August 27, 2017
In the last correspondence I mailed to you, we talked about the period before your first commercial harvest of grapes, otherwise known as the Pre-Productive Period. Now, let’s discuss what happens to costs after the vines meet the commercial production test.
We’re now into the Field Cost, Non-Field Cost and Pre-Bud Cost Periods. The confusing part of the IRS language in their Audit Techniques Guide is that they don’t refer to the same definitional categories. Field Costs and Non-Field Costs refer to types of costs. Pre-Bud Period refers to a time of year, not a type of cost.
This distinction is important because the IRS views your on-going annual costs in three time segments. The period from bud break to harvest is the growing period. The period from harvest of grapes until disposal of grapes (usually delivery to the crush pad) is the “Field Cost Period”. The period after the sale or disposal of grapes until next year’s bud break is the Pre-Bud Period.
Why does the IRS think these are important? It gets back to costs that are required to be capitalized versus costs that can be expensed.
Field Costs are generally defined as fertilizer, spraying, irrigation and pruning. Non-Field Costs are generally defined as overhead items such as administration, depreciation, repairs of vineyard buildings and vineyard related taxes (not income taxes) that indirectly benefit the production of grapes.
Field Costs that are incurred during the Field Cost Period and during the Pre-Bud Period can be deducted currently. Field Costs that are incurred during the growing period are required to be capitalized (deferred) until the grapes are sold.
Is this a distinction without a difference? For most growers, the answer is yes. If your growing season, which is the period for deferring these deductions, and your grape harvest falls within the same tax year, then you’ll end up deducting the costs in the same year they are incurred.
However, if you happen to operate on a fiscal year basis (for example, a September 30 fiscal year), then your growing season costs might be deferred until a subsequent fiscal year if your harvest occurs after September 30. Another situation in which deferral of costs may arise is if you sell your vineyard during the year at a point in time after bud break, but before harvest. Your Field Costs in this situation would be deferred and would become part of the cost of the un-harvested crop.
The deduction of Non-Field Costs is a bit trickier. We discussed in our last letter the requirements of the UNICAP rules of Internal Revenue Code Section 263A. In that discussion, we mentioned the ability of a cash- method vineyard operator to opt-out of the Pre-Productive Period cost rules.
Most such taxpayers may also be able to “opt-out” of applying UNICAP rules to Non-Field Costs. Here the application of the rules depends on the type of tax-paying entity and/or the level of income generated from the vineyard operation. This distinction is made in that any taxpayer required to use, or electing to use, the accrual method of accounting, is generally required to use UNICAP rules for crop accounting.
If you find yourself in this category, then your accounting system would recognize the three time periods of the year and your Non-Field Costs would be prorated or allocated to these periods. Consequently, the Non-Field Costs allocated to the growing period would also be deferred until disposal of the grapes.
Of course, the major distinction between the cash method of accounting and the accrual method of accounting is that; for cash method taxpayers, items are first deductible when they are paid whereas for accrual method taxpayers, items are first deductible when they are incurred. This added wrinkle may make the accounting for these costs even more difficult if the books are generally maintained on a cash method.
What’s the big deal with the Field Cost Period?
The Field Cost Period after the harvest of the grapes and before the disposal of the grapes is generally not a significant period of time. It was important enough to one critic of the IRS Regulations that cost capitalization stop as soon as the grapes are picked. The IRS agreed. However, this distinction was still controversial. Consequently, the IRS further clarified the issue for single-entity operations. In this situation where the vineyard operation and the winery operation are part of a unified single-entity operation, it’s likely the entity is using an accrual method of accounting. Consequently, the disposal of grapes is defined as the onset of crush and the Field Cost Period becomes moot. All of the costs from bud break to crush become part of the cost of the grapes brought into the winemaking operation.
There you have it. The IRS can now tell you with precision exactly when costs need to be deferred and when they may be deducted.
We hope you find these discussions helpful. If you have additional questions or concerns, our Wine Industry support group would be happy to assist you with advice specifically tailored to your situation. You may contact us at any time. If you prefer to receive these messages via email, please contact Trish Jensen (email@example.com). We will add you to our Wine Industry Interest Group list.