Although the U.S. Department of Agriculture (“USDA”) has suspended the citrus eradication program in the State of Florida, it is our understanding that the USDA is committed to fully fund the eradication efforts to date which, subject to availability of funds, includes payments to recover lost production income and lost citrus trees as a result of the removal of commercial citrus trees. The following article is the second in a series addressing the federal income tax consequences of the receipt by citrus growers of lost tree and lost production payments under differing scenarios. This article will address the federal income tax consequences of the receipt of such payments when the grower intends to reinvest the payments into a replacement citrus grove.
The money received by a grower as lost tree payments from the USDA or an insurance company is entitled to non-recognition treatment pursuant to Section 1033(a) of the Internal Revenue Code of 1986 as amended (the “Code”). Generally, no gain will be recognized by a grower on the receipt of lost tree payments if such payments are used to purchase property which is similar or related in service or use or is like kind to the condemned property pursuant to Code Sections 1033(a) and 1033(g).
If the grower intends to replant replacement groves on its existing property, the grower will generally have a period of two (2) years to complete the replanting. If the grower intends to use the lost tree payments to purchase any improved or unimproved real property constituting like-kind property, the grower will generally have a period of three (3) years to purchase such like-kind property. Citrus Canker Eradication regulations currently require a two (2) year quarantine (approval for replanting after one (1) year may be obtained) before replanting of citrus on the affected property. Therefore, filing an application for an extension of time to replant with the IRS may be necessary.
Generally, lost production payments are taxed as ordinary income and are eligible for income averaging. Depending on the particular facts of each grower, it may be argued that a portion of the proceeds are more properly allocable to the destruction of the grower’s business as a whole, and would be eligible for tax deferral under Code Section 1033 to the extent such amounts are reinvested in qualified property .
Once those funds which qualify under Code Section 1033 for reinvestment have been exhausted, Code Section 263A provides incentives to citrus growers to replant citrus and expense currently the cost of replanting. These expenses could offset the income recognized for lost production income. Code Section 263A generally requires the capitalization of the costs incurred to plant a citrus grove and bring it into production. However, Code Section 263A(d)(2) provides that if plants bearing an edible crop for human consumption were lost or damaged by reason of disease or other casualty, then Code Section 263A shall not apply to any costs of replanting plants bearing the same type of crop (whether on the same land under which such loss or damage occurred or any other land of the same acreage). There is no direct authority that the destruction of healthy trees due to the proximity to a diseased tree meets the requirement of this definition, but one may conclude that this would meet the requirement for the “by reason of disease” requirement. To be safe, you should consult with your tax advisor and consider obtaining a private letter ruling.
Code Section 263A(d) also encourages new investors to help finance the replanting efforts. A person other than the grower that owns the property at the time the plants are damaged are also allowed to currently deduct the costs of replanting and growing out a grove to a productive age, provided that the grower that owns the grove at such time of destruction continues to own an equity interest of more than fifty percent (50%) in such grove at all times during the taxable year in which the replanting costs are paid or incurred and such other person or investor (i.e., the person other than the grower) materially participates in the management of such replacement plants during the taxable year in which the replanting costs are paid or incurred. This could create some interesting new tax favored business opportunities.
In conclusion, lost tree payments that are fully reinvested in qualified property will not currently be subject to tax. Lost production payments may be deferred depending on the particular facts of the grower. Finally, the capitalization rules of Section 263A will not apply to the cost of replanting the replacement groves and encourage new tax favored business opportunities.
The authors are members of Dean Mead, a full-service law firm with offices in Orlando, Fort Pierce and Viera. The firm’s Citrus Canker Task Force assists citrus growers with the legal issues that result when canker is detected in their groves. For more information about Dean Mead and its Citrus Canker Task Force, please visit deanmead.deme.dev.