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Revenue Ruling 68-281

REV-RUL, SECTION 48.--DEFINITIONS; SPECIAL RULES, Revenue Ruling 68-281, 1968-1 CB 22, (Jan. 01, 1968)
Revenue Ruling 68-281, 1968-1 CB 22
SECTION 48.--DEFINITIONS; SPECIAL RULES
(Also Section 46; 26 CFR 1.46-3.)

A taxpayer's logging truck roads are "section 38 property" for investment credit purposes since they are an integral part of (1) the operation of sawmills, (2) the production of lumber, lumber products, or other building materials; or (3) the manufacture of paper.

Advice has been requested whether logging truck roads qualify as "section 38 property" for purposes of the investment credit allowed by section 38 of the Internal Revenue Code of 1954.

A taxpayer operates sawmills; produces lumber, lumber products, and other building materials; and manufactures paper. To supply cut timber to his processing mills and plants, the taxpayer harvests timber from his own land and the land of others.

To harvest the timber and to carry out associated management activities, as well as to transport the cut timber to the taxpayer's mills and plants where the timber is processed, the taxpayer constructed roads using his own equipment or had roads constructed for him after December 31, 1961. Some of these roads are constructed on the taxpayer's own land, on rights-of-way that the taxpayer has leased from others over their land, or under a timber sale contract that the taxpayer has with the landowner.

Some of the roads constructed are "permanent" and some are "temporary." A "permanent" road is a high specification mainline type and is intended for general use, including associated management activities, fire access, and logging, and will remain useful for a relatively long period. The cost of clearing, grubbing, and rough cut and fill (grading) of the road is placed in a nondepreciable account. The cost of the depreciable portion of a "permanent" road (such as bridges, culverts, graveling, and paving) is normally recovered by the taxpayer through one of the methods of depreciation under section 167(b) of the Code.

A "temporary" road is constructed primarily for the logging operation and is normally abandoned after the timber has been harvested in the area that the road serves. The total cost of such a temporary road is normally amortized over the period that it is used.

Section 38 of the Code allows a credit against Federal income tax for "qualified investment" in "section 38 property." The amount of this credit is determined in accordance with sections 46 through 48 of the Code. Under section 46(c) of the Code, the "qualified investment" of the taxpayer is the applicable percentage of the basis of each new "section 38 property" placed in service by the taxpayer during the taxable year plus the applicable percentage of the cost of each "used section 38 property" placed in service by the taxpayer during the taxable year. The applicable percentages are 331/3 percent if the useful life of the property is 4 years or more but less than 6 years; 662/ percent if useful life is 6 years or more but less than 8 years; and 100 percent if the useful life is 8 years or more.

Section 48(a)(1) of the Code provides, in part, that the term "section 38 property" means tangible personal property or other tangible property (not including a building or its structural components) but only if such other tangible property is used as an integral part of manufacturing, production, or extraction. Further, "section 38 property" includes only property with respect to which depreciation (or amortization in lieu of depreciation) is allowable and has a useful life of 4 years or more.

With respect to manufacturing, production, and extraction, section 1.48-1(d)(2) of the Income Tax Regulations provides, in part, that "section 38 property" would include property used as an integral part of the operation of sawmills; of the production of lumber, lumber products, or other building materials; or of the fabrication of paper.

Section 1.48-1(d)(4) of the regulations provides, in part, that property is used as an integral part of a specified activity if it is used directly in the activity and is essential to the completeness of the activity. That section also provides, in part, that all property (such as docks, railroad tracks, and bridges) used by a taxpayer in acquiring raw materials or supplies or in transporting raw materials or supplies to the point where the actual processing commences would be considered as property used as an integral part of manufacturing.

Section 1.48-1(k) of the regulations states, in part, that the term "section 38 property" does not include property used by the United States or any agency or instrumentality thereof. This section also states that the term "property used by the United States" means property owned by such governmental unit (whether or not leased to another person), and property leased to such governmental unit.

Section 1.46-3(c)(1) of the regulations states, in part, that for purposes of determining qualified investment, the basis of new section 38 property constructed, reconstructed, or erected by the taxpayer shall not include any depreciation sustained with respect to any other property used in the construction, reconstruction, or erection of such new section 38 property. See also section 1.48-1(b)(4) of the regulations.

With respect to estimated useful life, section 1.46-3(e)(4) of the regulations provides that property with respect to which amortization in lieu of depreciation is allowable, the term over which amortization deductions are taken shall be considered as the estimated useful life of such property. In addition, section 1.46-3(e)(5) of the regulations provides that if a taxpayer is using a method of depreciation, such as the unit of production or retirement method, that does not measure the useful life of the property in terms of years, he must estimate such useful life in years in order to compute his qualified investment.

Under the circumstances described above, it is held that the logging truck roads are integral parts of the taxpayer's operation of sawmills; his production of lumber, lumber products, or other building material; or his manufacture of paper.

The following additional facts with respect to specific roads of the taxpayer (which, except for Situation 6, are "section 38 property") are given, and are considered, in the following situations:

Situation 1. A "permanent" type road is constructed by the taxpayer on land that he owns. The depreciable portion of the road has a useful life greater than 8 years. The cost of clearing, grubbing, and grading is placed in a nondepreciable account. (See Revenue Ruling 65-265, C.B. 1965-2, 52.) The taxpayer's qualified investment would be 100 percent of the basis (or cost) of the depreciable portion of the road, determined under the provisions of section 1.46-3(c) of the regulations.

Situation 2. A "temporary" type road is constructed by the taxpayer on land that he owns, solely for the purpose of harvesting a small block of timber. The estimated time required to remove the timber is 4 years. The useful life of the road is considered 4 years, since after the timber is harvested the road will no longer be useful to the taxpayer. The taxpayer's qualified investment would be 331/3 percent of the depreciable basis (or cost) of the road, determined under the provisions of section 1.46-3(c) of the regulations.

Situation 3. A "temporary" type road is constructed by the taxpayer, on land owned by X corporation under a 10-year lease of right-of-way that the taxpayer has with X, solely to permit the taxpayer to harvest a small block of timber. The estimated time required to remove the timber is 7 years. The useful life of the road is considered to be 7 years, since after the timber is harvested the road will no longer be useful to the taxpayer. The taxpayer's qualified investment would be 662/3 percent of the basis (or cost) of the road, determined under the provisions of section 1.46-3 of the regulations.

Situation 4. A "permanent" type road is constructed by the taxpayer on the right-of-way he has leased for 99 years from Y corporation. The depreciable portion of the road has a useful life greater than 8 years. The cost of clearing, grubbing, and grading is placed in a nondepreciable account. The taxpayer's qualified investment would be determined in the same manner as in Situation 1.

Situation 5. A "permanent" type road is constructed by the taxpayer on land owned by Z corporation under a 20-year timber cutting contract the taxpayer has with Z. It is estimated that 20 years will be required by the taxpayer to harvest the timber. Except for occasional use by Z, the use of the road is limited to the taxpayer and the road will "revert" to Z at the expiration of the contract period. The useful life of the road is considered to be 20 years, since after the timber is harvested, and the timber cutting contract expires, the road will no longer be useful to the taxpayer. The taxpayer's qualified investment would be 100 percent of the basis (or cost) of the road, determined under the provisions of section 1.46-3(c) of the regulations.

Situation 6. A "temporary" type road is constructed by the taxpayer on land owned by the Federal Government under a U.S. Forest Service timber sale agreement and the timber is to be removed by the taxpayer in five years. No part of the road may qualify for the investment credit as "section 38 property," since the timber sale contract provides, in part, that all roads constructed by the purchaser (taxpayer) shall be the property of the United States and section 1.48-1(k) of the regulations excludes property owned by the United States from the term "section 38 property."