existing regulations to require that
gain characterized as depreciation recap-
ture be allocated, to the extent possible, to
the partners who took the depreciation or
amortization deductions. The final regu-
lations affect partnerships (and their part-
ners) that sell or dispose of certain depre-
ciable or amortizable property.
DATES: These regulations are effective
August 20, 1997.
For dates of applicability of these regula-
tions, see §§ 1.704–3(f) and 1.1245–
1(e)(2)(iv).
FOR FURTHER INFORMATION CON-
TACT: Daniel J. Coburn, (202) 622-3050
(not a toll-free number)
SUPPLEMENTARYINFORMATION:
Background
This document amends the Income Tax
Regulations (26 CFR part 1) relating to
the characterization and allocation of de-
preciation recapture among partners in a
partnership. Section 1245 of the Internal
Revenue Code requires taxpayers to re-
characterize as ordinary income some or
all of the gain on the disposition of certain
types of business properties. The amount
recharacterized as ordinary income (de-
preciation recapture) is the lesser of (1)
the gain realized on the disposition, or (2)
the total deductions allowed or allowable
for depreciation or amortization from the
property.
On December 12, 1996, the IRS pub-
lished in the Federal Register(61 F.R.
65371) a notice of proposed rulemaking
(REG–209762–95) to provide guidance
on partnership allocations of depreciation
recapture. Although a public hearing was
scheduled for March 27, 1997, the IRS
cancelled the hearing because it received
no requests to speak.
Explanation of Provisions
I. General Background
The regulations provide guidance on
allocating depreciation recapture among
partners, including depreciation recapture
attributable to contributed property.
The regulations provide that a partner’s
share of depreciation recapture is equal to
the lesser of (1) the partner’s share of total
gain arising from the disposition of the
property (gain limitation) or (2) the part-
ner’s share of depreciation or amortiza-
tion from the property (as defined in para-
graph (e)(2)(ii) of the regulations). This
rule seeks to insure, to the extent possible,
that a partner recognizes recapture on the
disposition of property in an amount
equal to the depreciation or amortization
deductions from the property previously
taken by the partner. Any depreciation re-
capture that is not allocated to a partner
due to the gain limitation is allocated
among those partners whose shares of
total gain on the disposition of the prop-
erty exceed their shares of depreciation or
amortization from the property. This un-
allocated depreciation recapture is allo-
cated among those partners in proportion
to their relative shares of the total gain on
the disposition of the property.
The regulations provide special rules
for determining a partner’s share of depre-
ciation or amortization from contributed
property subject to section 704(c). Under
the regulations, a contributing partner’s
share of depreciation or amortization in-
cludes depreciation or amortization al-
lowed or allowable prior to contribution.

In addition, the regulations provide that
curative and remedial allocations gener-
ally reduce the contributing partner’s
share of depreciation or amortization and
increase the noncontributing partners’
shares of depreciation or amortization.
II. Changes in Response to Comments
In response to comments, the regula-
tions clarify the effect of curative and re-
medial allocations on the partners’shares
of depreciation or amortization from con-
tributed property. The examples now
demonstrate that curative and remedial al-
locations can reduce the contributing part-
ner’s share of depreciation or amortization
to zero, but not below zero. Once the con-
tributing partner’s share of depreciation or
amortization has been reduced to zero, the
curative or remedial allocations do not af-
fect the contributing partner’s share of de-
preciation or amortization. However, the
curative or remedial allocations continue
to affect the noncontributing partners’
shares of depreciation or amortization.
The regulations have also been revised
to make it clear that these amendments to
the section 1245 regulations only affect
how the depreciation recapture recog-
nized by the partnership is allocated
among the partners; they do not affect the
computation of depreciation recapture at
the partnership level. The regulations rec-
ognize that even absent a gain limitation,
remedial and curative allocations may
cause the total of the partners’shares of
depreciation to exceed the amount of de-
preciation recapture recognized at the
partnership level. In such a case, the part-
nership’s depreciation recapture with re-
spect to the contributed property is to be
allocated among the partners in propor-
tion to their relative shares of depreciation
or amortization with respect to that prop-
erty. However, no partner’s share of de-
preciation recapture from the property can
exceed that partner’s share of the total
gain arising from the disposition of the
property.
Example 2 of paragraph (e)(2)(iii) of
the regulations has also been revised to
demonstrate more thoroughly how recap-
ture is allocated when a partner’s share of
depreciation recapture is capped by the
partner’s share of gain from the disposi-
tion of the property. As illustrated in the
example, some partnerships may find it
necessary to make multiple reallocations
of depreciation recapture from a property
if allocations under the general rule (allo-
cations in proportion to the remaining
partners’shares of gain from the disposi-
tion of the property) cause a remaining
partner’s share of depreciation to exceed
the partner’s share of gain from the dispo-
sition of the property.
One commentator requested that the
regulations allow but not require that part-
nerships allocate depreciation recapture in
proportion to the partners’shares of the
gain from the disposition of the property.
This change was not made because the
IRS and Treasury continue to believe that
matching depreciation recapture alloca-
tions to depreciation allocations most ap-
propriately carries out the policies under-
lying section 1245.
Anumber of terminology and stylistic
changes have also been made to these reg-
ulations. These changes were made for
purposes of economy and should not be
interpreted as substantive changes.
Special Analyses
It has been determined that this Trea-
sury decision is not a significant regula-
tory action as defined in EO 12866.
Therefore, a regulatory assessment is not
required. It also has been determined that
section 553(b) of the Administrative Pro-
cedure Act (5 U.S.C. chapter 5) does not
apply to these regulations, and because
the regulations do not impose a collection
of information on small entities, the Reg-
ulatory Flexibility Act (5 U.S.C. chapter
6) does not apply. Pursuant to section
7805(f) of the Internal Revenue Code, the
notice of proposed rulemaking preceding
these regulations was submitted to the
Small Business Administration for com-
ment on its impact on small business.
Drafting Information
The principal author of these regula-
tions is Daniel J. Coburn, Office of Assis-
tant Chief Counsel (Passthroughs and
Special Industries), IRS. However, other
personnel from the IRS and Treasury par-
ticipated in their development.
* * * * *
Adoption of Amendments to the
Regulations
Accordingly, 26 CFR part 1 is amended
as follows:
PART1—INCOME TAXES
Paragraph 1. The authority citation for
part 1 continues to read, in part, as fol-
lows:
Authority: 26 U.S.C. 7805 * * *
Par. 2. Section 1.704–3 is amended by:
(1) Adding new paragraph (a)(11).
(2) Revising paragraph (f).
The addition and revision read as fol-
lows:
§1.704–3 Contributed property.
(a) * * *
(11) Contributing and noncontributing
partners’recapture shares.For special
rules applicable to the allocation of depre-
ciation recapture with respect to property
contributed by a partner to a partnership,
see §§1.1245–1(e)(2) and 1.1250–1(f).
* * * * *
(f) Effective date.With the exception
of paragraph (a)(11) of this section, this
section applies to properties contributed
to a partnership and to restatements pur-
suant to §1.704–1(b)(2)(iv)(f) on or after
December 21, 1993. Paragraph (a)(11) of
this section applies to properties con-
tributed by a partner to a partnership on or
after August 20, 1997. However, partner-
ships may rely on paragraph (a)(11) of
this section for properties contributed be-
fore August 20, 1997, and disposed of on
or after August 20, 1997.
Par. 3. Section 1.1245–1 is amended
by revising paragraph (e)(2) to read as
follows:
§1.1245–1 General rule for treatment
of gain from dispositions of certain
depreciable property.
* * * * *
(e) * * *
(2)(i) Unless paragraph (e)(3) of this
section applies, a partner’s distributive
share of gain recognized under section
1245(a)(1) by the partnership is equal to
the lesser of the partner’s share of total
gain from the disposition of the property
(gain limitation) or the partner’s share of
depreciation or amortization with respect
to the property (as determined under para-
graph (e)(2)(ii) of this section). Any gain
recognized under section 1245(a)(1) by
the partnership that is not allocated under
the first sentence of this paragraph
1997–38 I.R.B.17September 22, 1997

(e)(2)(i) (excess depreciation recapture) is
allocated among the partners whose
shares of total gain from the disposition of
the property exceed their shares of depre-
ciation or amortization with respect to the
property. Excess depreciation recapture
is allocated among those partners in pro-
portion to their relative shares of the total
gain (including gain recognized under
section 1245(a)(1)) from the disposition
of the property that is allocated to the
partners who are not subject to the gain
limitation. See Example2 of paragraph
(e)(2)(iii) of this section.
(ii)(A) Subject to the adjustments de-
scribed in paragraphs (e)(2)(ii)(B) and
(e)(2)(ii)(C) of this section, a partner’s
share of depreciation or amortization with
respect to property equals the total amount
of allowed or allowable depreciation or
amortization previously allocated to that
partner with respect to the property.
(B) If a partner transfers a partnership
interest, a share of depreciation or amorti-
zation must be allocated to the transferee
partner as it would have been allocated to
the transferor partner. If the partner trans-
fers a portion of the partnership interest, a
share of depreciation or amortization pro-
portionate to the interest transferred must
be allocated to the transferee partner.
(C)(1) Apartner’s share of depreciation
or amortization with respect to property
contributed by the partner includes the
amount of depreciation or amortization
allowed or allowable to the partner for the
period before the property is contributed
(2) Apartner’s share of depreciation or
amortization with respect to property con-
tributed by a partner is adjusted to ac-
count for any curative allocations. (See
§1.704–3(c) for a description of the tradi-
tional method with curative allocations.)
The contributing partner’s share of depre-
ciation or amortization with respect to the
contributed property is decreased (but not
below zero) by the amount of any curative
allocation of ordinary income to the con-
tributing partner with respect to that prop-
erty and by the amount of any curative al-
location of deduction or loss (other than
capital loss) to the noncontributing part-
ners with respect to that property. Anon-
contributing partner’s share of deprecia-
tion or amortization with respect to the
contributed property is increased by the
noncontributing partner’s share of any cu-
rative allocation of ordinary income to the
contributing partner with respect to that
property and by the amount of any cura-
tive allocation of deduction or loss (other
than capital loss) to the noncontributing
partner with respect to that property. The
partners’shares of depreciation or amorti-
zation with respect to property from
which curative allocations of depreciation
or amortization are taken is determined
without regard to those curative alloca-
tions. See Example3(iii) of paragraph
(e)(2)(iii) of this section.
(3) Apartner’s share of depreciation or
amortization with respect to property con-
tributed by a partner is adjusted to ac-
count for any remedial allocations. (See
§1.704–3(d) for a description of the reme-
dial allocation method.) The contributing
partner’s share of depreciation or amorti-
zation with respect to the contributed
property is decreased (but not below zero)
by the amount of any remedial allocation
of income to the contributing partner with
respect to that property. Anoncontribut-
ing partner’s share of depreciation or
amortization with respect to the con-
tributed property is increased by the
amount of any remedial allocation of de-
preciation or amortization to the noncon-
tributing partner with respect to that prop-
erty. See Example3(iv) of paragraph
(e)(2)(iii) of this section.
(4) If, under paragraphs (e)(2)(ii)(C)(2)
and (e)(2)(ii)(C)(3) of this section, the
partners’shares of depreciation or amorti-
zation with respect to a contributed prop-
erty exceed the adjustments reflected in
the adjusted basis of the property under
§1.1245–2(a) at the partnership level,
then the partnership’s gain recognized
under section 1245(a)(1) with respect to
that property is allocated among the part-
ners in proportion to their relative shares
of depreciation or amortization (subject to
any gain limitation that might apply).
(5) This paragraph (e)(2)(ii)(C) also ap-
plies in determining a partner’s share of
depreciation or amortization with respect
to property for which differences between
book value and adjusted tax basis are cre-
ated when a partnership revalues partner-
ship property pursuant to §1.704–
1(b)(2)(iv)(f).
(iii) Examples.The application of this
paragraph (e)(2) may be illustrated by the
following examples:
Example 1.Recapture allocations.(i) Facts.A
and B each contribute $5,000 cash to form AB, a
general partnership. The partnership agreement pro-
vides that depreciation deductions will be allocated
90 percent to Aand 10 percent to B, and, on the sale
of depreciable property, Awill first be allocated gain
to the extent necessary to equalize A’s and B’s capi-
tal accounts. Any remaining gain will be allocated
50 percent to Aand 50 percent to B. In its first year
of operations, AB purchases depreciable equipment
for $5,000. AB depreciates the equipment over its
5-year recovery period and elects to use the straight-
line method. In its first year of operations, AB’s op-
erating income equals its expenses (other than de-
preciation). (To simplify this example, AB’s
depreciation deductions are determined without re-
gard to any first-year depreciation conventions.)
(ii) Year 1.In its first year of operations, AB has
$1,000 of depreciation from the partnership equip-
ment. In accordance with the partnership agree-
ment, AB allocates 90 percent ($900) of the depreci-
ation to Aand 10 percent ($100) of the depreciation
to B. At the end of the year, AB sells the equipment
for $5,200, recognizing $1,200 of gain ($5,200
amount realized less $4,000 adjusted tax basis). In
accordance with the partnership agreement, the first
$800 of gain is allocated to Ato equalize the part-
ners’capital accounts, and the remaining $400 of
gain is allocated $200 to Aand $200 to B.
(iii) Recapture allocations.$1,000 of the gain
from the sale of the equipment is treated as section
1245(a)(1) gain. Under paragraph (e)(2)(i) of this
section, each partner’s share of the section
1245(a)(1) gain is equal to the lesser of the partner’s
share of total gain recognized on the sale of the
equipment or the partner’s share of total deprecia-
tion with respect to the equipment. Thus, A’s share
of the section 1245(a)(1) gain is $900 (the lesser of
A’s share of the total gain ($1,000) and A’s share of
depreciation ($900)). B’s share of the section
1245(a)(1) gain is $100 (the lesser of B’s share of
the total gain ($200) and B’s share of depreciation
($100)). Accordingly, $900 of the $1,000 of total
gain allocated to Ais treated as ordinary income and
$100 of the $200 of total gain allocated to B is
treated as ordinary income.
Example 2. Recapture allocation subject to gain
limitation.(i) Facts.A, B, and C form general part-
nership ABC. The partnership agreement provides
that depreciation deductions will be allocated
equally among the partners, but that gain from the
sale of depreciable property will be allocated 75 per-
cent to Aand 25 percent to B. ABC purchases de-
preciable personal property for $300 and subse-
quently allocates $100 of depreciation deductions
each to A, B, and C, reducing the adjusted tax basis
of the property to $0. ABC then sells the property
for $440. ABC allocates $330 of the gain to A(75
percent of $440) and allocates $110 of the gain to B
(25 percent of $440). No gain is allocated to C.
(ii) Application of gain limitation.Each partner’s
share of depreciation with respect to the property is
$100. C’s share of the total gain from the disposi-
tion of the property, however, is $0. As a result,
under the gain limitation provision in paragraph
(e)(2)(i) of this section, C’s share of section
1245(a)(1) gain is limited to $0.
(iii) Excess depreciation recapture. Under para-
graph (e)(2)(i) of this section, the $100 of section
1245(a)(1) gain that cannot be allocated to C under
the gain limitation provision (excess depreciation re-
capture) is allocated to Aand B (the partners not
subject to the gain limitation at the time of the allo-
cation) in proportion to their relative shares of total
gain from the disposition of the property. A’s rela-
tive share of the total gain allocated to Aand B is 75
percent ($330 of $440 total gain). B’s relative share
of the total gain allocated to Aand B is 25 percent
($110 of $440 total gain). However, under the gain
limitation provision of paragraph (e)(2)(i) of this
September 22, 1997181997–38 I.R.B.

section, B cannot be allocated 25 percent of the ex-
cess depreciation recapture ($25) because that
would result in a total allocation of $125 of depreci-
ation recapture to B (a $100 allocation equal to B’s
share of depreciation plus a $25 allocation of excess
depreciation recapture), which is in excess of B’s
share of the total gain from the disposition of the
property ($110). Therefore, only $10 of excess de-
preciation recapture is allocated to B and the re-
maining $90 of excess depreciation recapture is allo-
cated to A. Ais not subject to the gain limitation
because A’s share of the total gain ($330) still ex-
ceeds A’s share of section 1245(a)(1) gain ($190).
Accordingly, all $110 of the total gain allocated to B
is treated as ordinary income ($100 share of depreci-
ation allocated to B plus $10 of excess depreciation
recapture) and $190 of the total gain allocated to Ais
treated as ordinary income ($100 share of deprecia-
tion allocated to Aplus $90 of excess depreciation
recapture).
Example 3. Determination of partners’shares of
depreciation with respect to contributed property. (i)
Facts.C and D form partnership CD as equal part-
ners. C contributes depreciable personal property
C1 with an adjusted tax basis of $800 and a fair mar-
ket value of $2,800. Prior to the contribution, C
claimed $200 of depreciation from C1. At the time
of the contribution, C1 is depreciable under the
straight-line method and has four years remaining
on its 5-year recovery period. D contributes $2,800
cash, which CD uses to purchase depreciable per-
sonal property D1, which is depreciable over seven
years under the straight-line method. (To simplify
the example, all depreciation is determined without
regard to any first-year depreciation conventions.)
(ii) Traditional method.C1 generates $700 of
book depreciation (1/4 of $2,800 book value) and
$200 of tax depreciation (1/4 of $800 adjusted tax
basis) each year. C and D will each be allocated
$350 of book depreciation from C1 in year 1. Under
the traditional method of making section 704(c) al-
locations, D will be allocated the entire $200 of tax
depreciation from C1 in year 1. D1 generates $400
of book and tax depreciation each year (1/7 of
$2,800 book value and adjusted tax basis). C and D
will each be allocated $200 of book and tax depreci-
ation from D1 in year 1. As a result, after the first
year of partnership operations, C’s share of depreci-
ation with respect to C1 is $200 (the depreciation
taken by C prior to contribution) and D’s share of
depreciation with respect to C1 is $200 (the amount
of tax depreciation allocated to D). C and D each
have a $200 share of depreciation with respect to
D1. At the end of four years, C’s share of deprecia-
tion with respect to C1 will be $200 (the deprecia-
tion taken by C prior to contribution) and D’s share
of depreciation with respect to C1 will be $800 (four
years of $200 depreciation per year). At the end of
four years, C and D will each have an $800 share of
depreciation with respect to D1 (four years of $200
depreciation per year).
(iii) Effect of curative allocations.(A) Year 1.If
the partnership elects to make curative allocations
under §1.704–3(c) using depreciation from D1, the
results will be the same as under the traditional
method, except that $150 of the $200 of tax depreci-
ation from D1 that would be allocated to C under the
traditional method will be allocated to D as addi-
tional depreciation with respect to C1. As a result,
after the first year of partnership operations, C’s
share of depreciation with respect to C1 will be re-
duced to $50 (the total depreciation taken by C prior
to contribution ($200) decreased by the amount of
the curative allocation to D ($150)). D’s share of de-
preciation with respect to C1 will be $350 (the de-
preciation allocated to D under the traditional
method ($200) increased by the amount of the cura-
tive allocation to D ($150)). C and D will each have
a $200 share of depreciation with respect to D1.
(B) Year 4.At the end of four years, C’s share of
depreciation with respect to C1 will be reduced to $0
(the total depreciation taken by C prior to contribu-
tion ($200) decreased, but not below zero, by the
amount of the curative allocations to D ($600)), and
D’s share of depreciation with respect to C1 will be
$1,400 (the total depreciation allocated to D under
the traditional method ($800) increased by the
amount of the curative allocations to D ($600)).
However, CD’s section 1245(a)(1) gain with respect
to C1 will not be more than $1,000 (CD’s tax depre-
ciation ($800) plus C’s tax depreciation prior to con-
tribution ($200)). Under paragraph (e)(2)(ii)(C)(4)
of this section, because the partners’shares of depre-
ciation with respect to C1 exceed the adjustments re-
flected in the property’s adjusted basis, CD’s section
1245(a)(1) gain will be allocated in proportion to the
partners’relative shares of depreciation with respect
to C1. Because C’s share of depreciation with re-
spect to C1 is $0, and D’s share of depreciation with
respect to C1 is $1,400, all of CD’s $1,000 of section
1245(a)(1) gain will be allocated to D. At the end of
four years, C and D will each have an $800 share of
depreciation with respect to D1 (four years of $200
depreciation per year).
(iv) Effect of remedial allocations.(A) Year 1.If
the partnership elects to make remedial allocations
under §1.704-3(d), there will be $600 of book depre-
ciation from C1 in year 1. (Under the remedial allo-
cation method, the amount by which C1’s book basis
($2,800) exceeds its tax basis ($800) is depreciated
over a 5-year life, rather than a 4-year life.) C and D
will each be allocated one-half ($300) of the total
book depreciation. As under the traditional method,
D will be allocated all $200 of tax depreciation from
C1. Because the ceiling rule would cause a disparity
of $100 between D’s book and tax allocations of de-
preciation, D will also receive a $100 remedial allo-
cation of depreciation with respect to C1, and C will
receive a $100 remedial allocation of income with
respect to C1. As a result, after the first year of part-
nership operations, D’s share of depreciation with
respect to C1 is $300 (the depreciation allocated to
D under the traditional method ($200) increased by
the amount of the remedial allocation ($100)). C’s
share of depreciation with respect to C1 is $100 (the
total depreciation taken by C prior to contribution
($200) decreased by the amount of the remedial al-
location of income ($100)). C and D will each have
a $200 share of depreciation with respect to D1.
(B) Year 5.At the end of five years, C’s share of
depreciation with respect to C1 will be $0 (the total
depreciation taken by C prior to contribution ($200)
decreased, but not below zero, by the total amount of
the remedial allocations of income to C ($600)). D’s
share of depreciation with respect to C1 will be
$1,400 (the total depreciation allocated to D under
the traditional method ($800) increased by the total
amount of the remedial allocations of depreciation to
D ($600)). However, CD’s section 1245(a)(1) gain
with respect to C1 will not be more than $1,000
(CD’s tax depreciation ($800) plus C’s tax deprecia-
tion prior to contribution ($200)). Under paragraph
(e)(2)(ii)(C)(4) of this section, because the partners’
shares of depreciation with respect to C1 exceed the
adjustments reflected in the property’s adjusted basis,
CD’s section 1245(a)(1) gain will be allocated in pro-
portion to the partners’relative shares of depreciation
with respect to C1. Because C’s share of deprecia-
tion with respect to C1 is $0, and D’s share of depre-
ciation with respect to C1 is $1,400, all of CD’s
$1,000 of section 1245(a)(1) gain will be allocated to
D. At the end of five years, C and D will each have a
$1,000 share of depreciation with respect to D1 (five
years of $200 depreciation per year).
(iv) Effective date.This paragraph
(e)(2) is effective for properties acquired
by a partnership on or after August 20,
1997. However, partnerships may rely on
this paragraph (e)(2) for properties ac-
quired before August 20, 1997, and dis-
posed of on or after August 20, 1997.
* * * * *
Michael P. Dolan,
Acting Commissioner of
Internal Revenue.
Approved July 8, 1997.
Donald C. Lubick,
Acting Assistant Secretary of
the Treasury.
(Filed by the Office of the Federal Register on Au-
gust 19, 1997, 8:45 a.m., and published in the issue
of the Federal Register for August 20, 1997, 62 F.R.
44214)
1997–38 I.R.B.19September 22, 1997

September 22, 1997201997–38 I.R.B.
Weighted Average Interest Rate
Update
Notice 97–51
Notice 88–73 provides guidelines for
determining the weighted average interest
rate and the resulting permissible range of
interest rates used to calculate current lia-
bility for the purpose of the full funding
limitation of § 412(c)(7) of the Internal
Revenue Code as amended by the Om-
nibus Budget Reconciliation Act of 1987
and as further amended by the Uruguay
Round Agreements Act, Pub. L. 103–465
(GATT).
The average yield on the 30-year Trea-
sury Constant Maturities for August 1997
is 6.58 percent.
The following rates were determined
for the plan years beginning in the month
shown below.
Part III. Administrative, Procedural, and Miscellaneous
90% to 107%90% to 110%
WeightedPermissiblePermissible
MonthYearAverageRangeRange
September19976.846.15 to 7.316.15 to 7.52
DRAFTING INFORMATION
The principal author of this notice is
Donna Prestia of the Employee Plans Di-
vision. For further information regarding
this notice, call (202) 622-6076 between
2:30 and 3:30 p.m. Eastern time (not a
toll-free number). Ms. Prestia’s number
is (202) 622-7377 (also not a toll-free
number).
Qualified State Tuition Programs
Notice 97–52
Section 529 of the Internal Revenue
Code provides tax-exempt status to quali-
fied State tuition programs (“QSTPs”).
This notice extends the relief granted in
Notice 96–58, 1996–2 C.B. 215 concern-
ing the reporting requirements applicable
to QSTPs described in § 529 through
1998. Notice 96–58 provides that report-
ing will not be required for any distribu-
tion made by, or benefit furnished in-kind
under, a QSTPprior to 1998. In addition,
Notice 96–58 provides that the Internal
Revenue Service will not assess penalties
against program administrators who do
not file information returns or provide
payee statements on distributions made
during 1997 and prior years.
Sections 211 and 1601(h)(1) of the
Taxpayer Relief Act of 1997, Pub. L.
105–34 (the “Act”) amend § 529. The
Act expands the definitions of “qualified
higher education expenses” to include
room and board expenses, “eligible edu-
cational institution” to include certain
proprietary institutions and post-sec-
ondary vocational institutions, and “mem-
ber of the family” to include persons de-
scribed in § 152(a)(1) through (8). The
Act clarifies the prohibition against in-
vestment direction in § 529(b)(5). The
Act amends the gift tax treatment of con-
tributions or transfers to QSTPs made
after August 5, 1997, and the estate tax
treatment for decedents dying after June
8, 1997.
The Internal Revenue Service is contin-
uing to develop reporting requirements for
QSTPs. Because guidance on the report-
ing requirements must now take account
of these amendments and because States
will need additional time to implement ap-
propriate recordkeeping and reporting pro-
cedures, reporting will not be required for
calendar years prior to 1999. Further, the
Internal Revenue Service will not assess
penalties against program administrators
who do not file information returns or pro-
vide payee statements on distributions
made during 1998 and prior years.
For further information concerning this
notice contact Monice Rosenbaum of the
Office of Associate Chief Counsel (Em-
ployee Benefits and Exempt Organiza-
tions) at (202) 622-6070 (not a toll-free
number).

1997–38 I.R.B.21September 22, 1997
Notice of Proposed Rulemaking
and Notice of Public Hearing
Rules for Property Produced in
a Farming Business
REG–208151–91
AGENCY: Internal Revenue Service
(IRS), Treasury.
ACTION: Notice of proposed rulemak-
ing by cross-reference to temporary regu-
lations and notice of public hearing.
SUMMARY: In T.D. 8729 on page 4 of
this Bulletin, the IRS is issuing temporary
regulations relating to the application of
section 263Aof the Internal Revenue
Code of 1986 to property produced in a
farming business. The regulations affect
taxpayers engaged in the business of
farming that grow or raise plants or ani-
mals. The text of T.D. 8729 also serves as
the text of these proposed regulations.
This document provides notice of a public
hearing on these proposed regulations.
DATES: Written comments must be re-
ceived by November 20, 1997. Requests
to speak and outlines of topics to be dis-
cussed at the public hearing scheduled for
November 19, 1997, must be received by
October 29, 1997.
ADDRESSES: Send submissions to:
CC:DOM:CORP:R (REG-208151–91),
room 5226, Internal Revenue Service,
POB 7604, Ben Franklin Station, Wash-
ington, DC 20044. Submissions may be
hand delivered between the hours of 8 a.m.
and 5 p.m. to: CC:DOM:CORP:R (REG-
208151–91), Courier’s Desk, Internal Rev-
enue Service, 1111 Constitution Avenue
NW, Washington, DC. Alternatively, tax-
payers may submit comments electroni-
cally via the internet by selecting the “Tax
Regs” option on the IRS Home Page, or by
submitting comments directly to the IRS
internet site at http://www.irs.ustreas.
gov/prod/tax_regs/comment.html. The
public hearing will be held in room 2615,
Internal Revenue Building, 1111 Constitu-
tion Avenue, NW, Washington, DC.
FOR FURTHER INFORMATION CON-
TACT: Concerning the regulations, Jan
Skelton, (202) 622-4970; concerning sub-
missions and the hearing, Michael
Slaughter, (202) 622-7190 (not toll-free
numbers).
SUPPLEMENTARYINFORMATION:
Background
T.D. 8729 amends Regulations on In-
come Taxes (26 CFR part 1). The regula-
tions provide guidance with respect to the
application of section 263Ato property
produced in a farming business.
The text of those temporary regulations
also serves as the text of these proposed
regulations. The preamble to the tempo-
rary regulations explains the temporary
regulations.
Special Analyses
It has been determined that this notice
of proposed rulemaking is not a signifi-
cant regulatory action as defined in EO
12866. Therefore, a regulatory assess-
ment is not required. It has also been de-
termined that section 553(b) of the Ad-
ministrative Procedure Act (5 U.S.C.
chapter 5) does not apply to these regula-
tions, and because the regulations do not
impose a collection of information on
small entities, the Regulatory Flexibility
Act (5 U.S.C. chapter 6) does not apply.
Pursuant to section 7805(f) of the Internal
Revenue Code, this notice of proposed
rulemaking will be submitted to the Chief
Counsel for Advocacy of the Small Busi-
ness Administration for comment on its
impact on small business.
Comments and Public Hearing
Before these proposed regulations are
adopted as final regulations, considera-
tion will be given to any written (a signed
original and eight (8) copies) or electronic
comments that are submitted timely to the
IRS. All comments will be available for
public inspection and copying.
Apublic hearing has been scheduled
for Wednesday, November 19, 1997, at 10
a.m., at the Internal Revenue Building,
1111 Constitution Ave., NW, Washington,
DC, 20224. Because of access restric-
tions, visitors will not be admitted beyond
the building lobby more than 15 minutes
before the hearing starts.
The rules of 26 CFR 601.601(a)(3)
apply to the hearing.
Persons that wish to present oral com-
ments at the hearing must submit written
comments by November 20, 1997 and
submit an outline of the topics to be dis-
cussed and the time to be devoted to each
topic (signed original and eight (8)
copies) by October 29, 1997.
Aperiod of ten minutes will be allotted
to each person for making comments.
An agenda showing the scheduling of
the speakers will be prepared after the
deadline for receiving outlines has
passed. Copies of the agenda will be
available free of charge at the hearing.
Drafting Information
The principal author of these regula-
tions is Jan Skelton of the Office of Assis-
tant Chief Counsel (Income Tax & Ac-
counting). However, other personnel
from the IRS and Treasury Department
participated in their development.
* * * * *
Proposed Amendments to the Regulations
Accordingly, 26 CFR part 1 is pro-
posed to be amended as follows:
PART1—INCOME TAXES
Paragraph 1. The authority citation for
part 1 continues to read in part as follows:
Authority: 26 U.S.C. 7805 * * *
Par. 2. Section 1.263A–0 is amended
by:
1. Revising the introductory text.
2. Adding the entries for §1.263A–4.
The addition and revision read as fol-
lows:
§1.263A–0 Outline of regulations under
section 263A.
This section lists the paragraphs in
§§1.263A–1 through 1.263A–4 and
§§1.263A–8 through 1.263A-15.
* * * * *
§1.263A–4 Rules for property produced
in a farming business.
[The text of the proposed entries for
§1.263A–4 in §1.263A–0 is the same as
Part IV. Items of General Interest

September 22, 1997221997–38 I.R.B.
the text of the entries for §1.263A–4Tin
§1.263A–0Tpublished in T.D. 8729].
* * * * *
Par. 3. Section 1.263A–4 is amended
by revising the section heading and
adding new text to read as follows:
§1.263A–4 Rules for property produced
in a farming business.
[The proposed text of §1.263A–4 is the
same as the text in §1.263A–4Tpublished
in T.D. 8729.]
Michael P. Dolan,
Acting Commissioner of
Internal Revenue.
(Filed by the Office of the Federal Register on Au-
gust 21, 1997, 8:45 a.m., and published in the issue
of the Federal Register for August 22, 1997, 62 F.R.
44607)
Foundations Status of Certain
Organizations
Announcement 97–97
The following organizations have
failed to establish or have been unable to
maintain their status as public charities or
as operating foundations. Accordingly,
grantors and contributors may not, after
this date, rely on previous rulings or des-
ignations in the Cumulative List of Orga-
nizations (Publication 78), or on the pre-
sumption arising from the filing of notices
under section 508(b) of the Code. This
listing does notindicate that the organiza-
tions have lost their status as organiza-
tions described in section 501(c)(3), eligi-
ble to receive deductible contributions.
Former Public Charities.The following
organizations (which have been treated as
organizations that are not private founda-
tions described in section 509(a) of the
Code) are now classified as private founda-
tions:
Acadia Homes for Students, Ellsworth,
ME
Advance, Inc., Derby, CT
Afghan Hindu Association, Inc.,
Flushing, NY
African Methodist Ministries Alliance,
Buffalo, NY
African Women Against Aids Network,
Inc., New Rochelle, NY
Akademia Duncan, New York, NY
Akiele, Inc., Yorktown Heights, NY
The Albany Civic Forum, Inc., Albany,
NY
Allied Printing Trades Council
Community Services, Inc., New York,
NY
All Species Wildlife Sanctuary &
Environmental Learning Center,
Rockport, ME
American Central European Dental
Institute, Ltd., Boston, MA
American Friends of Elah, Inc., New
York, NY
American Friends of the Cambodia Trust,
Inc., New York, NY
American Friends of the Russian
Academy, Inc., New York, NY
The American Music Ensemble, Inc.,
Winchester, MA
Americans for Exchange of Culture
Education & Language in East Central
Europe & Russia, Inc., Patchogue, NY
Anagram Productions, Inc., Boston, MA
Andrew E. Tyler Scholarship Foundation,
New York, NY
Animal Connection, Inc., New York, NY
Animal Control Officers Association of
Massachusetts, Inc., Canton, MA
Anna Anderson Doering Memorial
Scholarship Trust, Cromwell, CT
Aquila Legis Foundation of North
America, Inc., New York, NY
Armenian Art Alliance, Watertown, MA
Artspeak, Inc., North Andover, MA
Asgog Foundation, Inc., New York, NY
Ashland Elementary School PTO, Inc.,
Ashland, MA
Association of Citizen Advocacy
Programs in Connecticut, Inc.,
Bridgeport, CT
Ballet Bagata, Inc., Brooklyn, NY
Barnstable County Hospital Foundation,
Inc., Yarmouth, MA
Bartlett-Jackson Recreation Youth
Center, Intervale, NH
Beam Project, Inc., Allston, MA
Black Christians Against Substance
Abuse, Austin, TX
Bone Marrow Transplant Family Support
Network, Avon, CT
Brooklyn Heights Center for Counseling,
Inc., Brooklyn, NY
Central Harlem Local Development
Corporation, New York, NY
Central Harlem Partnership, New York,
NY
Citizens for a Safer Minnesota Education
Fund, St. Paul, MN
Community Television Association of
Maine, South Portland, ME
Connecticut Junior Academy of Science
and Engineering, Hamden, CT
Dekos AFoundation for Education,
Harvard, MA
Don Martin Pena Sabana, Inc., New
York, NY
East Hampton-Marlborough Foundation,
East Hampton, CT
84th Precinct Community Council,
Brooklyn, NY
1st Ward Boosters, Lackawanna, NY
Five Towns Jewish Council, Inc.,
Woodmere, NY
Flora T. Little Trust, Bridgewater, MA
Fraternidad Sangermenos Unidos, Inc.,
New York, NY
Golden Eagle Institute, Inc., Flushing,
NY
Heart Center Foundation, Manchester,
NH
Hingham Music Parents Association,
Hingham, MA
Hispanic Coalition of Greater Waterbury,
Inc., Waterbury, CT
Homeless Resource Center, Inc., Wards
Island, NY
International Midwives Exchange, Inc.,
Kingston, NY
Island Waldorf Community, Inc., West
Tisbury, MA
Jewish Deaf Congress, Inc., Potomac,
MD
Joshua Smith Foundation, Mystic, CT
Kids With Kids, Inc., New York, NY
Ladies of Color, Inc., Jamaica, NY
Lazarus Program for the Homeless, Inc.,
New York, NY
L. Frank Baum-Oz Museum, Inc.,
Chittenango, NY
Lightwing Institute in the Berkshires,
Inc., Farnams Cheshire, MA
Loving Family, Inc., New York, NY
Maine Energy Coalition, Bar Mills, ME
Massachusetts Black Lawyers
Community Service Association, Inc.,
Boston, MA
Mass-Cap Coalition, Inc., Lexington, MA
Mental Health Resources, Inc., Rockland,
ME
M.E.R.C.A., Lebanon, NH
Merrimack Valley Computer Society,
Inc., Lowell, MA
Michael Hefler Memorial Fund, Inc.,
New York, NY
Middlesex Spotlight Players, Inc.,
Middletown, CT
Modern Dance Center of Westchester,
Inc., Bronxville, NY

1997–38 I.R.B.23September 22, 1997
New Hampshire Coalition on Substance
Abuse & the Elderly, Bedford, NH
New Hampshire Dare Officers
Association, North Woodstock, NH
New Horizons Counseling Center,
Presque Isle, ME
North Shore Art Guild, Inc., Miller Place,
NY
Oyster River High School Athletic
Booster Club, Durham, NH
Pediatric & Medical Clinical Associates,
Inc., Valhalla, NY
Rainbow Repertory Theatre, Inc., New
York, NY
Reaching the Community Needs, Inc.,
Flushing, NY
The Region & Assembly of Overeaters
Anonymous, Brooklyn, NY
Rural Development, Inc., Turner Falls,
MA
Russian-American Council on Economic
Development, New Haven, CT
Sabai, Inc., Lowell, MA
Sebasticook Valley Boys and Girls Club,
Pittsfield, ME
2nd Renaissance Foundation, Inc.,
Natick, MA
Sharisa Advocacy Foundation for
Education and Research, Inc., New
City, NY
Society To Save Children and Families of
War-Torn Liberia, Inc., Jamaica, NY
Stafford Springs Volunteer Fire Dept.,
Inc., Stafford Springs, CT
Stageworks of Leominster, Inc.,
Leominster, MA
Sumoto An African-American Christian
Womens Group, Sacramento, CA
Twinfish Productions, Inc., East
Rockaway, NY
2000 Miracles Foundation, Inc.,
Greenwich, CT
United Conservationists of North
America, Inc., Lyons, NY
Veterans Assistance Foundation, Inc.,
Framingham, MA
Volunteers for Homeless Inc.,
Levittown, PA
The Wellness Foundation of Vermont,
Barre, VT
Worcester Project, Inc., Gardner, MA
Workforce Development Corp.
Downtown Brooklyn Training
Employment Council, New York, NY
If an organization listed above submits
information that warrants the renewal of its
classification as a public charity or as a pri-
vate operating foundation, the Internal
Revenue Service will issue a ruling or de-
termination letter with the revised classifi-
cation as to foundation status. Grantors and
contributors may thereafter rely upon such
ruling or determination letter as provided
in section 1.509(a)–7 of the Income Tax
Regulations. It is not the practice of the
Service to announce such revised classifi-
cation of foundation status in the Internal
Revenue Bulletin.

September 22, 1997241997–38 I.R.B.
Revenue rulings and revenue procedures
(hereinafter referred to as “rulings”) that
have an effect on previous rulings use the
following defined terms to describe the
effect:
Amplified describes a situation where
no change is being made in a prior pub-
lished position, but the prior position is
being extended to apply to a variation of
the fact situation set forth therein. Thus,
if an earlier ruling held that a principle
applied to A, and the new ruling holds
that the same principle also applies to B,
the earlier ruling is amplified. (Compare
with modified, below).
Clarified is used in those instances
where the language in a prior ruling is
being made clear because the language
has caused, or may cause, some confu-
sion. It is not used where a position in a
prior ruling is being changed.
Distinguisheddescribes a situation
where a ruling mentions a previously
published ruling and points out an essen-
tial difference between them.
Modified is used where the substance
of a previously published position is
being changed. Thus, if a prior ruling
held that a principle applied to Abut not
to B, and the new ruling holds that it ap-
plies to both Aand B, the prior ruling is
modified because it corrects a published
position. (Compare with amplified and
clarified, above).
Obsoleted describes a previously pub-
lished ruling that is not considered deter-
minative with respect to future transac-
tions. This term is most commonly used
in a ruling that lists previously published
rulings that are obsoleted because of
changes in law or regulations. Aruling
may also be obsoleted because the sub-
stance has been included in regulations
subsequently adopted.
Revoked describes situations where the
position in the previously published rul-
ing is not correct and the correct position
is being stated in the new ruling.
Superseded describes a situation where
the new ruling does nothing more than
restate the substance and situation of a
previously published ruling (or rulings).
Thus, the term is used to republish under
the 1986 Code and regulations the same
position published under the 1939 Code
and regulations. The term is also used
when it is desired to republish in a single
ruling a series of situations, names, etc.,
that were previously published over a pe-
riod of time in separate rulings. If the
new ruling does more than restate the
substance of a prior ruling, a combination
of terms is used. For example, modified
and superseded describes a situation
where the substance of a previously pub-
lished ruling is being changed in part and
is continued without change in part and it
is desired to restate the valid portion of
the previously published ruling in a new
ruling that is self contained. In this case
the previously published ruling is first
modified and then, as modified, is super-
seded.
Supplemented is used in situations in
which a list, such as a list of the names of
countries, is published in a ruling and
that list is expanded by adding further
names in subsequent rulings. After the
original ruling has been supplemented
several times, a new ruling may be pub-
lished that includes the list in the original
ruling and the additions, and supersedes
all prior rulings in the series.
Suspended is used in rare situations to
show that the previous published rulings
will not be applied pending some future
action such as the issuance of new or
amended regulations, the outcome of
cases in litigation, or the outcome of a
Service study.
Abbreviations
The following abbreviations in current use and for-
merly used will appear in material published in the
Bulletin.
A—Individual.
Acq.—Acquiescence.
B—Individual.
BE—Beneficiary.
BK—Bank.
B.T.A.—Board of Tax Appeals.
C.—Individual.
C.B.—Cumulative Bulletin.
CFR—Code of Federal Regulations.
CI—City.
COOP—Cooperative.
Ct.D.—Court Decision.
CY—County.
D—Decedent.
DC—Dummy Corporation.
DE—Donee.
Del. Order—Delegation Order.
DISC—Domestic International Sales Corporation.
DR—Donor.
E—Estate.
EE—Employee.
E.O.—Executive Order.
ER—Employer.
ERISA—Employee Retirement Income Security Act.
EX—Executor.
F—Fiduciary.
FC—Foreign Country.
FICA—Federal Insurance Contribution Act.
FISC—Foreign International Sales Company.
FPH—Foreign Personal Holding Company.
F.R.—Federal Register.
FUTA—Federal Unemployment Tax Act.
FX—Foreign Corporation.
G.C.M.—Chief Counsel’s Memorandum.
GE—Grantee.
GP—General Partner.
GR—Grantor.
IC—Insurance Company.
I.R.B.—Internal Revenue Bulletin.
LE—Lessee.
LP—Limited Partner.
LR—Lessor.
M—Minor.
Nonacq.—Nonacquiescence.
O—Organization.
P—Parent Corporation.
PHC—Personal Holding Company.
PO—Possession of the U.S.
PR—Partner.
PRS—Partnership.
PTE—Prohibited Transaction Exemption.
Pub. L.—Public Law.
REIT—Real Estate Investment Trust.
Rev. Proc.—Revenue Procedure.
Rev. Rul.—Revenue Ruling.
S—Subsidiary.
S.P.R.—Statements of Procedral Rules.
Stat.—Statutes at Large.
T—Target Corporation.
T.C.—Tax Court.
T.D.—Treasury Decision.
TFE—Transferee.
TFR—Transferor.
T.I.R.—Technical Information Release.
TP—Taxpayer.
TR—Trust.
TT—Trustee.
U.S.C.—United States Code.
X—Corporation.
Y—Corporation.
Z—Corporation.
Definition of Terms

1997–38 I.R.B.25September 22, 1997
Numerical Finding List
1
Bulletins 1997–27 through 1997–37
Announcements:
97–61, 1997–29 I.R.B. 13
97–67, 1997–27 I.R.B. 37
97–68, 1997–28 I.R.B. 13
97–69, 1997–28 I.R.B. 13
97–70, 1997–29 I.R.B. 14
97–71, 1997–29 I.R.B. 15
97–72, 1997–29 I.R.B. 15
97–73, 1997–30 I.R.B. 86
97–74, 1997–31 I.R.B.16
97–75, 1997–32 I.R.B. 28
97–76, 1997–32 I.R.B. 28
97–77, 1997–33 I.R.B. 58
97–78, 1997–34 I.R.B. 11
97–79, 1997–35 I.R.B. 8
97–80, 1997–34 I.R.B. 12
97–81, 1997–34 I.R.B. 12
97–82, 1997–34 I.R.B. 12
97–83, 1997–34 I.R.B. 13
97–84, 1997–34 I.R.B. 13
97–85, 1997–35 I.R.B. 8
97–86, 1997–35 I.R.B. 9
97–87, 1997–35 I.R.B. 9
97–88, 1997–35 I.R.B. 9
97–89, 1997–36 I.R.B. 10
97–90, 1997–36 I.R.B. 10
97–91, 1997–37 I.R.B. 25
97–92, 1997–37 I.R.B. 26
97–93, 1997–36 I.R.B. 11
97–94, 1997–36 I.R.B. 12
97–95, 1997–36 I.R.B. 12
Court Decisions:
2061, 1997–31 I.R.B. 5
2062, 1997–32 I.R.B. 8
Delegation Orders:
172 (Rev. 5), 1997–28 I.R.B. 6
Notices:
97–37, 1997–27 I.R.B. 4
97–38, 1997–27 I.R.B. 8
97–39, 1997–27 I.R.B. 8
97–40, 1997–28 I.R.B. 6
97–41, 1997–28 I.R.B. 6
97–42, 1997–29 I.R.B. 12
97–43, 1997–30 I.R.B. 9
97–44, 1997–31 I.R.B. 15
97–45, 1997–33 I.R.B. 7
97–46, 1997–34 I.R.B. 10
97–47, 1997–35 I.R.B. 5
97–48, 1997–35 I.R.B. 5
97–49, 1997–36 I.R.B. 8
97–50, 1997–37 I.R.B. 21
Railroad Retirement Quarterly Rate:
1997–28 I.R.B. 5
Proposed Regulations:
REG–104893–97, 1997–29 I.R.B. 13
REG–105160–97, 1997–37 I.R.B. 22
REG–106043–97, 1997–37 I.R.B. 24
REG–107644–97, 1997–32 I.R.B. 24
Revenue Procedures:
97–32, 1997–27 I.R.B. 9
97–32A, 1997–34 I.R.B. 10
97–33, 1997–30 I.R.B. 10
97–34, 1997–30 I.R.B.14
97–35, 1997–33 I.R.B. 11
97–36, 1997–33 I.R.B. 14
97–37, 1997–33 I.R.B. 18
97–38, 1997–33 I.R.B. 43
97–39, 1997–33 I.R.B. 48
97–40, 1997–33 I.R.B. 50
97–41, 1997–33 I.R.B. 5
97–42, 1997–33 I.R.B. 57
Revenue Rulings:
97–27, 1997–27 I.R.B. 4
97–28, 1997–28 I.R.B. 4
97–29, 1997–28 I.R.B. 4
97–30, 1997–31 I.R.B.12
97–31, 1997–32 I.R.B.4
97–32, 1997–33 I.R.B. 4
97–33, 1997–34 I.R.B. 4
97–34, 1997–34 I.R.B. 14
97–35, 1997–35 I.R.B. 4
97–36, 1997–36 I.R.B. 5
97–37, 1997–37 I.R.B.15
Treasury Decisions:
8722, 1997–29 I.R.B. 4
8723, 1997–30 I.R.B. 4
8724, 1997–36 I.R.B. 4
8725, 1997–37 I.R.B. 16
8726, 1997–34 I.R.B. 7
8727, 1997–34 I.R.B. 5
8728, 1997–37 I.R.B. 4
1
Acumulative list of all revenue rulings, revenue
procedures, Treasury decisions, etc., published in
Internal Revenue Bulletins 1997–1 through 1997–26
will be found in Internal Revenue Bulletin 1997–27,
dated July 7, 1997.

September 22, 1997261997–38 I.R.B.
Finding List of Current Action on
Previously Published Items
1
Bulletins 1997–27 through 1997–37
*Denotes entry since last publication
Revenue Procedures:
96–36
Superseded by
97–34, 1997–30 I.R.B. 14
96–42
Superseded by
97–27, 1997–27 I.R.B. 9
97–32
Modified and amplified by
97–32A, 1997–34 I.R.B. 10
Revenue Rulings:
89–42
Supplemented by
97–31, 1997–32 I.R.B. 4
1
Acumulative finding list for previously published
items mentioned in Internal Revenue Bulletins
1997–1 through 1997–26 will be found in Internal
Revenue Bulletin 1997–27, dated July 7, 1997.

1997–38 I.R.B.27September 22, 1997

September 22, 1997281997–38 I.R.B.
INTERNAL REVENUE BULLETIN
The Introduction on page 3 describes the purpose and content of this publication. The weekly Internal Revenue Bulletin is sold
on a yearly subscription basis by the Superintendent of Documents. Current subscribers are notified by the Superintendent of
Documents when their subscriptions must be renewed.
CUMULATIVE BULLETINS
The contents of this weekly Bulletin are consolidated semiannually into a permanent, indexed, Cumulative Bulletin. These are
sold on a single copy basis and are not included as part of the subscription to the Internal Revenue Bulletin. Subscribers to the week-
ly Bulletin are notified when copies of the Cumulative Bulletin are available. Certain issues of Cumulative Bulletins are out of print
and are not available. Persons desiring available Cumulative Bulletins, which are listed on the reverse, may purchase them from the
Superintendent of Documents.
HOW TO ORDER
Check the publications and/or subscription(s) desired on the reverse, complete the order blank, enclose the proper remittance,
detach entire page, and mail to the Superintendent of Documents, U.S. Government Printing Office, Washington, DC 20402. Please
allow two to six weeks, plus mailing time, for delivery.
WE WELCOME COMMENTS ABOUT THE
INTERNAL REVENUE BULLETIN
If you have comments concerning the format or production of the Internal Revenue Bulletin or suggestions for improving it, we
would be pleased to hear from you. You can e-mail us your suggestions or comments through the IRS Internet Home Page
(www.irs.ustreas.gov) or write to the IRS Bulletin Unit, T:FP:F:CD, Room 5560, 1111 Constitution Avenue NW, Washington, DC
20224. You can also leave a recorded message 24 hours a day, 7 days a week at 1–800–829–9043.
Superintendent of Documents
U.S. Government Printing Office
Washington, DC 20402
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First Class Mail
Postage and Fees Paid
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Permit No. G–26

1997–38 I.R.B.29September 22, 1997
INTERNAL REVENUE BULLETIN
The Introduction on page 3 describes the purpose and content of this publication. The weekly Internal Revenue Bulletin is sold
on a yearly subscription basis by the Superintendent of Documents. Current subscribers are notified by the Superintendent of
Documents when their subscriptions must be renewed.
CUMULATIVE BULLETINS
The contents of this weekly Bulletin are consolidated semiannually into a permanent, indexed, Cumulative Bulletin. These are
sold on a single copy basis and are not included as part of the subscription to the Internal Revenue Bulletin. Subscribers to the week-
ly Bulletin are notified when copies of the Cumulative Bulletin are available. Certain issues of Cumulative Bulletins are out of print
and are not available. Persons desiring available Cumulative Bulletins, which are listed on the reverse, may purchase them from the
Superintendent of Documents.
HOW TO ORDER
Check the publications and/or subscription(s) desired on the reverse, complete the order blank, enclose the proper remittance,
detach entire page, and mail to the Superintendent of Documents, U.S. Government Printing Office, Washington, DC 20402. Please
allow two to six weeks, plus mailing time, for delivery.
WE WELCOME COMMENTS ABOUT THE
INTERNAL REVENUE BULLETIN
If you have comments concerning the format or production of the Internal Revenue Bulletin or suggestions for improving it, we
would be pleased to hear from you. You can e-mail us your suggestions or comments through the IRS Internet Home Page
(www.irs.ustreas.gov) or write to the IRS Bulletin Unit, T:FP:F:CD, Room 5560, 1111 Constitution Avenue NW, Washington, DC
20224. You can also leave a recorded message 24 hours a day, 7 days a week at 1–800–829–9043.
Internal Revenue Service
Washington, DC 20224
Official Business
Penalty for Private Use, $300
First Class Mail
Postage and Fees Paid
IRS
Permit No. G–48