John and Louisa A. Hodel - Page 4

          ligustrum tree business.  Sec. 1.263A-4T(c)(4)(i)(A), Temporary             
          Income Tax Regs., 59 Fed. Reg. 39960 (Aug. 5, 1994).  Expenses              
          incurred in the farming business may be placed into three                   
          categories:  (1) The preparatory period; (2) the development or             
          preproductive period; and (3) the productive period.  Expenses              
          incurred during the preparatory period include drilling, clearing           
          brush, laying pipes, and installing ditches and drainage pipes.             
          Such expenses are generally required to be capitalized.  Maple v.           
          Commissioner, T.C. Memo. 1968-194, affd. 440 F.2d 1055 (9th Cir.            
          1971).  In contrast, ordinary and necessary expenses incurred               
          during the productive period, after the farm produces or is                 
          reasonably expected to produce its first yield, are generally               
          required to be deducted.  Id.  Farm expenditures that are clearly           
          capital in nature are not deductible at any time.  Thompson &               
          Floger Co. v. Commissioner, 17 T.C. 722, 724-726 (1951).                    
               During the development or preproductive period, farmers are            
          given the option under section 1.162-12(a), Income Tax Regs., to            
          either deduct or capitalize ordinary and necessary expenses.                
          This section provides in part:                                              
               If a farmer does not compute income upon the crop method,              
               the cost of seeds and young plants which are purchased for             
               further development and cultivation prior to sale in later             
               years may be deducted as an expense for the year of                    
               purchase, provided the farmer follows a consistent practice            
               of deducting such costs as an expense from year to year. * *           
               *  Amounts expended in the development of farms, orchards              
               and ranches prior to the time when the productive state is             
               reached may, at the election of taxpayer, be regarded as               
               investments of capital. * * *                                          

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