IRS Allows Some Farmers to Revoke Election out of UNICAP
On February 21, IRS issued a long-awaited revenue procedure, IRS Rev. Proc. 2020-13, to allow farmers who had elected out of UNICAP prior to the Tax Cuts and Jobs Act to revoke that election if they qualify as a small business taxpayer. Owners of orchards and vineyards, in particular, have been waiting for this revenue procedure since the Tax Cuts and Jobs Act went into effect.
Generally, the uniform capitalization rules (UNICAP) have required all farmers, regardless of size, to capitalize pre-productive costs of plants that have a pre-productive period of more than two years. IRC§ 263A(a)(1), (d)(1)(A)(ii). Pre-productive costs are the costs of raising plants after they are planted and before they are placed in service, including those associated with management, irrigation, fertilizing, depreciation, & repairs on buildings and equipment. Whether a plant has a pre-productive period of more than two years is based on the national average pre-productive period for that plant. IRS periodically publishes non-inclusive lists of such plants. Treas. Reg § 1.263A-4(b)(2)(i)(B). IRS Notice 2013-18 contained the following non-inclusive list of plants with a pre-productive period of more than two years:
almonds, apples, apricots, avocados, blueberries, cherries, chestnuts, coffee beans, currants, dates, figs, grapefruit, grapes, guavas, kiwifruit, kumquats, lemons, limes, macadamia nuts, mangoes, nectarines, olives, oranges, peaches, pears, pecans, persimmons, pistachio nuts, plums, pomegranates, prunes, tangelos, tangerines, tangors, and walnuts
Under pre-2018 rules, most farmers subject to these rules (except for corporations, partnerships and tax shelters required to use accrual accounting) could elect out of UNICAP and deduct the pre-productive costs in the year they were incurred. The price for this election, however, was that such farmers had to use the alternative depreciation system (ADS) to depreciate other farm assets. It also generally meant they were not eligible for bonus depreciation. The same rules did not apply to trees raised, harvested, or grown by the taxpayer that did not bear fruit or nuts. Nor did the rules apply to plants with a pre-productive period of two years or less, unless the farmer was required to use accrual accounting.
The TCJA significantly changed these rules. IRC § 463A(i)(1) provides an expanded exception from the UNICAP rules for “small businesses.” Under this provision, taxpayers (other than tax shelters) who meet the gross receipts test of IRC § 448(c) for any tax year, are not subject to the UNICAP rules for that tax year. The IRC § 448(c) test requires average annual gross receipts of $26 million or less during the preceding three years (as of 2019).
As a result of this law, many growers of trees and vines are excepted from the UNICAP rules and may currently expense or depreciate their pre-productive costs. A problem, however, has existed for those farmers who previously elected out of UNICAP. Until this revenue procedure was issued, IRS provided no method by which to revoke that election and take advantage of the new law, absent requesting a costly letter ruling.
Rev. Proc. 2020-13
Rev. Proc. 2020-13, Section 5, issued February 21, 2020, provides the exclusive procedures for a farmer who elected out of UNICAP, but now wants to revoke that election. This procedure applies if the farmer:
- wants to revoke its election under § 263A(d)(3);
- qualifies as a small business taxpayer within the meaning of § 263A(i); and
- wants to apply the exemption from § 263A that is provided in § 263A(i) beginning with the same taxable year.
Rev. Proc. 2020-13, Section 6, provides the exclusive procedures for a farmer that has applied the new small business taxpayer capitalization exception in § 263A(i) but no longer qualifies and wants to now elect out of UNICAP. This procedure applies if the farmer:
- no longer qualifies as a small business taxpayer eligible to use the exemption under § 263A(i); and
- wants to make an election under § 263A(d)(3) for certain plants produced for the first taxable year in which the taxpayer is ineligible to use the exemption in § 263A(i).
Revoking the Election (Rev. Proc. 2020-13, Section 5)
Except for a taxable year beginning in 2018, an eligible small business taxpayer revokes its § 263A(d)(3) election on its original federal income tax return, including extensions, for the taxable year for which the taxpayer wants to revoke its election, by:
- Continuing not to capitalize costs of plants produced in its farming business under § 263A;
- Changing depreciation to GDS (Beginning with the revocation year, a taxpayer that revokes its IRC § 263A(d)(3) election under these procedures is not required to use ADS to depreciate farming property, unless the property is otherwise required to be depreciated using ADS. This rule applies to both existing and newly-acquired property. Bonus depreciation is not allowed for existing property); and
- Continuing to treat plants that are or have been treated as § 1245 property for prior taxable years as § 1245 property. See §§ 263A(e)(1)(A)(ii), 1245(a)(3) and 1.1245-3(c).
Making a Late Revocation Election
If an eligible small business taxpayer timely filed its federal income tax return for its 2018 taxable year and wants to revoke its election under § 263A(d)(3) for 2018, the taxpayer has two choices:
- File an amended return or, for partnerships under the centralized partnership audit regime, file an administrative adjustment request for the 2018 taxable year, before the taxpayer files its federal return for 2019. The amended return (or AAR) must include the adjustment to taxable income for the revocation election as documented in the revenue procedure OR
- File a Form 3115 with a timely filed federal income tax return for the first, second, or third taxable years beginning after the 2018 taxable year. During this limited period, a late revocation of the § 263A(d)(3) election will be treated as a change in accounting method with a § 481(a) adjustment, and will be subject to automatic change procedures detailed in Rev. Proc. 2015-13 or its successor. Rev. Proc. 2019-43 has been modified to provide automatic consent for a late revocation of the election during the specified time period. The designated automatic accounting method change number for a change to the method of accounting under this section is “243.”
Changing from the Capitalization Exemption to Electing out of UNICAP (Rev. Proc. 2020-13, Section 6)
Section 6 of Rev. Proc. 2020-13 provides the exclusive procedures for a farmer who (1) used the capitalization exemption under § 263A(i), (2) is no longer eligible to use the exemption (i.e. gross receipts now too high); and (3) wants to elect out of UNICAP under § 263A(d)(3). Such a former eligible taxpayer makes its election out of UNICAP under § 263A(d)(3) on an original federal tax return, including extensions, for the first taxable year for which the taxpayer no longer qualifies to use the exemption under § 263A(i), by:
- Making a § 263A(d)(3) election out of the UNICAP rules by following the rules under Treas. Reg. § 1.263A-4(d)(3); and
- Continuing not to capitalize costs of plants produced in its farming business under § 263A.
A taxpayer who follows this procedure for the first taxable year the taxpayer no longer qualifies as a small business taxpayer is not treated as making an accounting method change.
If a taxpayer has already filed a Form 3115, asking for IRS permission to revoke its election out of UNICAP, the taxpayer has until the later of (1) March 22, 2020, or the (2) issuance of a letter ruling to notify IRS that it chooses to apply the revocation procedures allowed under Rev. Proc. 2020-13. IRS will acknowledge this request and return the user fee.
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