rr-04-62.pdf

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Part I

Section 162.--Trade or Business Expenses

26 CFR 1.162-1: Business expenses.
(Also §§ 263, 263A; 1.263(a)-1)

Rev. Rul. 2004-62

ISSUE

Whether costs incurred by a timber grower for the post-establishment fertilization
of an established timber stand are ordinary and necessary business expenses
deductible under § 162 of the Internal Revenue Code or capital expenditures under
§ 263.

FACTS

X owns and manages timberlands in the United States on which it grows trees for
use in its lumber and wood products business. After the target species of timber
establishes dominance in an area and becomes an established timber stand, X incurs
costs to perform various silvicultural practices for the purposes of managing,
maintaining, and protecting the stand. These post-establishment silvicultural costs
include labor and materials for fire, disease, insect, and brush control. X performs these
silvicultural practices to maintain optimal growing conditions that will promote healthy
development and maximize timber volume.

In 2004, X incurs costs to apply fertilizer to a portion of its timberlands underlying
an established stand of trees. This application, commonly referred to as “post-
establishment fertilization,” is performed after the target species of timber has
established dominance in the stand. X generally performs post-establishment
fertilization once during the long-term growth cycle of a timber stand. X performs the
fertilization to supplement nutrients in the soil to maintain optimal growing conditions
that will promote healthy development and maximize timber volume.

LAW AND ANALYSIS

Section 162 and § 1.162-1(a) of the Income Tax Regulations allow a deduction
for all the ordinary and necessary expenses paid or incurred during the taxable year in
carrying on any trade or business.

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Section 263(a)(1) provides that no deduction is allowed for any amount paid out
for new buildings or for permanent improvements or betterments made to increase the
value of any property. See also § 1.263(a)-1(a).

Section 1.263(a)-1(b) provides that capital expenditures include amounts paid or
incurred to (1) add to the value, or substantially prolong the useful life, of property
owned by the taxpayer, or (2) adapt property to a new or different use. However,
amounts paid or incurred for incidental repairs and maintenance of property for
purposes of § 162 and § 1.162-4 are not capital expenditures under § 1.263(a)-1.

Section 263A generally provides that the direct and indirect costs properly
allocable to real or tangible personal property produced by the taxpayer must be
capitalized. Section 263A(c)(5)(A) provides that § 263A shall not apply to trees raised,
harvested, or grown by the taxpayer other than trees bearing fruit, nuts, or other crops,
or ornamental trees (other than evergreen trees more than 6 years old at the time
severed from their roots).

Certain costs incurred by timber growers for silvicultural practices performed in
established timber stands are ordinary and necessary business expenses deductible
under § 162. These costs include amounts incurred for labor and materials for fire,
disease, insect, and brush control. See Barham v. United States, 301 F. Supp. 43
(M.D. Ga. 1969), aff’d on other grounds, 429 F.2d 40 (5
th
Cir. 1970); H.R. Conf. Rep.
No. 841, 99
th
Cong., 2d Sess. II-117 (1986); H.R. Rep. No. 426, 99
th
Cong., 1
st
Sess.
624 (1985). These costs are incurred for the management, maintenance, and
protection of the timber stand. These costs are not incurred to materially add value to
the timber stand, substantially prolong its useful life, or adapt the timber stand to a new
or different use. Accordingly, these costs are not required to be capitalized under
§ 263.

Like fire, disease, insect, and brush control, post-establishment fertilization
promotes healthy development and maximizes timber volume and is performed for the
management, maintenance, and protection of the timber stand. There are no significant
differences between post-establishment fertilization and the types of post-establishment
silvicultural practices, such as brush control, that have previously been held to be
ordinary and necessary business expenses deductible under § 162. Therefore, X’s
costs for post-establishment fertilization are deductible as ordinary and necessary
business expenses under § 162. Furthermore, because X is growing trees for timber
production, X is not required to capitalize the direct and indirect costs allocable to
producing such trees under § 263A. See § 263A(c)(5).

HOLDING

Costs incurred by a timber grower for the post-establishment fertilization of an
established timber stand are ordinary and necessary business expenses deductible
under § 162.

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CHANGE IN METHOD OF ACCOUNTING

Any change in a taxpayer’s treatment of post-establishment fertilization costs to
conform to this revenue ruling is a change in method of accounting to which the
provisions of '' 446 and 481 and the regulations thereunder apply. A taxpayer
changing its method of accounting to comply with this revenue ruling must file a Form
3115 in accordance with the automatic change in method of accounting provisions of
Rev. Proc. 2002-9, 2002-1 C.B. 327, as modified and clarified by Announcement 2002-
17, 2002-1 C.B. 561, modified and amplified by Rev. Proc. 2002-19, 2002-1 C.B. 696,
and amplified, clarified, and modified by Rev. Proc. 2002-54, 2002-2 C.B. 432, except
that the scope limitations in section 4.02 of Rev. Proc. 2002-9 are not applicable. For
purposes of line 1a of Form 3115, the designated number for the automatic accounting
method change authorized by this revenue ruling is “86.”

EFFECT ON OTHER DOCUMENTS

Rev. Proc. 2002-9 is modified and amplified to include in the APPENDIX the
automatic change provided in this revenue ruling.

DRAFTING INFORMATION

The principal author of this revenue ruling is Amy Pfalzgraf of the Office of
Associate Chief Counsel (Income Tax and Accounting). For further information
regarding this revenue ruling, contact Ms. Pfalzgraf at (202) 622-4950 (not a toll-free
call).