IRS Clarifies Position on Recovery Period for Assets Used in Fuel-Grade Ethanol Production
Last week the IRS announced that it will consider tangible assets used to produce ethanol depreciable over seven years instead of five when the same taxpayer further processes the ethanol to fuel-grade ethanol. The ruling involved a taxpayer producing fuel-grade ethanol from corn, but it could also impact producers making fuel-grade ethanol from other biomass, including cellulosic materials, or from solid waste. The ruling, Revenue Ruling 2014-17, will apply to property placed in service on or after June 9, 2014.
The taxpayer operated a facility to produce fuel-grade ethanol from corn. The process required production of ethanol, which was then further processed to fuel-grade ethanol. Two asset classes potentially applied. Assets used to manufacture basic organic and inorganic chemicals, such as ethanol, have a 5 year class life (class 28) under the general depreciation system of Section 168(a). Assets used in the conversion of refuse or other solid waste or biomass to heat or to a solid, liquid, or gaseous fuel have a 7 year class life (class 49.5).
First, the IRS reasoned that assets used to convert corn to fuel-grade ethanol were in class 49.5 by adopting the definition of "biomass" in former section 48(l). Prior to repeal in 1990, section 48(l) defined biomass as any organic substance other than oil, natural gas, coal, or a product of oil or natural gas or coal, including in this case corn. The IRS declined to rely on the alternative definition of "biomass" found in current section 48B(c)(4)(A), which would not include corn grown as food or to produce fuel. The IRS found the earlier definition more appropriate because it was "enacted near the same time asset class 49.5 was first established in 1979 by Rev. Proc. 79-26." The IRS explained, "Although § 48B(c)(4)(A) also includes a definition of biomass, that provision was enacted significantly later as part of the Energy Tax Incentives Act of 2005 and is specific to the production of synthesis gas."
Second, using the "primary use" test of Treasury Regulation 1.167(a)-11(b)(4)(iii), the IRS took the position that assets used to produce ethanol fell into the same recovery class as assets used to convert ethanol to fuel-grade ethanol. Under the primary use test, property is included in the asset guideline class "for the activity in which the property is primarily used." The IRS found that the primary use of all of the assets was the production of fuel-grade ethanol. Although production of ethanol was "integral to Taxpayer's production of the final product, fuel grade ethanol," it was not in itself the purpose of the production assets. More than fifty percent of the economic output from the taxpayer's facility was from fuel-grade ethanol production. The IRS concluded that "[t]he production of ethanol as an interim part of the production of fuel grade ethanol and the conversion of corn to fuel grade ethanol by chemical processes does not require classification in asset class 28.0 or preclude classification in the asset class that specifically applies to the conversion of biomass to fuel." The IRS position that the assets used in discreet phases of the production process fall within a single asset class is arguably inconsistent with the rule, under Section 263(a), which would treat the distillation assets used in creating ethanol as a separate unit of property from other plant assets, such as the blending facilities used to convert distilled ethanol to fuel grade ethanol.
Revenue Ruling 2014-17 finalizes a ruling that the IRS proposed in 2009. Prior to the 2009 proposed ruling, some producers took the position that assets used in the production of fuel grade ethanol were 5-year property. Though courts have not always agreed with the IRS's asset class determinations, taxpayers modeling future projects will need to take into account the IRS's position that these assets are 7-year property.
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